<PAGE>

                                   UNITED STATES
                         SECURITIES AND EXCHANGE COMMISSION
                               Washington, D.C. 20549
                                     FORM 10-Q

                                    -----------

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

                    For the quarterly period ended June 30, 1998

                                         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)


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

Common stock: 6,848,1483 shares outstanding as of July 31, 1998

     This report including exhibits consists of 14 pages.

<PAGE>

                          APPLIED MICROSYSTEMS CORPORATION

                                     FORM 10-Q

                            QUARTER ENDED JUNE 30, 1998

                                       INDEX

<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
<S>                                                                         <C>
PART I:  FINANCIAL INFORMATION

Item 1.  Financial Statements:

         Consolidated Statements of Operations for the quarter and 
         six months ended June 30, 1998 and 1997. . . . . . . . . . . . . .   3

         Consolidated Balance Sheets as of  June 30, 1998 and December 31, 
         1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   4

         Consolidated Statements of Cash Flows for the six months ended June
         30, 1998 and 1997. . . . . . . . . . . . . . . . . . . . . . . . .   5

         Notes to Consolidated Financial Statements . . . . . . . . . . . .   6

Item 2.  Management's Discussion and Analysis of Financial Condition and
         Results of Operations. . . . . . . . . . . . . . . . . . . . . . .   8


PART II:  OTHER INFORMATION

Item 6.   Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . 13

          Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . .  14
</TABLE>

                                      -2-

<PAGE>

                                          
PART I - FINANCIAL INFORMATION
                                          
ITEM 1.   FINANCIAL STATEMENTS

                          APPLIED MICROSYSTEMS CORPORATION
                                          
                       CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                       THREE MONTHS ENDED JUNE 30    SIX MONTHS ENDED JUNE 30
                                                       --------------------------    ------------------------
                                                          1998           1997           1998           1997
                                                       -----------    -----------    ----------     ---------
                                                              (IN THOUSANDS , EXCEPT PER SHARE AMOUNT)
                                                                             (UNAUDITED)
<S>                                                    <C>            <C>            <C>            <C>
Net sales. . . . . . . . . . . . . . . . . . . . .        $9,157        $10,009        $17,408        $18,911
Cost of sales. . . . . . . . . . . . . . . . . . .         2,325          2,698          4,638          5,154
                                                       -----------    -----------    ----------     ---------
Gross profit . . . . . . . . . . . . . . . . . . .         6,832          7,311         12,770         13,757

Operating expenses:
  Sales, general and administrative. . . . . . . .         4,418          4,609          8,759          8,968
  Research and development . . . . . . . . . . . .         2,583          2,104          4,933          4,290
                                                       -----------    -----------    ----------     ---------
Total operating expenses . . . . . . . . . . . . .         7,001          6,713         13,692         13,258
                                                       -----------    -----------    ----------     ---------
Income (loss) from operations. . . . . . . . . . .          (169)           598           (922)           499

Interest income and other. . . . . . . . . . . . .           227            167            422            331
Interest expense . . . . . . . . . . . . . . . . .          ----             (4)            (1)            (8)
                                                       -----------    -----------    ----------     ---------
Income (loss) before income taxes. . . . . . . . .            58            761           (501)           822
Income taxes . . . . . . . . . . . . . . . . . . .          ----            114           ----            133
                                                       -----------    -----------    ----------     ---------
Net income (loss). . . . . . . . . . . . . . . . .           $58           $647          ($501)          $689
                                                       -----------    -----------    ----------     ---------
                                                       -----------    -----------    ----------     ---------
Basic income (loss) per share. . . . . . . . . . .         $0.01          $0.10         ($0.07)         $0.10
Shares used in basic per share calculation . . . .         6,914          6,772          6,897          6,765

Diluted income (loss) per share. . . . . . . . . .         $0.01          $0.09         ($0.07)         $0.10
Shares used in diluted per share calculation . . .         7,113          7,259          6,897          7,217
</TABLE>

The accompanying notes are an integral part of these consolidated financial 
statements.

                                      -3-

<PAGE>

                          APPLIED MICROSYSTEMS CORPORATION

                            CONSOLIDATED BALANCE SHEETS
                                   (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                         JUNE 30,    DECEMBER 31,
                                                          1998           1997
                                                      -----------    ------------
                                                      (UNAUDITED)
<S>                                                   <C>            <C>
                      ASSETS
                                                   
Current assets:
  Cash and cash equivalents. . . . . . . . . . . . .      $5,678         $6,336
  Short term investments . . . . . . . . . . . . . .      10,009         10,345
  Accounts receivable. . . . . . . . . . . . . . . .       9,328          7,741
  Inventories. . . . . . . . . . . . . . . . . . . .       3,284          3,465
  Prepaid and other current assets . . . . . . . . .         304            951
                                                      -----------    ------------
    Total current assets . . . . . . . . . . . . . .      28,603         28,838

Property and equipment, net. . . . . . . . . . . . .       2,951          2,900
Other assets . . . . . . . . . . . . . . . . . . . .         789            844
                                                      -----------    ------------
    Total assets . . . . . . . . . . . . . . . . . .     $32,343        $32,582
                                                      -----------    ------------
                                                      -----------    ------------

       LIABILITIES AND SHAREHOLDERS' EQUITY      

Current liabilities:
  Accounts payable . . . . . . . . . . . . . . . . .      $2,859         $2,804
  Accrued payroll. . . . . . . . . . . . . . . . . .       1,659          1,684
  Other accrued expenses . . . . . . . . . . . . . .       1,341            991
  Deferred revenue . . . . . . . . . . . . . . . . .       3,079          2,797
  Current portion of long-term obligations . . . . .        ----             15
                                                      -----------    ------------
    Total current liabilities. . . . . . . . . . . .       8,938          8,291

Shareholders' equity:
  Preferred stock, par value $.01
    Authorized - 5,000,000 shares. . . . . . . . . .        ----           ----
  Common stock, par value $.01
    Authorized - 25,000,000 shares
    Issued - 6,860,000 and 6,827,000 shares at 
    June 30, 1998 and December 31, 1997, 
    respectively . . . . . . . . . . . . . . . . . .      26,171         26,387
  Cumulative translation adjustment. . . . . . . . .      (1,039)          (869)
  Accumulated deficit. . . . . . . . . . . . . . . .      (1,727)        (1,227)
                                                      -----------    ------------
    Total shareholders' equity . . . . . . . . . . . .    23,405         24,291
                                                      -----------    ------------
    Total liabilities and shareholders' equity . . . .   $32,343        $32,582
                                                      -----------    ------------
                                                      -----------    ------------
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

                                      -4-

<PAGE>

                          APPLIED MICROSYSTEMS CORPORATION

                       CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                      SIX MONTHS ENDED JUNE 30,
                                                                         1998           1997
                                                                      ----------     ----------
                                                                            (IN THOUSANDS)
                                                                              (UNAUDITED)
<S>                                                                   <C>            <C>
Cash flows from operating activities:
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . .          ($501)          $689
Adjustments to reconcile net income to net cash provided by  
 operating activities:
  Depreciation and amortization. . . . . . . . . . . . . . . . . .          601            567
Changes in operating assets and liabilities:
  Accounts receivable. . . . . . . . . . . . . . . . . . . . . . .       (1,587)           462
  Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . .          181           (307)
  Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . .          647             84
  Other assets . . . . . . . . . . . . . . . . . . . . . . . . . .          (43)            30
  Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . .          267            153
  Accounts payable and accrued expenses. . . . . . . . . . . . . .          380           (313)
                                                                      ----------     ----------
    Net cash provided by operating activities. . . . . . . . . . .          (55)         1,365

Cash flows from investing activities:
  Purchase of short-term investments . . . . . . . . . . . . . . .          336            (35)
  Property and equipment additions . . . . . . . . . . . . . . . .         (553)        (1,052)
                                                                      ----------     ----------
    Net cash used in investing activities. . . . . . . . . . . . .         (217)        (1,087)

Cash flows from financing activities:
  Stock options exercised. . . . . . . . . . . . . . . . . . . . .          111            136
  Purchase of treasury stock . . . . . . . . . . . . . . . . . . .         (327)          ----
  Repayment of long-term obligations . . . . . . . . . . . . . . .         ----            (15)
                                                                      ----------     ----------
    Net cash provided by financing activities. . . . . . . . . . .         (216)           121

Effects of foreign exchange rate changes on cash . . . . . . . .           (170)           (36)
                                                                      ----------     ----------
Increase (decrease) in cash and cash equivalents . . . . . . . .           (658)           363
Cash and cash equivalents at beginning of period . . . . . . . .          6,336          7,208
                                                                      ----------     ----------
Cash and cash equivalents at end of period . . . . . . . . . . .         $5,678         $7,571
                                                                      ----------     ----------
                                                                      ----------     ----------
Supplemental disclosures of cash paid:
  Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . .         ----             $8
  Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . .         ----           $582
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

                                      -5-

<PAGE>

                          APPLIED MICROSYSTEMS CORPORATION

                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   BASIS OF PRESENTATION

     The consolidated financial statements for the six month period ended June
30, 1998 and 1997 and the related footnote information are unaudited and have
been prepared on a basis substantially consistent with the 1997 audited
consolidated financial statements.  In the opinion of management, the financial
statements include all adjustments (consisting of only normal recurring
adjustments) necessary for fair presentation of the results of this interim
period.  These statements should be read in conjunction with the consolidated
financial statements and related notes included in the Company's 1997 Annual
Report to Shareholders.  The results of operations for the six months ended June
30, 1998 are not necessarily indicative of the results to be expected for the
entire year.

     Certain prior year amounts have been reclassified to conform to the current
year presentation.  Such reclassifications have no effect on previously reported
results of operations.

2.   COMPUTATION OF EARNINGS (LOSS) PER SHARE

     In 1997, the Financial Accounting Standards Board (FASB) issued 
Statement No. 128, "Earnings per Share" (FAS 128).  FAS 128 replaced the 
calculation of primary and fully diluted earnings per share with basic and 
diluted earnings per share.  Unlike primary earnings per share, basic 
earnings per share excludes any dilutive effects of  options, warrants and 
convertible securities.  Diluted earnings per share is very similar to the 
previously reported earnings per share. In addition, the Securities and 
Exchange Commission (SEC) previously had requirements for common and common 
stock equivalent shares issued during the 12-month period prior to filing of 
an initial public offering to be included in the calculation of earnings per 
share as if they were outstanding for all periods presented using the 
treasury stock method assuming the initial public offering price.  In 1998, 
the SEC issued new requirements for dilutive common stock equivalent shares.  
All earnings (loss) per share amounts for all periods have been presented to 
conform with FAS 128 and the new SEC requirements. 

3.   COMPREHENSIVE INCOME (LOSS)

     As of January 1, 1998, the Company adopted Statement 130, REPORTING
COMPREHENSIVE INCOME.  Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however the adaptation of
this Statement has no impact on the Company's net income or shareholders'
equity.  Statement 130 requires the Company's foreign currency translation
adjustments, which are reported separately in shareholders' equity to be 
included in other comprehensive income.

     During the second quarter of 1998 and 1997, total comprehensive loss and
income, respectively, amounted to $22,000 and $922,000.  For the first six
months of 1998 and 1997, total comprehensive loss and income, respectively, 
amounted to $671,000 and $654,000.

                                      -6-

<PAGE>

4.   SOFTWARE REVENUE RECOGNITION

     As of January 1, 1998, the Company adopted AICPA SOP 97-2, Software Revenue
Recognition, which was  effective for transactions that the Company entered into
in 1998.  Prior years were not restated.  The effect of adopting SOP 97-2 was
not material.

5.   INCOME (LOSS) PER SHARE

<TABLE>
<CAPTION>
                                                       THREE MONTHS ENDED JUNE 30,
                                                             1998       1997
                                                       ------------  -------------
<S>                                                    <C>           <C>
(in thousands, except per share amount)
Numerator:
   Numerator for basic and diluted income per share -
   net income. . . . . . . . . . . . . . . . . . . . . .       $58       $647
                                                       ------------  -------------
                                                       ------------  -------------
Denominator:
   Denominator for basic income per share - weighted
   average common shares . . . . . . . . . . . . . . . .     6,914      6,772
   Effect of dilutive securities:
   Stock options based on the treasury
   stock method using average market price . . . . . . .       199        487
                                                       ------------  -------------
                                                       ------------  -------------
   Denominator for diluted income per share. . . . . . .     7,113      7,259
                                                       ------------  -------------
                                                       ------------  -------------
Basic income per share . . . . . . . . . . . . . . . . .     $0.01      $0.10
                                                       ------------  -------------
                                                       ------------  -------------
Diluted income per share . . . . . . . . . . . . . . . .     $0.01      $0.09
                                                       ------------  -------------
                                                       ------------  -------------

<CAPTION>
                                                        SIX MONTHS ENDED JUNE 30,
                                                             1998       1997
                                                       ------------  -------------
<S>                                                    <C>           <C>
(in thousands, except per share amount)
Numerator:
   Numerator for basic and diluted income per share -
   net income (loss).  . . . . . . . . . . . . . . . . .     ($501)      $689
                                                       ------------  -------------
                                                       ------------  -------------
Denominator:
   Denominator for basic income per share - weighted
   average common shares . . . . . . . . . . . . . . . .     6,897      6,765
   Effect of dilutive securities:
   Stock options and warrants based on the treasury
   stock method using average market price . . . . . . .      ----        452
                                                       ------------  -------------
                                                       ------------  -------------
   Denominator for diluted income per share. . . . . . .     6,897      7,217
                                                       ------------  -------------
                                                       ------------  -------------
Basic income (loss) per share. . . . . . . . . . . . . .    ($0.07)     $0.10
                                                       ------------  -------------
                                                       ------------  -------------
Diluted income (loss) per share. . . . . . . . . . . . .    ($0.07)     $0.10
                                                       ------------  -------------
                                                       ------------  -------------
</TABLE>

For the six months ended June 30, 1998, the effect of outstanding options and
warrants have been excluded from the diluted calculation because they are
antidilutive.

                                      -7-

<PAGE>

6.    INVENTORIES

Inventories consist of:

<TABLE>
<CAPTION>
                                                          JUNE 30,  DECEMBER 31,
                                                            1998        1997
                                                          --------  ------------
                                                              (IN THOUSANDS)
<S>                                                       <C>       <C>

Finished goods . . . . . . . . . . . . . . . . . . . . .    $1,440     $1,303
Work in process. . . . . . . . . . . . . . . . . . . . .        74        157
Purchased parts. . . . . . . . . . . . . . . . . . . . .     1,770      2,005
                                                            ------     ------
                                                            $3,284     $3,465
                                                            ------     ------
                                                            ------     ------
</TABLE>

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

     Management's Discussion and Analysis of Financial Conditions and Results of
Operations should be read in conjunction with the accompanying financial
statements for the periods specified and the associated notes.  Further
reference should be made to the Company's 1997 Annual Report to Shareholders.

RESULTS OF OPERATIONS

     The following table sets forth for the period indicated the percentage of
total revenue represented by each line item in the Company's condensed
consolidated statements of income and the percentage change from comparative
prior period in each line item.

<TABLE>
<CAPTION>
                                                               Percent of          Period-to-Period
                                                               Net Sales           Percentage Change
                                                           ---------------------   ------------------
                                                            Three months Ended     Three months Ended
                                                                 June 30,            June 30, 1998
                                                            1998           1997     Compared to 1997
                                                           ------         ------   ------------------
<S>                                                        <C>            <C>      <C>
Net sales. . . . . . . . . . . . . . . . . . . . .         100.0%         100.0%          (8.5%)
Cost of sales. . . . . . . . . . . . . . . . . . .          25.4           27.0          (13.8)
                                                           ------         ------
Gross profit . . . . . . . . . . . . . . . . . . .          74.6           73.0           (6.6)

Operating expenses:
   Sales, general and administrative . . . . . . .          48.2           46.0           (4.1)
   Research and development. . . . . . . . . . . .          28.2           21.0           22.8
                                                           ------         ------
Total operating expenses . . . . . . . . . . . . .          76.4           67.0            4.3
                                                           ------         ------
Loss from operations . . . . . . . . . . . . . . .          (1.8)           6.0         (128.3)

Interest income and other. . . . . . . . . . . . .           2.4            1.7           35.9
Interest expense . . . . . . . . . . . . . . . . .          ----           ----           ----
                                                           ------         ------
Income (loss) before income taxes. . . . . . . . .           0.6            7.7          (92.4)
Income taxes . . . . . . . . . . . . . . . . . . .          ----            1.2           ----
                                                           ------         ------
Net income (loss). . . . . . . . . . . . . . . . .           0.6%           6.5%         (91.0%)
                                                           ------         ------
                                                           ------         ------
</TABLE>

                                      -8-

<PAGE>

<TABLE>
<CAPTION>
                                                               Percent of          Period-to-Period
                                                               Net Sales           Percentage Change
                                                           ---------------------   ------------------
                                                            Six months Ended       Six months Ended
                                                                 June 30,            June 30, 1998
                                                            1998           1997     Compared to 1997
                                                           ------         ------   ------------------
<S>                                                        <C>            <C>      <C>
Net sales. . . . . . . . . . . . . . . . . . . . .         100.0%         100.0%          (7.9%)
Cost of sales. . . . . . . . . . . . . . . . . . .          26.6           27.3          (10.0)
                                                           ------         ------
Gross profit . . . . . . . . . . . . . . . . . . .          73.4           72.7           (7.2)

Operating expenses:
   Sales, general and administrative . . . . . . .          50.3           47.4           (2.3)
   Research and development. . . . . . . . . . . .          28.3           22.7           15.0
                                                           ------         ------
Total operating expenses . . . . . . . . . . . . .          78.6           70.1            3.3
                                                           ------         ------
Loss from operations . . . . . . . . . . . . . . .          (5.2)           2.6         (284.8)

Interest income and other. . . . . . . . . . . . .           2.3            1.7           27.5
Interest expense . . . . . . . . . . . . . . . . .          ----           ----           ----
                                                           ------         ------
Income (loss) before income taxes. . . . . . . . .          (2.9)           4.3           ----
Income taxes . . . . . . . . . . . . . . . . . . .          ----            0.7           ----
                                                           ------         ------
Net income (loss). . . . . . . . . . . . . . . . .          (2.9%)          3.6%          ----
                                                           ------         ------
                                                           ------         ------
</TABLE>

NET SALES

     Net sales decreased by 8.5% to $9.2 million from $10.0 million for the 
quarters ended June 30, 1998 and 1997, respectively. For the first six months 
of 1998, revenue decreased by 7.9% to $17.4 million from $18.9 million for 
the same period of 1997.  These decreases were primarily attributable to the 
reduction in unit sales of higher priced  debug  tools directly related to 
the Asian financial crisis, particularly in Japan, and to a lesser extent 
currency exchange rate fluctuations affecting international sales.  The 
decreases were partially offset by an increase in unit sales and average 
selling price of the CodeTEST-TM- solutions, an increase in low cost debug 
patent license fees and an increase in the average selling price of low cost 
debug solutions. The Company's net sales are presently derived predominantly 
from sales of software design, debugging, and testing solutions and support 
service revenues.  The Company generally recognizes revenues from product 
sales upon shipment. Product support revenues increased by 4.2% and 5.8% over 
the prior three month and six month periods, respectively,  and increased as 
a percentage of sales to 12.8% from 11.2% of net sales for the quarters ended 
June 30, 1998 and 1997, respectively, and to 13.4% from 11.7% of net sales 
for the six months ended June 30, 1998 and 1997, respectively. The increases 
in product support revenue as a percentage of net sales is due to the 
continued pro rata recognition of revenue from product support contracts 
entered into in prior periods, in combination with a decrease in  product 
sales revenue compared to prior periods. 

     International sales expressed in U.S. dollars decreased by 28.4% for the 
quarter ended June 30, 1998 over the comparable period of 1997, to 38.8% of 
net sales as compared to 49.6% of net sales in the prior comparable quarter. 
For the six months ending June 30, 1998, international sales decreased 19.1% 
over the same period in 1997, representing 43.7% of the total sales versus 
49.7% in the prior comparable period.  The reduction in international sales 
as expressed in U.S. dollars is primarily attributable to the Asian financial 
crisis  that resulted in a decreases in unit sales and average selling price 
in Japan and the other Pacific Rim nations and to a lesser extent, currency 
exchange rates.  The decreases were partially offset by unit sales increases 
in Europe. The Company's sales through its foreign subsidiaries are 

                                      -9-

<PAGE>

generally denominated in local currencies, and as a result, fluctuations in 
currency exchange rates can have a significant effect on the Company's 
reported net sales. Had the exchange rates remained the same from the prior 
comparable periods, especially in Japan, overall sales would have decreased  
4.0 percentage points for the quarter ended June 30, 1998 and decreased 3.2 
percentage points for the six months ended June 30, 1998. 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. The Company expects international sales, especially in Japan, to 
continue to account for a significant percentage of its net sales.

GROSS PROFIT

     The Company's gross profit decreased to $6.8 million, or 74.6% of net
sales, from $7.3 million, or 73.0% of net sales, in the quarters ended June 30,
1998 and 1997, respectively. For the six months ending June 30, 1998, the
Company's gross profit decreased to $12.8 million from $13.8 million in the
prior comparable period, representing 73.4% and 72.7% of net sales,
respectively.  The increase in gross profit as a percentage of net sales was
primarily attributable to an increase in net sales of the higher margin CodeTEST
solution and  an increase in low cost debug patent licenses and other contract
licenses that had nominal costs and an increase in net sales of low cost debug
solutions.  These were partially offset by lower manufacturing throughput over
which to spread fixed manufacturing overhead costs and to a lesser extent due to
declines in sales revenue due to unfavorable currency exchange rate
fluctuations.  The company expects its gross profit to fluctuate based upon its
product mix, geographic mix, product and patent licenses and variances in
throughput and related absorption of factory overhead costs.

SALES, GENERAL AND ADMINISTRATIVE

     Sales, general and administrative expenses were $4.4 million or 48.2% of 
net sales, and $4.6 million, or 46.0% of net sales, for the quarters ended 
June 30, 1998 and 1997, respectively.  For the six month periods ended June 
30, 1998 and 1997, sales, general and administrative expenses were $8.8 
million or 50.3% of net sales, and $9.0 million or 47.4% of net sales, 
respectively.  The dollar amount decreases between comparable periods were 
primarily attributable to reduction in business taxes,  compensation related 
expenses and recruiting costs, and equipment leases which were partially 
offset by increased contract labor, professional fees and demonstration 
expenses in connection with the company's expansion of its sales and 
marketing efforts.  The percentage increase between comparable periods was 
primarily attributable to lower revenues for the quarter ending June 30, 
1998. Sales are difficult to predict and the majority occur late in the 
quarter, at which time budgeted expenditures are already committed. The 
Company expects its sales and marketing expenditures to continue to increase 
in absolute dollars  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, does from time to time,
hedge 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.  Although the
Company generally plans to continue to 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. 

RESEARCH AND DEVELOPMENT

                                     -10-

<PAGE>

     Research and development expenses were $2.6 million, or 28.2% of net sales,
and $2.1 million, or 21.0% of net sales, for the quarters ended June 30, 1998
and 1997, respectively.  For the six month periods ending June 30, 1998 and June
30 1997, research and development expenses were $4.9 million, or 28.3% of net
sales, and $4.3 million, or 22.7% of net sales, respectively.  The 22.8%
increase in the dollar amount between comparable periods was primarily
attributable to an increase in contract labor, headcount and compensation
related expenses which was partially offset by a reduction in hardware
prototyping costs and equipment leases.  The Company intends to continue to make
substantial investments in product development, including development of
software design, debugging and test tools for additional embedded
microprocessors as well as  continued advanced development in new product and
market directions.  As a result, the Company anticipates that net research and
development expenses are likely to increase for the foreseeable future.

OTHER

     The Company's interest (net) and other income increased by $60,000 between
the comparable three month periods and $91,000 between the comparable six month
periods due primarily to an increase in  marketable securities generated from
operations and a one time interest payment for settlement of a business tax
refund.

TAXES

     The Company's estimated annualized effective tax rate was reduced from 15%
to 0% due to loss carryforwards and credits for the quarter ending June 30,
1998.  A full valuation allowance has been provided for all deferred tax assets,
including net operating loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

     The Company requires capital principally for the financing of inventory, 
capital equipment and accounts receivable, and for investment in product 
development activities, new technologies and potential company or product 
line acquisitions. Proceeds from the Company's initial public offering were 
$13.0 million net of costs.  Since the offering, the Company has used $3.3 
million to purchase capital equipment, $2.5 million to pay off bank debt,  
$.5 million to purchase a product line and the remaining proceeds of $6.7 
million have been invested in short term commercial and government paper and 
money market funds. For the six months ended June 30, 1998 and 1997, the 
Company used $55,000 and generated $1.4 million,  respectively, of cash 
from operations, and utilized $217,000 and $1.1 million, respectively, of 
cash for purchases of short-term investments and equipment.  As of June 30, 
1998, the Company had working capital of $19.7 million, including $15.7 
million of cash, cash equivalents and short-term investments

     The Company believes that it's existing working capital, together with
funds from operations and 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, however, depend on a
number of factors, including costs associated with product development efforts,
the success of the commercial introduction of the Company's new products and the
acquisition of complementary businesses, products or technologies.  To the
extent additional capital is required, the Company may sell additional equity,
debt or convertible securities, or obtain additional credit facilities.

                                     -11-

<PAGE>

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

     Statements in this report concerning sales, costs, expenses, adequacy of
working capital and other matters which are not historical facts, constitute
forward-looking statements which are subject to a number of risks and
uncertainties which might cause actual results to differ materially from stated
expectations. Such risks and uncertainties include delays in shipments of the
Company's new products, declining product prices and margins, ability of its
suppliers to provide components and assemblies, uncertain market acceptance of
new products, growth in the marketplace in which the Company operates,
competitive product offerings, continuation of Asian financial crisis,
unfavorable foreign currency fluctuations and adverse changes in general
economic conditions in any of the countries in which the Company does business,
and other risks set forth in the Company's filings with the Securities and
Exchange Commission, including its annual report for the year ended December 31,
1997 on Form 10-K.  During the last twelve months, the Company's competitors
have continued to make a variety of product announcements and offerings. The
Company continues to release new versions of its product lines and the
successful acceptance of these products will be a key determinant of future
growth.  The impact of any of these factors is difficult to predict or forecast.

     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,
including factors noted above.  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, or even after the quarter is over, 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.

                                     -12-

<PAGE>

PART II - OTHER INFORMATION

ITEM 4.        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company's Annual Meeting of Shareholders was held on May 22, 1998.  The
following matters were voted upon by the shareholders with the following
results:

     (1)  The following persons were elected to serve as directors until the
          next Annual Meeting of Shareholders or until their earlier retirement,
          resignation or removal: Robert L. Deinhammer, Elwood D. Howse, Jr,
          Anthony Miadich, and Paul N. Risinger.

          The number of votes cast for or withheld for each director nominee was
          as follows:
<TABLE>
<CAPTION>
               Nominee                          For           Withheld
               -------                          ---           --------
               <S>                            <C>             <C>
               Robert L. Deinhammer           6,155,193        220,022

               Elwood D. Howse, Jr.           6,156,948        218,267

               Anthony Miadich                6,155,493        219,722

               Paul N. Risinger               6,159,918        218,297
</TABLE>
     (2)  The  shareholders voted 3,606,090 shares in the affirmative, 503,661
          shares in the negative, 31,570 abstained , 2,233,894 broker non-votes
          and 543,169 other unvoted to amend the existing Applied Microsystems
          Corporation 1992 Performance Stock Plan (the "1992 Plan"), as amended,
          to increase the number of shares issuable thereunder from 2,175,317
          shares to 2,575,317 shares.

     (3)  The shareholders voted 6,311,292 shares in the affirmative and 46,620
          shares in the negative to ratify the appointment of Ernst & Young LLP,
          as independent auditors for the Company's year ending December 31,
          1998.


ITEM 6.        EXHIBITS AND REPORTS ON FORM 8-K

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

          None.

     (B)  Report on Form 8-K

          The registrant did not file any reports on Form 8-K during the quarter
          ended June 30, 1998.


                                     -13-

<PAGE>

                                     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
Redmond, State of  Washington, on August 7, 1998.

                              APPLIED MICROSYSTEMS CORPORATION
                              (Registrant)

                              By    /s/   A. James Beach
                                 --------------------------
                                    A. James Beach
                                    VICE PRESIDENT, CHIEF FINANCIAL OFFICER,
                                    SECRETARY AND TREASURER
                                    (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)


                                     -14-