10-K405

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10–K

(Mark One)

/ X /   Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2000

or

/    /    Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______ to ______

Commission File Number 0-26778

APPLIED  MICROSYSTEMS  CORPORATION
(Exact name of registrant as specified in its charter)

Washington (State of  incorporation)	91–1074996 (I.R.S. Employer Identification Number)
5020 148th Avenue N.E. , Redmond, Washington   98052-5172 (425) 882-2000 (Address, including zip code, of registrant’s principal executive offices and telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes    X            No         

 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K.  /X/

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

Common stock: 7,003,921 shares outstanding as of March 14, 2001.

The aggregate market value of the common stock held by non–affiliates of the registrant, based on the closing price on March 14, 2001, as reported on the Nasdaq National Market, was $14,319,987. ¹

¹ Excludes shares held of record on that date by directors, executive officers and greater than 10% shareholders of the registrant. Exclusion of such shares should not be construed to indicate that any such person directly or indirectly possesses the power to direct or cause the direction of the management of the policies of the registrant.

Documents Incorporated by Reference

Portions of the registrant's Proxy Statement relating to the registrant's 2001 Annual Meeting of Shareholders to be held on May 22, 2001, are incorporated by reference into Part III of this report.

TABLE OF CONTENTS

PART I
ITEM 1.	Business
ITEM 2.	Properties
ITEM 3.	Legal Proceedings
ITEM 4.	Submission of Matters to a Vote of Security Holders

PART II
ITEM 5.	Market for Registrant’s Common Equity and Related Stockholder Matters
ITEM 6.	Selected Consolidated Financial Data
ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 7A.	Quantitative and Qualitative Disclosures about Market Risk
ITEM 8.	Financial Statements and Supplementary Data
ITEM 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

PART III
ITEM 10.	Directors and Executive Officers of the Registrant
ITEM 11.	Executive Compensation
ITEM 12.	Security Ownership of Certain Beneficial Owners and Management
ITEM 13.	Certain Relationships and Related Transactions

PART IV.
ITEM 14.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K

PART I

ITEM 1. BUSINESS

          The following Business section includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  The Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about their business so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results.  All statements other than statements of historical fact the Company makes in this document or in any document incorporated by reference are forward-looking.  In particular, the statements herein regarding industry prospects and the Company's future results of operations or financial position are forward-looking statements.  Forward-looking statements reflect management's current expectations and are inherently uncertain.  The Company's actual results may differ significantly from expectations.  The section entitled “Risk Factors Affecting Future Results and Forward-Looking Statements” describes some, but not all, of the factors that could cause these differences.

Overview

          Applied Microsystems Corporation (“Applied” or the “Company”) is a leader and innovator in software development tools and technologies. Applied’s products and services help customers bring products to market faster by providing innovative tools to develop, debug, and test products faster, more reliably, and at a lower cost.  For more than 20 years, the Company has targeted its products to meet the needs of embedded systems markets and has developed significant experience and expertise in high-end microprocessors, real-time systems, and software analysis technology – three key competencies that position the Company to meet the needs of software developers.  Applied develops, markets and supports a comprehensive suite of software and hardware-enhanced development and test tools for the development of complex embedded microprocessor-based applications.  The embedded systems market has in recent years expanded from its traditional base of industrial automation, medical devices, and avionic applications to include a number of rapidly growing market segments such as Internet devices, high-speed networking, wireless technologies, game consoles, and set top boxes.

          The Company’s products enhance customers’ productivity by providing a set of solutions that span a product’s lifecycle.  Applied’s products and services assist customers with the development of software and the integration of software and hardware in creating embedded products.  The Company’s software analysis tools include the CodeOPTIX™ family of high-level software visibility tools for application software verification, analysis and test as well as providing the ability to add executable code to programs running in the target systems.  Applied provides development tools for customers using a variety of third-party operating systems, including Wind River Systems’ VxWorksÒ and pSOSÔ, Sun Microsystems’ ChorusOSÔ, Enea OSE Systems’ OSE™, QNX Software Systems’ NeutrinoÒ, and Lynx Real-Time Systems’ LynxOSÔ operating systems.  The Company supports development, debug and testing for a wide range of popular microprocessors from companies such as Motorola, Inc., Intel Corporation, Advanced Micro Devices, Inc., Hitachi, and MIPS Technologies, Inc.  Applied offers its custom engineering capability to provide customers with specialized development tools and design services.  The Company has recently expanded its expertise into development tools for game consoles, and has signed agreements with Nintendo and Microsoft to develop and manufacture development tools for the Nintendo Gamecube™ and Microsoft Xbox™ video gaming systems.

          Applied distributes its development solutions primarily through a network of direct sales and service offices located in the United States, Japan, and Europe, through distributors in the rest of the world, as well as through partnerships with selected companies – including third-party developers of integrated development environments.

          Applied was incorporated in Washington in 1979 and is headquartered at 5020 148^th Avenue NE, Redmond, Washington. The Company is ISO 9002 certified.  For more information, visit Applied’s home page on the World Wide Web: http://www.amc.com.

Background

          Applied has developed significant expertise in providing development solutions to the embedded systems marketplace.  Embedded systems generally include an embedded microprocessor, program storage (e.g. in flash memory), real–time operating system (“RTOS”) software, and custom software to implement assigned applications.  Embedded systems are incorporated within electronic devices and are dedicated to performing specific tasks quickly and reliably in response to rapidly occurring external events.  Manufacturers worldwide are making increasing use of embedded systems to enhance the functionality and performance, reduce the cost and size, and improve the reliability of a broad variety of products.

          Manufacturers are faced with an expanding competitive market that requires them to bring increasingly complex products to market faster and at reduced costs. As the computing power of embedded microprocessors has grown, and as unit prices for embedded microprocessors have declined, manufacturers have been able to incorporate vastly improved features, speed and reliability into their products.  This additional sophistication has resulted in significantly larger and more complicated application software and increased challenges associated with delivering a product on schedule.

          The development of embedded systems using today's high–speed microprocessors requires the design, debugging and testing of substantial amounts of complex custom application software, which is typically written in a high–level programming language.  As the complexity and volume of such software increases, so does the potential for programming errors, the need to eliminate performance shortcomings, and the difficulty of thoroughly testing the complete system.

          In their efforts to remain competitive, manufacturers are increasingly faced with conflicting pressures.  As they incorporate advanced microprocessors into their products, these manufacturers must develop more embedded software and intensify their debugging and testing efforts, which tends to lengthen product development cycles and increase development costs.  At the same time, competitive demands for lower-cost, technologically superior products create pressures to minimize development costs and time–to–market.  Applied’s current development solutions are designed to help customers respond successfully to these conflicting demands.

          Game console manufacturers face similar pressures to design consoles with advanced hardware features, and then face the added complexity of coordinating with in-house and external game developers to develop games that fully utilize the advanced hardware features.  The time-to-market pressures in the games industry are significant, and Applied has expanded its expertise to provide DVD emulation technology that significantly aids in the rapid development of video games.

Products

          Applied develops, markets and supports a comprehensive suite of software and hardware-enhanced development and test tools for the development of complex embedded microprocessor-based applications.  Applied’s current development solutions are targeted principally for use by software engineers in the development of embedded software and associated products.  Applied designs its products to support major market segments utilizing  32 and 64–bit embedded microprocessors, as well as products to meet the specific needs of game console developers.

          The Company's products generally enable engineers to perform debugging functions in high–level programming languages and operate on IBM–compatible personal computers or engineering workstations.  The Company's tools also enable engineers to observe software interaction and functions with several commercially available RTOS products and to read file format output from compatible compilers.

          The Company’s current products can be classified into three broad categories: hardware-enhanced debugging tools, software analysis tools, and game development systems.

Hardware-Enhanced Debugging Tools

          The Company manufactures a wide range of hardware–enhanced software tools for the design and debugging of embedded software.  These in–circuit microprocessor and ROM emulators are utilized primarily by software engineers during the highly iterative software development and system integration phases of the embedded systems development process.  To a lesser extent, they are also used by software engineers for low–level testing of software functions and by hardware engineers in system integration and troubleshooting their designs.

          The Company's emulators perform four basic functions or subsets thereof, depending on product configuration:

          Applied offers a broad selection of hardware–enhanced software design and debugging tools with a variety of features and prices.  The tools are accessed through a high-level language debugger human interface licensed from CAD-UL, Mentor Graphics Corporation, Metrowerks (a subsidiary of Motorola), or Paradigm Systems, Inc. and generally resold with Applied’s product. Applied’s hardware-enhanced debugging products are available in two categories: lower-priced, feature-focused products and high-end, higher-priced products based on traditional embedded architecture.

          The lower-priced, feature-focused products include CodeTAPÒ, PowerTAP™, and SuperTAP™ tools that are pocket sized and provide a full range of feature capabilities; this category also includes NetROM™, which provides cost-efficient target ethernet access and memory substitution. These tools support a broad range of popular microprocessors used in embedded systems.  This product group represented the largest revenue category for Applied in 2000, totaling nearly 60% of revenues for the year (including support services).

          The high-end, higher-priced products include Applied’s EL Series and CodeICE™ emulators that represent previous-generation technology. These full-featured products support older families of microprocessors from Motorola (680X0 series) and Intel (80960 series).  Based upon a shift in designs to newer microprocessors, demand for these products has declined in recent years and represented less than 5% of the Company’s revenues in 2000.

          Applied plans to continue to support its hardware-enhanced debugging tools and expects to support existing and future microprocessors, as well as to continue to enhance and broaden its user–interface technology with third parties.

Software Analysis Tools

          The Company’s software analysis tools include the CodeOPTIX family of high-level software visibility tools based on instrumentation for application software verification, analysis and test as well as providing the ability to add executable code to programs running in the target systems.  Applied is focused on growing its software analysis tools business, which accounted for 19% of revenues in 2000 (including support services).

          Applied’s CodeTESTÒ software products consist of a line of software testing tools which are designed specifically to offer a broad range of optimization and testing capabilities to software developers.  These tools measure the performance and reliability of software, as well as the adequacy of the test process itself, in a minimally intrusive manner.  The measurements are then displayed in an intuitive format.  Software engineers use these products during the full range of system development – beginning with initial software development, extending to system integration, and then to final system test and validation.

          CodeTEST software analysis tools currently include the following modules:

          The CodeTEST product line currently includes software modules sold separately or with a separate hardware probe.  CodeTEST supports a range of the most popular 32-bit microprocessors and RTOS offerings, and Applied plans to support additional CodeTEST releases during 2001.  The Company’s development efforts in 2001 are expected to include extending CodeTEST to provide greater support for engineers developing complex multi-processor systems, in particular for developers at communications infrastructure companies.

          Applied has an OEM agreement with Wind River Systems, a third-party developer of real time operating systems, for integration of certain CodeTEST modules within its integrated development environment.  In 1998, Applied released and began shipping a software-only version of CodeTEST modules through Wind River.  This agreement remained in place throughout 2000, and an additional software module was added to the agreement.  The modules run on the embedded target within Wind River’s integrated development environment.

          In 1999, Applied announced LiveCODE™, the industry’s first interactive run-time tracing system.  LiveCODE incorporates Applied’s automated instrumentation technology, which allows users to interactively debug their software while the application runs in the target. With LiveCODE, developers can graphically display program execution at a high level to quickly understand its operation, trace details in areas of interest and insert code to diagnose problems.  All of this can be done without recompiling or stopping the program. Interactively debugging software while the application runs in the target means developers can significantly reduce the time spent debugging and spend more time on developing code.  During 2001, Applied intends to extend the LiveCODE technology to provide for remote monitoring and debugging of communications switches, base station controllers, and other communications equipment.

Game Development Systems

          In July 2000, the Company announced a letter of intent with Microsoft Corporation to develop and manufacture DVD-emulation technology for inclusion in Microsoft’s Xbox Development Kit, the development platform that allows game developers to optimize games for Xbox, Microsoft’s initial entry into the video gaming system.  In December 2000, the Company announced that it had signed definitive agreements with Microsoft, thus formalizing the relationship established by the letter of intent. Applied had previously signed an agreement with Nintendo in 1999 to develop and manufacture development kits for Gamecube, Nintendo’s next-generation video gaming system.  Applied intends to leverage these relationships over time to also provide its software analysis tools to game developers, as well as provide other products and services to the gaming markets.

          The Company’s game development tools currently include a DVD emulator, which replaces the game developer’s target DVD drive with a hard disk, DVD mechanics emulation, and may also provide specific DVD layout and mastering tools.  Data that would normally be read from the DVD is translated to files on a hard disk on the game developers’ computer. The emulator lets developers see their games run as if they were actually accessing target DVDs and eliminates the need to burn DVDs, which can be a time-consuming and expensive process. And because the data can be accessed more easily from the developer’s hard drive, the total development time for any game system is significantly reduced.

Customers

          The Company's sales are presently concentrated primarily in the telecommunications industry, with a secondary but increasing concentration in the video games industry.  Sales are generally made pursuant to customer purchase orders.

Sales, Marketing and Customer Support

          Applied distributes its development solutions primarily through a network of direct sales and service offices located in the United States, Japan, and Europe, through distributors in the rest of the world, as well as through partnerships with selected companies – including third-party developers of integrated development environments.  During 2000, Applied focused on two vertical market segments – high-speed networking equipment and networked game consoles.  As a result of that strategic decision, the Company aligned its sales force to focus on key global accounts that drive those defined markets.  This organizational-selling model increased the sales cycle somewhat in 2000, but is expected to increase overall revenues over time as the Company enhances relationships with large OEMs, provides a more complete solution to customers, and increases the average order size.  Applied also sought out partnerships to extend its marketing reach to other market segments, customers, or geographies. As a result, in 2000 Applied announced agreements with Arrow Electronics, Metrowerks, and Wind River, in addition to the aforementioned agreements with Microsoft and Nintendo for game development tools.

          As of December 31, 2000, the Company had 63 sales and support employees worldwide, including 42 field sales engineers, inside sales specialists and application engineers located at the Company's headquarters and in direct or home sales offices throughout North America, and in the Company's wholly owned subsidiaries in Japan, Germany, France and the United Kingdom.  Due to the technical nature of its products, the Company believes that an important aspect of its sales strategy is the technical support provided to customers.  In addition, a high level of customer service and support is important to customer adoption and successful utilization of design, debugging and testing technology.  The Company’s field application engineers offer product support and assist customers in incorporating Applied’s design, debugging and testing tools into their design process.

          The Company maintains international distribution agreements covering various countries.  These agreements generally have a term of three years and may be exclusive, on a country–by–country basis. The sale of products in foreign countries involves risks associated with currency exchange rate fluctuations and restrictions, export–import regulations, customs matters, potentially longer payment cycles, differing collection issues, and military, political and transportation risks.  The Company's sales through its foreign subsidiaries are generally denominated in foreign currencies.  As a result, fluctuations in currency exchange rates can have a significant effect on the Company's sales, even in the absence of an increase or decrease in unit sales to foreign customers.  In addition, foreign sales involve uncertainties arising from local business practices and cultural considerations, and risks associated with international trade tensions.  The Company expects that international sales will continue to account for a significant portion of Applied’s revenues in the future.

          Applied participates from time to time in cooperative marketing activities with other embedded systems development tools providers and embedded microprocessor manufacturers.  These relationships enable the Company to further leverage its technical capabilities, customer relationships and international sales and support infrastructure.  The Company believes that developing and maintaining these relationships is important to its ability to achieve broad market penetration.  Applied’s marketing efforts also include attending trade shows, publishing articles, and advertising in trade magazines and journals, direct mail and product demonstrations.

          The time between order and delivery of the Company's products is often quite short.  The number of orders, as well as the size of individual orders, can vary substantially from month to month. Because of the short period between order receipt and shipment of products, the Company typically does not have a meaningful backlog of unfilled orders and believes a backlog is neither significant to an understanding of its business nor representative of potential revenue for any future period.

Competition

          The traditional market for embedded software development solutions is fragmented and highly competitive, with many providers offering technical solutions to address the design, debugging, testing and service needs of embedded software developers.  In addition, many companies choose to develop their own proprietary solutions as opposed to purchasing development tools and services from outside vendors.  This market is also subject to rapid change, as technological developments create new needs and render prior technical solutions obsolete.  The Company's ability to compete successfully in this market will depend on its ability to develop and introduce new products and features that address the increasingly sophisticated needs of its customers, to implement business relationships that enable it to broaden its product offerings, to provide worldwide customer service and support, and to respond to technological advances, emerging industry standards and practices and competitive developments.

          The principal competition for the Company's hardware–enhanced debugging tools comes primarily from Agilent Technologies, Inc., Lauterbach Datentechnik GmbH, and a division of Wind River (formerly Embedded Support Tools Corporation), as well as from various other domestic and international providers of in–circuit emulators.  Many of these competitors focus primarily on developing products to support specific microprocessors.  To a lesser extent, competition also comes from domestic providers of embedded microprocessor simulators, RTOS debugging software, logic analyzers, ROM monitors and ROM emulators.

          Competition for Applied’s software analysis tools comes principally from domestic providers of embedded debug software, emulators and logic analyzers, which are generally able to perform only portions of the software testing functions offered by the Company’s CodeOPTIX tools.  The Company has also historically experienced competition from the engineering departments of major manufacturers, which may choose to develop internal technical solutions to their design, debugging or testing problems.

          Competition for game development solutions has historically been from console manufacturers who have proprietary development tools.  However, Applied anticipates that the opportunity in the game development market segment may lead other companies to pursue products that will compete with Applied’s game development solutions.

          Competition among providers of embedded software design, debugging, testing and services focuses on a variety of factors, including the availability of tools that are compatible with the customer's chosen embedded microprocessor, engineering workstation and other software development equipment; performance characteris­tics and features such as high–speed processing, real–time visibility and control, high–level programming language and ease–of–use; product reliability; price/performance characteristics; customer service and world­wide support; and product availability and delivery time.  The Company believes that the relative importance of each of these factors to a prospective customer varies for each development project, depending upon the complexity of the embedded system design, the microprocessor to be used, the project development schedule, and the engineering team’s budget and experience level.

          The Company anticipates that the embedded systems development market is likely to experience continued consolidation as companies strive to broaden their product offerings.  The Company expects competition to increase from both established and emerging companies.  The Company believes that much of its competition is now, and will increasingly be, from larger companies having substantially greater technical, financial and marketing resources, as well as larger customer bases and greater name recognition, than Applied.

Manufacturing

          The Company maintains manufacturing operations to support its hardware-enhanced development solutions and game development tools.  The manufacturing operations consist of the procurement and inspection of parts and components, assembly, software duplication, and extensive testing of components and finished products. Applied’s products incorporate the Company's proprietary software, as well as software licensed from others.  The Company conducts virtually all steps of the assembly process, including board assembly, at its facility in Redmond, Washington.  The Company has a computerized manufacturing inventory control system that integrates and monitors purchasing, inventory control and production.

          The Company thoroughly inspects and tests its manufactured products during the manufacturing process and tests finished products using tests designed and developed internally based on the custom requirements and functionality of the product.  In addition, the Company's products undergo thorough quality inspection and testing, including “burn–in” procedures throughout the manufacturing process to ensure the quality and reliability of the Company's products.  Applied also requires that all employees involved in the assembly process undergo thorough training.  The Company has maintained its ISO 9002 certification since December 1995.  The Company provides standard warranty that its hardware, software and mechanical parts will be free from defects in materials and workmanship for periods generally ranging from three to twelve months, depending on the product and location.

          The Company pursues a strategy of using the latest high–performance hardware components in the manufacture of its development tools.  Certain product components are available only from a single source or a limited number of distributors.  The Company has entered into agreements with a number of its vendors that include provisions requiring the vendor to maintain specified levels of key parts and components.  In addition, due to fluctuating demand levels and limits on production, it is typical for a number of key components to be on “allocation” at any given time.  There can be no assurance that the Company will be able to obtain key components in the future in a timely manner, in sufficient quantities, and/or on favorable price terms.  The Company has a limited ability to avoid or offset future price increases by suppliers of key components.  If the Company were to experience significant future delays, interruptions, or reductions in its supply of key components, or unfavorable price terms, its business, financial condition, and results of operations could be materially adversely affected.

          As part of its agreement with Microsoft relating to Xbox development tools, Applied must maintain certain levels of available inventory, manufacturing capacity, and quality control requirements.  In addition, the Company is responsible for reimbursing Microsoft for certain costs in the event of an “epidemic failure” of its products that are incorporated into Microsoft’s Xbox Development Kit.

          Although the Company's customers occasionally forecast projected purchase requirements in advance of shipment dates, customers more frequently order on an as–needed basis, and products are often shipped within a few weeks after an order is received.  As a result, the Company's ability to plan production and inventory levels is limited.  The need for immediate delivery by many customers, as well as the numerous products and configurations sold by the Company, require the Company to maintain a relatively high level of parts in inventory.

          The Company is subject to a variety of federal, state and local governmental regulations related to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in its manufactur­ing process.  The Company may be subject to future environmental regulations that may impose the need for additional capital equipment or other requirements.  Any failure by the Company to control the use of, or adequately to restrict the discharge of, hazardous substances under present or future regulations could subject the Company to liability.  The Company is not aware of any significant liability related to environmental issues.

Research and Development

          Applied believes that continued investment in research and development is critical to the Company’s future success.  Applied continues to make substantial investments in the development of new technologies and products.  Because of the competitive importance of offering development solutions that are compatible with particular microprocessors and other equipment to be used in developing embedded systems, solutions providers such as Applied are under continuing pressure to support major new families of embedded microprocessors, as well as advances in other development software and hardware.  Applied believes that its future growth and financial performance will depend heavily on its ability to enhance its existing products, develop and introduce new products and features that address the increasingly sophisticated needs of its customers, and respond to technological advances, emerging industry standards and practices, and competitive developments.  Applied’s engineering and development group includes 104 full-time employees.  During 2000, research and development expenses were $13.1 million, compared to $11.4 million in 1999 and $10.4 million in 1998.

Proprietary Rights

          The Company's success will depend in part on its ability to protect its technology and to preserve its trade secrets.  Although the Company relies primarily upon continuing technological innovations, trade secrets and know–how to develop and maintain its competitive position, it also relies on a combination of patent, copyright and trademark laws, confidentiality procedures, and contractual provisions to protect its proprietary rights.  The Company has limited patent protection, and there can be no assurance that any patents will provide a competitive advantage or will afford protection against competitors with similar technology, or will not be successfully challenged or circumvented by competitors.  The Company’s policies and other measures designed to protect trade secrets and proprietary rights may not be adequate to prevent or deter misappropriation of its technology; in addition, competitors may be able to independently develop technologies having similar functions or performance characteristics.  The laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States.  The Company may not have an adequate legal remedy to prevent or seek redress for future unauthorized misappropria­tions of the Company's technology.

          The embedded systems development market is characterized by rapid technological change, with frequent introductions of new products and technologies.  As a result, industry participants often find it necessary to develop products and features similar to those introduced by others, increasing the risk that their products and processes may give rise to claims that they infringe the patents of others.  Accordingly, the Company's current and future products and processes within the traditional embedded markets or in new markets may conflict with patents that have been granted or may be granted to competitors or others. Such competitors or others could bring legal actions against the Company or its customers, claiming damages and seeking to enjoin manufacturing, marketing or use of the affected product or processes.  Similarly, the Company may in the future find it necessary to commence litigation in order to enforce and protect its proprietary rights.  If the Company becomes involved in such litigation, it could consume a substantial portion of the Company's resources and result in a significant diversion of management attention.  If the outcome of any such litigation were adverse to the Company or its customers, the Company's business, financial condition and results of operations could be materially and adversely affected.

          The Company believes that it currently owns or has adequate rights to utilize all material technologies relating to its existing products; however, as it continues to develop new products and features, the Company anticipates that it may find it desirable or necessary to obtain nonexclusive or exclusive licenses from third parties entitling it to use certain technologies or software solutions.  Such licenses may not be available to the Company on acceptable terms, if at all.  The Company currently has licenses to several software programs that are used in its design, debugging and testing products.  Termination of any such agreement, or failure to renew any such agreement upon its expiration with respect to products the Company intended to continue to market, would require product redesign and could significantly increase the cost to the Company of manufacturing such products and have a material adverse effect on the Company's business, financial condition and results of operations.  The Company's loss of or inability to obtain necessary or desirable licenses from third parties could have a material adverse effect on the Company's business, financial condition and results of operations.

Employees

          As of December 31, 2000, the Company had 236 employees, of whom 204 were based in the United States and 32 were based internationally.  Of the total, 101 were engaged in Sales, General and Administrative, 104 were in research and development and 31 were in manufacturing. None of the Company's employees is represented by a labor union.  The Company has not experienced any work stoppages and considers its relations with its employees to be good.

ITEM 2. PROPERTIES

          The Company's principal administrative, sales, marketing, research and development and manufacturing facility is located in an approximately 59,000 square–foot building in Redmond, Washington that is leased through May 31, 2007.  The Company also leases seven other domestic research, sales and/or support offices in the United States, and sales offices in Japan, France, Germany and the United Kingdom. The Company believes that its facilities are adequate to satisfy its projected requirements, including its requirements for production capacity through 2001, and that additional space will be available if needed.

ITEM 3. LEGAL  PROCEEDINGS

          From time to time, Applied is involved in legal proceedings, none of which is currently considered material to the Company’s business.

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

          No matters were submitted to a vote of security holders during the fourth quarter of 2000.

Part II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

          Applied Microsystems’ common stock trades on The Nasdaq National Market (“Nasdaq”) under the symbol “APMC.”  The Company estimates that at March 14, 2001, there were approximately 3,000 beneficial owners of the Company’s common stock, as estimated by the number of record holders including participants in security positions listings.

          The closing price of the Company's common stock as reported by Nasdaq on March 14, 2001 was $3.00 per share.  The price per share in the following table sets forth the low and high closing prices on Nasdaq for the quarter indicated:

		Low	High
1999
	First quarter	$2.75	$4.81
	Second quarter	2.50	3.44
	Third quarter	2.19	4.13
	Fourth quarter	3.56	13.75
2000
	First quarter	$8.56	$21.25
	Second quarter	5.50	15.75
	Third quarter	6.19	13.00
	Fourth quarter	2.13	9.25

          The Company has not paid dividends and does not plan to pay dividends on its common stock in the foreseeable future.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

	Year Ended December 31,
	2000	1999	1998	1997	1996
	(in thousands, except per-share amounts)
Statement of Operations Data:
Net sales	$32,315	$33,241	$37,020	$39,124	$38,662
Cost of sales	9,674	8,664	9,587	10,532	10,793
Gross profit	22,641	24,577	27,433	28,592	27,869
Operating expenses:
Sales, general and administrative	17,094	18,929	18,104	18,542	15,142
Research and development	13,101	11,435	10,438	8,468	7,988
Total operating expenses	30,195	30,364	28,542	27,010	23,130
Income (loss) from operations	(7,554)	(5,787)	(1,109)	1,582	4,739
Interest income and other, net	659	706	783	669	559
Income (loss) before income taxes and cumulative effect of change in accounting principle	(6,895)	(5,081)	(326)	2,251	5,298
Income taxes	—	—	19	349	1,582
Income (loss) before cumulative effect of change in accounting principle	(6,895)	(5,081)	(345)	1,902	3,716
Cumulative effect of change in accounting principle	(1,110)	—	—	—	—
Net income (loss)	$(8,005)	$(5,081)	$(345)	$1,902	$3,716
Per-share amounts:
Basic earnings (loss) per share before cumulative effect of change in accounting principle	$(1.00)	$(0.76)	$(0.05)	$0.28	$0.57
Cumulative effect of change in accounting principle	(0.16)	—	—	—	—
Basic earnings (loss) per share	$(1.16)	$(0.76)	$(0.05)	$0.28	$0.57
Shares used in basic per-share calculation	6,915	6,727	6,811	6,769	6,545
Diluted earnings (loss) per share before cumulative effect of change in accounting principle	$(1.00)	$(0.76)	$(0.05)	$0.26	$0.52
Cumulative effect of change in accounting principle	(0.16)	—	—	—	—
Diluted earnings (loss) per share	$(1.16)	$(0.76)	$(0.05)	$0.26	$0.52
Shares used in diluted per-share calculation	6,915	6,727	6,811	7,297	7,097
Pro forma amounts, assuming the change in accounting principle was applied retroactively:
Net income (loss)	$(6,895)	$(4,514)	$(245)	$2,495	$2,942
Basic income (loss) per share	$(1.00)	$(0.67)	$(0.04)	$0.37	$0.45
Diluted income (loss) per share	$(1.00)	$(0.67)	$(0.04)	$0.34	$0.41

          See Note 1 of Notes to Consolidated Financial Statements for information on the change in accounting principle.

	December 31,
	2000	1999	1998	1997	1996
	(in thousands)
Balance Sheet Data:
Working capital	$8,253	$16,311	$20,116	$20,547	$19,415
Total assets	21,453	28,042	33,290	32,582	30,824
Long-term debt, net of current portion	—	—	—	—	15
Shareholders' equity	10,823	19,187	23,931	24,291	22,607

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

          Applied Microsystems Corporation is a leader and innovator in software development tools and technologies. Applied’s products and services help customers bring products to market faster by providing innovative tools to develop, debug, and test products faster, more reliably, and at a lower cost.  For more than 20 years, the Company has targeted its products to meet the needs of embedded systems markets and has developed significant experience and expertise in high-end microprocessors, real-time systems, and software analysis technology – three key competencies that position the Company to meet the needs of software developers.  Applied develops, markets and supports a comprehensive suite of software and hardware-enhanced development and test tools for the development of complex embedded microprocessor-based applications.  The embedded systems market has in recent years expanded from its traditional base of industrial automation, medical devices, and avionic applications to include a number of rapidly growing market segments such as Internet devices, high-speed networking, wireless technologies, game consoles, and set top boxes.

Results of Operations

(dollars in thousands)	2000	Change From Prior Year	1999	Change From Prior Year	1998
Net sales	$32,315	$(926)	$33,241	$(3,779)	$37,020
		(3%)		(10%)

          The Company earns revenue on the sale of hardware and software products.  The Company also earns revenue on the sale of services, including hardware and software support, installation, training, and professional engineering services.

          As further described under “Cumulative effect of change in accounting principle,” the Company adopted the Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in Financial Statements,” effective retroactive to January 1, 2000.  As a result, certain revenues that were previously recorded in 1999 were deferred under the new revenue rules, and then recognized in 2000, resulting in an additional $1.1 million in revenue in 2000.

          The Company’s sales have historically been derived primarily from sales of debug, test, and performance solutions, as well as product support and consulting services.  Over the past three years, the Company experienced continuing declines in sales volumes and average sales prices of its higher-priced “high-end” emulator products as the overall market demand for this type of product declined.  The Company’s high-end products support older families of microprocessors that are not used as frequently by customers in their development projects.  High-end debug products accounted for over 40% of net sales in 1997, but have since declined to 4% of net sales in 2000.  High-end debug products accounted for 9% of net sales in 1999, and 22% in 1998.

          The Company’s lower-priced, hardware-enhanced debug products have been 56% - 58% of net sales in each of the three years ended December 31, 2000.  The Company’s software analysis tools, including CodeTEST and LiveCODE products, accounted for 19% of net sales in 2000, compared to 25% in 1999 and 14% in 1998.  The decline in software analysis tools revenues in 2000, compared to 1999, was due primarily to the timing of customer orders from a third-party developer of integrated development environments.  The Company's net sales also include product support revenues, which are included within the aforementioned major categories of Applied’s products.  These support revenues represented approximately 13% of net sales in 2000, compared to 14% in 1999 and 13% in 1998.

          Development solutions for game consoles represent a new revenue source for Applied and, including non-recurring engineering fees, accounted for approximately 13% of 2000 net sales, compared to 2% of net sales in 1999.  These increases were offset by generally lower revenues in Applied’s hardware-enhanced debug development solutions.

          The decrease in net sales in 1999 as compared to 1998 was primarily attributable to a decrease in unit sales of high-end debug products and decreases in unit sales of certain older lower-priced debug products.  The overall lower net sales were partially offset by increased sales of software analysis tools, primarily from the CodeTEST product line, and increased consulting revenues as the Company progressed under its agreement with Nintendo to provide development kits for Nintendo’s next-generation gaming system.  Applied also had improved sales in 1999 of certain lower-priced debug products, including PowerTAP, and favorable year-over-year currency exchange rate fluctuations affecting the dollar value of international sales.

          International sales represented 41% of net sales in 2000, compared to 38% in 1999 and 44% in 1998.  In U.S. dollars, international sales outside of North America increased 5% in 2000, as compared to 1999.  The increase in 2000 was affected by the Company’s adoption of SAB 101, which increased 2000 revenues in Japan.  International sales decreased 22% in 1999, as compared to 1998.  The decrease in 1999 was attributable primarily to a reduction in unit sales and average selling price of the Company’s products internationally, particularly as the Asian economies have experienced overall weakness.

          Applied’s sales through its foreign subsidiaries are generally denominated in local currencies; as a result, fluctuations in currency exchange rates can have a significant effect on the Company's reported net sales.  Had the average exchange rates in 2000 remained constant from 1999, the dollar amount of overall Company net sales would have decreased approximately the same as the reported 3% decrease.  However, had the average exchange rates in 1999 remained constant from 1998, the dollar amount of overall Company sales would have decreased 13% instead of the reported 10% decrease.  The Company is unable to predict currency exchange rate fluctuations and anticipates that such fluctuations will continue to affect its net sales to varying degrees in the future.  While international sales have fluctuated over the past three years in total and as a percentage of revenues, the Company expects international sales to continue to account for a significant percentage of its net sales.

(dollars in thousands)	2000	Percentage of Net Sales	1999	Percentage of Net Sales	1998	Percentage of Net Sales
Cost of sales	$9,674	30%	$8,664	26%	$9,587	26%
Gross Profit	$22,641	70%	$24,577	74%	$27,433	74%

          Cost of sales includes materials, labor and overhead incurred in the manufacturing of products as well as the cost of providing professional services, performing non-recurring engineering, and estimated warranty.  The Company performs periodic assessments of required reserves for potential inventory obsolescence, and corresponding adjustments to such reserves are included within cost of sales.  The dollar amounts of cost of sales and gross profit fluctuate based on a number of factors, including the volume of corresponding net sales and pricing pressures.

          The Company’s gross profit percentage declined in 2000, as compared to 1999 and 1998, due primarily to changes in product mix, including lower margins in Applied’s new game development tools business.

          The Company expects its gross profit percentage to fluctuate based upon its product and service mix, geographic mix, foreign currency fluctuations, product and patent license royalties, and variances in volume and related absorption of overhead costs.  Sales of game development kits are expected to be at lower margins than the Company has historically maintained, thus adding to the potential for future fluctuations in gross profit percentages.

(dollars in thousands)	2000	Change From Prior Year	1999	Change From Prior Year	1998
Sales, general and administrative expenses	$17,094	$(1,835)	$18,929	$825	$18,104
		(10%)		5%

          Applied’s total operating expenses have remained flat over the past ten quarters, in the range of $7.4 to $7.7 million per quarter.  However, over that same period of time, Applied’s management team has shifted operating resources to pursue opportunities in high-growth markets through developing new products.  That shift is reflected in the overall decrease in sales, general and administrative expenses in 2000 as compared to 1999, with a similar increase in research and development expenses.  In December 2000, the Company announced it had adopted a profit improvement plan that included a modest reduction in personnel to lower the Company’s overall expense run rate and better position the Company for improved operating results.

          The decrease in sales, general and administrative expenses in 2000, as compared to 1999, was achieved primarily through lower marketing-related expenditures.  In the first several months of 1999, Applied incurred marketing expenses relative to the launch of its CodeOPTIX™ product family, as well as other marketing expenses to build general awareness of Applied’s traditional embedded software solutions.  Marketing expenditures in the latter part of 1999 and throughout 2000 were at lower levels than in 1998 and early 1999, and included focused expenses for repositioning the Company into new market areas.  The lower sales, general and administrative expenses in 2000 were also the result of lower personnel-related expenses.  The Company expects its sales and marketing expenditures to increase over time as it introduces and markets new products and services and incurs higher selling expenses to increase net sales.

          The increase in sales, general, and administrative expenses in 1999 was due primarily to higher marketing expenditures incurred as the Company launched its CodeOPTIX product family, as well as certain higher personnel-related expenditures.  The higher overall expenses for the year were offset in part by lower sales commissions, commensurate with lower reported revenues in 1999, as well as certain lower consulting expenses.

          When incurred, minor foreign exchange gains and losses are included in sales, general and administrative expenses. In order to mitigate certain intercompany risks associated with exchange rate fluctuations, the Company at times hedges a portion of its foreign exchange risk in Japan as it relates to the debt the Company’s Japanese subsidiary owes to the Company.  No such hedging activities were in effect during 1999 or 2000.  Although the Company may engage in exchange-rate hedging activities with respect to certain exchange-rate risks, there can be no assurance that it will do so or that any such activities will successfully protect the Company against such risks.

(dollars in thousands)	2000	Change From Prior Year	1999	Change From Prior Year	1998
Research and development     expenses	$13,101	$1,666	$11,435	$997	$10,438
		15%		10%

          The increase in research and development expenses in 2000, as compared to 1999, was primarily attributable to increased engineering resources and correspondingly higher consulting and compensation-related expenses.  These increased expenses were a direct result of the Company’s investment in strategic new initiatives, such as the games development tools now offered by the Company and enhancements to Applied’s line of software analysis tools.

          The increase in research and development expenses in 1999, as compared to 1998, was primarily attributable to increased engineering headcount and correspondingly higher compensation-related expenses.  These increased expenses were a direct result of the Company’s investment in strategic new initiatives.

          The Company believes that its continued investment in focused research and development activities is critical to Applied’s future success, and that the Company’s engineering resources represent a competitive advantage.  Therefore, the Company intends to continue to make substantial investments in product development.   Research and development expenses may also fluctuate to the extent that Applied’s engineering resources are utilized to fulfill the needs of customers under contractual research and development arrangements.  In such cases, engineering costs are charged to costs of goods sold.

(dollars in thousands)	2000	Change From Prior Year	1999	Change From Prior Year	1998
Interest income and other, net	$659	$(47)	$706	$(77)	$783
		(7%)		(10%)

          The Company’s interest income and other, net, decreased in 2000 in comparison to 1999, and decreased in 1999 in comparison to 1998, due primarily to a decrease in cash available for short-term investments.

(dollars in thousands)	2000	Change From Prior Year		1999		Change From Prior Year		1998
Cumulative effect of change in accounting principle	$(1,110)		$(1,110)		—		—		—

          Applied implemented SAB 101 in the fourth quarter of 2000, effective retroactive to January 1, 2000.  SAB 101 provides guidance related to revenue recognition policies based on interpretations and practices followed by the SEC.  As a result of the Company’s assessment of these new guidelines, Applied changed its revenue recognition practices for sales in Japan to reflect revenues upon the earlier of customer inspection and acceptance or, in the absence of notification of inspection and acceptance, upon receipt of payment.  Applied adopted SAB 101 under the cumulative catch-up method of accounting, which is the manner prescribed under applicable accounting and reporting rules.  Under these rules, the cumulative effect of a change in accounting principle is recognized as an additional item on the Company’s statement of operations in the first quarter of the year in which the change is made.  Applied’s adoption of this new standard resulted in a $1.1 million cumulative adjustment increasing the Company’s Q1 2000 net loss.  Revenues and expenses in each of the 2000 quarters were likewise adjusted as if the new accounting principle had been adopted since January 1, 2000.  See Note 1 in Notes to Consolidated Financial Statements.

Income Taxes

          As of December 31, 2000 the Company had net operating loss carryforwards of approximately $14.4 million and research and development credit carryforwards of approximately $2.6 million for federal income tax purposes, both of which expire in various amounts through 2020.  The utilization of some of these carryforwards is subject to an annual limit of approximately $392,000 under rules of the Internal Revenue Code.

          Deferred income taxes reflect the net tax effects of temporary differences between the tax basis of assets and liabilities and the corresponding financial statement amounts.  Due to the uncertainty of the Company’s ability to utilize its net deferred tax assets, including its net operating losses and research and development credits, a valuation allowance has been established for financial reporting purposes equal to the amount of the net deferred tax assets.  See Note 5 of Notes to Consolidated Financial Statements.

Quarterly Results of Operations

          The Company's results of operations have historically fluctuated significantly from quarter to quarter, and the Company expects that such fluctuations may continue as a result of a variety of factors.  These factors include the following: product and price competition, fluctuating levels of internal research and development expenses, the volume and timing of customer development projects and orders, seasonality of customer orders, introductions of new embedded microprocessors, announcements or introductions of new products or technologies by the Company or its competitors, fluctuations in foreign currency exchange rates, fluctuating levels of required investments in marketing and distribution, price increases by the Company’s suppliers, potential parts shortages, general conditions in the Company’s target markets, and national and global economic conditions.  Therefore, the Company’s quarterly results of operations are not necessarily indicative of results for any future period.  Moreover, a significant portion of the Company's quarterly net sales have historically been generated from shipments during the last few weeks of the quarter – as a result of customers placing orders late in the quarter –  thereby adding to the potential for future fluctuations in operating performance.

Liquidity and Capital Resources

          As of December 31, 2000, the Company had $10.5 million in cash, cash equivalents, and short-term investments, compared to $16.3 million as of December 31, 1999.  The Company requires capital primarily for the financing of inventories and accounts receivable, sales and marketing efforts, product development activities, and capital equipment purchases.  As a result of its operating losses, Applied used cash of $5.4 million for operating activities in 2000, compared to $648,000 in 1999 and compared to generating $2.2 million in 1998.  The Company purchased $753,000 in equipment during 2000, compared to purchasing $730,000 in 1999 and $1.3 million in 1998.  As of December 31, 2000, the Company had no significant commitments with regard to capital purchases, but expects to spend approximately $900,000 in 2001 for new capital items.  The Company also has facility and equipment operating lease commitments totaling $1.3 million in 2001.  The Company anticipates that its annual capital and operating lease needs will increase in the future as a function of replacement cycles and anticipated growth of Applied’s business.

          The Company believes that its existing cash, cash equivalents, and investments will provide the Company with sufficient funds to finance its operations for at least the next 12 months.  The Company anticipates improved operating results in 2001, which is expected to lead to future increased working capital.  The Company's future capital requirements will depend on a number of factors, including required inventory levels to support new manufacturing agreements, costs associated with sales and marketing programs, product development efforts, the success of the commercial introduction of new products, and the potential use of funds for strategic purposes.  To the extent additional funds are required, the Company may sell additional equity, debt or convertible securities, or obtain credit facilities; however, there can be no assurance that the Company will be able to obtain such funds or on terms that are acceptable.

Risk Factors Affecting Future Results and Forward-Looking Statements

          The preceding “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, and other areas within this document, contain forward-looking statements that involve risks and uncertainties.  The statements in this document that are not purely historical are forward-looking statements.  Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions identify forward-looking statements, but the absence of these words does not mean the statement is not forward-looking.  The Company cannot guarantee these statements, which are subject to risks, uncertainties, and assumptions that are difficult to predict.  The Company’s actual results may differ materially from those anticipated due to a variety of factors, including those set forth in the following risk factors and elsewhere in this document.  The Company will not update any forward-looking statements due to new information, future events or otherwise.

          Recent operating losses.  The Company’s revenues have declined the past three years, and Applied incurred corresponding operating losses in each of these years.  Applied believes that its success will depend in large part on its ability to improve its financial performance and long-term strategic direction, including the introduction of new products and services.  Certain traditional products have eroded in recent years, and the Company expects that it will need to conceive new sources of revenues in the future.  As the Company enters new lines of business, it also expects to encounter new competitors and different business challenges.  The Company’s future success is not assured.

          Rapidly changing technology.  The introduction of products embodying new technologies and the emergence of new industry standards and practices can render existing products obsolete and unmarketable.  The Company’s declining sales of its high-end debug products are indicative of this type of change in market requirements.  The Company’s future business, financial condition and results of operations will depend upon its ability to anticipate market demand for specific development solutions, develop new products and features that address the increasingly sophisticated needs of its customers, and respond to technological advances and emerging industry standards and practices.

          Manufacturing and product ship schedules.  Certain components used in the Company’s products are manufactured by a single source or distributed through a limited number of outlets.  The Company may be unable to obtain key components in a timely manner, in sufficient quantities, or on favorable price terms.  In addition, delays in new-product introductions could delay the Company’s expected revenue growth rates and cause its customer base to become dissatisfied and erode.  Certain agreements with customers require that the Company maintain specified levels of inventory and manufacturing capacity, and the Company could incur penalties – including cancellation of the contract – if it is unable to maintain such inventory levels.

          Design starts.  The Company’s development solutions span a wide range of microprocessors, real-time operating systems, and development environments.  However, a substantial decline in the number of design starts for embedded microprocessors supported by Applied, or delays by semiconductor manufacturers in the release of embedded microprocessors for which the Company has developed tools, could have an adverse effect on the Company’s revenues.

          Relationship with semiconductor manufacturers.  The Company’s ability to provide timely new products to its customers is enhanced by Applied’s relationship with major semiconductor manufacturers. With access to new embedded microprocessor technology, Applied is able to adapt its tools to these new designs and make its tools available at the time the Company’s customers begin to incorporate the new microprocessors into their product designs.  Should Applied be unable to obtain timely access to new embedded microprocessor technology, the Company’s operating results and market share could suffer.

          Industry focus.  The Company’s sales are currently derived primarily from the telecommunications and games markets, and negative events affecting these markets could have an adverse effect on the Company’s revenues.

          Contracts with Game Console Developers.  The Company anticipates that sales of game development tools may represent 20% to 25% of net sales in 2001, and such sales are expected to be primarily to two customers – Microsoft and Nintendo.  Delays by Microsoft or Nintendo in launching their products to the consumer market could have a correspondingly significant negative impact on Applied’s revenues in 2001 and beyond.  Also, the Company is required to meet technical design requirements, maintain manufacturing capacity and inventory levels, and otherwise meet the needs of these customers; failure to do so could have a significant negative effect on Applied through loss of sales and non-compliance with contractual obligations.

          Competition.  The Company has historically participated in the embedded systems development tools market.  This market is rapidly evolving and intensely competitive.  Applied has also entered into new markets, such as providing development solutions to the gaming industry through its initial agreements with Nintendo and Microsoft.  Competitors may develop and offer products and services similar to Applied’s current or planned product offerings.  Applied’s business would be harmed if the Company is not able to compete successfully against current or future competitors.

          Increased competition may result in price reductions, reduced gross margins, and loss of market share, any of which could harm Applied’s business.  The Company’s competitors may be able to devote significantly greater resources to marketing campaigns, adopt more aggressive pricing policies and may expend substantially more resources on product development.  If Applied is unable to compete effectively, the Company’s revenues and earnings may suffer.

          Dependence on key personnel.  The Company believes that its future success will depend significantly on its ability to retain and attract key personnel and skilled employees.  There is intense competition for qualified management, engineering and sales and marketing personnel, and the Company’s failure to recruit, retain, and motivate such skilled employees could affect the Company’s ability to develop new products and increase revenues.  The Company’s employees are not subject to employee contracts and are free to leave at any time.  To date, the Company has been successful in meeting its requirements for highly skilled sales and support personnel and research and development engineers.  However, competition for these personnel is intense and likely to become more so in the future.

          Management of growth.  The Company seeks to grow its business by strengthening its sales and marketing programs, expanding its product lines, and providing development solutions to new markets. Such growth, if achieved, would place additional burden on management and increase the requirement to recruit and retain personnel with the right skill sets, as well as require additional infrastructure expenditures.  The Company is unable to assure that it will increase its revenues, nor that it will be able to expand its management and operational infrastructure to manage such growth successfully.

          Intellectual property rights and litigation.  The Company relies on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect its intellectual property rights.  The Company also enters into nondisclosure agreements with its employees, consultants and corporate partners, and controls access to proprietary information.  Litigation may be necessary in order to enforce the Company’s intellectual property rights, to protect its trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement.  Litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company’s business, financial condition and results of operations.  Although the Company is not aware of any significant third-party intellectual property rights that would prevent the use and sale of Applied products, the Company may unknowingly infringe the proprietary rights of others.  Any infringement could result in significant liability to the Company.

          Product liability.  The Company’s products and services may result in exposure to product liability claims in the event that the Company’s development solutions are deemed to pose a risk of injury or harm.  The Company maintains product liability insurance; however, such insurance may be inadequate for all potential claims.

          International operations.  A significant portion of the Company’s business occurs outside of North America.  Economic difficulties or significant fluctuations in foreign currency exchange rates in any of these regions, particularly in Japan and Europe, could have a material adverse effect on the Company’s business.  As a result of the Company’s international operations, the Company incurs certain expenses in foreign currencies.  The Company's operating results are therefore subject to foreign exchange rate fluctuations, which are difficult to predict.

          Potential fluctuations in quarterly operating results and volatility of stock price.  The Company’s future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis, due to a variety of factors, some of which are outside of the Company’s control.  Any shortfall in revenue or earnings from expected levels could have an immediate and significant adverse effect on the trading price of the Company’s common stock in any given period.  Additionally, the Company often does not learn of such shortfalls until late in the fiscal quarter, at which time budgeted expenses have already been committed, which could result in an even more immediate and adverse effect on the trading price of the Company’s common stock.  The Company participates in a highly dynamic industry, which often results in significant volatility of the Company’s common stock price.  Consequently, purchasing or holding of the Company’s stock involves a high degree of risk.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          Applied develops products in the United States and sells primarily in North America, Asia and Europe.  As a result, financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.  Since the Company’s products are generally initially priced in U.S. Dollars and translated to local currency amounts, a strengthening of the dollar could make the Company’s products less competitive in foreign markets.

          The Company is exposed to market risk related to changes in interest rates, which could adversely affect the value of the Company's short-term investments.  Applied maintains a short-term investment portfolio consisting of interest-bearing securities with an average maturity of less than one year.  These securities are classified as “available-for-sale” securities.  These interest-bearing securities are subject to interest rate risk and will fall in value if market interest rates increase.  If market interest rates were to increase immediately and uniformly by 10% from levels at December 31, 2000, the fair value of the portfolio would decline by an immaterial amount.  The Company does not expect its operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

APPLIED MICROSYSTEMS CORPORATION

INDEX TO FINANCIAL STATEMENTS

Audited Annual Financial Statements:

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

Shareholders and Board of Directors
Applied Microsystems Corporation

          We have audited the accompanying consolidated balance sheets of Applied Microsystems Corporation as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2000.  Our audits also included the financial statement schedule listed in the Index at Item 14(a).  These financial statements and schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

          We conducted our audits in accordance with auditing standards generally accepted in the United States.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

          In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Applied Microsystems Corporation at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.  Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

          As discussed in Note 1 to the financial statements, in 2000 the Company changed its method of accounting for revenue recognition in accordance with guidance provided in SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.”

                              ERNST & YOUNG LLP

Seattle, Washington
February 2, 2001

APPLIED MICROSYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
	December 31,
	2000	1999
	(in thousands)
ASSETS
Current assets:
Cash and cash equivalents	$7,956	$5,682
Securities available-for-sale	2,526	10,664
Accounts receivable, net	5,729	5,848
Inventories	2,358	2,471
Prepaid and other current assets	314	501
Total current assets	18,883	25,166
Property and equipment, net	2,109	2,372
Other assets	461	504
Total assets	$21,453	$28,042
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$2,954	$2,494
Accrued payroll	1,993	1,704
Other accrued expenses	1,029	1,058
Deferred revenue	4,654	3,599
Total current liabilities	10,630	8,855
Commitments and contingencies
Shareholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized; none issued and outstanding	—	—
Common stock, $0.01 par value; 25,000,000 shares authorized; 6,959,000 and 6,830,000 shares issued and outstanding at December 31, 2000 and 1999, respectively	26,360	25,792
Accumulated other comprehensive income (loss)	(879)	48
Accumulated deficit	(14,658)	(6,653)
Total shareholders' equity	10,823	19,187
Total liabilities and shareholders' equity	$21,453	$28,042
See accompanying notes.

APPLIED MICROSYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
	Year Ended December 31,
	2000	1999	1998
	(in thousands, except per-share amounts)
Net sales	$32,315	$33,241	$37,020
Cost of sales	9,674	8,664	9,587
Gross profit	22,641	24,577	27,433
Operating expenses:
Sales, general and administrative	17,094	18,929	18,104
Research and development	13,101	11,435	10,438
Total operating expenses	30,195	30,364	28,542
Loss from operations	(7,554)	(5,787)	(1,109)
Interest income and other, net	659	706	783
Loss before income taxes and cumulative effect of change in accounting principle	(6,895)	(5,081)	(326)
Income taxes	—	—	19
Loss before cumulative effect of change in accounting principle	(6,895)	(5,081)	(345)
Cumulative effect of change in accounting principle	(1,110)	—	—
Net loss	$(8,005)	$(5,081)	$(345)
Per-share amounts:
Basic and diluted loss per share before cumulative effect of change in accounting principle	$(1.00)	$(0.76)	$(0.05)
Cumulative effect of change in accounting principle	(0.16)	—	—
Basic and diluted net loss per share	$(1.16)	$(0.76)	$(0.05)
Shares used in per-share calculation	6,915	6,727	6,811
Pro forma amounts, assuming the change in accounting principle was applied retroactively:
Net loss	$(6,895)	$(4,514)	$(245)
Basic and diluted net loss per share	$(1.00)	$(0.67)	$(0.04)
See accompanying notes.

APPLIED MICROSYSTEMS CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

	Common Stock		Accumulated	Accumulated Other Comprehensive	Total Shareholders’
	Shares	Amount	Deficit	Income (Loss)	Equity
		(in thousands)
Balance at December 31, 1997	6,827	$26,387	$(1,227)	$(869)	$24,291
Stock options exercised	126	12	—	—	12
Sale of common stock to employees	55	194	—	—	194
Common stock repurchased	(327)	(1,210)	—	—	(1,210)
Net loss	—	—	(345)	—	(345)
Foreign currency translation    adjustment	—	—	—	989	989
Comprehensive income					644
Balance at December 31, 1998	6,681	25,383	(1,572)	120	23,931
Stock options exercised	80	228	—	—	228
Sale of common stock to    employees	69	181	—	—	181
Net loss	—	—	(5,081)	—	(5,081)
Foreign currency translation    adjustment	—	—	—	(72)	(72)
Comprehensive loss					(5,153)
Balance at December 31, 1999	6,830	25,792	(6,653)	48	19,187
Stock options exercised	109	426	—	—	426
Sale of common stock to    employees	20	142	—	—	142
Net loss	—	—	(8,005)	—	(8,005)
Foreign currency translation    adjustment	—	—	—	(927)	(927)
Comprehensive loss					(8,932)
Balance at December 31, 2000	6,959	$26,360	$(14,658)	$(879)	$10,823
See accompanying notes.

APPLIED MICROSYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
	Year Ended December 31,
	2000	1999	1998
	(in thousands)
Operating activities
Net loss	$(8,005)	$(5,081)	$(345)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	1,053	1,671	1,219
Cumulative effect of change in accounting principle	1,110	—	—
Net change in operating accounts:
Accounts receivable	(204)	2,785	(184)
Inventories	(23)	533	100
Prepaid and other current assets	181	10	443
Other assets	(21)	9	5
Accounts payable and accrued expenses	796	(1,050)	685
Deferred revenue	(276)	475	236
Net cash provided by (used in) operating activities	(5,389)	(648)	2,159
Investing activities
Purchases of securities available-for-sale	(5,322)	(14,477)	(16,871)
Maturities of securities available-for-sale	13,460	14,914	16,115
Additions to property and equipment	(753)	(730)	(1,268)
Net cash provided by (used in) investing activities	7,385	(293)	(2,024)
Financing activities
Sale of common stock to employees	142	181	194
Stock options exercised	426	228	12
Common stock repurchased	—	—	(1,210)
Payments on long-term obligations	—	—	(15)
Net cash provided by (used in) financing activities	568	409	(1,019)
Effects of foreign currency exchange rate changes on cash	(290)	173	589
Net increase (decrease) in cash and cash equivalents	2,274	(359)	(295)
Cash and cash equivalents at beginning of year	5,682	6,041	6,336
Cash and cash equivalents at end of year	$7,956	$5,682	$6,041
Supplemental disclosure of cash paid for income taxes	$—	$—	$128
See accompanying notes.

APPLIED MICROSYSTEMS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       Description of Business and Summary of Significant Accounting Policies

          Business

          Applied Microsystems Corporation (“Applied” or the “Company”) is a leader and innovator of software tools and technologies.  Applied develops, markets and supports a comprehensive suite of software and hardware-enhanced development and test tools for the development of complex embedded microprocessor-based applications.  Applied markets its products and services primarily through its domestic and international direct sales organizations in the United States, Japan, the United Kingdom, Germany, and France, and through distributors in key markets throughout the rest of the world.  The Company also markets its products through partnerships with third-party developers of integrated development environments and through other third-party distribution channels.

          Principles of Consolidation

          The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: Applied Microsystems Corporation Limited, a United Kingdom corporation; Applied Microsystems Japan Limited, a Japanese corporation; Applied Microsystems Gmbh, a German corporation; Applied Microsystems SARL, a French corporation; and Applied Microsystems Foreign Sales Corporation.  All significant intercompany accounts and transactions are eliminated in consolidation.

          Cash Equivalents

          The Company considers all highly liquid investments purchased with a remaining maturity of three months or less at the date of purchase to be cash equivalents.  Cash equivalents are carried at cost, which approximates market value.

          Securities Available-for-Sale

          Applied’s investment portfolio is classified as available-for-sale, and as such securities are stated at fair value based on quoted market prices.  Interest earned on securities available-for-sale is included in interest income.  The amortized cost of investments in this category is adjusted for amortization of premiums and accretion of discounts to maturity.  Such amortization and accretion are included in interest income.  Realized gains and losses and declines in value judged to be other than temporary are also included in interest income and other, but were insignificant for all periods presented.  The cost of securities sold is calculated using the specific identification method.

          Fair Value of Financial Instruments

          The Company’s financial instruments consist of cash and cash equivalents, securities available-for-sale, accounts receivable, and accounts payable.  The recorded value of these instruments approximates their fair value due to their short maturities.

          Concentrations

          Applied’s financial instruments that are exposed to concentrations of credit risk consist primarily of cash, cash equivalents, securities available-for-sale, and accounts receivable.  The Company’s investment policy limits Applied’s exposure to concentration of credit risk by limiting the amounts that may be invested in similar investment categories.  The Company’s accounts receivable are typically unsecured and result primarily from sales to a broad customer base primarily within the telecommunications and video game manufacturer industries.  Accounts receivable include amounts due from domestic and international customers, with approximately 30% of consolidated receivables at December 31, 2000 resulting from sales in Japan.  Applied performs on-going credit evaluations of its customers' financial condition, limits the amount of credit when deemed necessary, and maintains allowances for potential credit losses; historically, such losses have been immaterial.  As a consequence, concentrations of credit risk are limited.

The Company pursues a strategy of using the latest high–performance hardware components in the manufacture of its hardware-based development tools.  Certain product components are available only from a single source or a limited number of distributors.

          Inventories

          Inventories are stated at the lower of cost (first-in, first-out basis) or market.  Inventory costs include shipping and handling expenses incurred for the purchase of raw materials.

Property and Equipment

          Property and equipment are carried at cost.  The Company provides for depreciation and amortization using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes.  Leasehold improvements are amortized over the lesser of their estimated useful lives or the term of the lease.

          The estimated useful lives of equipment for financial reporting purposes are as follows:

Machinery and equipment	3 to 5 years
Office furniture	5 to 15 years

          Acquired Technology

          Costs to acquire technology are capitalized to the extent the products are technologically feasible.  Such amounts are included in other assets on the balance sheet.  The Company amortizes these costs over periods ranging from 5 to 10 years to match the anticipated revenue stream for the products incorporating the acquired technology.  As of December 31, 2000 and 1999, the Company had recorded acquired technology with a net book value of $225,000 and $270,000, respectively, and a corresponding accumulated amortization balance of $225,000 at December 31, 2000 (after removal of fully amortized amounts) and $583,000 at December 31, 1999.  Amortization expense was $45,000 in 2000, compared to amortization expense of $444,000 in 1999 and $150,000 in 1998.

          Research and Development Costs

          Research and development costs are expensed as incurred.  Financial accounting standards require the capitalization of certain software development costs after technological feasibility of the software is established.  In the development of the Company’s new products and enhancements to existing products, the technological feasibility of the software is not established until substantially all product development is complete, including the development of a working model.

          Long-Lived Assets

          Applied evaluates the recoverability of its long-lived assets in accordance with Statement of Financial Accounting Standards (“SFAS”) 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.”  SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets.  Accordingly, the Company evaluates asset recoverability at each balance sheet date or when an event occurs that may impair recoverability of the asset.  Applied’s recoverability analysis may include a review of the following factors: the undiscounted value of expected operating cash flows in relation to its net capital investments, the estimated useful or contractual life of the intangible asset, the contract or product supporting the intangible asset, and in the case of purchased technology, the Company periodically reviews the recoverability of asset values by evaluating products with respect to technological advances, competitive products, and the needs of the Company’s customers.

          Revenue Recognition and Cumulative Effect of a Change in Accounting Principle

          The Company earns revenue on the sale of hardware and software products.  The Company also earns revenue on the sale of services, including hardware and software support, installation, training, and professional engineering services.

          Revenue from the sale or licensing of products is recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable, and collectibility is probable.  If the fee due from a customer is not fixed or determinable, revenue is recognized as payments become due from a customer.  If customers have inspection or acceptance rights beyond standard warranty provisions, revenue is recognized when formal notification of inspection or acceptance has been received from the customer.  Specifically, due to business customs in Japan and the Company’s interpretation of Japanese law, product sales are recognized when the customer notifies the Company that it has inspected and accepted the product.  In the absence of receiving written notification of inspection and acceptance, Applied recognizes revenue in Japan on receipt of payment by the customer as an indication of acceptance.  When products are sold with significant installation services, all revenue is deferred until installation is completed.  Revenue from training and contract engineering services are generally recognized as the services are performed.  Revenue from longer-term agreements to perform development services is recognized under the percentage-of-completion method, measured based on labor effort or cost incurred to total estimated labor effort or cost (assuming other revenue recognition criteria are met).

          The Company previously recognized revenue in Japan at the time of shipment. Effective January 1, 2000, the Company changed its method of accounting for product sales in Japan to recognize such revenue at the earlier of when it has been notified by the customer that it has inspected and accepted the product or upon receipt of payment.  The Company believes the change in accounting principle is consistent with the guidance provided in SEC Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in Financial Statements.”  In accordance with SAB 101, the Company recorded a non-cash charge of $1,110,000 (or $0.16 per share, basic and diluted), to reflect the cumulative effect of the change as of the beginning of the year.  The decrease to net loss before the cumulative effect of the change in accounting principle as a result of the adoption of SAB 101 was $886,000 (or $0.13 per share, basic and diluted) for the year ended December 31, 2000.  Deferred revenue at January 1, 2000 includes $1,406,000 related to goods that were shipped and previously recognized as revenue but do not meet the new revenue recognition policy.  All of these deferred revenues were recognized during the year ended December 31, 2000.

          The cumulative effect of the change in accounting principle includes product revenue and cost of sales that will be recognized when customers have inspected and accepted the products.  The pro forma amounts shown on the statements of operations are presented as if the new revenue recognition policy had been applied retroactively for all periods presented.

          Advertising Expenses

          Advertising costs are expensed as incurred.  The Company incurred $134,000 in advertising expenses in 2000, compared to  $900,000 in 1999 and $766,000 in 1998.

          Foreign Currencies

          Assets and liabilities of foreign subsidiaries are translated to U.S. dollars at the exchange rates on the balance sheet date.  Revenues and expenses of foreign subsidiaries are translated at the average rates of exchange prevailing during the year.  The cumulative translation adjustments resulting from this process are accumulated in other comprehensive income (loss).  Gains and losses on foreign currency transactions are netted and included in other income.

          The Company may enter into foreign currency forward contracts to hedge anticipated foreign currency transactions, primarily intercompany transactions resulting from sales to foreign subsidiaries.  Such forward contracts typically mature within three months.  Gains and losses on contracts that are designated and effective as hedges of such transactions are deferred and recognized in income in the same period as the hedged transactions.  No such contracts were outstanding at any time during 2000 or 1999.

          Basic and Diluted Loss per Share

          Basic loss per share excludes the dilutive effects of stock options, and is computed using the weighted-average number of common shares outstanding during the period.  Diluted earnings (loss) per share would be computed using the weighted-average number of common shares and dilutive common stock equivalent shares outstanding during the period.  Because Applied’s stock options are not dilutive (due to net losses) there is no difference between basic net loss per share and diluted net loss per share.  For the years ended December 31, 2000, 1999, and 1998, weighted average options to purchase 775,531, 254,070, and 239,086 shares of common stock, respectively, were excluded from the calculation of earnings (loss) per share because their effect was antidilutive.

          Stock-Based Compensation

          Applied has elected to follow the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for its stock options.  Because the exercise price of the Company’s common stock options equals the market price of the underlying stock on the date of grant, no corresponding compensation expense has been recognized.  (See Note 6 for SFAS 123, “Accounting for Stock-Based Compensation,” pro forma disclosures.)

          Accounting Pronouncement

          In June 1998, the FASB issued SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.”  SFAS 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value.  Gains or losses resulting from changes in the fair values of those derivatives would be accounted for in current earnings unless specific hedge criteria are met.  The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows.  Applied must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting, if any.  SFAS 133 will be effective for the Company’s consolidated financial statements for the fiscal year ending December 31, 2001. The pronouncement will not affect the Company’s financial statements unless the Company in the future enters into transactions which involve the acquisition of derivative instruments.

          Use of Estimates

          The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.

          Reclassifications

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

2.       Securities Available-for-Sale

          Securities available-for-sale consist of the following:

	December 31, 2000
		Gross	Gross
	Amortized	Unrealized	Unrealized
	Cost	Gains	Losses	Fair Value
	(in thousands)
U.S. Treasury and other U.S. Government obligations	$966	$—	$—	$966
Corporate debt securities	1,559	1	—	1,560
	$2,525	$1	$—	$2,526

	December 31, 1999
		Gross	Gross
	Amortized	Unrealized	Unrealized
	Cost	Gains	Losses	Fair Value
	(in thousands)
U.S. Treasury and other U.S. Government obligations	$5,023	$9	$—	$5,032
Corporate debt securities	5,623	9	—	5,632
	$10,646	$18	$—	$10,664

          As of December 31, 2000, all of the Company’s securities available-for-sale had contractual maturities of less than one year.  Expected maturities may differ from contractual maturities because issuers may have the right to prepay obligations.

3.       Balance Sheet Information

          Detailed balance sheet data is as follows:

	December 31,
	2000	1999
	(in thousands)
Accounts receivable
Receivables	$5,785	$5,940
Allowance for sales returns and doubtful accounts	(56)	(92)
	$5,729	$5,848
Inventories
Finished goods	$794	$557
Work in process	72	60
Purchased parts	1,492	1,854
	$2,358	$2,471
Property and equipment
Machinery and equipment	$2,757	$3,095
Office furniture	3,010	2,855
Total property and equipment	5,767	5,950
Accumulated depreciation	(3,658)	(3,578)
	$2,109	$2,372

4.       Commitments and Contingencies

          The Company leases office space and equipment under noncancelable operating leases, including certain leases that contain renewal options.  Minimum future payments as of December 31, 2000 are as follows (in thousands):

2001	$1,298
2002	1,362
2003	1,375
2004	1,402
2005	1,396
Thereafter	2,007
	$8,840

          Total rent expense in 2000 was $1,430,000, as compared to rent expense of $1,393,000 in 1999 and $1,393,000 in 1998.

          In October 2000, the Company renewed the lease for its headquarters facility, with the new lease to commence in June 2001.  The new agreement specifies monthly rent amounts that increase annually over the six-year term of the lease.  In order to secure favorable lease terms, the Company agreed to maintain an irrevocable letter of credit in favor of the lessor throughout the lease term, which expires in May 2007.  The letter of credit will expire annually on May 31 each year unless renewed at the Company’s option.  The letter of credit was initially established at $325,000, and is reduced to lower levels during the lease term if Company meets its obligations under specified lease provisions.  To secure the letter of credit through the initial May 2001 expiration date, the Company pledged a $400,000 certificate of deposit with a bank, which amount is subject to withdrawal restrictions.  The certificate of deposit is included within the cash balance on the balance sheet at December 31, 2000.

          As part of Applied’s agreement to provide development tools for Microsoft’s Xbox video game system, the Company must maintain certain levels of available inventory, manufacturing capacity, and quality control requirements.  In addition, the Company is responsible for reimbursing Microsoft for certain costs in the event of an “epidemic failure” of its products that are incorporated into the Xbox Development Kit.  The Company’s ability to meet its requirements under the Microsoft contract, as well as meet other customer demands, depends on availability of sufficient components at reasonable prices, as well as many other factors.  As of December 31, 2000, the Company had non-cancelable inventory purchase obligations totaling approximately $470,000, due primarily to the Company’s agreement to provide Xbox development tools.

5.       Income Taxes

          The provision for income taxes is as follows:

	Year Ended December 31,
	2000	1999	1998
	(in thousands)
Federal	$—	$—	$(9)
Foreign	—	—	28
	$—	$—	$19

          The provision for income taxes differs from the amount computed using the statutory federal income tax rate as follows:

	Year Ended December 31,
	2000	1999	1998
	(in thousands)
Tax at U.S. statutory rate	$(2,722)	$(1,727)	$(114)
Foreign taxes	—	—	28
State taxes, net of federal benefit	—	—	10
Foreign losses with no tax benefit	—	91	132
Tax credits	(723)	(429)	(429)
Foreign currency translation	—	143	375
Change in deferred tax valuation allowance	3,580	1,868	(42)
Other	(135)	54	59
	$—	$—	$19

          Deferred income taxes reflect the net tax effects of temporary differences between the tax basis of assets and liabilities and the corresponding financial statement amounts.  Significant components of the Company’s deferred income taxes are as follows:

	December 31,
	2000	1999
	(in thousands)
Deferred tax assets:
Reserves for sales returns and doubtful accounts	$61	$215
Accrued and other expenses	215	212
Inventories and other	655	689
Foreign currency translation	153	—
Net operating loss carryforwards	4,895	2,047
Tax credit carryforwards	2,637	1,914
	8,616	5,077
Deferred tax liabilities:
Depreciation	(84)	(87)
Foreign currency	—	(38)
	(84)	(125)
Valuation allowance	(8,532)	(4,952)
Net deferred taxes	$—	$—

          Due to the uncertainty of the Company’s ability to generate sufficient taxable income to realize its deferred tax assets, a valuation allowance has been established for financial reporting purposes equal to the amount of the net deferred tax assets.  The valuation allowance increased $3.6 million in 2000, and increased $1.9 million in 1999.

          As of December 31, 2000, the Company had net operating loss carryforwards for federal tax purposes of approximately $14.4 million available to offset future taxable income.  To the extent that net operating losses, when realized, relate to stock option deductions, the resulting benefits will be credited to shareholders’ equity.  The Company also had research and development credits of approximately $2.6 million that may be carried forward, subject to certain limitations, to offset future tax liabilities.  The net operating loss and research and development tax credit carryforwards expire in various amounts from 2001 to 2020.  Due to the issuance and sale of shares of preferred stock in 1992, the Company incurred “ownership changes” pursuant to applicable regulations in effect under the Internal Revenue Code of 1986, as amended.  Therefore, the Company’s use of losses incurred through the date of the ownership change will be limited during the carryforward period to approximately $392,000 per year.

6.       Shareholders’ Equity

          Stock Options

          The Company has stock option plans that provide for option grants to employees, directors, and others.  The exercise price of options granted under these plans has been at fair market value on the date of grant.  Options are not transferable, and expire no later than ten years following the grant date.

          Prior to February 2000, options granted under the Applied Microsystems Corporation 1992 Performance Stock Plan (the “1992 Plan”) generally were immediately exercisable, but then subject to the Company’s right to repurchase any shares of common stock received upon exercise in the event that the optionee’s employment with the Company should terminate.  Such repurchase rights generally lapsed at a rate of 25% per year from the date of grant.  For presentation purposes, outstanding but unexercised options that could be exercised subject to repurchase rights are treated as unvested.  Beginning in February 2000, options granted under the 1992 plan are not exercisable immediately, have no Company repurchase rights, and generally vest in 3 to 4 years.

          In April 1999, the Company issued a nonqualified stock option to its new President and Chief Executive Officer from a specific-purpose stock option plan.  The option was for the purchase of 215,000 shares of the Company’s common stock, and was immediately exercisable; however, the Company retained repurchase rights similar to options issued under the 1992 Plan during that period of time.

          Options granted under the Applied Microsystems Corporation Director Stock Option Plan vest one year following grant date.

          A summary of the Company’s stock option activity and related information is as follows:

	Year Ended December 31,
	2000		1999		1998
	Options (000)	Weighted-Average Exercise Price	Options (000)	Weighted-Average Exercise Price	Options (000)	Weighted-Average Exercise Price
Outstanding at  beginning of year	1,381	$3.49	1,114	$3.79	864	$3.13
Granted	448	6.34	642	3.19	525	4.45
Canceled	(315)	4.89	(295)	4.17	(149)	5.34
Exercised	(109)	3.89	(80)	2.85	(126)	0.10
Outstanding at end  of year	1,405	$4.05	1,381	$3.49	1,114	$3.79
Vested options	541	$3.10	360	$3.05	290	$2.34

          Using the Black-Scholes multiple option pricing model, the weighted average fair value of options granted during 2000 was $5.00, compared to $2.47 in 1999 and $3.39 in 1998.  As of December 31, 2000, 289,341 options were available for grant.

          The following table summarizes information related to outstanding and vested options at December 31, 2000:

	Outstanding			Vested
Range of Exercise Prices	Shares (000)	Weighted Average Exercise Price	Weighted Average Remaining Term	Shares (000)	Weighted Average Exercise Price
$0.02 - 2.00	120	$0.23	2.7	120	$0.23
2.01 - 4.00	645	2.91	7.9	181	2.84
4.01 - 7.00	435	4.54	6.9	232	4.36
7.01 - 17.50	205	8.87	9.0	8	15.88
	1,405	4.05	7.3	541	3.10

          Pro forma information regarding net loss and net loss per share is required by SFAS 123 and has been determined as if the Company had accounted for its stock options under the fair value method of SFAS 123.  The fair value for these options was estimated at the date of grant using a Black-Scholes multiple option pricing model with the following weighted-average assumptions:

	2000	1999	1998
Annualized volatility factor	1.102	0.979	0.947
Risk-free interest rate	6.2%	5.7%	5.0%
Expected life of options	4.5 years	5.2 years	5.4 years
Expected dividend rate	nil	nil	nil

          The Black-Scholes option value model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable.  In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options.

          For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.  The Company's pro forma information follows:

	2000	1999	1998
	(in thousands, except per-share data)
Net loss, as reported	$(8,005)	$(5,081)	$(345)
Pro forma net loss	(9,963)	(5,482)	(883)
Net loss per share as reported	(1.16)	(0.76)	(0.05)
Pro forma net loss per share	(1.44)	(0.81)	(0.13)

          SFAS 123 pro forma disclosures above are not necessarily indicative of future pro forma disclosures because of the manner in which SFAS 123 calculations are phased in over time.

          Stock Repurchase Plan

          In 1998, the Board of Directors authorized the Company to repurchase up to 500,000 shares of its common stock in an effort to offset dilution associated with stock options issued under the Company’s stock incentive programs and for general corporate purposes.  During 1998, the Company repurchased a total of 327,000 shares for $1,210,000.  The repurchase plan was subsequently suspended, and no further repurchases have been made.

          Common Stock Reserved

          At December 31, 2000, common stock was reserved for future issuance as follows (in thousands):

Employee stock purchase plan	294
Stock options	1,694
	1,988

          Shareholder Rights Plan

          In 1998, the Company adopted a Shareholder Rights Plan, declaring a dividend of one preferred share purchase right (“Right”) for each outstanding share of the Company's common stock. The Rights become exercisable upon the earlier of a person or group announcing (1) an acquisition of 15% or more of the common stock of the Company or (2) the commencement of a tender or exchange offer that would result in such person acquiring ownership of 15% or more of the common stock of the Company.  Each Right entitles the holder to purchase 1/100th of a preferred share at an exercise price of $30.  Upon a triggering event, each holder of a Right shall be entitled to purchase common stock that has a market value equal to two times the exercise price of the Right.  The Company is entitled to redeem the Rights at $0.01 each under specified circumstances.

7.       Employee Benefits

          The Company has a retirement plan covering substantially all U.S. employees that provides for voluntary salary deferral contributions on a pre-tax basis in accordance with Section 401(k) of the Internal Revenue Code.  The Company provides matching contributions based on a defined formula, and may also make discretionary contributions.  During 2000, the Company made contributions of $234,000, as compared to contributions of $219,000 in 1999 and $192,000 in 1998.

          The Company also has an employee stock purchase plan (the “ESPP”) through which the Company is authorized to issue up to 500,000 shares of common stock.  The ESPP permits eligible personnel to purchase the Company’s common stock at the lesser of 85% of fair market value on certain prescribed dates, as defined in the ESPP, through payroll deductions of up to 15% of their compensation, provided that no employee may purchase common stock worth more than $25,000 in any calendar year.  At December 31, 2000, 294,000 shares were available under the plan.

8.       Product, Geographic, and Related Information

          Through 2000, the Company was engaged in a single line of business: the design, manufacture, and distribution of development and test hardware and software tools for embedded product manufacturers.  No customer accounted for more than 10% of net sales in 2000 and 1998; sales to a single customer accounted for 10% of net sales in 1999.  While the Company is focused on a single line of business, the following table provides information concerning products and services offered within this line of business:

	Year Ended December 31,
	2000	1999	1998
	(in thousands)
Net sales
Hardware and software debug and analysis tools	$22,685	$26,503	$31,421
Game development tools	2,839	—	—
Total product sales	25,524	26,503	31,421
Services	6,791	6,738	5,599
	$32,315	$33,241	$37,020
Cost of goods sold
Products	7,827	7,068	8,485
Services	1,847	1,596	1,102
	$9,674	$8,664	$9,587

          Certain operating information by geographic area is provided in the table below, based on the location of the Company’s facilities.  Sales are not recognized for financial statement purposes until there has been a sale to an unaffiliated customer.

	Year Ended December 31,
	2000	1999	1998
	(in thousands)
Net sales
United States	$20,659	$21,720	$22,325
Japan	8,111	7,820	10,664
Europe	3,545	3,701	4,031
	$32,315	$33,241	$37,020
Export sales to unaffiliated customers	$1,611	$1,147	$1,597
Income (loss) before income taxes
United States	$(6,675)	$(3,867)	$1,139
Japan	63	(175)	34
Europe	(818)	(982)	(1,037)
Corporate eliminations and cumulative effect of change in accounting principle	(575)	(57)	(462)
	$(8,005)	$(5,081)	$(326)

	December 31,
	2000	1999
	(in thousands)
Long-lived assets
Property and equipment, net
United States	$2,002	$2,284
Japan	28	41
Europe	79	47
	$2,109	$2,372
Other assets, net
United States	$284	$326
Japan	130	145
Europe	47	33
	$461	$504

          At December 31, 2000, the Company’s net assets in defined geographic areas were as follows (in thousands):

United States	$8,645
Japan	1,302
Europe	876
	$10,823

9.       Quarterly Financial Information (unaudited)

          Based on the guidance provided by the SEC in SAB 101, the Company determined that it was preferable to recognize revenues in Japan at the time of the customer written notification as to inspection and acceptance of the product or, in the absence of such notification, at the time of payment.  The Company’s previous revenue recognition policy was to recognize revenue on sales to customers in Japan at the time of shipment.  The Company recorded a non-cash charge of $1,110,000 ($0.16 per share, basic and diluted) to reflect the cumulative effect of the accounting change as of the beginning of the fiscal year.  The Company’s revenue recognition policies are disclosed in Note 1.

          The Company has included the following information to reflect the retroactive application of SAB 101 beginning January 1, 2000:

	Quarters Ended in 2000
	March 31		June 30		Sept. 30		Dec. 31
	As Previously Reported	As Restated	As Previously Reported	As Restated	As Previously Reported	As Restated
	(in thousands, except per-share data)
Net Sales	$7,969	$7,683	$7,251	$7,862	$7,819	$7,968	$8,802
Gross Profit	5,783	5,579	4,801	5,324	5,550	5,598	6,140
Loss before cumulative effect of change in accounting principle	$(1,608)	$(1,811)	$(2,618)	$(2,095)	$(1,894)	$(1,846)	$(1,143)
Cumulative effect of change in accounting principle	—	(1,110)	—	—	—	—	—
Net loss	$(1,608)	$(2,921)	$(2,618)	$(2,095)	$(1,894)	$(1,846)	$(1,143)
Basic and diluted loss per share before cumulative effect of change in accounting principle	$(0.23)	$(0.27)	$(0.38)	$(0.30)	$(0.27)	$(0.27)	$(0.16)
Cumulative effect of change in accounting principle	—	(0.16)	—	—	—	—	—
Basic and diluted loss per share	$(0.23)	$(0.43)	$(0.38)	$(0.30)	$(0.27)	$(0.27)	$(0.16)
Shares used in per-share calculation	6,858	6,858	6,909	6,909	6,938	6,938	6,954

          Summarized quarterly financial information for 1999 is as follows:

	Quarters Ended in 1999
	March 31	June 30	Sept. 30	Dec. 31
	(in thousands, except per-share data)
Net sales	$8,518	$7,435	$8,328	$8,960
Gross profit	6,472	5,463	5,995	6,647
Net Loss	(934)	(2,107)	(1,423)	(617)
Basic and diluted loss per share	$(0.14)	$(0.31)	$(0.21)	$(0.09)
Shares used in per-share calculation	6,703	6,708	6,738	6,752

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

          None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

          The information required by this Item is incorporated by reference to the information contained in the sections captioned “Board of Directors ^__ Nominees for Director,” “Voting Securities and Principal Holders ^__ Section 16(a) Beneficial Ownership Reporting Compliance,” and “Management Information, Compensation, and Benefits – Executive Officers” in the definitive Proxy Statement for the Company's Annual Meeting of Shareholders scheduled to be held on May 22, 2001 (the “Proxy Statement”).  Such Proxy Statement will be filed within 120 days of the Company’s last fiscal year end, December 31, 2000.

ITEM 11. EXECUTIVE COMPENSATION

          The information required by this Item is incorporated by reference to the information contained in the section captioned “Compensation and Benefits” of the Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

          The information required by this Item is incorporated by reference to the information contained in the section captioned “Voting Securities and Principal Holders” of the Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

          Not applicable.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)      Index to list of documents filed as part of this report

(1)      Financial Statements - See Index to Financial Statements at Item 8 of this report.

(2)      Financial Statement Schedules

          Schedule II:  Valuation and Qualifying Accounts

All other schedules have been omitted because they were not applicable or were not required under the applicable regulations of the Securities and Exchange Commission.

(3)      Exhibits

Exhibit No.	Description
3.1 (1)	Second Restated Articles of Incorporation of Registrant
3.2 (1)	Restated Bylaws of Registrant
10.3 (1)	1992 Performance Stock Plan
10.4 (1)	1995 Directors Stock Option Plan
10.7 (1)	Lease Agreement between W.R.C. Properties, Inc. and the Registrant dated February 27, 1989; and Amendments to Lease Agreement dated November 7, 1990, May 11, 1992, August 18, 1993 and March 31, 1994
10.8 (1)	Third Amended and Restated Investment Agreement dated as of September 15, 1995
10.12 (1) **	Source License and Distribution Agreement between the Registrant and Microtec Research, Inc. dated August 1, 1994
10.17 (2)	Employment Agreement by and between Robert L. Deinhammer and the Registrant, dated January 4, 1999
10.18 (3)	Employment Agreement by and between Stephen J. Verleye and the Registrant, dated April 1, 1999
10.19	Lease Agreement between Teachers Insurance & Annuity Association of America and the Registrant dated October 3, 2000
21	Subsidiaries of the Registrant
23	Consent of Ernst & Young LLP, Independent Auditors

(1)	Incorporated by reference from the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)
(2)	Incorporated by reference from the Registrant’s March 31, 1999 Form 10-Q filed with the Securities and Exchange Commission
(3)	Incorporated by reference from the Registrant’s June 30, 1999 and September 30, 1999 reports on Form 10-Q filed with the Securities and Exchange Commission

** Confidential treatment has been granted for portions of this exhibit.

(b)      Reports on Form 8–K

None.

SIGNATURES

          Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on March 28, 2001.

APPLIED MICROSYSTEMS CORPORATION

By /s/ Robert C. Bateman

   Robert C. Bateman

   Vice President, Chief Financial Officer,

   Corporate Secretary, and Treasurer

   (Principal Financial and Accounting Officer)

          Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ Stephen J. Verleye	President, Chief Executive Officer and Director (Principal Executive Officer)	March 28, 2001
Stephen J. Verleye
/s/ Robert C. Bateman	Vice President, Chief Financial Officer, Corporate Secretary, and Treasurer (Principal Financial and Accounting Officer)	March 28, 2001
Robert C. Bateman
/s/ Charles H. House	Chairman of the Board	March 28, 2001
Charles H. House
/s/ Lary L. Evans	Director	March 28, 2001
Lary L. Evans
/s/ Elwood D. Howse, Jr.	Director	March 28, 2001
Elwood D. Howse, Jr
/s/ Anthony Miadich	Director	March 28, 2001
Anthony Miadich

EXHIBIT INDEX

Exhibit No.	Description
3.1 (1)	Second Restated Articles of Incorporation of Registrant
3.2 (1)	Restated Bylaws of Registrant
10.3 (1)	1992 Performance Stock Plan
10.4 (1)	1995 Directors Stock Option Plan
10.7 (1)	Lease Agreement between W.R.C. Properties, Inc. and the Registrant dated February 27, 1989; and Amendments to Lease Agreement dated November 7, 1990, May 11, 1992, August 18, 1993 and March 31, 1994
10.8 (1)	Third Amended and Restated Investment Agreement dated as of September 15, 1995
10.12 (1) **	Source License and Distribution Agreement between the Registrant and Microtec Research, Inc. dated August 1, 1994
10.17 (2)	Employment Agreement by and between Robert L. Deinhammer and the Registrant, dated January 4, 1999
10.18 (3)	Employment Agreement by and between Stephen J. Verleye and the Registrant, dated April 1, 1999
10.19	Lease Agreement between Teachers Insurance & Annuity Association of America and the Registrant dated October 3, 2000
21	Subsidiaries of the Registrant
23	Consent of Ernst & Young LLP, Independent Auditors

(1)	Incorporated by reference from the Registrant's Registration Statement on Form S -1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)
(2)	Incorporated by reference from the Registrant’s March 31, 1999 Form 10-Q filed with the Securities and Exchange Commission
(3)	Incorporated by reference from the Registrant’s June 30, 1999 and September 30, 1999 reports on Form 10-Q filed with the Securities and Exchange Commission

** Confidential treatment has been granted for portions of this exhibit.

COL A.	COL B.	COL C.		COL D.	COL E.
		ADDITIONS
Description	Balance at Beginning of Period	(1) Charged to Costs and Expenses	(2) Charged to Other Accounts: Describe	Deductions: Describe	Balance at End of Period
Year ended December 31, 2000: Deducted from asset accounts:    Allowance for sales returns       and doubtful account	92,000	—	34,000(B)	(70,000)(A)	56,000
Year ended December 31, 1999: Deducted from asset accounts:    Allowance for sales returns      and doubtful accounts	177,000	1,000	92,000(B)	(178,000)(A)	92,000
Year ended December 31, 1998: Deducted from asset accounts:    Allowance for sales returns      and doubtful accounts	337,000	12,000	(56,000)(B)	(116,000)(A)	177,000

(A)     Uncollectible accounts written off, net of recoveries, and actual sales returns

(B)     Estimated future sales returns charged to revenue

EX-10.19

Exhibit 10.19

1.	BASIC LEASE TERMS
	a.	DATE OF LEASE:	October [3], 2000
	b.	TENANT:	Applied Microsystems Corporation, a Washington Corporation
		Trade Name:
		Address (Leased Premises):	5020 148th Avenue NE, Redmond, WA 98052
		Building/Unit	Building A
		Address (For Notices):	5020 148th Avenue NE, Redmond, WA 98052
		Facsimile:
	c.	LANDLORD:	Teachers Insurance & Annuity Association of America
		Address (For Notices):	c/o JSH Properties, Inc. 10220 NE Points Drive, Suite 203 Kirkland, WA 98033 (425) 889-0600
		Facsimile:	(425) 889-0606
		with a copy to	Teachers Insurance & Annuity Association of America Attn:  Legal Counsel 730 Third Avenue New York, NY  10017
		or to such other place as Landlord may from time to time designate by notice to Tenant.
	d.	TENANT'S USE OF PREMISES:	Light manufacturing, distribution, wholesaling, warehouse of electronic equipment parts and ancillary office use.
	e.	PREMISES AREA:	An agreed 53,159 Rentable Square Feet
	f.	PROJECT AREA:	An agreed 144,337 Rentable Square Feet
	g.	TERM OF LEASE:	This Lease shall commence on June 1, 2001 (the "Commencement Date"), and shall terminate on May 31, 2007 (the "Expiration Date")

h.	BASE MONTHLY RENT (months refer to period through applicable full calendar month):
		Period		Monthly Rent
		06/01/01 – 05/31/02		$84,168.42
		06/01/02 – 05/31/03		$88,598.33
		06/01/03 – 05/31/04		$93,028.25
		06/01/04 – 05/31/05		$97,458.16
		06/01/05 – 05/31/06		$101,888.08
		06/01/06 – 05/31/07		$106,318.00
i.	PREPAID RENT (for months in addition to first month's rent):  $  N/A
j.	SECURITY DEPOSIT / LETTER OF CREDIT:
			Retained Security Deposit:			$  48,008.00
			Letter of Credit:			$325,000.00
k.	BROKER(S):		Tenant’s Broker: Landlord’s Broker:		N/A JSH Properties, Inc
l.	GUARANTOR(S):		N/A
m.	EXHIBITS:		Exhibit A –The Premises Exhibit B – The Project Exhibit C – Work Letter Agreement Exhibit D – Rules and Regulations Exhibit E – Letter of Credit

2.       PREMISES/COMMON AREAS/PROJECT.
a.       Premises.  Landlord leases to Tenant the premises described in Section 1 and in Exhibit A (the "Premises"), located in this project described on Exhibit B (the "Project").  By entry on the Premises, Tenant acknowledges that it has examined the Premises and accepts the Premises in their present condition, subject to any Landlord's Work required under this Lease.  Landlord's Work shall consist of such work, if any, as is specifically identified as Landlord's responsibility under Exhibit C.  Unless otherwise identified in written notice from Tenant to Landlord prior to the dates specified below, Landlord's Work shall be deemed approved by Tenant in all respects on the earlier of (a) the date Tenant commences construction or installation of any Tenant's Work, or (b) the date Tenant begins to move its personal property into the Premises.  Tenant represents and warrants that it agrees with the square footage specified for the Premises and the Project in Section 1 and will not hereafter challenge such determination and agreement.
b.       Common Areas.  As used in this Lease, "Common Areas" shall mean all portions of the Project not leased or demised for lease to specific tenants.  During the Lease Term, Tenant and its licensees, invitees, customers and employees shall have the non–exclusive right to use the public portions of the Common Areas, including all parking areas, landscaped areas, entrances, lobbies, elevators, stairs, corridors, and public restrooms in common with Landlord, other Project tenants and their respective licensees, invitees, customers and employees, subject to Tenant’s rights under the license granted in Section 11.  Landlord shall at all times have exclusive control and management of the Common Areas and no diminution thereof shall be deemed a constructive or actual eviction or entitle Tenant to compensation or a reduction or abatement of rent, subject to Tenant’s rights under the license granted in Section 11.  Landlord in its discretion may increase, decrease or change the number, locations and dimensions of any Common Areas and other improvements shown on Exhibit A which are not within the Premises, subject to Tenant’s rights under the license granted in Section 11.
c.       Project.  Landlord reserves the right in its sole discretion to modify or alter the configuration or number of buildings in the Project, provided only that upon such modification or alteration, the Project Area as set forth in Section 1(f) shall be adjusted to reflect such modification or alteration.
3.       TERM.  This Lease shall be for a term (the “Lease Term”) beginning on the Commencement Date and ending on the Expiration Date, as set forth in Article 1(g), unless extended or sooner terminated in accordance with the terms of this Lease.

4.       RENT
a.       Base Monthly Rent.  Tenant shall pay Landlord monthly base rent in the initial amount in Section 1 which shall be payable monthly in advance on the first day of each and every calendar month ("Base Monthly Rent").
          For purposes of Section 467 of the Internal Revenue Code, the parties to this Lease hereby agree to allocate the stated Rents, provided herein, to the periods which correspond to the actual Rent payments as provided under the terms and conditions of this agreement.
b.       Expenses.  The purpose of this Section 4(b) is to ensure that Tenant bears a share of all Expenses related to the use, maintenance, ownership, repair or replacement, and insurance of the Project.  Accordingly, beginning on the Commencement Date, Tenant shall each month pay to Landlord one-twelfth (1/12) of Tenant's Share of Expenses related to the Project. As used in this Lease, "Tenant's Share" shall mean the Premises Area, as defined in Section 1(e), divided by the Project Area, as defined in Section 1(f), and "Tenant's Share of Expenses" shall mean the total Expenses for the Project for the applicable calendar year multiplied by Tenant's Share.  Landlord may specially allocate individual expenses where and in the manner necessary, in Landlord's reasonable discretion and upon prior written notice to Tenant, to appropriately reflect the consumption of the expense or service.  For example where some but not all premises in the Project have HVAC, Landlord may reallocate Project Expenses for HVAC to all premises utilizing HVAC to be apportioned on a per square foot basis, or could allocate to each premises utilizing HVAC the cost of maintaining that space's individual unit.  In the event the average occupancy level of the Project for any year is less than ninety five percent (95%), the actual Expenses for such year shall be proportionately adjusted to reflect those costs which Landlord estimates would have been incurred, had the Project been ninety five percent (95%) occupied during such year.
1)       Expenses Defined.  The term "Expenses" shall mean all costs and expenses of the ownership, operation, maintenance, repair or replacement, and insurance of the Project, including without limitation, the following costs:
(a)      All supplies, materials, labor, equipment, and utilities used in or related to the operation and maintenance of the Project,
(b)      All maintenance, janitorial, legal, accounting, insurance, service agreement and management (including on-site management office) costs related to the Project;
(c)      All maintenance, replacement and repair costs relating to the areas within or around the Project, including, without limitation, air conditioning systems, sidewalks, landscaping, service areas, driveways, parking Areas (including resurfacing and restriping parking areas), walkways, building exteriors (including painting), signs and directories, repairing and replacing roofs, walls, etc.  These costs may be included either based on actual expenditures or the use of an accounting reserve based on past cost experience for the Project.
(d)        Amortization (along with reasonable financing charges) of capital additions or improvements made to the Project which may be required by any government authority or which will improve the operating efficiency of the Project (provided, however, that the amount of such amortization for improvements not mandated by government authority shall not exceed in any year the amount of costs reasonably determined by Landlord in its sole discretion to have been saved by the expenditure either through the reduction or minimization of increases which would have otherwise occurred).
(e)        Real Property Taxes including all taxes, assessments (general and special) and other impositions or charges which may be taxed, charged, levied, assessed or imposed upon all or any portion of or in relation to the Project or any portion thereof, any leasehold estate in the Premises or measured by Rent from the Premises, including any increase caused by the transfer, sale or encumbrance of the Project or any portion thereof.  "Real Property Taxes" shall also include any form of assessment, levy, penalty, charge or tax (other than estate, inheritance, net income, or franchise taxes) imposed by any authority having a direct or indirect power to tax or charge, including, without limitation, any city, county, state federal or any improvement or other district, whether such tax is (1) determined by the value of the Project or the Rent or other sums payable under this Lease; (2) upon or with respect to any legal or equitable interest of Landlord in the Project or any part thereof; (3) upon this transaction or any document to which Tenant is a party creating a transfer in any interest in the Project, (4) in lieu of or as a direct substitute in whole or in part of or in addition to any real property taxes on the Project, (5) based on any parking spaces or parking facilities provided in the Project, 6) in consideration for services, such as police protection, fire protection, street, sidewalk and roadway maintenance, refuse removal or other services that may be provided by any governmental or quasi-­governmental agency from time to time which were formerly provided without charge or with less charge to property owners or occupants, or (7) otherwise based on the operation of the Project (such as transit, carpooling or environmental facilities.
(f)         Landlord agrees that Expenses as defined in Section 4(b) shall not include leasing commissions; payments of principal and interest on any mortgages, deeds of trust or other encumbrances upon the Project; depreciation of the capital cost of capital additions or improvements except as provided at 4(b)(1)(d); Landlord's executive salaries, management fees in excess of market rates; costs resulting from defective design or construction of the Project; costs incurred in connection with entering into new leases; costs of disputes under existing leases; any cost or expense incurred by reason of the remediation or cleanup of any contamination of the Premises or Project, or the soils or ground water underlying the Premises or Project, by hazardous materials or toxic substances existing as of the Commencement Date (except such materials as were brought thereon by Tenant prior to the Commencement Date, including but not limited to during Tenant’s occupancy pursuant to the prior lease dated February 27, 1989) or brought on to the Premises or Project after the Commencement Date by Landlord, its agents or contractors. In no event shall Expenses include any charge for which Landlord receives reimbursement from insurance or from another Tenant, nor shall any item of Expense be counted more than once, nor shall Landlord collect more than one hundred percent (100%) of Expenses.
2)       Annual Estimate of Expenses.  Upon the Commencement Date, Landlord shall estimate Tenant's Share of Expenses for the remainder of the calendar year, and at the commencement of each calendar year thereafter, Landlord shall provide Tenant with an estimate of Tenant's Share of Expenses for the ensuing calendar year.
3)       Monthly Payment of Expenses.  Tenant shall pay to Landlord, monthly in advance, as Additional Rent, one-twelfth (1/12) of the Annual Estimate of Tenant's Share of Expenses beginning on the Commencement Date.  As soon as practical following each calendar year, Landlord shall prepare an accounting of actual Expenses incurred during the prior calendar year and such accounting shall reflect Tenant's Share of Expenses.  If the Additional Rent paid by Tenant under this Section 4(b)(3) during the preceding calendar year was less than the actual amount of Tenant's Share of Expenses, Landlord shall so notify Tenant and Tenant shall pay such amount to Landlord within 30 days of receipt of such notice.  Such amount shall be deemed to have accrued during the prior calendar year and shall be due and payable from Tenant even though the term of this Lease has expired or this Lease has been terminated prior to Tenant's receipt of this notice.  Tenant shall have ninety (90) days from receipt of such notice to contest the amount due, failure to so notify Landlord shall represent final determination of Tenant's Share of Expenses.  In the event that Tenant so contests the amount due, Landlord will provide Tenant with supporting records in sufficient detail such that Tenant may audit Tenant’s Share of Expenses with respect to the applicable Lease Year to verify actual Expenses. Tenant may not use a property manager or developer (or an affiliate of a property manager or developer) to conduct such an audit.  If Tenant's payments were greater than the actual amount, then such overpayment shall be credited by Landlord to Tenant's Share of Expenses due under this Section 4(b)(3) or, if such determination is after termination of the Lease, then returned to Tenant, after deduction of any other sums due from Tenant to Landlord.
c.       Rent Without Offset and Late Charge.  As used herein, "Rent" shall mean all monetary sums due from Tenant to Landlord.  All Base Monthly Rent shall be paid by Tenant to Landlord without prior notice or demand in advance on the first day of every calendar month, at the address shown in Section 1, or such other place as landlord may designate in writing from time to time.  Whether or not so designated, all other sums due from Tenant under this Lease shall constitute Additional Rent, payable without prior notice or demand when specified in this Lease, but if not specified, then within ten (10) days of demand.  All Rent shall be paid without any deduction or offset whatsoever.  All Rent shall be paid in lawful currency of the United States of America.  Proration of Rent due for any partial month shall be calculated by dividing the number of days in the month for which Rent is due by the actual number of days in that month and multiplying by the applicable monthly rate.  Tenant acknowledges that late payment by Tenant to Landlord of any Rent or other sums due under this Lease will cause Landlord to incur costs not contemplated by this Lease, the exact amount of such cost being extremely difficult and impracticable to ascertain.  Such costs include, without limitation, processing and accounting charges and late charges that may be imposed on Landlord by the terms of any encumbrance or note secured by the Premises.  Therefore, if any Rent or other sum due from Tenant is not received within ten (10) days after the date due, Tenant shall pay to Landlord an additional sum equal to 10% of such overdue payment.  Landlord and Tenant hereby agree that such late charge represents an agreed estimate of the costs that Landlord will incur by reason of any such late payment and that the late charge is in addition to any and all remedies available to the Landlord and that the assessment and/or collection of the late charge shall not be deemed a waiver of any other default.  Additionally, all such delinquent Rent or other sums, plus this late charge, shall bear interest at the rate of 18 percent per annum.  If the interest rate specified in this Lease is higher than the rate permitted by law, the interest rate is hereby decreased to the maximum legal interest rate permitted by law.  Any payments of any kind returned for insufficient funds will be subject to an additional handling charge of $25.00, and thereafter, Landlord may require Tenant to pay all future payments of Rent or other sums due by money order or cashier's check.
5.       PREPAID RENT. {INTENTIONALLY DELETED}
6.       DEPOSIT.  On or before the Commencement Date, Tenant shall deposit with Landlord a security deposit as set forth in Section 1(j) (which is an amount separate from the Letter of Credit that may also be applied in the same manner as the Security Deposit).  This deposit may be accomplished by roll over of any security deposit then held by Landlord under Tenant's prior lease.  If Tenant is in default, Landlord can use the Security Deposit or any portion of it to cure the default or to compensate Landlord for any damages sustained by Landlord resulting from Tenant's default.  Upon demand, Tenant shall immediately pay to Landlord a sum equal to the portion of the Security Deposit expended or applied by Landlord to restore the Security Deposit to its full amount.  In no event will Tenant have the right to apply any part of the Security Deposit to any Rent or other sums due under this Lease.  If Landlord transfers its interest in the Premises, Landlord shall transfer the Security Deposit to its successor in interest, whereupon Landlord shall be automatically released from any liability for the return of the Security Deposit.  If, at the end of the Lease Term, Tenant has fully complied with all obligations under this Lease, then the remaining Security Deposit shall be returned to Tenant after Landlord has verified that Tenant has fully vacated the Premises, removed all of its property and surrendered the Premises in the condition required under this Lease; provided that Landlord may hold back a portion of the Security Deposit until final determination of Tenant’s share of Common Expenses, whereupon a final adjustment shall be made and any remaining Security Deposit shall be returned to Tenant.  Landlord's obligations with respect to the Security Deposit are those of a debtor and not of a trustee, and Landlord can commingle the Security Deposit with Landlord's general funds.  Landlord shall not be required to pay Tenant interest on the deposit. Each time the Base Monthly Rent is increased, Tenant shall deposit additional funds with Landlord sum sufficient to increase the Security Deposit to an amount which bears the same relationship to the adjusted Base Monthly Rent as the initial Security Deposit bore to the initial Base Monthly Rent.
7.       USE OF PREMISES AND PROJECT FACILITIES.  Tenant shall use the Premises solely for the purposes set forth in Section 1 and for no other purpose whatsoever without obtaining the prior written consent of Landlord, which consent shall not be unreasonably withheld for uses then being allowed by Landlord for other tenants in the Project.  Tenant acknowledges that neither Landlord nor any agent of Landlord has made any representation or warranty with respect to the Premises or with respect to the suitability of the Premises or the Project for the conduct of Tenant's business, nor has Landlord agreed to undertake any modification, alteration or improvement to the Premises or the Project, except as provided in writing in this Lease.  Tenant acknowledges that Landlord may from time to time, at its sole discretion, make such modifications, alterations, deletions or improvements to the Project as Landlord may deem necessary or desirable, without compensation or notice to Tenant.  Tenant shall promptly comply with all laws, ordinances, orders and regulations affecting the Premises and the Project, including, without limitation, the rules and regulations attached hereto as Exhibit D and any reasonable modifications to these rules and regulations as Landlord may adopt from time to time.  Tenant acknowledges that, except for Landlord's obligations pursuant to Section 13, Tenant is solely responsible for ensuring that the Premises comply with any and all governmental regulations applicable to Tenant's conduct of business on the Premises, and that Tenant is solely responsible for any alterations or improvements that may be required by such regulations, now existing or hereafter adopted.  Tenant shall not do or permit anything to be done in or about the Premises or bring or keep anything in the Premises that will in any way increase the premiums paid by Landlord on its insurance related to the Project or which will in any way increase the premiums for fire or casualty insurance carried by other tenants in the Project.  Tenant will not perform any act or carry on any practices that may injure the Premises or the Project; that may be a nuisance or menace to other tenants in the Project; or that shall in any way interfere with the quiet enjoyment of such other tenants.  Tenant shall not use the Premises for sleeping, washing clothes, cooking or the preparation, manufacture or mixing of anything that might emit any objectionable odor, noises, vibrations or lights onto such other tenants.  If sound insulation is required to muffle noise produced by Tenant on the Premises, Tenant at its own cost shall provide all necessary insulation.  Tenant shall not do anything on the premises which will overload any existing parking or service to the Premises.  Pets and/or animals of any type shall not be kept on the Premises.
8.       HAZARDOUS SUBSTANCES; DISRUPTIVE ACTIVITIES
a.       Hazardous Substances.
                    (1)  Presence and Use of Hazardous Substances. As used in this Lease, "Hazardous Substances" shall mean anything which may be harmful to persons or property, including, but not limited to, materials designated as a "Hazardous Substance" pursuant to Section 101 of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as now or hereafter amended, 42 USC 9601, et seq., or as a Hazardous Substance, Hazardous Household Substance, Moderate Risk Waste or Hazardous Waste under RCW 70.105.010, or which is regulated by any federal, state, or local law, statute, ordinance or regulation pertaining to health, industrial hygiene or the environment.  Tenant shall not, without Landlord's prior written consent, keep on or around the Premises, Common Areas or Building, for use, disposal, treatment, generation, storage or sale, any Hazardous Substances except such Hazardous Substances as are commonly used in general administrative office operations plus such incidental Hazardous Substances as may be used in the light electronic manufacturing specified in Tenant’s Use of Premises.  With respect to any Hazardous Substance, Tenant shall:
                              (i)  Comply promptly, timely, and completely with all governmental requirements for reporting, keeping, and submitting manifests, and obtaining and keeping current identification numbers;
                              (ii)  Submit to Landlord true and correct copies of all reports, manifests, and identification numbers at the same time as they are required to be and/or are submitted to the appropriate governmental authorities;
                              (iii)  Within five (5) days of Landlord's request, submit written reports to Landlord regarding Tenant's use, storage, treatment, transportation, generation, disposal or sale of Hazardous Substances and provide evidence satisfactory to Landlord of Tenant's compliance with the applicable government regulations;
                              (iv)  Allow Landlord or Landlord's agent or representative to come on the premises at all times to check Tenant's compliance with all applicable governmental regulations regarding Hazardous Substances;
                              (v)  Comply with minimum levels, standards or other performance standards or requirements which may be set forth or established for certain Hazardous Substances (if minimum standards or levels are applicable to Hazardous Substances present on the Premises, such levels or standards shall be established by an on-site inspection by the appropriate governmental authorities and shall be set forth in an addendum to this Lease); and
                              (vi)  Comply with all applicable governmental rules, regulations and requirements regarding the proper and lawful use, sale, transportation, generation, treatment, and disposal of Hazardous Substances.
                    (2)  Any and all costs reasonably incurred by Landlord and associated with Landlord's monitoring of Tenant's compliance with this Section 8, including Landlord's reasonable attorneys' fees and costs, shall be Additional Rent and shall be due and payable to Landlord within ten (10) days of written demand by Landlord.
          b.       Cleanup Costs, Default and Indemnification.
                    (1)  Tenant shall be fully and completely liable to Landlord for any and all cleanup costs, and any and all other charges, fees, penalties (civil and criminal) imposed by any governmental authority with respect to Tenant's use, disposal, transportation, generation and/or sale of Hazardous Substances, in or about the Premises, Common Areas, or Building.
                    (2)  Tenant shall indemnify, defend and save Landlord and Landlord's lender, if any, harmless from any and all of the costs, fees, penalties and charges assessed against or imposed upon Landlord (as well as Landlord's and Landlord's lender's attorneys' fees and costs) as a result of Tenant's use, disposal, transportation, generation and/or sale of Hazardous Substances.
                    (3)  Upon Tenant's material default under this Section 8, in addition to the rights and remedies set forth elsewhere in this Lease, Landlord shall be entitled to the following rights and remedies:
                              (i)  At Landlord's option, to terminate this Lease immediately; and/or
                              (ii)  To recover any and all damages associated with the default, including, but not limited to cleanup costs and charges, civil and criminal penalties and fees, loss of business and sales by Landlord and other tenants of the Building, any and all damages and claims asserted by third parties and Landlord's attorneys' fees and costs.
          c.       Disposal of Waste
                    (1)  Refuse Disposal.  Tenant shall not keep any trash, garbage, waste or other refuse on the Premises except in sanitary containers and shall regularly and frequently remove same from the Premises.  Tenant shall keep all incinerators, containers or other equipment used for storage or disposal of such materials in a clean and sanitary condition.
                    (2)  Sewage Disposal.  Tenant shall properly dispose of all sanitary sewage and shall not use the sewage disposal system (a) for the disposal of anything except sanitary sewage or (b) in excess of the lesser amount (i) reasonably contemplated by the uses permitted under this Lease or (ii) permitted by any governmental entity.  Tenant shall keep the sewage disposal system free of all obstructions and in good operating condition.
                    (3)  Disposal of Other Waste.  Tenant shall properly dispose of all other waste or other matter delivered to, stored upon, located upon or within, used on, or removed from, the Premises, in compliance with all laws.
          d.       Disruptive Activities.  Tenant shall not:
                    (1)  Produce, or permit to be produced, any intense glare, light or heat except within an enclosed or screened area and then only in such manner that the glare, light or heat shall not, outside the Premises, be materially different that the light or heat from other sources outside the Premises;
                    (2)  Create, or permit to be created, any sound pressure level which will interfere with the quiet enjoyment of any real property outside the Premises, or which will create a nuisance or violate any governmental law, rule, regulation or requirement;
                    (3)  Create, or permit to be created, any ground vibration that is materially discernible outside the Premises;
                    (4)  Transmit, receive or permit to be transmitted or received, any electromagnetic, microwave or other radiation which is harmful or hazardous to any person or property in, or about the Project; or
                    (5)  Create, or permit to be created, any noxious odor that is disruptive to the business operations of any other tenant in the Project.
9.       SIGNAGE.  All signing shall comply with rules and regulations set forth by Landlord as may be modified from time to time.  Current rules and regulations relating to signs are described on Exhibit D. Tenant shall place no window covering (e.g., shades, blinds, curtains, drapes, screens, or tinting materials), stickers, signs, lettering, banners or advertising or display material on or near exterior windows or doors if such materials are visible from the exterior of the Premises, without Landlord's prior written consent.  Similarly, Tenant may not install any alarm boxes, foil protection tape or other security equipment on the Premises without Landlord's prior written consent.  Any material violating this provision may be destroyed by Landlord without compensation to Tenant.
10.     PERSONAL PROPERTY TAXES.  Tenant shall pay before delinquency all taxes, assessments, license fees and public charges levied, assessed or imposed upon its business operations as well as upon all trade fixtures, leasehold improvements, merchandise and other personal property owned by Tenant in or about the Premises.
11.     PARKING.  Landlord grants to Tenant and Tenant's customers, suppliers, employees and invitees, a non-exclusive license to use the designated parking areas in the Project for the use of motor vehicles during the term of this Lease.  Landlord reserves the right at any time to grant similar non-exclusive use to other tenants, to promulgate rules and regulations relating to the use of such parking areas, including reasonable restrictions on parking by tenants and employees, to designate specific spaces for the use of any tenant, to make changes in the parking layout from time to time, and to establish reasonable time limits on parking.  Overnight parking is prohibited and any vehicle violating this or any other vehicle regulation adopted by Landlord is subject to removal at the owner's expense.
Tenant shall have the right to use up to one hundred fifty nine (159) unassigned parking spaces in the Project during the initial Lease Term and during the Extended Term, which use shall be without charge during the Initial Term.  Tenant’s  parking ratio shall not be reduced below three stalls per 1,000 square feet of rentable area except as may be needed to accomplish compliance with changes in governmental regulations.

12.     UTILITIES; SERVICES.
          Landlord shall furnish the Premises with electricity for office use, including lighting and low power usage for office machines and water for restroom facilities.  From 7:00 a.m. to 6:00 p.m. on weekdays and 9:00 a.m. to 1:00 p.m. on Saturday, excluding legal holidays (“Normal Business Hours”), Landlord shall furnish the Premises with heat and air conditioning services as required, in Landlord's judgment, for the comfortable use and occupancy of the Premises.  If requested by Tenant, Landlord shall furnish heat and air conditioning services at times other than Normal Business Hours, and Tenant shall pay for the actual cost of such services either by direct payment to the utility provider or as Additional Rent to Landlord.
The mechanical system is designed to accommodate heating loads generated by the types and quantities of lights and equipment commonly found in suburban office park general administrative offices.  Before installing lights and equipment in the Premises which in the aggregate exceed such amount (e.g. devoting the Premises to high density computer work station operations) or require a voltage other than 120 volts single phase, Tenant shall obtain the written permission of Landlord.  Landlord may refuse to grant such permission unless Tenant agrees to pay Landlord’s costs of installing any supplementary air conditioning or electrical systems required by such equipment or lights.  In addition, Tenant shall pay Landlord in advance, as additional rent, on the first day of each month during the Term, the amount estimated by Landlord as the cost of furnishing electricity for the operation of such equipment or lights and the amount estimated by Landlord as the cost of operating and maintaining supplementary air conditioning units necessitated by Tenant's use of such equipment or lights.  Landlord shall be entitled to install and operate, at Tenant's cost, a monitoring/metering system in the Premises to measure the added demands on electricity and the HVAC systems resulting from such equipment and lights, and from Tenant's HVAC requirements during other than Normal Business Hours.  Tenant shall comply with Landlord's instruction for the use of drapes, blinds and thermostats.  Tenant acknowledges that Landlord shall have sole control over the determination of what utility providers serve the Project, and Landlord shall have no obligation to give access or easement rights or otherwise allow onto the Project any utility providers except those approved by Landlord in its discretion. .  If, for any reason, Landlord permits Tenant to purchase utility services from a provider other than Landlord's designated compan(ies), such provider shall be considered a contractor of Tenant and Tenant shall indemnify defend and hold Landlord harmless from such provider's acts and omissions while in, or in connection with their services to, the Building or Project in accordance with the terms and conditions of Article 15.  In addition, Tenant shall allow Landlord to purchase such utility service from Tenant's provider at Tenant's rate or at such lower rate as can be negotiated by the aggregation of Landlord's tenants' requirements for such utility.
Except for the costs of above-building standard and/or after-hours services, which shall be paid directly by Tenant, the costs of all utilities and services provided pursuant to this Section 12 shall be Expenses allocated to Tenant as part of Tenant’s Share of Expenses pursuant to Section 4(b). above.  Tenant shall pay when due and directly to the service provider any telephone or other services metered, chargeable or provided to the Premises and not charged as part of Tenant’s Share of Expenses.
Landlord does not warrant that any utilities or services will be free from interruption including by reason of accident, repairs, alterations or improvements and including by reason of computer programming weaknesses known generally as the “Year 2000” problem.  No utility interruption shall be deemed an eviction or disturbance of Tenant, or render Landlord liable to Tenant for damages, or relieve Tenant from the full and complete performance of all of Tenant's obligations under this Lease.
Landlord shall provide such security for the Project as it deems appropriate.  During other than Normal Business Hours, Landlord may restrict access to the Project in accordance with the Project’s security system.  Landlord shall not be liable to Tenant for injury to its agents, employees, customers or invitees, or for losses due to theft or burglary, or for damages done by unauthorized persons in the Project.
Landlord shall provide two keys for the corridor door entering the Premises, and additional keys at a charge by Landlord on an order signed by Tenant.  All such keys shall remain the property of Landlord.  No additional locks shall be allowed on any door of the Premises without Landlord's written permission, and Tenant shall not make, or permit to be made, any duplicate keys, except those furnished by Landlord.  Upon termination of this Lease, Tenant shall surrender to Landlord all keys to the Premises.
13.     MAINTENANCE.  Landlord shall maintain, in good condition, the structural parts of the Premises, which shall include only the foundations, bearing and exterior walls (excluding glass), subflooring and roof (excluding skylights), the unexposed electrical, plumbing and sewerage systems, including those portions of the systems lying outside the Premises, gutters and downspouts on the Building and the heating, ventilating and air conditioning system servicing the Premises; provided, however, the cost of all such maintenance shall be considered "Expenses" for purposes of Section 4(b) except maintenance necessitated by the gross negligence of the Landlord, Landlord’s agents, employees or invitees.  Except as provided above, Tenant shall maintain and repair the Premises in good condition, including, without limitation, maintaining and repairing all walls, storefronts, floors, ceilings, interior and exterior doors, exterior and interior windows and fixtures and interior plumbing as well as damage caused by Tenant, its agents, employees or invitees.  Upon expiration or termination of this Lease, Tenant shall surrender the Premises to Landlord in the same condition as existed at the commencement of the term, except for reasonable wear and tear or damage caused by fire or other casualty for which Landlord has received all funds necessary for restoration of the Premises from insurance proceeds.
14.     ALTERATIONS.  Tenant shall not make any alterations to the Premises, or to the Project, including any changes to the existing landscaping, without Landlord's prior written consent, provided that Landlord's consent shall not be required, but Tenant shall notify Landlord in advance of, alterations costing less than $10,000 that are not affixed to the Premises and do not affect building structure or building systems.  Tenant may, at the time of requesting Landlord's consent to alterations, further request in writing that Landlord elect, at the time of granting consent, whether such alterations must be removed upon termination of the Lease.  If Tenant so requests, Landlord shall make such election at the time of granting consent to the alteration (or if no consent is required, then within fifteen days of Tenant's request).  Failure of Landlord to respond to Tenant's request shall be deemed an election that the alteration need not be removed on termination of this Lease.  Landlord may post notices of non-responsibility in accordance with the laws of the state in which the premises are located.  Any alterations made shall remain on and be surrendered with the Premises upon expiration or termination of this Lease, except that Landlord may, within 30 days before or 30 days after expiration of the term, elect to require Tenant to remove any alterations which Tenant may have made to the Premises (including any alterations made during the term of Tenant’s initial occupancy of the Premises pursuant to the Lease dated February 27, 1989) excepting only such alterations as Tenant has received consent to leave as provided above.  If Landlord elects to require removal of an alteration, at its own cost Tenant shall restore the Premises to the condition designated by Landlord in its election, before the last day of the term or within 30 days after notice of its election is given, whichever is later.
Should Landlord consent in writing to Tenant's alteration of the Premises (or where no consent is required), Tenant shall contract with a contractor approved by Landlord for the construction of such alterations, shall secure all appropriate governmental approvals and permits, and shall complete such alterations with due diligence in compliance with plans and specifications approved by Landlord.  All such construction shall be performed in a manner which will not interfere with the quiet enjoyment of other tenants of the Project.  Tenant shall pay all costs for such construction and shall keep the Premises and the Project free and clear of all mechanics' liens which may result from construction by Tenant. Tenant shall not use any portion of the common areas in connection with an alteration without the prior written consent of Landlord.
15.     RELEASE AND INDEMNITY.
a.       Indemnity.  Tenant shall indemnify, defend (using legal counsel reasonably acceptable to Landlord) and save Landlord and its property manager harmless from all claims, suits, losses, damages, fines, penalties, liabilities and expenses (including Landlord's personnel and overhead costs and attorneys fees and other costs incurred in connection with claims, regardless of whether such claims involve litigation) resulting from any actual or alleged injury (including death) of any person or from any actual or alleged loss of or damage to, any property arising out of or in connection with (i) Tenant's occupation, use or improvement of the Premises, or that of its employees, agents or contractors, (ii) Tenant's breach of its obligations hereunder, or (iii) any act or omission of Tenant or any subtenant, licensee, assignee or concessionaire of Tenant, or of any officer, agent, employee, guest or invitee of Tenant, or of any such entity in or about the Premises.  Tenant agrees that the foregoing indemnity specifically covers actions brought by its own employees.  This indemnity with respect to acts or omissions during the term of this Lease shall survive termination or expiration of this Lease.  The foregoing indemnity is specifically and expressly intended to, constitute a waiver of Tenant's immunity under Washington's Industrial Insurance Act, RCW Title 51, to the extent necessary to provide Landlord with a full and complete indemnity from claims made by Tenant and its employees, to the extent provided herein.  Tenant shall promptly notify Landlord of casualties or accidents occurring in or about the Premises.  LANDLORD AND TENANT ACKNOWLEDGE THAT THE INDEMNIFICATION PROVISIONS OF SECTION 8 AND THIS SECTION 15 WERE SPECIFICALLY NEGOTIATED AND AGREED UPON BY THEM.
b.       Release.  Tenant hereby fully and completely waives and releases all claims against Landlord for any losses or other damages sustained by Tenant or any person claiming through Tenant resulting from any accident or occurrence in or upon the Premises, including but not limited to:  any defect in or failure of Project equipment; any failure to make repairs; any defect, failure, surge in, or interruption of Project facilities or services; any defect in or failure of Common Areas; broken glass; water leakage; the collapse of any Building component; or any act, omission or negligence of co–tenants, licensees or any other persons or occupants of the Building, provided only that the release contained in this Section 15(b) shall not apply to claims for actual damage to persons or property (excluding consequential damages such as lost profits) resulting directly from Landlord's breach of its express obligations under this Lease which Landlord has not cured within a reasonable time after receipt of written notice of such breach from Tenant. Notwithstanding any other provision of this Lease, and to the fullest extent permitted by law, Tenant hereby agrees that Landlord shall not be liable for injury to Tenant's business or any loss of income therefrom, whether such injury or loss results from conditions arising upon the Premises or the Project, or from other sources or places including, without limitation, any interruption of services and utilities or any casualty, or from any cause whatsoever, including, Landlord's negligence, and regardless of whether the cause of such injury or loss or the means of repairing the same is inaccessible to Landlord or Tenant.  Tenant may elect, at its sole cost and expense, to obtain business interruption insurance with respect to such potential injury or loss.
c.       Limitation on Indemnity.  In compliance with RCW 4.24.115 as in effect on the date of this Lease, all provisions of this Lease pursuant to which Landlord or Tenant (the "Indemnitor") agrees to indemnify the other (the "Indemnitee") against liability for damages arising out of bodily injury to Persons or damage to property relative to the construction, alteration, repair, addition to, subtraction from, improvement to, or maintenance of, any building, road, or other structure, project, development, or improvement attached to real estate, including the Premises, (i) shall not apply to damages caused by or resulting from the sole negligence of the Indemnitee, its agents or employees, and (ii) to the extent caused by or resulting from the concurrent negligence of (a) the Indemnitee or the Indemnitee's agents or employees, and (b) the Indemnitor or the Indemnitor's agents or employees, shall apply only to the extent of the Indemnitor's negligence; PROVIDED, HOWEVER, the limitations on indemnity set forth in this Section shall automatically and without further act by either Landlord or Tenant be deemed amended so as to remove any of the restrictions contained in this Section no longer required by then applicable law.
d.       Definitions.  As used in any Section establishing indemnity or release of Landlord, "Landlord" shall include Landlord, its partners, officers, agents, employees and contractors, and "Tenant" shall include Tenant and any person or entity claiming through Tenant.
16.     INSURANCE. Tenant shall, throughout the term of this Lease and any renewal hereof, at its own expense, keep and maintain in full force and effect, a policy of commercial general liability (occurrence form) insurance, including contractual liability (including Tenant's indemnification obligations under this Lease) insuring Tenant's activities upon, in or about the Premises or the Project, against claims of bodily injury or death or property damage or loss with a combined single limit of not less than One Million Dollars ($1,000,000) per occurrence and Four Million Dollars ($4,000,000) in the aggregate, with such increases in limits as Landlord may from time to time require consistent with insurance requirements of institutional landlords in similar projects in the area.  If Tenant manufactures on the Premises consumer goods using any materials supplied by  Landlord (including but not limited to water supplied as part of utilities to the Premises), Tenant's insurance shall include products liability insurance in the amounts specified for the commercial general liability insurance.
Tenant shall further, throughout the term of this Lease and any renewal thereof, at its own expense, keep and maintain in full force and effect, what is commonly referred to as “Special Cause of Loss” or “Special” coverage insurance (excluding earthquake and flood) on  tenant's leasehold improvements in an amount equal to one hundred percent (100%) of the replacement value thereof with a coinsurance waiver. The proceeds from any such policy shall be used by Tenant for the restoration of Tenant's improvements or alterations.  As used in this Lease, “tenant’s leasehold improvements” shall mean any alterations, additions or improvements installed in or about the Premises by or with Landlord’s permission or otherwise permitted by this Lease, whether or not the cost thereof was paid for by Tenant.
All insurance required to be provided by Tenant under this Lease: (a) shall be issued by Insurance companies authorized to do business in the state in which the premises are located with a financial rating of at least an A+X status as rated in the most recent edition of Best's Insurance Reports; (b) shall be issued as a primary policy; shall be on an occurrence basis; (c) name Landlord and Landlord's property manager as additional insured; and (d) shall contain an endorsement requiring at least 30 days prior written notice of cancellation to Landlord and Landlord's lender, before cancellation or change in coverage, scope or amount of any policy.  Tenant shall deliver a certificate or copy of such policy together with evidence of payment of all current premiums to Landlord within 30 days of execution of this Lease and at the time of all renewals thereof.  If Tenant fails at any time to maintain the insurance required by this Lease, and fails to cure such default within five (5) business days of written notice from Landlord then, in addition to all other remedies available under this Lease and applicable law, Landlord may purchase such insurance on Tenant's behalf and the cost of such insurance shall be Additional Rent due within ten (10) days of written invoice from Landlord to Tenant.
Tenant hereby releases Landlord, and waives its entire right of recovery for loss or damage to property located within or constituting a part or all of the Building or the Project to the extent that the loss or damage is covered by (a) Tenant's insurance, or (b) the insurance Tenant is required to carry under this Article 16, whichever is greater.  This waiver applies whether or not the loss is due to the negligent acts or omissions of Landlord or Tenant, or their respective officers, directors, employees, agents, contractors, or invitees.  Tenant shall have its insurers endorse the applicable insurance policies to reflect the foregoing waiver of claims, provided however, that the endorsement shall not be required if the applicable policy of insurance permits the named insured to waive rights of subrogation on a blanket basis, in which case the blanket waiver shall be acceptable
17.     DESTRUCTION.  If during the term, the Premises or Project are more than 30% destroyed from any cause, or rendered inaccessible or unusable from any cause, Landlord may, in its sole discretion, terminate this Lease by delivery of notice to Tenant within 30 days of such event without compensation to Tenant.  If in Landlord's estimation, the Premises cannot be restored within 90 days following such destruction, the Landlord shall notify Tenant and Tenant may terminate this Lease by delivery of notice to Landlord within 30 days of receipt of Landlord's notice.  If neither Landlord nor Tenant terminates this Lease as provided above, then Landlord shall commence to restore the Premises in compliance with then existing laws and shall complete such restoration with due diligence.  In such event, this Lease shall remain in full force and effect, but there shall be an abatement of Base Monthly Rent and Tenant's Share of Expenses between the date of destruction and the date of completion of restoration, based on the extent to which destruction interferes with Tenant's use of the Premises.
18.     CONDEMNATION.
a.       Taking.  If all of the Premises are taken by Eminent Domain, this Lease shall terminate as of the date Tenant is required to vacate the Premises and all Base and Additional Rent shall be paid to that date.  The term "Eminent Domain" shall include the taking or damaging of property by, through or under any governmental or statutory authority, and any purchase or acquisition in lieu thereof, whether the damaging or taking is by government or any other person.  If a taking of any part of the Premises by Eminent Domain renders the remainder thereof unusable for the business of Tenant (or the cost of restoration of the Premises is not commercially reasonable), the Lease may, at the option of either party, be terminated by written notice given to the other party not more than thirty (30) days after Landlord gives Tenant written notice of the taking, and such termination shall be effective as of the date when Tenant is required to vacate the portion of the Premises so taken.  If this Lease is so terminated, all Base and Additional Rent shall be paid to the date of termination.  Whenever any portion of the Premises is taken by Eminent Domain and this Lease is not terminated, Landlord shall at its expense proceed with all reasonable dispatch to restore, to the extent of available proceeds and to the extent it is reasonably prudent to do so, the remainder of the Premises to the condition they were in immediately prior to such taking, and Tenant shall at its expense proceed with all reasonable dispatch to restore its personal property and all improvements made by it to the Premises to the same condition they were in immediately prior to such taking.  The Base and Additional Rent payable hereunder shall be reduced from the date Tenant is required to partially vacate the Premises in the same proportion that the Rentable Area taken bears to the total Rentable Area of the Premises prior to taking.
b.       Award.  Landlord reserves all right to the entire damage award or payment for any taking by Eminent Domain, and Tenant waives all claim whatsoever against Landlord for damages for termination of its leasehold interest in the Premises or for interference with its business.  Tenant hereby grants and assigns to Landlord any right Tenant may now have or hereafter acquire to such damages and agrees to execute and deliver such further instruments of assignment as Landlord may from time to time request.  Tenant shall, however, have the right to claim from the condemning authority all compensation that may be recoverable by Tenant on account of any loss incurred by Tenant in moving Tenant's merchandise, furniture, trade fixtures and equipment, provided, however, that Tenant may claim such damages only if they are awarded separately in the eminent domain proceeding and not out of or as part of Landlord's damages.
19.     ASSIGNMENT OR SUBLEASE.  Tenant shall not assign or encumber its interest in this Lease or the Premises or sublease all or any part of the Premises or allow any other person or entity (except a successor by merger or acquisition which is continuing Tenant’s use, Tenant's authorized representatives, employees, invitees, or guests) to occupy or use all or any part of the Premises without first obtaining Landlord's consent which consent shall not be unreasonably withheld for tenants meeting Landlord’s then existing standards for creditworthiness and use.  No assignment or sublease shall release Tenant from the obligation to perform all obligations under this Lease. Any assignment, encumbrance or sublease without Landlord's written consent shall be voidable and at Landlord's election, shall constitute a default.  If Tenant is a partnership, a withdrawal or change, voluntary, involuntary or by operation of law of any partner, or the dissolution of the partnership, shall be deemed a voluntary assignment.  If Tenant consists of more than one person, a purported assignment, voluntary or involuntary or by operation of law from one person to the other shall be deemed a voluntary assignment.  If Tenant is a corporation, any dissolution, merger, consolidation or other reorganization of Tenant, or sale or other transfer of a controlling percentage of the capital stock of Tenant, or the sale of at least 25% of the value of the assets of Tenant shall be deemed a voluntary assignment.  The phrase "controlling percentage" means ownership of and right to vote stock possessing at least 25% of the total combined voting power of all classes of Tenant's capital stock issued, outstanding and entitled to vote for election of directors.  This Section 19 shall not apply to corporations the stock of which is traded through an exchange or over the counter.  All rent received by Tenant from its subtenants in excess of the Rent payable by Tenant to Landlord under this Lease shall be paid to Landlord (provided that Tenant may amortize the costs of leasing commissions and improvements made for the new tenant over the term of the assignment or sublease in equal monthly installments without interest, and such amortization may be deducted from the excess rent otherwise due Landlord), or any sums to be paid by an assignee to Tenant in consideration of the assignment of this Lease shall be paid to Landlord.  In lieu of granting consent to any proposed Transfer for which Tenant is required to obtain Landlord’s consent, Landlord reserves the right to terminate this Lease or, in the case of subletting of less than all the Premises, to terminate this Lease with respect to such portion of the Premises, as of the proposed effective date of such Transfer, in which event Landlord may enter into the relationship of landlord and tenant with such proposed Transferee.  Notwithstanding the foregoing, Landlord’s recapture right shall not apply to a sublease if (a) the term of the sublease ends at least 1 year prior to the end of the term of the Lease and contains no extension rights, and (b) the total area subleased, including the sublease at issue, will be less than 80% of the Premises. If Tenant requests Landlord to consent to a proposed assignment or subletting, Tenant shall pay to Landlord, whether or not consent is ultimately given, $100 or Landlord's reasonable attorney's fees incurred in connection with such request, whichever is greater.
No interest of Tenant in this Lease shall be assignable by involuntary assignment through operation of law (including without limitation the transfer of this Lease by testacy or intestacy).  Each of the following acts shall be considered an involuntary assignment: (a) if Tenant is or becomes bankrupt or insolvent, makes an assignment for the benefit of creditors, or institutes proceedings under the Bankruptcy Act in which Tenant is the bankrupt; or if Tenant is a partnership or consists of more than one person or entity, if any partner of the partnership or other person or entity is or becomes bankrupt or insolvent, or makes an assignment for the benefit of creditors; or (b) if a writ of attachment or execution is levied on this Lease; or (c) if in any proceeding or action to which Tenant is a party, a receiver is appointed with authority to take possession of the Premises.  An involuntary assignment shall constitute a default by Tenant and Landlord shall have the right to elect to terminate this Lease, in which case this Lease shall not be treated as an asset of Tenant.
20.     DEFAULT.  The occurrence of any of the following shall constitute a default by Tenant: (a) a failure to pay Rent or other charge when due, provided that Landlord shall not exercise any of its rights under this Section 20(a) until Landlord has given Tenant notice of such default and a cure period of ten (10) days from receipt of such notice, and Tenant has failed to pay such rent or other charge within such cure period; (b) abandonment and vacation of the Premises (failure to occupy and operate the Premises for ten consecutive days while in monetary default under this Lease shall be conclusively deemed an abandonment and vacation); or (c) failure to perform any other provision of this Lease, provided that Landlord shall not exercise any of its rights under this Section 20(c) until Landlord has given Tenant notice of such default and a cure period of thirty (30) days from receipt of such notice, and Tenant has failed to cure such default within such cure period, provided further that if more than thirty (30) days are required to complete such performance, the cure period shall not be deemed to have run so long as Tenant commences to cure such default within the thirty (30) day period and thereafter diligently pursues its completion.  The notice required by this Section is intended to satisfy any and all notice requirements imposed by law on Landlord and is not in addition to any such requirement
21.     LANDLORD'S REMEDIES.  Landlord shall have the following remedies if Tenant is in default and after providing Tenant with prior written notice and expiration of all applicable cure periods to the extent and as required pursuant to Section 20. (These remedies are not exclusive; they are cumulative and in addition to any remedies now or later allowed by law): Landlord may terminate Tenant's right to possession of the Premises at any time.  No act by Landlord other than giving notice to Tenant shall terminate this Lease.  Acts of maintenance, efforts to relet the Premises, or the appointment of a receiver on Landlord's initiative to protect Landlord's interest under this Lease shall not constitute a termination of Tenant's right to possession.  Upon termination of Tenant's right to possession, Landlord has the right to recover from Tenant: (1) the worth of the unpaid Rent that had been earned at the time of termination of Tenant's right to possession; (2) the worth of the amount of the unpaid Rent that would have been earned after the date of termination of Tenant's right to possession less the amount that Tenant proves Landlord should be able to earn during such period net of all releasing costs; (3) any other amount, including but not limited to, expenses incurred to relet the Premises, court, attorney and collection costs, necessary to compensate Landlord for all detriment caused by Tenant's default.
22.     ENTRY ON PREMISES.  Landlord and its authorized representatives shall have the right to enter the Premises at all reasonable times, with reasonable prior notice (except in an emergency, when no notice is required), for any of the following purposes: (a) to determine whether the Premises are in good condition and whether Tenant is complying with its obligations under this Lease; (b) to do any necessary maintenance and to make any restoration to the Premises or the Project that Landlord has the right or obligation to perform; (c) to post "for sale" signs at any time during the term, to post "for rent" or "for lease" signs during the last 90 days of the term, or during any period while Tenant is in default; (d) to show the Premises to prospective brokers, agents, buyers, tenants or persons interested in leasing or purchasing the Premises, at any time during the term; or (e) to repair, maintain or improve the Project and to erect scaffolding and protective barricades around and about the Premises but not so as to prevent entry to the Premises and to do any other act or thing necessary for the safety or preservation of the Premises or the Project.  Landlord shall not be liable in any manner for any inconvenience, disturbance, loss of business, nuisance or other damage arising out of Landlord's entry onto the Premises as provided in this Section 22.  Tenant shall not be entitled to an abatement or reduction of Rent if Landlord exercises any rights reserved in this Section 22.  Landlord shall conduct his activities on the Premises as provided herein in a commercially reasonable manner so as to limit inconvenience, annoyance or disturbance to Tenant to the maximum extent practicable.  For each of these purposes, Landlord shall at all times have and retain a key with which to unlock all the doors in, upon and about the Premises, excluding Tenant's vaults and safes.  Tenant shall not alter any lock or install a new or additional lock or bolt on any door of the Premises without prior written consent of Landlord.  If Landlord gives its consent, Tenant shall furnish Landlord with a key for any such lock.
23.     SUBORDINATION; ESTOPPEL CERTIFICATE.
a.       Subordination.  Without the necessity of any additional document being executed by Tenant for the purpose of effecting a subordination, and at the election of Landlord or any mortgagee or any beneficiary of a Deed of Trust with a lien on the Project or any ground lessor with respect to the Project, this Lease shall be subject and subordinate at all times to (a) all ground leases or underlying leases which may now exist or hereafter be executed affecting the Project, and (b) the lien of any mortgage or deed of trust which may now exist or hereafter be executed in any amount for which the Project, ground leases or underlying leases, or Landlord's interest or estate in any of said items is specified as security.  In the event that any ground lease or underlying lease terminates for any reason or any mortgage or Deed of Trust is foreclosed or a conveyance in lieu of foreclosure is made for any reason, Tenant shall, notwithstanding any subordination, attorn to and become the Tenant of the successor in interest to Landlord, at the option of such successor in interest.  Tenant covenants and agrees to execute and deliver, upon demand by Landlord and in the form requested by Landlord any additional documents evidencing the priority or subordination of this Lease with respect to any such ground lease or underlying leases or the lien of any such mortgage or Deed of Trust.  Tenant hereby irrevocably appoints Landlord as attorney-in-fact of Tenant to execute, deliver and record any such document in the name and on behalf of Tenant.
b.       Estoppel Certificate. Tenant shall, within 15 days of demand, execute and deliver to Landlord a written statement certifying:  (i) the commencement and the expiration date of the Term; (ii) the amount of Base Rent and the date to which it has been paid; (iii) that this Lease is in full force and effect and has not been assigned or amended in any way (or specifying the date and terms of each agreement so affecting this Lease) and that no part of the Premises has been sublet (or to the extent such is not the case, a copy of any sublease); (iv) that Landlord is not in default under this Lease (or if such is not the case, the extent and nature of such default);  (v) on the date of such certification, there are no existing defenses or claims which Tenant has against Landlord (or if such is not the case, the extent and nature of such defenses or claims); (vi) the amount of the Security Deposit held by Landlord; and (vii) any other fact or representation that a mortgagee or purchaser may reasonably request.  It is intended that any such statement shall be binding upon Tenant and may be relied upon by a prospective purchaser or mortgagee.  If Tenant fails to respond within 10 days of receipt of a written request by Landlord therefor, (a) Tenant shall be deemed to have given a certificate as above provided, without modification, and shall be conclusively deemed to have admitted the accuracy of any information supplied by Landlord to a prospective purchaser or mortgagee, and (b) Landlord may impose a fee of $100 per day for each day of delay in providing the statement by Tenant after the 10 day period.
24.     NOTICE.  Any notice, demand or request required hereunder shall be given in writing to the party's facsimile number or address set forth in Section 1 hereof by any of the following means: (a) personal service; (b) electronic communication, whether by telex, telegram or facsimile with electronic confirmation; (c) overnight courier; or (d) registered or certified, first class mail, return receipt requested.  Such addresses may be changed by notice to the other parties given in the same manner as above provided.  Any notice, demand or request sent pursuant to either subsection (a) or (b) hereof shall be deemed received upon such personal service or upon dis­patch by electronic means with electronic confirmation of receipt.  Any notice, demand or request sent pursuant to subsection (c) hereof shall be deemed received on the business day immediately following deposit with the overnight courier and, if sent pursuant to subsection (d), shall be deemed received forty-eight (48) hours following deposit in the U.S. mail.
25.     WAIVER.  No delay or omission in the exercise of any right or remedy by Landlord shall impair such right or remedy or be construed as a waiver.  No act or conduct of Landlord, including without limitation, acceptance of the keys to the Premises, shall constitute an acceptance of the surrender of the Premises by Tenant before the expiration of the term.  Only written notice from Landlord to Tenant shall constitute acceptance of the surrender of the Premises and accomplish termination of the Lease.  Landlord's consent to or approval of any act by Tenant requiring Landlord's consent or approval shall not be deemed to waive or render unnecessary Landlord's consent to or approval of any subsequent act by Tenant.  Any waiver by Landlord of any default must be in writing and shall not be a waiver of any other default concerning the same or any other provision of the Lease.  TENANT SPECIFICALLY ACKNOWLEDGES AND AGREES THAT, WHERE TENANT HAS RECEIVED A NOTICE TO CURE DEFAULT (WHETHER RENT OR NON-RENT), NO ACCEPTANCE BY LANDLORD OF RENT SHALL BE DEEMED A WAIVER OF SUCH NOTICE, AND, INCLUDING BUT WITHOUT LIMITATION, NO ACCEPTANCE BY LANDLORD OF PARTIAL RENT SHALL BE DEEMED TO WAIVE OR CURE ANY RENT DEFAULT.  LANDLORD MAY, IN ITS DISCRETION, AFTER RECEIPT OF PARTIAL PAYMENT OF RENT, REFUND SAME AND CONTINUE ANY PENDING ACTION TO COLLECT THE FULL AMOUNT DUE, OR MAY MODIFY ITS DEMAND TO THE UNPAID PORTION.  IN EITHER EVENT THE DEFAULT SHALL BE DEEMED UNCURED UNTIL THE FULL AMOUNT IS PAID IN GOOD FUNDS.
26.     SURRENDER OF PREMISES; HOLDING OVER.  Upon expiration of the Term, Tenant shall surrender to Landlord the Premises and all Tenant improvements and alterations in good condition, except for ordinary wear and tear and alterations Tenant has the right or is obligated to remove under the provisions of Section 14 herein.  Tenant shall remove all personal property including, without limitation, all data and phone wires, wallpaper, paneling and other decorative improvements or fixtures and shall perform all restoration made necessary by the removal of any alterations or Tenant's personal property before the expiration of the term, including for example, restoring all wall surfaces to their condition prior to the commencement of this Lease.  Landlord can elect to retain or dispose of in any manner Tenant's personal property not removed from the Premises by Tenant prior to the expiration of the term.  Tenant waives all claims against Landlord for any damage to Tenant resulting from Landlord's retention or disposition of Tenant's personal property.  Tenant shall be liable to Landlord for Landlord's cost for storage, removal or disposal of Tenant's personal property.
If Tenant, with Landlord's consent, remains in possession of the Premises after expiration or termination of the term, or after the date in any notice given by Landlord to Tenant terminating this Lease, such possession by Tenant shall be deemed to be a month-to-month tenancy terminable as provided under Washington law, by either party.  All provisions of this Lease, except those pertaining to term and Rent, shall apply to the month-to-month tenancy.  During any holdover term, Tenant shall pay Base Monthly Rent in an amount equal to 150% of Base Monthly Rent for the last full calendar month during the regular term plus 100% of Tenant's share of Expenses pursuant to Section 4(b)(3).  If Tenant fails to surrender possession of the Premises upon termination or expiration of this Lease and if Tenant does not obtain Landlord’s written consent to Tenant’s continued occupancy, then Tenant shall be deemed a trespasser and shall be liable to Landlord for all damages sustained by Landlord as a result thereof, together with Base Rate at a rate double the Latest Rate.
27.     LIMITATION OF LANDLORD'S LIABILITY.  In consideration of the benefits accruing hereunder, Tenant agrees that, in the event of any actual or alleged failure, breach or default of this Lease by Landlord, Landlord's liability under this Lease shall be limited to, and Tenant shall look only to Landlord interest in the Project and the rents and proceeds thereof.
28.     BUILDING PLANNING.  If Landlord requires the Premises for use in conjunction with another suite or for other reasons connected with the Project planning program, upon notifying Tenant in writing at least sixty (60) days in advance, Landlord shall have the right to move Tenant to other space in the Project that is substantially the same in size, configuration and tenant improvements, such move (including out-of-pocket ancillary costs such as reprinting of stationary) to be at Landlord's sole cost and expense.  Upon such move, the terms and conditions of the original Lease shall remain in full force and effect, save and excepting that a revised Exhibit "A" shall become part of this Lease and shall reflect the location of the new space and Section 1 of this Lease shall be amended to include and state all correct data as to the new space.

29.     MISCELLANEOUS PROVISIONS.
a.       Time of Essence.  Time is of the essence of each provision of this Lease.
b.       Successor.  This Lease shall be binding on and inure to the benefit of the parties and their successors, except as provided in Section 19 herein.
c.       Landlord's Consent.  Any consent required by Landlord under this Lease must be granted in writing and may be withheld or conditioned by Landlord in its sole and absolute discretion.
d.       Commissions.  Each party represents that it has not had dealings with any real estate broker, finder or other person with respect to this Lease in any manner, except for the broker(s) identified in Section 1, who shall be compensated by Landlord.  Landlord and Tenant recognize that it is possible that they may hereafter make additional agreements regarding further extension or renewal of this Lease or a new lease or leases for all or one or more parts of the Premises or other space in the Project for a term or terms commencing after the Commencement Date of this Lease.  Landlord and Tenant recognize that it is also possible that they may hereafter modify this Lease to add additional space or to substitute space as part of the Premises.  If any such additional agreements, new leases or modifications to this Lease are made, Landlord shall not have any obligation to pay any compensation to any real estate broker or to any other third person engaged by Tenant to render services to Tenant in connection with negotiating such matters, regardless of whether under the circumstances such person is or is not regarded by the law as an agent of Landlord.
e.       Other Charges.  If either party commences any litigation against the other party or files an appeal of a decision arising out of or in connection with the Lease, the prevailing party shall be entitled to recover from the other party reasonable attorney's fees and costs of suit.  Tenant shall pay a charge of $75 to Landlord for preparation of a demand for delinquent Rent.
f.        Force Majeure.Except for the obligation to pay Rent and Additional Rent, neither Landlord nor Tenant shall be deemed in default hereof nor liable for damages arising from its failure to perform its duties or obligations hereunder if such is due to causes beyond its reasonable control, including, but not limited to, acts of God, acts of civil or military authorities, fires, floods, windstorms, earthquakes, strikes or labor disturbances, civil commotion, delays in transportation, governmental delays or war.
g.       Rules and Regulations.  Tenant shall faithfully observe and comply with the "Rules and Regulations", a copy of which is attached hereto, and all reasonable and nondiscriminatory modifications thereof and additions thereto from time to time put into effect by Landlord.  Landlord shall not be responsible to Tenant for the violation or non-performance by any other tenant or occupant of the building or Project of said tenant or occupant's lease or of any of said Rules and Regulations.
h.       Landlord's Successors.  In the event of a sale or conveyance by Landlord of the Project, the same shall operate to release Landlord from any liability under this Lease, and in such event Landlord's successor in interest shall be solely responsible for all obligations of Landlord under this Lease.
i.        Interpretation.  This Lease shall be construed and interpreted in accordance with the laws of the state in which the premises are located.  This Lease constitutes the entire agreement between the parties with respect to the Premises and the Project, except for such guarantees or modifications as may be executed in writing by the parties from time to time.  When required by the context of this Lease, the singular shall include the plural, and the masculine shall include the feminine and/or neuter.  "Party" shall mean Landlord or Tenant.  If more than one person or entity constitutes Landlord or Tenant, the obligations imposed upon that party shall be joint and several.  The enforceability, invalidity or illegality of any provision shall not render the other provisions unenforceable, invalid or illegal.
j.        Prior Understandings. Tenant acknowledges that neither Landlord nor anyone representing Landlord has made statements of any kind whatsoever on which Tenant has relied in entering into this Lease.  Tenant further acknowledges that Tenant has relied solely on its independent investigation and its own business judgment in entering into this Lease.  Landlord and Tenant agree that:  this Lease supersedes all prior and contemporaneous understandings and agreement; the provisions of this Lease are intended by them as the final expression of their agreement; this Lease constitutes the complete and exclusive statement of its terms; and no extrinsic evidence whatsoever may be introduced in any judicial proceeding involving this Lease.  No provision of this Lease may be amended except by an agreement in writing signed by the parties hereto or their respective successors in interest, whether or not such amendment is supported by new consideration.
k.       Authority.  If Tenant is a corporation, each individual executing this Lease on behalf of said corporation represents and warrants that he/she is duly authorized to execute and deliver this Lease on behalf of said corporation.  Concurrently with the execution of this Lease, Tenant shall deliver to Landlord a certified copy of a resolution of the Board of Directors of said corporation authorizing the execution of this Lease.  If Tenant is a partnership, each individual executing this Lease on behalf of said partnership represents and warrants that he/she is duly authorized to execute and deliver this Lease on behalf of said partnership and that this Lease is binding upon said partnership in accordance with its terms, and concurrently with execution of this Lease, Tenant shall deliver to Landlord such evidence of authorization as Landlord may require.  If Tenant is a marital community, or a member of a marital community, both members of the marital community shall execute this Lease.  Where Tenant is comprised of more than one person or entity, all covenants, agreements and obligations of Tenant hereunder shall be the joint and several covenants, agreements and obligations of each person or entity comprising
l.        Clean Air Act.  Tenant acknowledges that Landlord has not made any portion of the Premises or the Building accessible for smoking in compliance with WAC 296-62-12000.  If Tenant wishes to make any portion of the Premises accessible for smoking, Tenant shall make all improvements necessary to comply with all applicable governmental rules and regulations.  Tenant acknowledges that the indemnity contained in Section 15 of the Lease includes, but is not limited to claims based on the presence of tobacco smoke as a result of the activities of Tenant, its employees, agents, or guests.
30.     LETTER OF CREDIT.  On or before the earlier of (i) ninety (90) days after mutual execution of this Lease or (ii) the date on which Tenant wishes to obtain disbursement of any portion of the T.I. Allowance, Tenant shall cause to be delivered to Landlord an irrevocable, unconditional, transferable standby Letter of Credit in the initial sum of $325,000.00 naming Landlord as beneficiary, issued by a lender acceptable to Landlord and otherwise substantially in the form of attached Exhibit E, provided that if the issuing bank does not have a New York branch on which the letter may be drawn, then Tenant shall further obtain from the Bank of New York a Confirmation Advice in the form attached as Exhibit E-1 (collectively the “Letter of Credit”).  Tenant shall be required to maintain the Letter of Credit through the Lease Term.  The Letter of Credit shall be governed by the rules of the International Standby Practices of 1998 or such later revision as may be published by the Institute of International Banking Law and Practice.
If Tenant breaches any covenant or condition of this Lease, including but not limited to the payment of rent or additional rent, and fails to cure such breach within any cure period provided in this Lease, Landlord may draw on the Letter of Credit and apply any sums so drawn to reimburse itself for any damages or other amounts due from Tenant relating to such breach, regardless of whether Landlord has previously taken any other action against Tenant.  Further, if Tenant fails to renew the Letter of Credit at least ninety (90) days prior to its expiration during the Term of this Lease, then such failure shall be deemed to be an immediate default entitling Landlord to draw the entire Letter of Credit and hold it as a cash security deposit.  Any payment to Landlord from the Letter of Credit shall not be construed as a payment of liquidated damages for any default.
Provided that Tenant has not at any time been in default of any of its monetary obligations under this Lease and has not been in material default of any other obligations under this Lease, then as of June 1, 2003, Tenant may reduce the Letter of Credit to $216,667 and subject to the same precondition may reduce the Letter of Credit to $108,334 on June 1, 2005.  This right to reduce the Letter of Credit shall be subject to (and conditioned on) Landlord's confirming in writing that Tenant has satisfied such conditions.  Landlord shall promptly respond to Tenant's request for such confirmation and, if Landlord deems the conditions not met, shall specify the reasons for its conclusion
31.     OPTION TO RENEW.  Tenant is granted the right (the “Extension Right”) to extend the term of this Lease beyond the expiration date of the initial term for one period of seventy-two (72) months (the “Extended Term”).  Tenant may not exercise its Extension Right if it is in default beyond any applicable cure period at the time Tenant exercised its Extension Right, or if it has ever been in default beyond any applicable cure period more than two (2) times in any twelve (12) month period.  Tenant may exercise its Extension Right by delivering written notice thereof to Landlord not later than three hundred sixty five (365) days prior to the expiration of the initial term.  In the Extended Term, all terms and conditions of this Lease shall apply, except (i) Section 31 of this Lease shall not apply, and (ii) the Base Monthly Rent for the Extended Term shall be the then prevailing market rate for a similar lease and term for similarly situated and improved space (“Fair Market Rent”), provided that in no event shall the Base Monthly Rent plus Additional Rent for the Extended Term be less than the Base Monthly Rent plus Additional Rent for the last month of the initial term.  In the event Tenant exercises its option, Landlord shall provide a tenant improvement allowance in an amount not to exceed $4.00 per square foot.
Extension Rights shall apply to all of the Premises then under lease to Tenant.  Tenant’s Extension Right is personal and may not be exercised by any assignee or sublessee.
DATED as of the day and year first written above.

LANDLORD:	TEACHERS INSURANCE & ANNUITY ASSOCIATION OF AMERICA
	By:     /s/ James P. Garofalo_______________________
	Its:      [Assistant Secretary]_______________________
	By:     _______________________________________
	Its:      _______________________________________
TENANT:	APPLIED MICROSYSTEMS CORPORATION
	By:     /s/ Robert C. Bateman_____________________
	Its:      [VP and CFO]___________________________
	By:     _______________________________________
	Its:      _______________________________________

EX-21

EXHIBIT 21

Applied Microsystems Corporation

SUBSIDIARIES

Applied Microsystems Corporation, Ltd.,
organized under the laws of England and Wales

Applied Microsystems GmbH,
organized under the laws of the Federal Republic of Germany

Applied Microsystems Japan, Ltd.,
organized under the laws of Japan

Applied Microsystems Foreign Sales Corporation,
a Washington Corporation

Applied Microsystems S.A.R.L.,
organized under the laws of France

EX-23

Exhibit 23

Consent of Ernst & Young LLP, Independent Auditors

We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-07331) pertaining to the Applied Microsystems Corporation 1996 Employee Stock Purchase Plan, the Registration Statement (Form S-8 No. 333-03396) pertaining to the Applied Microsystems Corporation 1990 Stock Benefit Plan, the Applied Microsystems Corporation 1992 Performance Stock Plan, and the Applied Microsystems Corporation Director Stock Option Plan, the Registration Statement (Form S-8 No. 333-14823) pertaining to the Applied Microsystems Corporation 1992 Performance Stock Plan and the Registration Statement (Form S-8 No. 333-52164) pertaining to the Applied Microsystems Corporation 1992 Performance Stock Plan, the 1996 Employee Stock Purchase Plan, and the Nonqualified Stock Option Grant to Stephen J. Verleye of our report dated February 2, 2001 with respect to the consolidated financial statements and schedule of Applied Microsystems Corporation included in the Annual Report (Form 10-K) for the year ended December 31, 2000.

ERNST & YOUNG LLP

Seattle, Washington
March 28, 2001