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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION


Washington, D.C. 20549




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Form 10-K



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(Mark One)



|  |  |                                                                                        
|- |  | ---------------------------------------------------------------------------------------
|þ |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) 
	 OF THE SECURITIES EXCHANGE ACT OF 1934



| |                                             
| | --------------------------------------------
| | For the fiscal year ended December 31,
	2001

or



|  |  |                                                                                            
|- |  | -------------------------------------------------------------------------------------------
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) 
	 OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-31101

Applied Molecular Evolution, Inc.

(Exact name of Registrant as specified in its
charter)


|                                                                |  |                                      
|--------------------------------------------------------------- |  | -------------------------------------
|Delaware                                                        |  | 33-0374014                           
|(State or other jurisdiction of
	incorporation or organization) |  | (I.R.S. Employer
	Identification No.)

3520 Dunhill Street

San Diego, CA 92121


(Address, including zip code, of principal
executive offices)


Registrants telephone number, including
area code: (858) 597-4990

Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $0.001 par value


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
than the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days.     Yes
þ          No
o

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
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.          o

The aggregate market value of the voting stock
held by non-affiliates of the registrant was approximately
$130,450,261 as of February 26, 2002, based upon the
closing sale price on the Nasdaq National Market reported for
such date. Shares of Common Stock held by each officer and
director and by each person who owns 5% of more of the
outstanding Common Stock have been excluded in that such persons
may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other
purposes.

There were 23,619,457 shares of the
registrants Common Stock issued and outstanding as of
February 26, 2002.

DOCUMENTS INCORPORATED BY REFERENCE

Registrants Proxy Statement to be filed
with the Securities and Exchange Commission in connection with
the solicitation of proxies for the Registrants Annual
Meeting of Stockholders to be held in 2002, is incorporated by
reference in Part III, Items 10, 11, 12 and 13 on this
Form 10-K.



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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 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 Report on Form 8-K.                    
|SIGNATURES                                
|INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|                                           |                                                                                               | REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
|                                           |                                                                                               | CONSOLIDATED BALANCE SHEETS                      
|                                           |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS            
|                                           |                                                                                               | CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY  
|                                           |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS            
|                                           |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|EXHIBIT 10.19                             
|EXHIBIT 10.20                             
|EXHIBIT 10.21                             
|EXHIBIT 10.22                             
|EXHIBIT 10.23                             
|EXHIBIT 10.24                             
|EXHIBIT 10.25                             
|EXHIBIT 10.26                             
|EXHIBIT 10.27                             
|EXHIBIT 21.1                              
|EXHIBIT 23.1                              



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PART I

This Form 10-K contains, in addition to
historical information, forward-looking statements that involve
risks and uncertainties. Our actual results could differ
materially from the results discussed in any such
forward-looking statements. Factors that could cause or
contribute to such differences include those discussed in
Risk Factors as well as those discussed elsewhere in
this Form 10-K. These forward-looking statements represent
our judgment as of the date of the filing of this
Form 10-K. We disclaim, however, any intent or obligation
to update these forward-looking statements.




Item 1.     Business.

Overview

Applied Molecular Evolution, Inc. (the
Company or AME), a Delaware corporation,
was incorporated on August 14, 1989. We are a leader in the
application of directed molecular evolution to the optimization
and development of biotherapeutics. Directed molecular evolution
is a process for optimizing genes and proteins for specific
commercial purposes. Our technology has been validated by, among
other things, the ongoing clinical trials of
VitaxinTM, an optimized version of the monoclonal
antibody LM609, that AME licensed to MedImmune, Inc.
(MedImmune) and our success in optimizing
Synagis® for MedImmune. We use our proprietary
AMEsystemTM technology to rapidly create improvements
in proteins that would be too inefficient and expensive to
achieve through conventional methods. Since our inception, our
principal focus has been on applying our technology to human
biotherapeutics, the largest and most profitable target market
for directed molecular evolution. We plan to use our directed
molecular evolution technology to develop improved versions of
currently marketed, FDA-approved biopharmaceuticals as well as
novel human biotherapeutics.

Background

DNA, Codons, Genes and Proteins




The graphic above depicts a protein being
produced from DNA as described in the text below.

DNA is a molecule found in all living cells and
is responsible for determining the inherited characteristics of
all living organisms. The entire DNA content of an organism is
called its genome. The human genome is organized into
46 chromosomes, and each chromosome contains a DNA
molecule. Each DNA molecule

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consists of two complementary strands comprised
of four different chemical bases called nucleotides, commonly
referred to as A, C, G and T. Each set of three adjacent
nucleotides (e.g., CAG or GAG) is referred to as a codon, and
codons are organized into discrete units called genes. Genes
direct the cell to make proteins, and the sequence of codons
within a gene determines the protein that will be made by the
cell.


Scientific evidence amassed to date suggests that
the human genome contains approximately 30,000 genes, with each
gene consisting of anywhere from tens to millions of codons.
Genes are critically involved in the regulation of almost all
aspects of human biology and disease because they serve as the
blueprints for the production of proteins that control virtually
all of a cells normal biological functions. For an
organism to be healthy, genes must produce specific proteins at
the right time in the appropriate amounts in the correct cells,
a process known as gene expression. When a gene is expressed,
its DNA directs the production of a specific protein.

Human proteins are composed of combinations of 20
different subunits called amino acids which are linked together
like beads on a string. The specific sequence and types of amino
acids in a protein determine the ultimate structure and function
of the protein. Each codon in a gene specifies a corresponding
amino acid in a protein. Therefore, the specific sequence of
codons contained in the gene determines the amino acid
composition and function of the protein. Any change in any of
the three nucleotides in a codon could result in the
incorporation of a different amino acid into the protein. This
type of alteration may lead to the production of a protein with
altered biological properties. Consequently, changes in
nucleotides, e.g., if C is replaced by G within a codon, can
have a significant functional impact on the inherited biological
characteristics of an organism.

Natural Evolution and Its
Limitations

Evolution is the process by which living
organisms adapt to their environment. There are two fundamental
steps in the evolutionary process. The first step is the
creation of genetic diversity through random events. The second
step is the natural selection of organisms which possess
beneficially adaptive characteristics that will be passed to the
next generation.

The following critical limitations preclude
natural evolution from efficiently developing proteins optimized
for specific commercial purposes:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | It is extremely slow, often requiring the passage
	of thousands to millions of years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Natural evolution creates only a portion of the
	possible protein diversity because it introduces changes at the
	nucleotide level. Changes in individual nucleotides within a
	gene may or may not alter the amino acid sequence of the
	resulting protein. Therefore, a change that occurs at the
	nucleotide level may not alter the functional characteristics of
	the protein that is eventually produced. In contrast, by
	changing individual codons, it is possible to explore the full
	range of possible amino acid changes in a protein. Consequently,
	natural evolution is much less efficient at exploring the full
	range of protein diversity than a process which introduces
	change at the codon level.
|
| |  | Selection occurs at the level of the whole
	organism, therefore individual proteins are not necessarily
	optimized.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

These limitations create an opportunity to
improve natural proteins for commercial purposes.

Biotechnology and Its Current
Limitations

The biotechnology industry aims to discover genes
from natural sources and subsequently develop proteins with
important commercial applications from these genes.

Genomics, as it relates to healthcare, is the
study of all the genetic information of a species and its
relationship to disease. Recent technological advances in
molecular biology and in scientific instrumentation have greatly
increased the ability of researchers to identify genes and
subsequently determine their functions. These developments are
ultimately expected to lead to the identification of all the
genes in the human genome. To date, tens of thousands of genes
have already been identified. In spite of these recent
successes, genomics

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companies have been limited in their ability to
develop commercially successful protein products. As described
above, a major reason for this limitation is that naturally
occurring genes produce proteins that have not been evolved for
specific commercial purposes, and typically yield proteins that
may be deficient with respect to characteristics including
safety, efficacy, potency, convenience (e.g. serum half-life and
route of administration), manufacturing cost and intellectual
property.


Traditionally, the biotechnology industry has
attempted to modify genes for commercial purposes by employing
two different strategies: random mutagenesis and rational
design. Random mutagenesis involves inducing random mutations in
genes in an effort to produce commercially viable proteins.
Empirical evidence suggests that random mutagenesis offers a low
probability of improving a protein and usually results in
changes which are detrimental to the function of the protein.
Rational design involves deliberately modifying a gene in an
effort to change the structure of the resultant protein. This
approach is predicated on the theory that analyzing the
structure and shape of a protein will provide an understanding
of its function. Consequently, once the structure of a protein
is known, it may be possible to modify the underlying gene to
improve the function of the protein. The major drawbacks to
rational design are that it is expensive, time-consuming and,
most significantly, imprecise. Moreover, rational design has
rarely been successfully implemented in practice.

Directed Molecular Evolution and Limitations
of Competing Approaches

The goal of directed molecular evolution is to
optimize proteins for specific commercial purposes. Protein
optimization generally involves improving the functional
characteristics of a particular protein by changing its amino
acids. For example, a particular protein may have an initial
amino acid sequence that makes it susceptible to degradation at
temperatures approximating that of the human body. Consequently,
its utility as a therapeutic agent would be severely limited. By
using directed molecular evolution, the stability of this
protein could be dramatically improved by introducing changes in
the amino acid sequence of the protein, and then screening for
those changes that allow the protein to survive at higher
temperatures while retaining its other important
characteristics. Because the sequence of amino acids in a
protein determines the proteins structure and function,
and the sequence of amino acids is specified in genes, proteins
can be modified by altering the genes that produce them.

There are three fundamental steps in the process
of directed molecular evolution. In the first step, a library,
or collection, of genes is created by introducing changes in the
initial gene that produces the protein of interest. Ideally,
this library of genes should contain the optimal amount of
genetic diversity. If the process introduces too much genetic
diversity, the efficiency of directed molecular evolution may be
significantly reduced because excessive change in the genes of
interest is likely to destroy the function of most resulting
proteins. Conversely, the creation of an insufficient amount of
genetic diversity significantly reduces the probability of
producing a functionally-improved protein. The second step
involves expressing proteins from all the different genes that
were produced in the first step to create a library of diverse
proteins. The third step in the process entails screening, or
evaluating, this library to identify those proteins with
improvements in the desired characteristics. The process is then
repeated until a sufficiently improved protein is identified.

We believe that directed molecular evolution
potentially offers several advantages over natural evolution and
traditional biotechnology approaches to improve proteins. The
entire process can be rapidly completed, efficiently and
cost-effectively accomplishing in months what it takes
traditional methods years to achieve. Because directed molecular
evolution does not require any knowledge of the structure of the
protein being optimized, it is much more rapid than conventional
approaches such as rational design, which are based on
time-consuming modeling techniques.

Directed molecular evolution represents a
significant step forward in the optimization of proteins. There
are currently a number of different competing approaches for
conducting directed molecular evolution, including gene
shuffling. We believe that these competing approaches do not
take full advantage of the potential of directed molecular
evolution to optimize proteins, particularly biotherapeutics,
our primary target market.

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| |               
| | --------------
| | Gene Shuffling

Gene shuffling involves cleaving a collection of
genes into fragments and then recombining the fragments to
create new gene variants. Gene shuffling does not control the
extent or precise location of changes introduced into the gene
of interest nor does it explore the full range of protein
diversity. These shortcomings significantly limit the usefulness
of this approach in developing improved proteins:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Completeness of Diversity:Gene shuffling lacks the ability to
	substitute each of the 20 human amino acids at a particular
	location in a protein. For example, if all the various genes in
	a gene family begin with the same codon ATG, they will all
	produce a protein that begins with the same amino acid. If this
	family of genes is then shuffled in an effort to create genetic
	diversity, all the gene variants that are produced will still
	begin with the same codon ATG. Therefore, in this particular
	situation, shuffling fails to introduce any of the other 19
	possible human amino acids into the beginning of the protein. If
	modifying the first amino acid is critical to enhancing the
	proteins function, gene shuffling will be unable to
	produce a functionally-improved protein.
|
| |  | Extent of Change:The very nature of gene shuffling
	requires the cleavage of a collection of genes in multiple
	locations. Consequently, the shuffling process cannot precisely
	control the number of changes introduced into the genes. The
	greater the number of changes, the more likely it is that
	harmful changes will be introduced. Furthermore, extensive
	change requires the screening of larger libraries, which is more
	time-consuming and expensive.                                                                                                                                                                                                                                                                                                                                             
|
| |  | Location of Change:The gene shuffling approach lacks the
	ability to precisely control where changes are introduced into a
	gene. This limitation severely curtails the application of this
	technology to developing biotherapeutics because changing just a
	single amino acid at an inappropriate location can adversely
	impact the safety, efficacy, potency, convenience, manufacturing
	costs and intellectual property of a biotherapeutic.                                                                                                                                                                                                                                                                                                                                                               



| |                       
| | ----------------------
| | Extremophile Isolation

Extremophile isolation attempts to identify
previously undiscovered genetic diversity in nature by
collecting unusual organisms that have adapted through natural
selection to be able to survive in extreme environments. We
believe that this approach has limited application to the
biotherapeutic market. It has taken over two decades to
transform mouse proteins, which are closely related to human
proteins, into biotherapeutics that the human immune system will
not reject. We expect it to be even more challenging to convert
proteins from organisms that are extremely different from humans
into biotherapeutics which will not be rejected by the human
immune system.

Our AMEsystem Technology

We use our proprietary AMEsystem technology to
improve the function of a target protein in order to enhance its
commercial potential. The components of our AMEsystem are
precise and efficient methods for conducting the three
fundamental steps of directed molecular evolution and address
the limitations of alternative directed molecular evolution
approaches. There are three components to our AMEsystem
technology:



| |   |                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | DirectAMETM:
	DirectAME is a gene synthesis process that enables the rapid
	production of a library of variant genes based on an initial
	gene.                                                                               
|
| |  | ExpressAMETM:
	ExpressAME consists of gene expression systems that efficiently
	produce proteins from the genes generated using DirectAME.                                                                                    
|
| |  | SelectAMETM:
	SelectAME is a series of tests or screens which facilitate the
	selection and identification of proteins with the optimal,
	desired commercial properties from the protein libraries
	produced using ExpressAME.

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(AMEsystem GRAPHIC)



| |                    
| | -------------------
| | Step One: DirectAME

Our patented DirectAME technology addresses the
limitations of competing directed molecular evolution approaches
by rapidly and precisely generating the appropriate amount of
genetic diversity, thereby significantly increasing the
probability of creating and identifying functionally improved
proteins. In contrast to alternative directed molecular
evolution approaches, our DirectAME approach has the following
strengths:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Completeness of Diversity:When optimizing the function of a
	protein by applying directed molecular evolution technology, it
	is critical that all 20 possible human amino acids be evaluated
	at each position of interest in the protein. By changing codons
	as opposed to single nucleotides, our patented DirectAME
	technology ensures that all 20 possible human amino acids are
	expressed at each position of interest within the protein.
	Competing approaches cannot achieve such complete diversity
	without producing enormous protein libraries that are not
	economically feasible to screen.                                                                                                                                                                                                                                                                                                                        
|
| |  | Extent of Change:The simultaneous introduction of a
	large number of amino acid changes in each protein in a library
	is undesirable because most amino acid changes are detrimental
	to the function of a protein. If multiple changes are made at
	once, the majority of the proteins produced will not possess the
	desired function, needlessly complicating the subsequent
	screening process. We can use our DirectAME technology to create
	a diverse library of proteins that differ from the initial
	target protein by a specific number of amino acids. In doing so,
	we significantly increase the probability of preserving the
	desired characteristics while keeping the number of proteins at
	a level that is efficient to express and screen. As we repeat
	the process, we introduce additional changes into the protein
	and only select those changes that combine to produce a protein
	with improved function.
|
| |  | Location of Change:Our DirectAME technology has the
	ability to change specific, carefully targeted areas of a gene
	and ultimately a protein. This ability to precisely alter a
	specific region of a target protein greatly facilitates the
	synthesis of more focused libraries, significantly increasing
	the likelihood of identifying improved proteins. The ability to
	change specific regions of a protein in a deliberate and precise
	manner while leaving all other regions unchanged has profound
	implications for the development of new biotherapeutics as well
	as for improving currently marketed, FDA-approved drugs.                                                                                                                                                                                                                                                                                            
|
| |   | Optimizing monoclonal antibodies demonstrates the
	importance of having the ability to change amino acids only at
	specific locations. While antibodies are relatively large
	proteins consisting of hundreds of                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

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| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | amino acids, the crucial sites on an antibody
	that determine its affinity or ability to bind to a particular
	target, and ultimately its therapeutic effectiveness, constitute
	less than 5% of the overall protein. These sites consist of six
	different stretches of amino acids that are separated from one
	another. Therefore, antibody affinity optimization requires the
	ability to precisely confine amino acid changes to these six
	specific regions while leaving the remainder of the antibody
	unchanged.



| |                     
| | --------------------
| | Step Two: ExpressAME

Our ExpressAME technology encompasses a number of
proprietary gene expression systems that we use to produce
protein libraries. A unique feature of our ExpressAME system is
that it enables us to apply our directed molecular evolution
technology to virtually any protein, including those that cannot
be functionally expressed in bacteria. A significant shortcoming
of competing technologies is that they rely primarily on
bacterial expression systems. However, many currently marketed,
FDA-approved biopharmaceuticals cannot be expressed in their
functional, properly folded states by bacteria, and thus require
expression in mammalian cells.

ExpressAME has been developed specifically to
address the technical challenges of conducting directed
molecular evolution in both bacterial and mammalian cells. As a
result, we can now rapidly optimize many biotherapeutics which
were previously not amenable to directed molecular evolution.



| |                      
| | ---------------------
| | Step Three: SelectAME

Our SelectAME technology is a set of broadly
applicable proprietary tests or screens that are highly
sensitive and capable of characterizing thousands to millions of
proteins simultaneously. In selecting a screen for use in the
directed molecular evolution process, there is often a trade-off
between the speed of throughput, the rate at which proteins can
be screened, and the ability to predict the functional
performance of the protein in the human body. We believe that
using the most predictive screen available, regardless of its
throughput, is essential for identifying the most improved
proteins. By using our AMEsystem technology, we have the
flexibility to create libraries of proteins which are
appropriately matched to the throughput of the particular screen
that is being used. If the most predictive screen that is
available is low throughput, we can use DirectAME to create
smaller, more focused libraries containing proteins that have
each been changed at only one or two amino acid positions.
Alternatively, when a high throughput and highly predictive
screen is available, DirectAME can be used to generate larger
protein libraries with multiple amino acid substitutions. In
contrast, competing technologies that do not have the control
and precision of DirectAME, and which therefore produce larger,
less focused protein libraries, predominantly rely on high
throughput screens, which are often less predictive.



| |                      
| | ---------------------
| | Repeating the Process

We repeat the process starting with one or more
of the improved proteins produced by our AMEsystem to further
improve the function of the target protein. We can also combine
beneficial amino acid changes identified in the initial protein
library as a second strategy to achieve the same objective.

Market Opportunities

While virtually any product or process that
utilizes or could utilize DNA or proteins might be improved
though the application of our technology, we focus our efforts
on the biotherapeutic market, the largest and most profitable
target market for directed molecular evolution. We believe that
the level of technological sophistication and precision required
to improve currently marketed, FDA-approved biopharmaceuticals
as well as to develop novel biotherapeutics is significantly
greater than that required by other potential target markets for
directed molecular evolution technologies. Since our inception,
we have focused on developing and optimizing our AMEsystem
technology to address the multibillion dollar market
opportunities in human biotherapeutics.

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| |                
| | ---------------
| | Biotherapeutics

Proteins are essential to all cellular processes
and have tremendous commercial value, particularly in the
pharmaceutical industry. The worldwide sales of therapeutic
proteins are projected to approach $20.0 billion by 2004.
The biotherapeutic market encompasses four major classes of
compounds, each with tremendous potential to improve human
health:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Antibodies:Antibodies currently represent the
	fastest growing biotherapeutic product category in dollar and
	percentage terms, due to the application of recently developed,
	novel approaches for generating, modifying and manufacturing
	antibodies. The FDA has approved twelve therapeutic antibodies,
	with total sales in 2000 of approximately $2.0 billion. The
	worldwide sales of antibody therapeutics are projected to exceed
	$20.0 billion by 2010. In 2001, worldwide sales for
	Synagis, a therapeutic antibody marketed by MedImmune, totaled
	more than $500.0 million. As demonstrated with our
	corporate collaborations and by our own internal development
	projects, our proprietary AMEsystem technology enables us to
	optimize antibodies with respect to safety, efficacy, potency,
	convenience, manufacturing cost and intellectual property. To
	date, we have optimized over 10 antibodies with commercial
	potential.
|
| |  | Cytokines:Cytokines
	are proteins secreted by cells that regulate the bodys
	immune system as well as its responses to inflammation.
	Cytokines have been implicated in a wide variety of diseases
	such as rheumatoid arthritis, sepsis and lupus that afflict
	millions of individuals. Perhaps the best-known and well-studied
	cytokine is granulocyte-colony-stimulating factor, commonly
	known as G-CSF, which acts on the bone marrow to increase its
	production of white blood cells.                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Hormones:Hormones
	are proteins that are critical to the daily function and normal
	growth and development of the human body. Many of the most
	debilitating and chronic human diseases are due to hormone
	deficiencies. Human growth hormone, for example, is a naturally
	occurring human protein produced in the pituitary gland that
	regulates metabolism and is responsible for growth in children.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | Enzymes:Enzymes
	constitute the majority of proteins in all cells. These proteins
	speed up cellular processes and are therefore critical to the
	normal function of cells. Enzymatic deficiencies are often
	fatal. Gauchers disease, for example, is a seriously
	debilitating, sometimes fatal, genetic disorder caused by a
	deficiency in an important enzyme called glucocerebrosidase.
	Administration of the synthetic form of this enzyme, called
	Cerezyme, is currently the only treatment available to these
	patients. As demonstrated through our work on
	Butyrylcholinesterase (BChE) that is funded by the
	National Institutes of Health, (NIH), our
	proprietary AMEsystem technology, including the Mammalian Cell
	Expression System (MCES), enables us to optimize
	enzymes with respect to catalytic activity.                                                                                                           

Commercial Problems Solved Using Our AMEsystem
Technology

By applying our proprietary AMEsystem technology,
we have successfully addressed many significant challenges
involved in the biopharmaceutical development process. We
believe that our technology platform has been validated through
its successful application to critical, time-sensitive projects
for MedImmune, Bristol-Myers Squibb Company (Bristol-Myers
Squibb), Seattle Genetics, Inc. (Seattle
Genetics) and CancerVax, Inc. (CancerVax).



| |                  
| | -----------------
| | Increased Potency

The use of Synagis, MedImmunes monoclonal
antibody against Respiratory Syncytial Virus, is limited to the
treatment of high-risk infants due to the drugs high cost
and requirement for intramuscular administration. By using our
directed molecular evolution technology, we created several new
drug candidates for MedImmune that have been demonstrated in
disease models to be at least 10 times more potent than Synagis.
MedImmune is expected to initiate clinical trials with one of
these candidates, and if successful, market it as
NumaxTM. If Numaxs significantly increased
potency is confirmed in human clinical trials, MedImmune

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could develop Numax for new markets including the
elderly, reduce production costs, and pursue various delivery
forms to broaden the products use.




| |                              
| | -----------------------------
| | Decreased Manufacturing Costs

A significant manufacturing problem was
encountered during the development of VitaxinTM, a
monoclonal antibody product candidate designed to treat diseases
including cancer and arthritis by cutting off their blood
supply, a process known as anti-angiogenesis. A particular
structural feature in the first-generation antibody made it
susceptible to significant degradation during the manufacturing
process, resulting in a loss of over 70% of the product yield.
By applying our AMEsystem technology to Vitaxin, we successfully
created a second-generation version of the antibody that is
significantly more stable than its predecessor. Our directed
molecular evolution technology decreased manufacturing costs by
improving the yield by more than 300% and also increased the
affinity of the antibody for its target by 90-fold.
Second-generation Vitaxin entered two Phase I clinical trials
for cancer and one Phase I trial for rheumatoid arthritis with
MedImmune during 2001.



| |                 
| | ----------------
| | Increased Safety

Bristol-Myers Squibbs anti-CD40 antibody is
a mouse antibody, which, if administered to humans, would cause
a significant immune reaction, rendering the antibody
ineffective and potentially causing serious side effects in
patients. Prior to collaborating with us, Bristol-Myers Squibb
had attempted unsuccessfully to improve its anti-CD40 antibody
by applying rational design techniques. Through the application
of our AMEsystem technology, we optimized the antibody, yielding
an antibody with a 500-fold increased affinity for its target
and a significantly reduced risk for causing an immune reaction.
Bristol-Myers Squibb is in preclinical development with
anti-CD40.



| |                     
| | --------------------
| | Enhanced Convenience

Seattle Genetics BR96 is an antibody for
the potential treatment of solid tumors. The commercial
potential of BR96 was limited by its recognition of only a
narrow set of tumors. We optimized this antibody by increasing
its affinity and broadening its ability to recognize tumors.
Seattle Genetics is now in preclinical development with the
improved version, hBR96.



| |                                                          
| | ---------------------------------------------------------
| | Enabling the Commercialization of a
	Discovery Technology

Subtractive immunization is a novel approach to
discover antibodies that recognize unique therapeutic targets.
However, this approach usually results in low-affinity
antibodies that are unlikely to be commercially successful. By
applying our AMEsystem technology to this problem, we can
increase the affinity of antibodies produced by this process.
For Cell-Matrix, Inc. (Cell-Matrix), we optimized
HUI77 and HUIV26, anti-angiogenic mouse antibodies discovered
using subtractive immunization, which could enable Cell-Matrix
to pursue the commercialization of these antibodies. CancerVax
acquired Cell-Matrix in January 2002 and is in preclinical
development with these optimized antibodies.

Business Strategy

We are a leader in applying directed molecular
evolution to the optimization and development of human
biotherapeutics. We have selected biotherapeutics as our primary
target market because it is the largest and highest margin
market for directed molecular evolution. Our business strategy
includes five basic elements:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Optimize Currently Marketed
	Biopharmaceuticals.We are seeking to
	optimize FDA-approved biopharmaceuticals to create improved
	versions of these drugs with broader patent protection. We are
	already using our proprietary AMEsystem technology to
	significantly improve important characteristics of established
	biopharmaceuticals, acting independently or in collaboration
	with the initial developers. We believe that focusing on
	approved products with known therapeutic profiles and proven
	markets represent an attractive, lower risk development strategy.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Develop Novel Biotherapeutics.We plan to access and develop novel
	human biotherapeutics from a wide variety of sources including
	leading academic institutions and corporate collaborations. We
	also expect genomics and the sequencing of the human genome to
	yield an expanding number of novel proteins to optimize and
	commercially develop.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Leverage Corporate Collaborations.We plan to continue to expand the
	number of our corporate collaborations with leading
	pharmaceutical and biotechnology companies that are facing
	technical challenges to the development and commercialization of
	their therapeutic proteins and to leverage these corporate
	collaborations to expand our pipeline of product candidates. Our
	goal is to combine our expertise with that of our collaborators.
	We believe that we can add the greatest value to a project by
	applying our AMEsystem technology early on in the development
	process while relying on our collaborators to further develop
	and commercialize the improved product candidates. Corporate
	collaborators provide financial support for research and
	development, potential milestone payments and royalties on the
	sale of any products resulting from the collaboration.
|
| |  | Invest in Selected Internal Development
	Projects.We plan to select a limited
	number of promising candidates for internal development
	projects. We plan to focus on projects that we believe have
	lower development risks and target large, highly profitable
	markets including oncology, infectious diseases and autoimmune
	diseases.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | Enhance Our AMEsystem Technology.We plan to continue to develop our
	AMEsystem technology by investing significantly in research and
	development while simultaneously protecting and expanding our
	leading intellectual property position in directed molecular
	evolution. We plan to license and acquire from others
	technologies that complement and expand our core capabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

Development Programs

Since inception, we have entered into numerous
corporate collaborations and have pursued our own internal
development projects. We expect that corporate collaborations
will continue to be an important element of our business
strategy. Unless specifically mentioned, we do not have
commercialization rights to the intellectual property of
products developed from our collaborations. The following is a
summary of our development programs and related corporate
collaborations:



| |          
| | ---------
| | MedImmune

In February 1999, we entered into a four-antibody
corporate collaboration with MedImmune. The agreement covers the
licensing of Vitaxin to MedImmune as well as the optimization of
three additional antibodies, including Synagis and an antibody
against IL-9. Licenses granted under this agreement are
exclusive and worldwide covering the right to research, develop,
sell and sublicense. The business terms of the agreement
includes research and development support, potential milestone
payments, royalties on the sales of products resulting from the
collaboration and an equity investment. The duration of the
research and development aspect of this agreement has been
extended through February 2003.

Synagis, MedImmunes flagship product, is
currently the only FDA-approved monoclonal antibody for the
prevention of Respiratory Syncytial Virus infection. By applying
our AMEsystem technology, we created several new drug candidates
for treating this serious lung infection that have been
demonstrated in disease models to be at least 10 times more
potent than Synagis. MedImmune is expected to initiate clinical
trials with one of these candidates, and if successful, market
it as Numax. This more potent version of Synagis could enable
MedImmune to address new markets including the elderly, reduce
production costs and pursue additional methods for administering
the drug in order to broaden the products use.

Vitaxin is an anti-angiogenic antibody with
potential applications in cancer and arthritis. We licensed
LM609, the mouse antibody from which Vitaxin was derived, from
The Scripps Research Institute. We then improved Vitaxin to
overcome a potential immune reaction in humans and licensed it
to MedImmune. MedImmune is now in clinical development with a
second-generation version of Vitaxin that we developed using our
AMEsystem technology. This version of the antibody has
significantly improved affinity as well as

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decreased manufacturing costs. During 2001,
MedImmune initiated two Phase I clinical trials for cancer
and one Phase I trial for rheumatoid arthritis with this
antibody.


Anti-IL-9 is an antibody with potential
applications in respiratory disease including asthma.



| |                      
| | ---------------------
| | Eli Lilly and Company

In December 2001, we entered into a corporate
collaboration covering the optimization of an antibody and a
non-antibody protein therapeutic with Eli Lilly and Company
(Lilly). Under the terms of the agreement, AME
received an upfront signing fee and may receive milestone
payments and royalties on the sales of products resulting from
the collaboration. In February 2002, an additional agreement was
entered into by AME and Lilly to include the optimization of an
additional antibody therapeutic.



| |       
| | ------
| | Chiron

In December 2001, we entered in to a corporate
collaboration covering the optimization of a non-antibody
protein therapeutic with Chiron Corporation. Under the terms of
the agreement, AME received an upfront signing fee and may
receive milestone payments and royalties on the sales of
products resulting from the collaboration.



| |          
| | ---------
| | CancerVax

In November 1999, we entered into a corporate
collaboration covering up to four novel antibody therapeutics
with Cell-Matrix. During 2000, we completed the optimization of
the first two compounds, and the agreement was not extended to
include the remaining two potential compounds. Under the terms
of the agreement, we may receive milestone payments and
royalties relating to the two optimized compounds. CancerVax
acquired Cell-Matrix in January 2002.



| |           
| | ----------
| | Biosynexus

In December 2000, we entered into a corporate
collaboration covering the optimization of an antibody
therapeutic, HU96-110, with Biosynexus. During 2001 we completed
the optimization of HU96-110, which is being developed for the
treatment of staphylococcal bacterial infections. The business
terms of the agreement include research and development support,
potential milestone payments and royalties on the sale of
products resulting from the collaboration.



| |                     
| | --------------------
| | Bristol-Myers Squibb

We have entered into two separate agreements with
Bristol-Myers Squibb. We have completed our optimization work
under these agreements and may receive milestone payments and
royalties on the sale of products resulting from the
collaboration. Under the terms of the agreement, portions of the
milestone payments may be creditable against royalties.

In June 1993, we entered into our initial
corporate collaboration with Bristol-Myers Squibb to optimize
their BR96 anti-solid tumor antibody and to develop a discovery
technology program to treat tumors. Bristol-Myers Squibb renewed
this collaboration in 1995. As discussed below, hBR96, our
improved version of BR96, is currently in preclinical
development with Seattle Genetics, a biotechnology company
founded by former Bristol-Myers Squibb scientists. Based on the
success of our initial collaborations, Bristol-Myers Squibb
amended our agreement in 1998 to include the optimization of its
anti-CD40 antibody for treating inflammatory disease, which has
now been completed. Bristol-Myers Squibb is in preclinical
development with the optimized anti-CD40 antibody.



| |                 
| | ----------------
| | Seattle Genetics

Seattle Genetics is in preclinical development
with hBR96 for the potential treatment of cancers. After we
optimized BR96 for Bristol-Myers Squibb, Seattle Genetics
licensed this product candidate from Bristol-Myers Squibb. Under
our original agreement with Bristol-Myers Squibb and an
agreement among Bristol-

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Myers Squibb, Seattle Genetics and AME, we may
receive milestone payments and royalties on the sale of products
resulting from the collaboration.


Internal Development Programs

We are using our AMEsystem technology to develop
both improved versions of currently marketed biopharmaceuticals
and novel human protein therapeutics. We are working on
improving multiple FDA-approved drugs that are already marketed
by third parties and in their present, unimproved forms are
expected to each have sales in excess of $100.0 million in
2002.



| |     
| | ----
| | BChE

In September 2001, we announced the award of a
$1.0 million grant from the NIH to support the development
of BChE, a therapeutic enzyme we licensed from the University of
Nebraska Medical Center in March 2000 and the Mayo Clinic in
January 2001, for the potential treatment of acute cocaine
toxicity and chronic cocaine addiction. BChE is a naturally
occurring human serum enzyme that breaks down cocaine to
inactive byproducts before it can exert its psychopharmacologic
effects. AME has developed BChE variants using the AMEsystem
demonstrating over 100-fold increased activity compared with
naturally occurring BChE and have taken the resulting candidate
molecules into preclinical development.

We have full commercialization rights to these
internal development projects.

Intellectual Property

We hold patents and rights to patents within the
field of directed molecular evolution with an extensive
portfolio that includes 20 issued U.S. patents related to our
proprietary directed molecular evolution technology. Forty
counterpart patents to these U.S. patents are issued in other
major industrialized countries. We have an additional 29 pending
U.S. patent applications and 54 pending foreign and
international counterpart applications relating to our AMEsystem
technology and the application of this technology to diverse
industries including protein pharmaceuticals and industrial
enzymes.

Our intellectual property portfolio includes
trade secrets, know-how, trademarks, patents and patent
applications related to DirectAME gene synthesis, ExpressAME
protein expression and SelectAME protein screening as well as
the exclusive license to the Kauffman patents.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | DirectAME:The
	DirectAME gene synthesis patents are directed to methods for
	generating genetic diversity which can be used for conducting
	directed molecular evolution. They claim methods for introducing
	changes at the codon level to generate genetic diversity.                                                                                                                                                                                                                                                                                                                                             
|
| |  | ExpressAME:ExpressAME is a system used for
	conducting directed molecular evolution in both bacterial and
	mammalian cells. This system enables the expression of many
	therapeutic proteins in their functional, properly folded
	states, a feature that cannot always be achieved by relying
	exclusively on bacterial expression systems.                                                                                                                                                                                                                                                                        
|
| |  | SelectAME:We have a
	number of issued patents and pending patent applications
	relating to our SelectAME technologies for screening protein
	libraries. The patents and patent applications describe methods
	for evaluating protein function.                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | Kauffman Patents:The Kauffman patent family comprises six issued U.S. patents
	with claims covering methods of randomly generating proteins,
	which we believe is required by many directed molecular
	evolution technologies. We were granted an exclusive license to
	the Kauffman patent family in 1994. The first Kauffman patent
	application was filed in 1985, and the first U.S. Kauffman
	patent issued in 1998 with a term extending into 2015. Their
	patent prosecution history includes a successful defense to an
	opponents challenge in Japan as well as being issued in
	Europe with no challenge.

We are fully committed to investing in the
further development, expansion and enforcement of our leading
intellectual property position in directed molecular evolution.

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On June 25, 2001, we filed a complaint
against MorphoSys AG and its wholly owned subsidiary MorphoSys
USA, Inc. in the United States District Court for the District
of Massachusetts seeking injunctive relief and damages on behalf
of the Company. The complaint alleges that MorphoSys AG and
MorphoSys USA, Inc. are willfully infringing the Kauffman patent
family under which we hold an exclusive license.

Competition

We are a leader in the application of directed
molecular evolution to the optimization and development of
biotherapeutics. We are aware that companies such as Maxygen,
Inc., Diversa Corporation, Genencor International, Inc., and
Enchira Biotechnology Corporation rely on alternative methods
such as gene shuffling and extremophile isolation for obtaining
or generating genetic diversity. Some or all of these companies
will compete against us to develop novel human biotherapeutic
products and to improve currently marketed, FDA-approved drugs.
Academic institutions such as the California Institute of
Technology and the University of Washington are also working in
this field. In the future, we expect the field to become highly
competitive and that companies and academic and research
institutions will seek to develop technologies that could be
competitive with our AMEsystem technology. Any products that we
may develop through our AMEsystem technology will compete in
highly competitive markets, especially our improved versions of
currently marketed, FDA-approved biopharmaceuticals.

Many of our potential competitors have
substantially greater financial, technical and personnel
resources than we do, and we cannot be certain that they will
not succeed in developing technologies and products that would
render our technology and products or those of our collaborators
obsolete or noncompetitive. In addition, many of those
competitors have significantly greater experience than we do in
their respective fields. Our ability to compete successfully
will depend, in part, on:



| |   |                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------
| |  | our ability to demonstrate the applicability of
	our technology to optimizing a broad range of proteins
|
| |  | the cost-effectiveness of our optimization
	approach                                                   
|
| |  | our ability to develop products that reach the
	market first                                           
|
| |  | our ability to develop products that are
	technologically superior to other products in the market     
|
| |  | our ability to obtain and enforce patents
	covering our technology                                     

Government Regulation

Our collaborators are in early stages of the FDA
regulatory process for drug candidates we have optimized.

One of the product candidates with respect to
which we have a collaboration is currently in human clinical
trials. MedImmune commenced three Phase I human clinical trials
with second-generation Vitaxin in 2001.

Our corporate collaborators control all aspects
of the clinical testing of product candidates we optimized for
them. We do not have any internal development product candidates
in clinical development.

Any product candidates that we, or our
collaborators, develop will require regulatory clearances prior
to clinical trials and additional regulatory clearances prior to
commercialization. Drugs are subject to regulation under the
Federal Food, Drug and Cosmetic Act, and biological products, in
addition to being subject to provisions of that Act, are
regulated under the Public Health Service Act. Both statutes and
related regulations govern, among other things, the testing,
manufacturing, safety, efficacy, labeling, storage, record
keeping, advertising and other promotional practices.

FDA approval is required prior to marketing a
pharmaceutical product in the United States. To obtain this
approval the FDA requires clinical trials to demonstrate the
safety, efficacy and potency of the product candidates. Clinical
trials are the means by which experimental drugs or treatments
are tested in humans. New therapies typically advance from
laboratory, research, animal, preclinical, testing and finally
through several phases of clinical, human testing. Upon
successful completion of clinical trials, approval to market the

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therapy for a particular patient population may
be requested from the FDA in the United States and/or its
counterparts in other countries.


Clinical trials are normally done in three
phases. In Phase I, trials are conducted with a small number of
patients or healthy volunteers to determine the safety profile,
the pattern of drug distribution and metabolism and early
evidence of effectiveness. In Phase II, trials are conducted
with a larger group of patients afflicted with a target disease
in order to determine preliminary efficacy, optimal dosages and
expanded evidence of safety. In Phase III, large scale,
multicenter, comparative trials are conducted with patients
afflicted with a target disease in order to provide enough data
for the statistical proof of safety, efficacy and potency
required by the FDA and other regulatory authorities. For
life-threatening diseases, initial human testing generally is
done in patients rather than healthy volunteers. These studies
may provide results traditionally obtained in Phase II trials
and are referred to as Phase I/ II trials.

Obtaining FDA approval is a costly and
time-consuming process. Generally, in order to gain FDA
pre-market approval, preclinical studies must be conducted in
the laboratory and in animal model systems to gain preliminary
information on an agents efficacy and to identify any
major safety concerns. The results of these studies are
submitted as a part of an application for an Investigational New
Drug, or IND, which the FDA must review and allow before human
clinical trials can commence. The IND includes a detailed
description of the clinical investigations.

A company must sponsor and file an IND for each
proposed product and must conduct clinical studies to
demonstrate the safety, efficacy and potency that are necessary
to obtain FDA approval. The FDA receives reports on the progress
of each phase of clinical testing, and it may require the
modification, suspension or termination of clinical trials if an
unwarranted risk is presented to patients.

After completion of clinical trials of a new
product, FDA marketing approval must be obtained. If the product
is regulated as a biologic, a Biologic License Application, or
BLA, is required. If the product is classified as a new drug, a
New Drug Application, or NDA, is required. The NDA or BLA must
include results of product development activities, preclinical
studies and clinical trials in addition to detailed
manufacturing information.

Applications submitted to the FDA are subject to
an unpredictable and potentially prolonged approval process. The
FDA may require additional preclinical or clinical studies or
ultimately decide that the application does not satisfy its
criteria for approval. Even if FDA regulatory clearances are
obtained, a marketed product is subject to continual review, and
later discovery of previously unknown problems or failure to
comply with the applicable regulatory requirements may result in
restrictions on the marketing of a product or withdrawal of the
product from the market as well as possible civil or criminal
sanctions. Before marketing clearance is secured, the
manufacturing facility will be inspected for current Good
Manufacturing Practices, or GMP, compliance by FDA inspectors.
The manufacturing facility must satisfy current GMP requirements
prior to marketing clearance. In addition, after marketing
clearance is secured, the manufacturing facility will be
inspected periodically for GMP compliance by FDA inspectors,
and, if the facility is located in California, by inspectors
from the Food and Drug Branch of the California Department of
Health Services.

In both domestic and foreign markets, sales of
any approved products will depend on reimbursement from
third-party payers, such as government and private insurance
plans. Third-party payers are increasingly challenging the
prices charged for medical products and services. If we succeed
in bringing one or more product candidates to market, these
products may not be considered cost-effective, reimbursement may
not be available, or reimbursement policies may adversely affect
our ability to sell our products on a profitable basis.

We also are subject to various federal, state and
local laws, regulations and recommendations relating to safe
working conditions, laboratory and manufacturing practices, the
experimental use of animals and the use and disposal of
hazardous or potentially hazardous substances, including
radioactive compounds and infectious disease agents, used in
connection with our research. The extent of government
regulation which might result from any future legislation or
administrative action cannot be accurately predicted.

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Employees

As of December 31, 2001, we had 83 full-time
employees, 37 of whom hold advanced degrees. Sixty-four of our
full-time employees were engaged in research and development and
19 were engaged in business development, finance and general
administration. None of our employees is represented by labor
unions or covered by collective bargaining agreements. We have
not experienced any work stoppages and consider our employee
relations to be good.

RISK FACTORS

We have not achieved profitability and may
never become profitable.

We are at an early stage of development. We
incurred a net loss of $13.2 million for the year ended
December 31, 2001, and our revenue for 2001 was $3.6
million. Additionally, we have had net losses each year since
inception and as of December 31, 2001, had an accumulated
deficit of $54.1 million. We expect to report a net loss
for fiscal year 2002, and we expect to report increasing net
losses for the foreseeable future. We may never achieve
profitability. The size of our net losses will depend, in part,
on the rate of growth, if any, in our contract revenue and on
the level of our expenses. To date, we have derived most of our
revenue from corporate collaborations and expect to continue to
do so for the foreseeable future. Revenue from corporate
collaborations is uncertain because our ability to secure future
agreements will depend upon our ability to address the needs of
our potential collaborators. We expect to spend significant
amounts to fund research and development and enhance our core
technology. We expect that our operating expenses will increase
significantly in the near term and, consequently, we will need
to generate significant additional revenue to achieve
profitability. Even if we do achieve profitability, we may not
be able to sustain or increase profitability on a quarterly or
annual basis.

We may need additional capital in the future.
If additional capital is not available, we may have to curtail
or cease operations.

We may need to raise more money to continue our
operations. We may seek additional funds from public and private
stock offerings, corporate collaborations, borrowings under
lease lines of credit or other sources. If we cannot raise more
money, we may have to reduce our capital expenditures, scale
back our development of new products, reduce our workforce or
license to others product candidates or products that we
otherwise would seek to commercialize ourselves. We expect that
our current resources, together with future operating revenues,
will be sufficient to fund operations for at least the next two
years. The amount of money we will need will depend on many
factors, including:



| |   |                                                     
| | - | ----------------------------------------------------
| |  | the success of our research and development
	efforts
|
| |  | our ability to establish collaborative agreements   
|
| |  | our costs of prosecuting and maintaining patents    
|
| |  | market and competing technological developments     

Additional capital may not be available on terms
acceptable to us, or at all. Any additional equity financing may
be dilutive to stockholders, and debt financing, if available,
may include restrictive covenants.

The commercial utility of our AMEsystem
technology is unproven and may never be realized.

While we have met with initial success in
applying our AMEsystem technology, to prove the commercial value
of our technology, we or our collaborators will need to
commercialize biotherapeutics that we have optimized. Successful
commercialization of biotherapeutics requires: preclinical
testing, clinical trials, regulatory approval and commercial
manufacturing. It will take us or our collaborators many years
to complete these steps for any biotherapeutic. If we or our
collaborators do not undertake and successfully complete these
activities, then our AMEsystem technology will be of little
commercial value, and our ability

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to generate revenue will be limited. Currently,
there is one product candidate, Vitaxin, in clinical trials that
has been developed using our technology.


We have announced the optimization of only two
types of proteins and may not be able to optimize others,
thereby limiting our market potential.

To date we have announced the optimization of
only proteins from the classes of antibodies and enzymes for
corporate collaborators and internal development projects. If we
are unable to apply our AMEsystem technology to other types of
proteins, the scope of our potential business will be
significantly limited.

If our collaborators are not successful or if
we are unable to find collaborators in the future, we may not be
able to commercialize product candidates.

Our strategy for developing and commercializing
product candidates calls for us to enter into contractual
arrangements with collaborators. We may be unsuccessful in
attracting collaborators to develop and commercialize our
product candidates. Some collaborators may not perform their
obligations as we expect, or we may not derive any revenue from
these arrangements. We do not know whether these collaborators
will successfully develop and market any product candidates
under their respective agreements. Moreover, some of our
collaborators are also researching competing technologies and
product candidates targeted by our collaborative programs. Our
success depends in part upon the performance by these
collaborators of their responsibilities under these
arrangements. We have no control over the resources that any
collaborator may devote to the development and commercialization
of product candidates under these collaborations. Our
collaborators may terminate their agreements with us or
otherwise fail to conduct their collaborative activities
successfully and in a timely manner. Our collaborators may elect
not to develop product candidates arising out of our
collaborative arrangements or not to devote sufficient resources
to develop, manufacture, market or sell these product candidates.

If product candidates we optimize do not
receive regulatory approval, neither we nor our collaborators
will be able to commercialize these product
candidates.

The FDA must approve any therapeutic product
candidate before it can be marketed in the United States. The
regulatory process is expensive and time-consuming. Before we or
a collaborator can file a new drug application with the FDA, the
product candidate must undergo extensive testing, including
animal studies and human clinical trials that can take many
years and may require substantial expenditures. Data obtained
from such testing may be susceptible to varying interpretations
which could delay, limit or prevent regulatory approval. Changes
in regulatory policy for product approval may cause delays or
rejections. Because our product candidates will be developed in
a novel way, government regulatory authorities may subject these
product candidates to greater scrutiny than those developed
using more conventional methods. Our collaborators are in early
stages of the FDA regulatory process for product candidates we
have optimized.

If we are unable to adequately protect our
proprietary technology, our competitive position could be
hurt.

The patent positions of pharmaceutical and
biotechnology companies, including our patent position, are
generally uncertain and involve complex legal and factual
questions. We may be able to protect our proprietary rights from
infringement by third parties only to the extent that our
proprietary technologies are covered by valid and enforceable
patents or are effectively maintained as trade secrets.
Furthermore, others may independently develop similar or
alternative technologies or design around our patented
technologies. Litigation or other proceedings to defend or
enforce our intellectual property rights could require us to
spend significant time and money and could disrupt and harm our
business.

We also rely upon trade secrets, technical
know-how and continuing inventions to develop and maintain our
competitive position. Others may independently develop
substantially equivalent proprietary information and techniques
or otherwise gain access to our trade secrets or disclose our
technology, and we may not be able to meaningfully protect our
trade secrets, or be capable of protecting our rights to our
trade secrets.

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If we infringe third-party patents or breach
our license agreements, litigation may deplete our resources and
undermine our ability to use our AMEsystem technology.

Our commercial success also depends in part on
neither infringing valid, enforceable patents or proprietary
rights of third parties, nor breaching any licenses that may
relate to our technology and product candidates. We are aware of
third-party patents that may relate to our technology. It is
possible that we may unintentionally infringe these patents or
other patents or proprietary rights of third parties. Any legal
action taken against us or our collaborative partners claiming
damages and seeking to enjoin commercial activities relating to
our product candidates and processes affected by third-party
rights may require us or our collaborators to obtain licenses in
order to continue to manufacture or market the affected product
candidates and processes. In addition, these actions may subject
us to potential liability for damages. We or our collaborators
may not prevail in an action, and any license required under a
patent may not be made available on commercially acceptable
terms, or at all. Litigation could result in substantial costs
and the diversion of managements efforts, regardless of
the result of the litigation.

If we lose our key personnel or are unable to
attract and retain additional personnel, we may be unable to
successfully develop our technology.

We are highly dependent on the principal members
of our management and scientific staff, particularly our
President and Chief Executive Officer, William D. Huse, M.D.,
Ph.D. If we lose their services we may not achieve our
objectives. In addition, recruiting and retaining qualified
scientific personnel to perform future research and development
work will be critical to our success. We do not have sufficient
personnel to fully execute our business plan, and there is
currently a shortage of skilled executives and scientists, which
is likely to continue. As a result, competition for experienced
executives and scientists from numerous companies and academic
and other research institutions may limit our ability to hire or
retain personnel on acceptable terms. If we fail to attract and
retain sufficient personnel, we may not be able to develop or
implement our technology.

Public perception of ethical and social issues
may limit the use of our technology, which could reduce our
revenue.

Our success will depend upon our ability to
develop product candidates through the application of our
directed molecular evolution technology. Governmental
authorities could, for social or other purposes, limit the use
of genetic modification or prohibit the practice of our
technology. Ethical and other concerns about the use of products
derived from modified genes could adversely affect their market
acceptance. If our technology or the product candidates we
develop cannot be marketed as a result, we would lose our core
business.

We use hazardous chemicals and radioactive and
biological materials in our business. Any claims relating to
improper handling, storage or disposal of these materials could
be time-consuming and costly.

We use hazardous materials, including chemicals,
and radioactive and biological materials. These materials
include o-phenylenediamine dihydrochloride, ethidium bromide and
acrylamide. Our operations also produce hazardous waste
products. We cannot eliminate the risk of accidental
contamination or discharge and any resultant injury from these
materials. We could be subject to civil damages in the event of
an improper or unauthorized release of, or exposure of
individuals to, hazardous materials. In addition, claimants may
sue us for injury or contamination that results from the use of
these materials. Federal, state and local laws and regulations
govern the use, manufacture, storage, handling and disposal of
these materials. Compliance with environmental laws and
regulations may be expensive, and current or future
environmental regulations may impair our research, development
or production efforts.

If people are harmed by drugs developed using
our AMEsystem technology, we may be sued for product
liability.

We may be sued for product liability and other
claims if our technology or products developed from our
technology are alleged to have caused harm. We may not be able
to avoid significant liability exposure. We

16



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maintain product liability insurance, but we may
not have sufficient coverage. If we are sued for any injury
caused by our product candidates and found liable, our financial
condition, reputation and ability to find collaborators may be
harmed.


Substantial sales of our common stock by our
existing stockholders could cause our stock price to
fall.

Future sales of common stock by our stockholders
under Rule 144 of the Securities Act of 1933 (the
Securities Act), or through the exercise of outstanding
registration rights or otherwise could have an adverse effect on
the price of our common stock. Shares of our common stock are
eligible for sale in the public market in reliance on
Rule 144(k) or Rule 701 under the Securities Act,
without any volume restrictions. Additionally, we registered a
total of 5,950,000 shares of common stock reserved for issuance
under our stock plans. Some of our existing stockholders have
rights to require us to register their shares for future sale.

Our financial condition could be affected by
offerings of our subsidiarys stock.

We could engage in future offerings or other
sales of the common or preferred stock of our subsidiary if our
board determines that it is in the best interests of the
stockholders to pursue that course of action. This could
adversely affect our business, financial condition and results
of operations. For example, any offering or other sale of a
minority portion of our subsidiarys stock could reduce the
subsidiarys contribution to our gross revenues.

We are subject to influence from our executive
officers and directors who may vote in ways with which you
disagree because they have interests both as managers and
stockholders.

Our officers and directors and their affiliates,
in the aggregate, own beneficially approximately 30% of our
outstanding shares of common stock. As a result, these
stockholders, acting together, would be able to effectively
control most matters requiring approval by our stockholders,
including the election of a majority of the directors. If your
interests as a stockholder are different from their interests as
both managers and stockholders, you may not agree with their
decisions.

MANAGEMENT

Executive Officers

Our executive officers and key employees, and
their ages and positions as of March 5, 2002, are:

|                                 |  |     |    |          |  |                                                
|-------------------------------- |  | --- | -- | -------- |  | -----------------------------------------------
|Name                             |  | Age |    | Position
|                                 |  |     |    |         
|William D. Huse, M.D., Ph.D.     |  |     | 47 |          |  | Chief Executive Officer, President and Director
|Lawrence E. Bloch, M.D., J.D.    |  |     | 36 |          |  | Chief Financial Officer and Secretary          
|Jeffry D. Watkins, Ph.D.         |  |     | 40 |          |  | Chief Scientific Officer                       
|James B. Breitmeyer, M.D., Ph.D. |  |     | 48 |          |  | Chief Medical Officer                          
|Keith S. Manchester, M.D.        |  |     | 33 |          |  | Vice President of Business Development         

William D. Huse, M.D., Ph.D.,founded our company in 1989 and has
been our Chief Executive Officer since January 1999.
Dr. Huse was affiliated with The Scripps Research Institute
from 1989 to 1990. Prior to joining Scripps, Dr. Huse was
Vice President, Research and Development at Stratagene, Inc., a
private biotechnology company, from 1986 to 1989. Dr. Huse
was an Assistant Professor at Yale University School of
Medicine, Section of Molecular Neurobiology, from 1984 to 1986.
Dr. Huse received his M.D. and Ph.D. in Neurosciences from
the Albert Einstein School of Medicine. Dr. Huse completed
his postdoctoral work at Cold Spring Harbor Laboratory.

Lawrence E. Bloch, M.D., J.D.,has been our Chief Financial Officer
since March 2000 and our Secretary since April 2000. From 1999
to 2002, he held the position of Vice President of Business
Development in our Company. From 1998 to 1999, he served as a
consultant to several private biotechnology companies, including
our Company and U.S. Genomics, Inc. In 1995, Dr. Bloch
co-founded CareCom, Inc., a developer of patient-

17



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oriented bioinformatics applications, and served
as its President from 1995 to 1999. Dr. Bloch received a
J.D. from Harvard Law School, an M.D. from Harvard Medical
School and an M.B.A. from Harvard Business School.
Dr. Bloch is also a member of the Board of Directors of our
subsidiary, Novasite Pharmaceuticals, Inc.


Jeffry D. Watkins, Ph.D.,has been our Chief Scientific Officer
since January 2002. From 1998 to 2002, he served as our Vice
President of Research. From 1994 to 1998, Dr. Watkins held
a variety of research positions in our Company. From 1993 to
1994, he was a research scientist at Hybritech, Inc., a public
biotechnology company focused on diagnostics. Dr. Watkins
received a Ph.D. in Biochemistry from Purdue University. He
completed his postdoctoral research at The Scripps Research
Institute and at Purdue University. He is also the recipient of
a National Institutes of Health Postdoctoral Fellowship. Dr.
Watkins has authored multiple scientific peer-reviewed articles,
is named inventor on numerous directed molecular evolution
patents and has been the principal investigator on multiple
federal grants.

James B. Breitmeyer, M.D., Ph.D.,has been our Chief Medical Officer
since December 2001. From 2000 to 2001, Dr. Breitmeyer was
President and CEO of the Harvard Clinical Research Institute.
From 1991 to 2000, Dr. Breitmeyer held a variety of
positions at Serono Laboratories, Inc., including Chief Medical
Officer and Senior Vice President of Research and Development.
Prior to Serono, Dr. Breitmeyer served as a consultant to
Immunogen, Inc., and held clinical and teaching positions at the
Dana Farber Cancer Institute and Harvard Medical School.
Dr. Breitmeyer received his M.D. and Ph.D. from Washington
University School of Medicine and is board certified in Internal
Medicine and Oncology.

Keith S. Manchester, M.D.,has been our Vice President of
Business Development since January 2002. From 2000 to 2002 he
held the position of Director of Business Development in our
Company. From 1999 to 2000, Dr. Manchester was an associate at
Vestar Capital Partners, a private equity firm specializing in
management buyouts. From 1997 to 1999, Dr. Manchester was
an investment banker in the healthcare group at Goldman, Sachs
& Co. He completed his surgical internship at Parkland
Medical Hospital in Dallas, Texas. Dr. Manchester received an
A.B. from Harvard College and an M.D. from Harvard Medical
School.




Item 2.     Properties.

Our executive office and research facilities are
located in San Diego, California, and comprise approximately
40,000 square feet of space. The leases on these facilities
expire in December 2003. We believe that our existing facilities
and equipment are well maintained and in good working condition
and that our current facilities will provide adequate capacity
through the term of the leases.

On March 4, 2002, AME Torrey View, LLC
(Torrey View), a 99% owned subsidiary of the
Company, which is consolidated in our financial statements,
purchased a 10.73 acre parcel of undeveloped land in San Diego
County from a third party at a cost of approximately
$8.0 million. The Company intends to develop this property
over the next few years as its corporate headquarters.

In connection with the purchase, the Company
borrowed approximately $10.0 million, under a $15.0 million
collateralized credit facility, from Merrill Lynch Bank USA to
fund the purchase price and certain development costs. The
Company expects to borrow the remaining $5.0 million under
the credit facility during 2002. The Company also entered into a
$3.0 million loan and a development and management
agreement with a group, that is not affiliated with the Company,
but that is affiliated with the 1% owner of Torrey View, who
will assist the Company with the development of the project. The
$3.0 million loan from the Company to the group is
collateralized by a perfected security interest in the 1%
owners membership rights in Torrey View and is due in 2004.




Item 3.     Legal
Proceedings.

On June 25, 2001, we filed a complaint
against MorphoSys AG and its wholly owned subsidiary MorphoSys
USA, Inc., in the United States District Court for the District
of Massachusetts seeking injunctive relief and damages on behalf
of the Company. The complaint alleges that MorphoSys AG and

18



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MorphoSys USA, Inc., are willfully infringing the
Kauffman patent family under which we hold an exclusive license.





Item 4.     Submission
of Matters to a Vote of Security Holders.

Not applicable.




PART II




Item 5.     Market
for Registrants Common Equity and Related Stockholder
Matters.

(a) Our common stock has been traded on the
Nasdaq National Market since our initial public offering on
July 27, 2000, under the symbol AMEV. Prior to such time,
there was no public market for our common stock. The following
table sets forth the range of the high and low sale prices for
our common stock, as reported on the Nasdaq National Market, for
the periods indicated since our initial public offering:

|                                   |  |      |       |     |  |   |       | 
|---------------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|Year Ended December 31, 2000       |  | High |       | Low
|                                   |  |      |       |    
|Third Quarter (from July 27, 2000) |  | $    | 40.25 |     |  | $ | 24.19 | 
|Fourth Quarter                     |  | $    | 39.88 |     |  | $ | 11.75 | 

|                             |  |      |       |     |  |   |      | 
|---------------------------- |  | ---- | ----- | --- |  | - | ---- | 
|Year Ended December 31, 2001 |  | High |       | Low
|                             |  |      |       |    
|First Quarter                |  | $    | 18.23 |     |  | $ | 5.75 | 
|Second Quarter               |  | $    | 14.06 |     |  | $ | 6.18 | 
|Third Quarter                |  | $    | 13.80 |     |  | $ | 7.00 | 
|Fourth Quarter               |  | $    | 12.80 |     |  | $ | 7.00 | 

On February 26, 2002, the last reported sale
price of our common stock on the Nasdaq National Market was
$7.89 per share. On February 26, 2002, there were
approximately 161 holders of record of our common stock.

We have never declared or paid any cash dividends
on our capital stock. We currently intend to retain future
earnings, if any, for development of our business and,
therefore, do not anticipate that we will declare or pay cash
dividends on our capital stock in the foreseeable future.

(b) The effective date of our first
registration statement, filed on Form S-1 under the
Securities Act of 1933 (No. 333-36830) relating to our
initial public offering of common stock, was July 26, 2000.
A total of 5,347,500 shares of our common stock were sold at a
price of $19.00 per share to an underwriting syndicate led by
CIBC World Markets, UBS PaineWebber Incorporated, formerly known
as PaineWebber Incorporated, and SG Cowen. Of these 5,347,500
shares, 697,500 shares were issued upon exercise of the
underwriters over-allotment option. The offering commenced
on July 27, 2000, and closed on August 2, 2000. The
initial public offering resulted in gross proceeds of
$101.6 million, $7.1 million of which was applied toward
the underwriting discount. Expenses related to the offering
totaled approximately $1.6 million. No direct or indirect
payments were made to any directors, officers, owners of ten
percent or more of any class of our equity securities, or other
affiliates of the Company other than for reimbursement of
expenses. Net proceeds to us, after deducting these expenses,
were approximately $92.9 million. We have used
approximately $3.6 million of the net offering proceeds for
a portion of the repurchase of 1.2 million shares of our
stock for $14.4 million. The balance of the proceeds was
applied towards the purchase of temporary investments consisting
of U.S. government agencies obligations, corporate
bonds, asset-backed securities, and cash and cash equivalents.

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Item 6.     Selected
Financial Data.

The following table presents our selected
historical financial data. The selected data should be read in
conjunction with Managements Discussion and Analysis
of Financial Condition and Results of Operations and the
financial statements included elsewhere in this Form 10-K,
including the notes to the consolidated financial statements.
The selected data in this section is not intended to replace the
consolidated financial statements.

|                                                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |       |       | 
|------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------- | ------- | ------- | ------ | ------- | ------- | ------ | ------ | ---- | ------ | ----- | ----- | - | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                                  |                                                                                                                                                                                                  |                                      
|                                                  |                                                                                                                                                                                                  | Years Ended December 31,             
|                                                  |                                                                                                                                                                                                  |                                      
|                                                  |                                                                                                                                                                                                  | 2001(1)(2)                            |         | 2000(1) |        | 1999(1) |         | 1998   |        | 1997
|                                                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |     
|                                                  |                                                                                                                                                                                                  |                                      
|                                                  |                                                                                                                                                                                                  | (In thousands, except per share data)
|Consolidated Statement of Operations
	Data:       |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|Revenue                                           |                                                                                                                                                                                                  | $                                     | 3,613   |         |        | $       | 2,693   |        |        | $    | 2,592  |       |       | $ | 2,590  |       |       | $ | 3,329  |      
|Operating expenses:                               |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|                                                  | Research and development                                                                                                                                                                         |                                       |         | 10,933  |        |         |         | 4,462  |        |      |        | 4,408 |       |   |        | 2,583 |       |   |        | 2,992 |      
|                                                  | General and administrative                                                                                                                                                                       |                                       |         | 4,361   |        |         |         | 2,834  |        |      |        | 1,363 |       |   |        | 1,975 |       |   |        | 2,637 |      
|                                                  | Stock-based compensation ($2,120, $3,882 and $78
	related to research and development and $4,687, $8,343 and $377
	related to general and administrative for 2001, 2000 and 1999,
	respectively) |                                       |         | 6,807   |        |         |         | 12,225 |        |      |        | 455   |       |   |        |      |       |   |        |      |      
|                                                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|                                                  |                                                                                                                                                                                                  | Total operating expenses              |         |         | 22,101 |         |         |        | 19,521 |      |        |       | 6,226 |   |        |       | 4,558 |   |        |       | 5,629 | 
|                                                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|Loss from operations                              |                                                                                                                                                                                                  |                                       | (18,488 | )       |        |         | (16,828 | )      |        |      | (3,634 | )     |       |   | (1,968 | )     |       |   | (2,300 | )    
|Minority interest                                 |                                                                                                                                                                                                  |                                       | 372     |         |        |         | 127     |        |        |      | 45     |       |       |   |       |       |       |   |       |      
|Interest income, net                              |                                                                                                                                                                                                  |                                       | 4,886   |         |        |         | 3,142   |        |        |      | 213    |       |       |   | 101    |       |       |   | 79     |      
|                                                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|Net loss                                          |                                                                                                                                                                                                  |                                       | (13,230 | )       |        |         | (13,559 | )      |        |      | (3,376 | )     |       |   | (1,867 | )     |       |   | (2,221 | )    
|Deemed dividend on Series F preferred stock       |                                                                                                                                                                                                  |                                       |        |         |        |         | (10,100 | )      |        |      |       |       |       |   |       |       |       |   |       |      
|                                                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|Net loss applicable to common stockholders        |                                                                                                                                                                                                  | $                                     | (13,230 | )       |        | $       | (23,659 | )      |        | $    | (3,376 | )     |       | $ | (1,867 | )     |       | $ | (2,221 | )    
|                                                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|Basic and diluted net loss per common share       |                                                                                                                                                                                                  | $                                     | (0.62   | )       |        | $       | (2.17   | )      |        | $    | (1.39  | )     |       | $ | (1.13  | )     |       | $ | (1.43  | )    
|                                                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|Weighted average shares outstanding               |                                                                                                                                                                                                  |                                       | 21,394  |         |        |         | 10,910  |        |        |      | 2,429  |       |       |   | 1,659  |       |       |   | 1,551  |      
|Consolidated Balance Sheet Data:                  |                                                                                                                                                                                                  |                                       |         |         |        |         |         |        |        |      |        |       |       |   |        |       |       |   |        |      
|Cash, cash equivalents and short-term investments |                                                                                                                                                                                                  | $                                     | 80,196  |         |        | $       | 89,550  |        |        | $    | 3,498  |       |       | $ | 824    |       |       | $ | 3,920  |      
|Working capital                                   |                                                                                                                                                                                                  |                                       | 79,742  |         |        |         | 90,565  |        |        |      | 3,225  |       |       |   | 313    |       |       |   | 1,052  |      
|Total assets                                      |                                                                                                                                                                                                  |                                       | 90,682  |         |        |         | 94,874  |        |        |      | 5,938  |       |       |   | 2,752  |       |       |   | 5,717  |      
|Long-term obligations                             |                                                                                                                                                                                                  |                                       |        |         |        |         |        |        |        |      | 17     |       |       |   |       |       |       |   | 17     |      
|Minority interest                                 |                                                                                                                                                                                                  |                                       |        |         |        |         | 372     |        |        |      | 225    |       |       |   |       |       |       |   |       |      
|Stockholders equity                              |                                                                                                                                                                                                  |                                       | 85,936  |         |        |         | 91,917  |        |        |      | 3,830  |       |       |   | 725    |       |       |   | 2,592  |      



---



|    |                                                                                                                                                                                                                        
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Amounts include the results of Novasite
	Pharmaceuticals, Inc. (Novasite), our majority-owned
	subsidiary, from July 13, 1999, its date of incorporation
	(see Note 1 of Notes to Consolidated Financial Statements).
|(2) | Amounts include the results of AME Torrey View,
	LLC (Torrey View), our majority-owned subsidiary,
	from August 17, 2001, its date of incorporation (see
	Note 1 of Notes to Consolidated Financial Statements).     

20



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|        |                                                                                       
|------- | --------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
	of Financial Condition and Results of Operations

The following discussion of the financial
condition and results of our operations should be read in
conjunction with the consolidated financial statements and notes
thereto included elsewhere in our Annual Report on
Form 10-K. This discussion contains forward-looking
statements concerning the Companys operating results and
timing of anticipated expenditures. Such statements involve
risks and uncertainties that could cause actual results to
differ materially from those projected. Factors that could cause
or contribute to such differences are described in the
Risk Factors and elsewhere in the Form 10-K.
Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect our analysis only as
of the date hereof. We assume no obligation to update these
forward-looking statements to reflect actual results or changes
in factors or assumptions affecting such forward-looking
statements.

Overview

We are a leader in the application of directed
molecular evolution to the optimization and development of
biotherapeutics. Directed molecular evolution is a process by
which genes and proteins are optimized for specific commercial
purposes. We focus principally on applying our technology to
human biotherapeutics, the largest and most profitable target
market for directed molecular evolution.

Since our formation, we have expended
considerable resources on the development of our AMEsystem
technology and the development of Vitaxin, a product candidate
engineered from an antibody we licensed from The Scripps
Research Institute. Much of our research and development from
1995 to 1999 was allocated to preclinical development and
initial clinical trials for Vitaxin. In 1999, we licensed
Vitaxin to MedImmune, which is responsible for future clinical
development expenses and commercialization. In 2001, MedImmune
initiated Phase I clinical trials with an improved,
second-generation version of Vitaxin that we enhanced using our
AMEsystem technology.

To date we have generated revenue from corporate
collaborations, product and technology licenses, prepaid
royalties and government grants. We have corporate
collaborations with MedImmune, Eli Lilly, Chiron, CancerVax,
Biosynexus, Bristol-Myers Squibb, Seattle Genetics and Aventis
Pharmaceuticals, Inc., the final one through our majority owned
subsidiary, Novasite. We have licensed intellectual property to
Biosite Incorporated, formerly Biosite Diagnostics, Inc., in
exchange for a nonrefundable, prepaid, fixed royalty which is
being recognized over six years, the estimated useful lives of
the related patents. Our government grants have come from the
National Institutes of Health. Research funding from corporate
collaborators and government grants is recognized as revenue
when the services are rendered.

We have incurred losses since our inception. As
of December 31, 2001, we had an accumulated deficit of
$54.1 million. These losses and this accumulated deficit
resulted from the significant costs incurred in the development
of our technology platform and the preclinical and clinical
development of Vitaxin. We expect these losses to increase as we
continue to invest in our AMEsystem technology and internal
development projects.

On August 17, 2001, we entered into an
Operating Agreement with Torrey View Phase II, L.P., to
establish AME Torrey View, LLC (Torrey View). Torrey
View is a 99% owned subsidiary and is consolidated in the
Companys financial statements. On March 4, 2002,
Torrey View purchased a 10.73 acre parcel of undeveloped
land in San Diego County from a third party at a cost of
approximately $8.0 million. The Company intends to develop
this property over the next few years as its corporate
headquarters.

In connection with the purchase, the Company
borrowed approximately $10.0 million, under a
$15.0 million collateralized credit facility, from Merrill
Lynch Bank USA to fund the purchase price and certain
development costs. The Company expects to borrow the remaining
$5.0 million under the credit facility during 2002. The
Company also entered into a $3.0 million loan and a
development and management agreement with a group, that is not
affiliated with the Company, but that is affiliated with the 1%
owner of Torrey View, who will assist the Company with the
development of the project. The $3.0 million loan from the
Company to the group is collateralized by a perfected security
interest in the 1% owners membership rights in Torrey View
and is due in 2004.

21



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Critical Accounting Policies and
Estimates

Our discussion and analysis of our financial
condition and results of operations are based upon the
Companys consolidated financial statements, which have
been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments
that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent
assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to revenue recognition,
patent costs and income taxes. We base our estimates on
historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

We believe the following critical accounting
policies affect the significant judgments and estimates used in
the preparation of our consolidated financial statements (see
note 1 to our financial statements on page F-7).



| |                    
| | -------------------
| | Revenue recognition

We recognize revenue when all four of the
following criteria are met: (i) persuasive evidence that an
arrangement exists; (ii) delivery of the products and/or
services has occurred; (iii) the selling price is fixed or
determinable; and (iv) collectibility is reasonably
assured. In addition, we follow the provisions of the Securities
and Exchange Commissions Staff Accounting Bulletin
No. 101 (SAB101), Revenue Recognition,
which sets forth guidelines in the timing of revenue recognition
based upon factors such as passage of title, installation,
payments and customer acceptance. Amounts received for upfront
product and technology license fees under multiple-element
arrangements are deferred and recognized over the period of such
services or performance if such arrangements require on-going
services or performance. Amounts received for milestones are
recognized upon achievement of the milestone, unless the amounts
received are creditable against royalties or we have ongoing
performance obligations. Royalty revenue will be recognized upon
sale of the related products, provided the royalty amounts are
fixed and determinable and collection of the related receivable
is probable. Any amounts received prior to satisfying our
revenue recognition criteria will be recorded as deferred
revenue in the accompanying balance sheets.



| |             
| | ------------
| | Patent costs

We capitalize the costs incurred to file patent
applications. These costs are amortized over a six-year
estimated life from the date of patent issuance. At
December 31, 2001, capitalized costs related to issued
patents total approximately $527,000 (net of accumulated
amortization) and approximately $1,338,000 related to unissued
patents. Our results of operations could be materially impacted
when we begin amortizing the costs related to unissued patents.
In addition, we expense all costs related to abandoned patent
applications. If we elect to abandon any of our currently issued
or unissued patents, the related expense could be material to
our results of operations for the period of the abandonment.



| |             
| | ------------
| | Income taxes

We record a valuation allowance to reduce our
deferred tax assets to the amount that is more likely than not
to be realized. While we have considered future taxable income
and ongoing prudent and feasible tax planning strategies in
assessing the need for the valuation allowance, in the event we
were to determine that we would be able to realize our deferred
tax assets in the future in excess of its net recorded amount,
an adjustment to the deferred tax asset would increase income in
the period such determination was made. Likewise, should we
determine that we would not be able to realize all or part of
our net deferred tax asset in the future, an adjustment to the
deferred tax asset would be charged to income in the period such
determination was made.

22



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##### Table of Contents



Results of Operations



| |                                                                        
| | -----------------------------------------------------------------------
| | Year Ended December 31, 2001, Compared
	to Year Ended December 31, 2000

Revenue.Revenue was
$3.6 million for the year ended December 31, 2001,
compared to $2.7 million for the year ended
December 31, 2000, an increase of $900,000. Revenues from
collaborators were $1.5 million for each of the years ended
December 31, 2001 and 2000. Other revenue increased to
$2.1 million for the year ended December 31, 2001,
from $1.2 million for the year ended December 31,
2000, an increase of approximately $900,000. This increase was
primarily due to additional grant revenue from the NIH earned in
2001.

Research and development.Research and development expenses
consist primarily of compensation and other expenses related to
research and development personnel, costs associated with
preclinical development of our product candidates, and
facilities expenses. We generally do not track our historical
research and development costs by projects, therefore we cannot
accurately estimate with any degree of certainty what our
historical costs have been for any particular research and
development project. Research and development expenses were
$10.9 million for the year ended December 31, 2001,
compared to $4.5 million for the year ended
December 31, 2000, an increase of $6.4 million. This
increase was primarily attributable to salaries and other
personnel related expenses, expansion of facilities and
additional supplies and equipment, due to an increase in
scientific staffing to support our internal development
projects, collaborations and grants.

General and administrative.General and administrative expenses
increased to $4.4 million for the year ended
December 31, 2001, from $2.8 million for the year
ended December 31, 2000, an increase of $1.6 million.
The increase was due primarily to the expansion of our
administrative infrastructure, including increases in salaries
and other personnel related expenses, expansion of facilities
and travel and professional fees, to support our growth and
increased business development efforts.

Stock-based compensation.Deferred compensation for options
granted to employees is the difference between the exercise
price and the estimated fair value of our common stock on the
date options were granted. Deferred compensation is included as
a component of stockholders equity and is being amortized
in accordance with Financial Accounting Standards Board (FASB)
Interpretation No. 28 over the vesting periods of the
related options, which is generally four years. Amortization of
deferred compensation, which is reported as stock-based
compensation in the statement of operations, was approximately
$6.8 million for the year ended December 31, 2001
($2.1 million related to research and development and
$4.7 million related to general and administrative), and
$12.2 million for the year ended December 31, 2000
($3.9 million related to research and development and
$8.3 million related to general and administrative).

Interest income, net.Net interest income increased to
$4.9 million for the year ended December 31, 2001,
from $3.1 million for the year ended December 31,
2000, an increase of $1.8 million. The increase was due
primarily to our higher average cash and investment balances
during 2001 as a result of the cash proceeds from the initial
public offering, which closed in the third quarter of 2000.



| |                                                                        
| | -----------------------------------------------------------------------
| | Year Ended December 31, 2000, Compared
	to Year Ended December 31, 1999

Revenue.Revenue was
$2.7 million for the year ended December 31, 2000,
compared to $2.6 million for the year ended
December 31, 1999, an increase of $100,000. Revenues from
collaborators decreased to $1.5 million for the year ended
December 31, 2000, from $2.0 million for the year
ended December 31, 1999, a decrease of approximately
$500,000. This decrease was primarily due to the onetime Vitaxin
licensing revenue of $1.2 million received from MedImmune
in 1999, offset by an increase in research collaboration revenue
of approximately $700,000 in 2000. Other revenue increased to
$1.2 million for the year ended December 31, 2000,
from $584,000 for the year ended December 31, 1999, an
increase of approximately $616,000. This increase was primarily
due to additional grant revenue earned in 2000.

Research and development.Research and development expenses were
$4.5 million for the year ended December 31, 2000,
compared to $4.4 million for the year ended
December 31, 1999, an increase of $100,000. Research and
development expenses attributable to salaries and other
personnel related expenses, and supplies and equipment,
increased approximately $1.8 million in 2000 due to an
increase in scientific staffing to support

23



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##### Table of Contents



our internal development projects, collaborations
and grants. This increase was offset by a reduction in research
and development expenses of approximately $1.7 million
incurred for clinical costs related to Vitaxin. These clinical
costs were incurred in 1999, and were not incurred in 2000, as
Vitaxin was licensed to MedImmune in 1999.


General and administrative.General and administrative expenses
increased to $2.8 million for the year ended
December 31, 2000, from $1.4 million for the year
ended December 31, 1999, an increase of approximately
$1.4 million. The increase was due primarily to increases
in salaries and other personnel related expenses, and travel and
professional fees for the expansion of the administrative
infrastructure to support the needs of a public company, and
professional fees in connection with the expansion of our
business development efforts.

Stock-based compensation.Deferred compensation for options
granted to employees is the difference between the exercise
price and the estimated fair value of our common stock on the
date options were granted. Deferred compensation is included as
a component of stockholders equity and is being amortized
in accordance with FASB Interpretation No. 28 over the
vesting periods of the related options, which is generally three
or four years.

Deferred compensation for options granted to
consultants has been determined in accordance with Statement of
Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation,as the fair
value of the equity instruments issued, and is periodically
remeasured as the underlying options vest in accordance with the
Emerging Issues Task Forces (EITF) 96-18,
Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services.

In connection with our granting stock options to
employees and consultants, we recorded aggregate deferred stock
compensation of $21.2 million for the year ended
December 31, 2000, compared to $1.1 million for the
year ended December 31, 1999. Amortization of deferred
compensation was approximately $12.2 million for the year
ended December 31, 2000 ($3.9 million related to
research and development and $8.3 million related to
general and administrative), and $455,000 for the year ended
December 31, 1999 ($78,000 related to research and
development and $377,000 related to general and administrative).

Interest income, net.Net interest income increased to
$3.1 million for the year ended December 31, 2000,
from $213,000 for the year ended December 31, 1999, an
increase of $2.9 million. The increase was due primarily to
our higher average cash and investment balances during 2000 as a
result of the cash proceeds from the initial public offering,
which closed in the third quarter of 2000.

Deemed dividend on beneficial conversion of
Series F preferred stock.On
May 3, 2000, and June 15, 2000, we issued 1,133,333
shares and 1,111,111 shares of our Series F preferred stock
for gross proceeds of $5.1 million and $5.0 million,
respectively, which converted into shares of common stock upon
the closing of our initial public offering. We recognized a
charge of $10.1 million to net loss applicable to common
stockholders for the beneficial conversion feature embedded in
the Series F preferred stock.

Liquidity and Capital Resources

In July 2000, we sold approximately
5.3 million shares of common stock in an initial public
offering, resulting in net proceeds to the Company of
approximately $92.9 million. Prior to the initial public
offering, we had financed our operations primarily through
private placements of equity securities, with aggregate net
proceeds of approximately $39.6 million. In addition, we
had generated $18.0 million of cash from research
collaborations through December 31, 2001.

In December 2000, we repurchased 1.2 million
shares of our common stock at a cost to us of $14.4 million.

As of December 31, 2001, we had
approximately $80.2 million in cash, cash equivalents and
short-term investments, compared to $89.6 million of cash,
cash equivalents and short-term investments as of
December 31, 2000.

For the year ended December 31, 2001, we
used cash of approximately $6.6 million in operating
activities primarily to fund our net losses of
$13.2 million, offset by non-cash charges for stock-based
compensation

24



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##### Table of Contents



totaling $6.5 million. We used approximately
$2.9 million of cash for operations in 2000 and
$3.2 million in 1999.


For the year ended December 31, 2001, we
used cash of approximately $4.4 million in investing
activities compared to the use of cash of approximately
$51.8 million for the year ended December 31, 2000.
For the year ended December 31, 1999, we used cash of
approximately $1.9 million in investing activities. Our
investing activities consisted primarily of purchases and sales
of short-term investments, and capital expenditures for property
and equipment. We expect to continue to make investments in our
infrastructure, including purchasing property and equipment to
support our operations.

For the year ended December 31, 2001, we
generated approximately $71,000 of cash from financing
activities. For the year ended December 31, 2000, we
generated $89.5 million of cash from financing activities,
primarily from the net proceeds of approximately
$92.9 million from the initial public offering,
$10.0 million of net proceeds from the sale of
Series F preferred stock, and $583,000 from the private
placement of equity securities in Novasite, offset by the
repurchase of 1.2 million shares of our common stock for
$14.4 million. In 1999, we generated $6.3 million of
cash from financing activities, primarily from the net proceeds
of sales of common stock, including $1.2 million from the
private placement of equity securities of Novasite.

We expect our cash requirements to increase
significantly in 2002 as we continue our research and
development efforts, hire additional personnel, grow our
administrative support activities and plan for our future
facility needs. These facility needs include property purchased
by Torrey View, the Companys 99% owned subsidiary. The
Company intends to develop this property as its corporate
headquarters over the next few years, which could involve a
substantial commitment. We believe that our current cash, cash
equivalents and investments and interest earned thereon,
together with funding received from collaborators and government
grants will be sufficient to satisfy our anticipated cash needs
for working capital and capital expenditures for at least the
next two years. However, it is possible that we will seek
additional financing within this timeframe. We may raise
additional funds through public or private financing,
collaborative relationships or other arrangements. We cannot
assure you that additional funding, if sought, will be available
on terms favorable to us. Further, any additional equity
financing may be dilutive to stockholders, and debt financing,
if available, may involve restrictive covenants. Our failure to
raise capital when needed may harm our business and operating
results.

On June 25, 2001, we filed a complaint
against MorphoSys AG and its wholly owned subsidiary MorphoSys
USA, Inc., in the United States District Court for the District
of Massachusetts seeking injunctive relief and damages on behalf
of the Company. The complaint alleges that MorphoSys AG and
MorphoSys USA, Inc., are willfully infringing the Kauffman
patent family under which we hold an exclusive license.

Income Taxes

We incurred net operating losses in 2001, 2000
and 1999, and consequently we did not pay any federal or state
income taxes. As of December 31, 2001, we had federal net
operating loss carryforwards of approximately
$26.0 million, which begin to expire in 2005. At
December 31, 2001, the net operating loss carryforwards for
state tax purposes were approximately $6.1 million, which
began to expire in 1999. We also had federal and state research
and development tax credit carryforwards at December 31,
2001, of $821,000 and $493,000, respectively, which begin to
expire in 2005, unless previously utilized.

Recently Issued Accounting
Pronouncements

In June 2001, the Financial Accounting Standards
Board issued SFAS No. 141, Business Combinations,and No. 142, Goodwill and Other Intangible Assets.SFAS No. 141 requires all business combinations
initiated after June 30, 2001, to be accounted for by the
purchase method. Under SFAS No. 142, goodwill and
intangible assets with indefinite lives are no longer amortized
but are reviewed annually (or more frequently if impairment
indicators arise) for impairment. Separate intangible assets
that are not deemed to have an indefinite life will continue to
be amortized over their useful lives (but with no maximum life).
The amortization provisions of SFAS No. 142 apply to
goodwill and intangible assets acquired after June 30,
2001. With respect to goodwill and intangible assets acquired
prior to July 1, 2001, we are required to adopt SFAS
No. 142 effective January 1, 2002. The Company does
not expect the adoption of these pronouncements to

25



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##### Table of Contents



have an effect on the consolidated financial
statements as the Company has not recorded any goodwill or other
intangible assets as a result of a business combination.


In August 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, which establishes one accounting model to
be used for long-lived assets to be disposed of by sale and
broadens the presentation of discontinued operations to include
more disposal transactions. SFAS No. 144 supercedes SFAS
No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30.
SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001. The Company does not believe the
adoption of SFAS No. 144 will have a material impact on its
financial statements.






|         |                                                             
|-------- | ------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
	About Market Risk.

The primary objective of our investment
activities is to preserve principal while at the same time
maximizing the income we receive from our investments without
significantly increasing risk. Some of the securities that we
invest in may have market risk. This means that a change in
prevailing interest rates may cause the principal amount of the
investment to fluctuate. For example, if we hold a security that
was issued with a fixed interest rate at the then-prevailing
rate and the prevailing interest rate later rises, the market
value of our investment will probably decline. To minimize this
risk in the future, we intend to maintain our portfolio of cash
equivalents and short-term investments in a variety of
securities, including commercial paper, money market funds, and
government and nongovernment debt securities. The average
duration of all of our investments in 2001 was approximately two
years. Due to the short-term nature of these investments, we
believe that we have no material exposure to interest rates
arising from our investments. A hypothetical 100 basis
point adverse move in interest rates along the entire interest
rate yield curve would not materially affect the fair value of
our interest sensitive financial instruments. Declines in
interest rates over time will, however, reduce our investment
income while increases in interest rates over time will increase
our interest expense.






|        |                                              
|------- | ---------------------------------------------
|Item 8. | Financial Statements and Supplementary
	Data.

The consolidated financial statements and
supplementary data of the Company required by this item are set
forth at the pages indicated in Item 14(a)(1).






|        |                                                                                        
|------- | ---------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
	Accountants on Accounting and Financial
	Disclosure.

Not applicable.




PART III






Item 10.     Directors
and Executive Officers of the Registrant.


Information regarding directors is incorporated
by reference to the section entitled Election of
Directors in the Proxy Statement. Information regarding
executive officers is contained in Part I of this
Form 10-K. Information regarding Section 16 reporting
compliance is incorporated by reference to the Proxy Statement
under the heading Section 16 Beneficial Ownership
Reporting Compliance.






Item 11.     Executive
Compensation.


The information required by this item is
incorporated by reference to the Proxy Statement under the
heading Executive Compensation.




Item 12.     Security
Ownership of Certain Beneficial Owners and
Management.

The information required by this item is
incorporated by reference to the Proxy Statement under the
heading Security Ownership of Certain Beneficial Owners
and Management.

26



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##### Table of Contents






Item 13.     Certain
Relationships and Related Transactions.

The information required by this item is
incorporated by reference to the Proxy Statement under the
heading Certain Transactions.




PART IV




Item 14.     Exhibits,
Financial Statement Schedules, and Report on
Form 8-K.

(a) The following documents are filed as
part of this report:



| |                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) Financial Statements                                                                                                                                                                                                          
|
| | The financial statements of the Company are
	included herein as required under Item 8 of this Annual
	Report on Form 10-K. See Index on page F-l.                                                                                 
|
| | (2) Financial Statement Schedules                                                                                                                                                                                                 
|
| | Schedules have been omitted because information
	required to be set forth therein is not applicable or is
	included in the financial statements or notes thereto.                                                                 
|
| | (3) Exhibits                                                                                                                                                                                                                      
|
| | The exhibits listed below are required by
	Item 601 of Regulation S-K. Each management contract
	or compensatory plan or arrangement required to be filed as an
	exhibit to the Form 10-K has been identified. See paragraph
	(c).

(b) Reports on Form 8-K

There were no reports on Form 8-K filed by
the Company during the fourth quarter of the fiscal year ended
December 31, 2001.

(c) Exhibits

|        |           |                         |  |                                                                                                                   
|------- | --------- | ----------------------- |  | ------------------------------------------------------------------------------------------------------------------
|Exhibit |           |                        
|Number  |           | Description of Document
|        |           |                        
|        | 3(i)(1)   |                         |  | Restated Certificate of Incorporation, as filed
	with the Delaware Secretary of State on August 1, 2000.          
|        | 3(ii)(2)  |                         |  | Amended and Restated Bylaws of the Company.                                                                       
|        | 4.1(3)    |                         |  | Form of Common Stock Certificate.                                                                                 
|        | 4.2(3)    |                         |  | Stock Purchase Agreement with MedImmune, Inc.
	dated as of February 24, 1999.                                     
|        | 4.3(3)    |                         |  | Stock Purchase Agreement with each of Hilal
	Capital Management LLC and Keith Manchester dated as of
	May 3, 2000.
|        | 4.4(4)    |                         |  | Stock Purchase Agreement with Attenuon, L.L.C.
	dated as of November 30, 2000.                                    
|        | 10.1.1(3) |                         |  | 1992 Stock Plan.                                                                                                  
|        | 10.1.2(3) |                         |  | Form of Stock Option Agreement under the 1992
	Stock Plan.                                                        
|        | 10.2.1(3) |                         |  | 2000 Stock Plan.                                                                                                  
|        | 10.2.2(3) |                         |  | Form of Stock Option Agreement under the 2000
	Stock Plan.                                                        
|        | 10.3(3)   |                         |  | License Agreement with Stuart A. Kauffman, M.D.
	dated as of November 3, 1994.                                    
|        | 10.4(3)  |                         |  | License Agreement with MedImmune, Inc. dated as
	of February 24, 1999.                                            
|        | 10.5(3)  |                         |  | Research and Assignment and License Agreement
	with MedImmune, Inc. dated as of February 24, 1999.                
|        | 10.6(3)  |                         |  | Selection Agreement with MedImmune, Inc. dated as
	of February 24, 1999.                                          
|        | 10.7(3)  |                         |  | License Agreement with The Scripps Research
	Institute dated as of May 20, 1994.                                  
|        | 10.8(3)  |                         |  | Collaboration Agreement with Cell-Matrix, dated
	as of November 29, 1999.                                         

27



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##### Table of Contents



|        |           |                         |  |                                                                                                                                                                                                                                                              
|------- | --------- | ----------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |           |                        
|Number  |           | Description of Document
|        |           |                        
|        | 10.9(3)   |                         |  | Lease Agreement for 3520 Dunhill Street, San
	Diego, California dated as of June 1, 1993, as amended.                                                                                                                                                        
|        | 10.10(3)  |                         |  | Form of Indemnification Agreement with executive
	officers and directors.                                                                                                                                                                                    
|        | 10.11(3)  |                         |  | Warrants issued August 30, 1996.                                                                                                                                                                                                                             
|        | 10.12(3)  |                         |  | Warrants issued June 23, 1997.                                                                                                                                                                                                                               
|        | 10.13(3)  |                         |  | 2000 Employee Stock Purchase Plan.                                                                                                                                                                                                                           
|        | 10.14(3) |                         |  | License Agreement with Biosite Diagnostics
	Incorporated dated as of September 9, 1998.                                                                                                                                                                      
|        | 10.15(3)  |                         |  | Amendment dated as of July 3, 2000, to
	Collaboration Agreement with Cell-Matrix, Inc.                                                                                                                                                                       
|        | 10.16(4)  |                         |  | Lease Agreement for 11095 Flintkote Avenue, San
	Diego, California dated as of November 20, 2000.                                                                                                                                                            
|        | 10.17(4)  |                         |  | Amendment dated as of March 8, 2001 to
	Selection Agreement with MedImmune, Inc.                                                                                                                                                                             
|        | 10.18(5)  |                         |  | 2001 Stock Incentive Plan.                                                                                                                                                                                                                                   
|        | 10.19     |                         |  | Amended and Restated Operating Agreement of AME
	Torrey View, LLC, with Torrey View Phase II, L.P., dated as of
	August 17, 2001.                                                                                                                            
|        | 10.20     |                         |  | Assignment Agreement by and between Torrey View
	Phase II, L.P. and AME Torrey View, LLC, dated as of
	September 12, 2001.                                                                                                                                   
|        | 10.21     |                         |  | Commercial Land Purchase and Sale Agreement and
	Joint Escrow Instructions by and between Torrey View Phase II,
	L.P. and Westbrook Torrey Hills, L.P., dated as of July 10,
	2001.                                                                          
|        | 10.22     |                         |  | First Amendment to Commercial Land Purchase and
	Sale Agreement and Joint Escrow Instructions by and between AME
	Torrey View, LLC, as successor-in-interest to Torrey View Phase
	II, L.P., and Westbrook Torrey Hills, L.P., dated as of
	October 11, 2001.
|        | 10.23     |                         |  | Lease Agreement with AME Torrey View, LLC dated
	as of August 20, 2001.                                                                                                                                                                                      
|        | 10.24     |                         |  | Secured Promissory Note with Ocean Air
	Associates, LLC dated March 4, 2002.                                                                                                                                                                                 
|        | 10.25     |                         |  | Pledge Agreement with Torrey View Phase II, L.P.
	dated as of March 4, 2002.                                                                                                                                                                                 
|        | 10.26     |                         |  | Portfolio Reserve Plus Loan, Letter of Credit and
	Collateral Account Agreement with Merrill Lynch Bank USA.                                                                                                                                                 
|        | 10.27     |                         |  | Employment Agreement with James B. Breitmeyer
	dated November 20, 2001.                                                                                                                                                                                      
|        | 21.1      |                         |  | Subsidiaries of the Company.                                                                                                                                                                                                                                 
|        | 23.1      |                         |  | Consent of Ernst & Young LLP, Independent
	Auditors.                                                                                                                                                                                                         
|        | 24.1      |                         |  | Power of Attorney (see page 29).                                                                                                                                                                                                                             



---



|    |                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to Exhibit 3(i).2
	filed with the Companys Registration Statement on
	Form S-1 (No. 333-36830) filed on May 12, 2000.                 
|   
|(2) | Incorporated by reference to Exhibit 3(ii).2
	filed with the Companys Registration Statement on
	Form S-1 (No. 333-36830) filed on May 12, 2000.                
|   
|(3) | Incorporated by reference to the exhibits of the
	same number filed with the Companys Registration Statement
	on Form S-1 (No. 333-36830) filed on May 12, 2000.
|   
|(4) | Incorporated by reference to the exhibits of the
	same number filed with the Companys Annual Report on
	form 10-K (No. 000-31101) filed on March 19, 2001.      
|   
|(5) | Incorporated by reference to Exhibit A filed
	with the Companys Proxy Statement on Schedule 14A
	(File No. 000-31101) filed on April 23, 2001.                  



|  |                                                                                          
|- | -----------------------------------------------------------------------------------------
| | The Company has received confidential treatment
	of certain portions of these agreements.

28



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##### Table of Contents






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 on Form 10-K to be signed on
its behalf by the undersigned, thereunto duly authorized, in the
City of San Diego, State of California, on the fifth day of
March, 2002.



| |                                  
| | ---------------------------------
| | APPLIED MOLECULAR EVOLUTION, INC.



| |     |                                 
| | --- | --------------------------------
| | By: | /s/ WILLIAM D. HUSE, M.D., PH.D.

| |                                       
| | --------------------------------------
| |                                       
| | William D. Huse, M.D., Ph.D.          
| | President and Chief Executive
	Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each
person whose signature appears below constitutes and appoints
William D. Huse, M.D., Ph.D., and Lawrence E. Bloch, M.D., J.D.,
and each of them, his or her true and lawful attorneys-in-fact
and agents, each with full power of substitution and
resubstitution, for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments, including
post-effective amendments, to this Report on Form 10-K, and
to file the same, with all exhibits thereto and other documents
in connection herewith, with the Securities and Exchange
Commission, granting unto the attorneys-in-fact and agents, and
each of them, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he
or she might or could do in person, hereby ratifying and
confirming all that the attorneys-in-fact and agents, or either
of them, or their, his or her substitutes or substitute, may
lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities
Exchange Act of 1934, as amended, this Report on Form 10-K
has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

|                                                                 |  |                                                                                   |  |              
|---------------------------------------------------------------- |  | --------------------------------------------------------------------------------- |  | -------------
|Name                                                             |  | Title                                                                             |  | Date         
|                                                                 |  |                                                                                   |  |              
|/s/ WILLIAM D. HUSE, M.D., PH.D.William D. Huse, M.D., Ph.D.     |  | President and Chief Executive Officer (Principal
	Executive Officer) and Director |  | March 5, 2002
|/s/ LAWRENCE E. BLOCH, M.D., J.D.Lawrence E. Bloch, M.D., J.D    |  | Chief Financial Officer (Principal Financial and
	Accounting Officer)             |  | March 5, 2002
|/s/ COSTA G. SEVASTOPOULOS, PH.D.Costa G. Sevastopoulos, Ph.D.   |  | Chairman of the Board                                                             |  | March 5, 2002
|/s/ PETER K. HILAL, M.D.Peter K. Hilal, M.D.                     |  | Director                                                                          |  | March 5, 2002
|/s/ JOHN F. RICHARDSJohn F. Richards                             |  | Director                                                                          |  | March 5, 2002
|/s/ STANLEY T. CROOKE, M.D., PH.D.Stanley T. Crooke, M.D., Ph.D. |  | Director                                                                          |  | March 5, 2002

29



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##### Table of Contents






INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                                                                      |  |      |     | 
|----------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                      |  | Page
|                                                                                                      |  |     
|Report of Ernst & Young LLP, Independent
	Auditors                                                    |  |      | F-2 | 
|Consolidated Balance Sheets as of
	December 31, 2001 and 2000                                         |  |      | F-3 | 
|Consolidated Statements of Operations for the
	years ended December 31, 2001, 2000 and 1999           |  |      | F-4 | 
|Consolidated Statements of Stockholders
	Equity for the years ended December 31, 2001, 2000 and 1999 |  |      | F-5 | 
|Consolidated Statements of Cash Flows for the
	years ended December 31, 2001, 2000 and 1999           |  |      | F-6 | 
|Notes to Consolidated Financial Statements                                                            |  |      | F-7 | 

F-1



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##### Table of Contents






REPORT OF ERNST & YOUNG LLP, INDEPENDENT
AUDITORS

The Board of Directors and Stockholders

Applied Molecular Evolution, Inc.


We have audited the accompanying consolidated
balance sheets of Applied Molecular Evolution, Inc. as of
December 31, 2001 and 2000, and the related consolidated
statements of operations, stockholders equity, and cash
flows for each of the three years in the period ended
December 31, 2001. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements 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 financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the consolidated financial position of Applied
Molecular Evolution, Inc. at December 31, 2001 and 2000,
and the consolidated results of its operations and its cash
flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles
generally accepted in the United States.



| |                      
| | ---------------------
| | /s/ ERNST & YOUNG LLP

San Diego, California

February 8, 2002,


except for the second paragraph of Note 6


and Note 11, as to which the date is


March 4, 2002


F-2



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.






CONSOLIDATED BALANCE SHEETS


(In thousands, except share and per share
data)


|                                           |                                                  |                                                                                                         |        |         |    |   |        |         |    | 
|------------------------------------------ | ------------------------------------------------ | ------------------------------------------------------------------------------------------------------- | ------ | ------- | -- | - | ------ | ------- | -- | 
|                                           |                                                  |                                                                                                        
|                                           |                                                  | December 31,                                                                                           
|                                           |                                                  |                                                                                                        
|                                           |                                                  | 2001                                                                                                    |        | 2000   
|                                           |                                                  |                                                                                                         |        |        
|ASSETS                                    
|Current assets:                            |                                                  |                                                                                                         |        |         |    |   |        |        
|                                           | Cash and cash equivalents                        |                                                                                                         | $      | 25,927  |    |   | $      | 36,865  |   
|                                           | Short-term investments                           |                                                                                                         |        | 54,269  |    |   |        | 52,685  |   
|                                           | Prepaid expenses                                 |                                                                                                         |        | 429     |    |   |        | 552     |   
|                                           | Other current assets                             |                                                                                                         |        | 3,385   |    |   |        | 2,317   |   
|                                           |                                                  |                                                                                                         |        |         |    |   |        |        
|Total current assets                       |                                                  |                                                                                                         | 84,010 |         |    |   | 92,419 |        
|Property and equipment, net                |                                                  |                                                                                                         | 3,223  |         |    |   | 851    |        
|Patents, net                               |                                                  |                                                                                                         | 1,865  |         |    |   | 1,532  |        
|Other assets                               |                                                  |                                                                                                         | 1,584  |         |    |   | 72     |        
|                                           |                                                  |                                                                                                         |        |         |    |   |        |        
|Total assets                               |                                                  | $                                                                                                       | 90,682 |         |    | $ | 94,874 |        
|                                           |                                                  |                                                                                                         |        |         |    |   |        |        
|LIABILITIES AND STOCKHOLDERS
	EQUITY     
|Current liabilities:                       |                                                  |                                                                                                         |        |         |    |   |        |        
|                                           | Accounts payables                                |                                                                                                         | $      | 1,128   |    |   | $      | 957     |   
|                                           | Accrued liabilities                              |                                                                                                         |        | 1,173   |    |   |        | 622     |   
|                                           | Current portion of deferred revenue              |                                                                                                         |        | 1,967   |    |   |        | 258     |   
|                                           | Current portion of long-term obligations         |                                                                                                         |        |        |    |   |        | 17      |   
|                                           |                                                  |                                                                                                         |        |         |    |   |        |        
|Total current liabilities                  |                                                  |                                                                                                         | 4,268  |         |    |   | 1,854  |        
|Deferred revenue                           |                                                  |                                                                                                         | 394    |         |    |   | 631    |        
|Deferred rent                              |                                                  |                                                                                                         | 84     |         |    |   | 100    |        
|Minority interest                          |                                                  |                                                                                                         |       |         |    |   | 372    |        
|Commitments (Note 4)                       |                                                  |                                                                                                         |        |         |    |   |        |        
|Stockholders equity:                      |                                                  |                                                                                                         |        |         |    |   |        |        
|                                           | Preferred stock, $0.001 par value:               |                                                                                                         |        |         |    |   |        |         |   
|                                           |                                                  | Authorized shares  5,000,000, none
	issued and outstanding                                             |        |         |   |   |        |         |   | 
|                                           | Common stock, $0.001 par value:                  |                                                                                                         |        |         |    |   |        |         |   
|                                           |                                                  | Authorized shares  45,000,000 at
	December 31, 2001                                                    |        |         |    |   |        |         |    | 
|                                           |                                                  | Issued and outstanding shares 
	23,607,058 and 23,592,264 at December 31, 2001 and 2000,
	respectively |        |         | 24 |   |        |         | 24 | 
|                                           | Additional paid-in capital                       |                                                                                                         |        | 159,126 |    |   |        | 158,776 |   
|                                           | Deferred compensation                            |                                                                                                         |        | (4,373  | )  |   |        | (10,918 | ) 
|                                           | Notes receivable from employees                  |                                                                                                         |        | (880    | )  |   |        | (827    | ) 
|                                           | Accumulated other comprehensive income           |                                                                                                         |        | 587     |    |   |        | 180     |   
|                                           | Accumulated deficit                              |                                                                                                         |        | (54,148 | )  |   |        | (40,918 | ) 
|                                           | Less: Treasury stock at cost 
	1,200,000 shares |                                                                                                         |        | (14,400 | )  |   |        | (14,400 | ) 
|                                           |                                                  |                                                                                                         |        |         |    |   |        |        
|Total stockholders equity                 |                                                  |                                                                                                         | 85,936 |         |    |   | 91,917 |        
|                                           |                                                  |                                                                                                         |        |         |    |   |        |        
|Total liabilities and stockholders equity |                                                  | $                                                                                                       | 90,682 |         |    | $ | 94,874 |        
|                                           |                                                  |                                                                                                         |        |         |    |   |        |        

See accompanying notes.

F-3



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.






CONSOLIDATED STATEMENTS OF
OPERATIONS


(In thousands, except per share
data)


|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |       | 
|---------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------ | ------- | ------ |  | ---- | ------- | ------ |  | - | ------ | ----- | 
|                                                                                               |                                                                                                                                                                                                  |                         
|                                                                                               |                                                                                                                                                                                                  | Years Ended December 31,
|                                                                                               |                                                                                                                                                                                                  |                         
|                                                                                               |                                                                                                                                                                                                  | 2001                     |         | 2000   |  | 1999
|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |     
|Revenue:                                                                                       |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|                                                                                               | Contract revenue                                                                                                                                                                                 |                          | $       | 1,515  |  |      | $       | 1,539  |  |   | $      | 2,008 | 
|                                                                                               | Other revenue                                                                                                                                                                                    |                          |         | 2,098  |  |      |         | 1,154  |  |   |        | 584   | 
|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|Total revenue                                                                                  |                                                                                                                                                                                                  |                          | 3,613   |        |  |      | 2,693   |        |  |   | 2,592  |      
|Operating expenses:                                                                            |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|                                                                                               | Research and development                                                                                                                                                                         |                          |         | 10,933 |  |      |         | 4,462  |  |   |        | 4,408 | 
|                                                                                               | General and administrative                                                                                                                                                                       |                          |         | 4,361  |  |      |         | 2,834  |  |   |        | 1,363 | 
|                                                                                               | Stock-based compensation ($2,120, $3,882 and $78
	related to research and development and $4,687, $8,343 and $377
	related to general and administrative for 2001, 2000 and 1999,
	respectively) |                          |         | 6,807  |  |      |         | 12,225 |  |   |        | 455   | 
|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|Total operating expenses                                                                       |                                                                                                                                                                                                  |                          | 22,101  |        |  |      | 19,521  |        |  |   | 6,226  |      
|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|Loss from operations                                                                           |                                                                                                                                                                                                  |                          | (18,488 | )      |  |      | (16,828 | )      |  |   | (3,634 | )    
|Minority interest                                                                              |                                                                                                                                                                                                  |                          | 372     |        |  |      | 127     |        |  |   | 45     |      
|Interest income, net                                                                           |                                                                                                                                                                                                  |                          | 4,886   |        |  |      | 3,142   |        |  |   | 213    |      
|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|Net loss                                                                                       |                                                                                                                                                                                                  |                          | (13,230 | )      |  |      | (13,559 | )      |  |   | (3,376 | )    
|Deemed dividend on Series F preferred stock                                                    |                                                                                                                                                                                                  |                          |        |        |  |      | (10,100 | )      |  |   |       |      
|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|Net loss applicable to common stockholders                                                     |                                                                                                                                                                                                  | $                        | (13,230 | )      |  | $    | (23,659 | )      |  | $ | (3,376 | )    
|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|Basic and diluted net loss per common share                                                    |                                                                                                                                                                                                  | $                        | (0.62   | )      |  | $    | (2.17   | )      |  | $ | (1.39  | )    
|                                                                                               |                                                                                                                                                                                                  |                          |         |        |  |      |         |        |  |   |        |      
|Weighted average shares outstanding used in
	computing basic and diluted loss per common share |                                                                                                                                                                                                  |                          | 21,394  |        |  |      | 10,910  |        |  |   | 2,429  |      

See accompanying notes.

F-4



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.






CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY


(In thousands, except share data)


|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    |                |  |               |         |        |   |        |         |         |   |   |      |      |   |   |     |     |   |   |         |         |   |  |            |            |   |   |         |         |   |   |        |         |  
|---------------------------- | ------------------------------------------------------------------------ | --------------- | ---------- | ------------ | - | ---------- | -- | -------- | - | ---------- | ---------- | ------------- | - | ----------- | -- | -------------- |  | ------------- | ------- | ------ | - | ------ | ------- | ------- | - | - | ---- | ---- | - | - | --- | --- | - | - | ------- | ------- | - |  | ---------- | ---------- | - | - | ------- | ------- | - | - | ------ | ------- | -
|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    | Accumulated    |  |               |         |        |   |       
|                             |                                                                          |                 |            |              |   |            |    |          |   | Notes      |            | Other         |   |             |    | Treasury Stock |  |              
|                             |                                                                          | Preferred Stock |            | Common Stock |   | Additional |    |          |   | Receivable |            | Comprehensive |   |             |    | at Cost        |  | Total        
|                             |                                                                          |                 |            |              |   | Paid-in    |    | Deferred |   | from       |            | Income        |   | Accumulated |    |                |  | Stockholders
|                             |                                                                          | Shares          |            | Amount       |   | Shares     |    | Amount   |   | Capital    |            | Compensation  |   | Employees   |    | (Loss)         |  | Deficit       |         | Shares |   | Amount |         | Equity 
|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    |                |  |               |         |        |   |        |         |        
|Balance at December 31, 1998 |                                                                          |                 | 11,640,124 |              |   | $          | 12 |          |   |            | 1,659,478  |               |   | $           | 2  |                |  | $             | 24,695  |        |   | $      |        |         |   | $ |     |      |   | $ |    |     |   | $ | (23,984 | )       |   |  |           |            |   | $ |        |         |   | $ | 725    |        
|                             | Issuance of common stock, net                                            |                 |            |             |   |            |    |         |   |            |            | 907,143       |   |             |    | 1              |  |               |         | 5,109  |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 5,110   |  
|                             | Exercise of stock options for cash                                       |                 |            |             |   |            |    |         |   |            |            | 3,225         |   |             |    |               |  |               |         | 1      |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 1       |  
|                             | Deferred compensation                                                    |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | 1,080  |   |        |         | (1,080  | ) |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        |        |  
|                             | Amortization of deferred compensation                                    |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         | 435     |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        |        |  
|                             | Issuance of stock options to consultants                                 |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | 24     |   |        |         | (24     | ) |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        |        |  
|                             | Compensation related to consultant stock options                         |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         | 20      |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 20      |  
|                             | Minority investors investment in Novasite                               |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | 922    |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 922     |  
|                             | Unrealized loss on short-term investments                                |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     | (8  | ) |   |         |        |   |  |            |           |   |   |         |        |   |   |        | (8      | )
|                             | Net loss                                                                 |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         | (3,375  | ) |  |            |           |   |   |         |        |   |   |        | (3,375  | )
|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    |                |  |               |         |        |   |        |         |         |   |   |      |      |   |   |     |     |   |   |         |         |   |  |            |            |   |   |         |         |   |   |        |        
|                             | Comprehensive loss                                                       |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | (3,383  | )
|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    |                |  |               |         |        |   |        |         |         |   |   |      |      |   |   |     |     |   |   |         |         |   |  |            |            |   |   |         |         |   |   |        |        
|Balance at December 31, 1999 |                                                                          |                 | 11,640,124 |              |   |            | 12 |          |   |            | 2,569,846  |               |   |             | 3  |                |  |               | 31,831  |        |   |        | (649    | )       |   |   |     |      |   |   | (8  | )   |   |   | (27,359 | )       |   |  |           |            |   |   |        |         |   |   | 3,830  |        
|                             | Exercise of stock options for cash and notes
	receivable                 |                 |            |             |   |            |    |         |   |            |            | 1,735,335     |   |             |    | 2              |  |               |         | 1,228  |   |        |         |        |   |   |      | (799 | ) |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 431     |  
|                             | Deferred compensation                                                    |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | 21,220 |   |        |         | (21,220 | ) |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        |        |  
|                             | Amortization of deferred compensation                                    |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         | 10,948  |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 10,948  |  
|                             | Issuance of stock options to consultants                                 |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | 4      |   |        |         | (4      | ) |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        |        |  
|                             | Compensation related to consultant stock options                         |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | 1,270  |   |        |         | 7       |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 1,277   |  
|                             | Interest on notes receivable                                             |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      | (28  | ) |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | (28     | )
|                             | Issuance of Series F preferred stock, net of
	issuance costs             |                 |            | 2,244,444    |   |            |    | 2        |   |            |            |              |   |             |    |               |  |               |         | 10,006 |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 10,008  |  
|                             | Issuance of common stock at IPO, net of issuance
	costs                  |                 |            |             |   |            |    |         |   |            |            | 5,347,500     |   |             |    | 5              |  |               |         | 92,909 |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 92,914  |  
|                             | Issuance of common stock for conversion of
	preferred stock upon IPO     |                 |            | (13,884,568  | ) |            |    | (14      | ) |            |            | 13,884,568    |   |             |    | 14             |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        |        |  
|                             | Issuance of common stock for exercise of warrants                        |                 |            |             |   |            |    |         |   |            |            | 55,015        |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        |        |  
|                             | Minority investors investment in Novasite                               |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | 308    |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 308     |  
|                             | Purchase of treasury stock                                               |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            | (1,200,000 | ) |   |         | (14,400 | ) |   |        | (14,400 | )
|                             | Unrealized gain on short-term investments                                |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     | 188 |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 188     |  
|                             | Net loss                                                                 |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         | (13,559 | ) |  |            |           |   |   |         |        |   |   |        | (13,559 | )
|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    |                |  |               |         |        |   |        |         |         |   |   |      |      |   |   |     |     |   |   |         |         |   |  |            |            |   |   |         |         |   |   |        |        
|                             | Comprehensive loss                                                       |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | (13,371 | )
|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    |                |  |               |         |        |   |        |         |         |   |   |      |      |   |   |     |     |   |   |         |         |   |  |            |            |   |   |         |         |   |   |        |        
|Balance at December 31, 2000 |                                                                          |                 |           |              |   |            |   |          |   |            | 23,592,264 |               |   |             | 24 |                |  |               | 158,776 |        |   |        | (10,918 | )       |   |   | (827 | )    |   |   | 180 |     |   |   | (40,918 | )       |   |  | (1,200,000 | )          |   |   | (14,400 | )       |   |   | 91,917 |        
|                             | Exercise of stock options for cash                                       |                 |            |             |   |            |    |         |   |            |            | 9,947         |   |             |    |               |  |               |         | 14     |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 14      |  
|                             | Issuance of common stock under employee stock
	purchase plan             |                 |            |             |   |            |    |         |   |            |            | 7,036         |   |             |    |               |  |               |         | 75     |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 75      |  
|                             | Repurchase of restricted stock                                           |                 |            |             |   |            |    |         |   |            |            | (2,189        | ) |             |    |               |  |               |         | (1     | ) |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | (1      | )
|                             | Amortization of deferred compensation                                    |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         | 6,481   |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 6,481   |  
|                             | Elimination of deferred compensation related to
	stock options forfeited |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | (64    | ) |        |         | 64      |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        |        |  
|                             | Compensation related to consultant stock options                         |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         | 326    |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 326     |  
|                             | Interest on notes receivable                                             |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      | (53  | ) |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | (53     | )
|                             | Unrealized gain on short-term investments                                |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     | 407 |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | 407     |  
|                             | Net loss                                                                 |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         | (13,230 | ) |  |            |           |   |   |         |        |   |   |        | (13,230 | )
|                             | Comprehensive loss                                                       |                 |            |             |   |            |    |         |   |            |            |              |   |             |    |               |  |               |         |       |   |        |         |        |   |   |      |     |   |   |     |    |   |   |         |        |   |  |            |           |   |   |         |        |   |   |        | (12,823 | )
|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    |                |  |               |         |        |   |        |         |         |   |   |      |      |   |   |     |     |   |   |         |         |   |  |            |            |   |   |         |         |   |   |        |        
|Balance at December 31, 2001 |                                                                          |                 |           |              |   | $          |   |          |   |            | 23,607,058 |               |   | $           | 24 |                |  | $             | 159,126 |        |   | $      | (4,373  | )       |   | $ | (880 | )    |   | $ | 587 |     |   | $ | (54,148 | )       |   |  | (1,200,000 | )          |   | $ | (14,400 | )       |   | $ | 85,936 |        
|                             |                                                                          |                 |            |              |   |            |    |          |   |            |            |               |   |             |    |                |  |               |         |        |   |        |         |         |   |   |      |      |   |   |     |     |   |   |         |         |   |  |            |            |   |   |         |         |   |   |        |        

See accompanying notes.

F-5



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.






CONSOLIDATED STATEMENTS OF CASH
FLOWS


(In thousands)


|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |      |      |  
|---------------------------------------------------------------------------- | ---------------------------------------------------- | ------------------------------------- | ------- | ----- | ------ | ---- | -------- | ------ | ------ | - | ------ | ---- | ---- | -
|                                                                             |                                                      |                                      
|                                                                             |                                                      | Years Ended December 31,             
|                                                                             |                                                      |                                      
|                                                                             |                                                      | 2001                                  |         | 2000  |        | 1999
|                                                                             |                                                      |                                       |         |       |        |     
|Operating Activities                                                         |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Net loss                                                                     |                                                      | $                                     | (13,230 | )     |        | $    | (13,559  | )      |        | $ | (3,376 | )   
|Adjustments to reconcile net loss to net cash
	used in operating activities: |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|                                                                             | Depreciation and amortization                        |                                       |         | 930   |        |      |          | 264    |        |   |        | 244  |     
|                                                                             | Amortization of deferred compensation                |                                       |         | 6,481 |        |      |          | 10,948 |        |   |        | 435  |     
|                                                                             | Compensation related to consultant stock options     |                                       |         | 326   |        |      |          | 1,277  |        |   |        | 20   |     
|                                                                             | Deferred revenue                                     |                                       |         | 1,472 |        |      |          | (216   | )      |   |        | (237 | )   
|                                                                             | Deferred rent                                        |                                       |         | (16   | )      |      |          | (14    | )      |   |        | (7   | )   
|                                                                             | Minority interest                                    |                                       |         | (372  | )      |      |          | (127   | )      |   |        | (45  | )   
|                                                                             | Realized gain on short-term investments              |                                       |         | (408  | )      |      |          | (124   | )      |   |        |     |     
|                                                                             | Accrued interest on notes receivable from
	employees |                                       |         | (53   | )      |      |          | (28    | )      |   |        |     |     
|                                                                             | Write-off of abandoned patents                       |                                       |         |      |        |      |          | 49     |        |   |        | 3    |     
|                                                                             | Changes in operating assets and liabilities:         |                                       |         |       |        |      |          |        |        |   |        |      |     
|                                                                             |                                                      | Prepaid expenses and other assets     |         |       | (2,457 | )    |          |        | (2,287 | ) |        |      | (308 | )
|                                                                             |                                                      | Accounts payable and accrued expenses |         |       | 722    |      |          |        | 950    |   |        |      | 83   |  
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Net cash flows used in operations                                            |                                                      |                                       | (6,605  | )     |        |      | (2,867   | )      |        |   | (3,188 | )   
|                                                                            
|Investing Activities                                                         |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Purchase of property and equipment                                           |                                                      |                                       | (3,180  | )     |        |      | (565     | )      |        |   | (182   | )   
|Purchase of short-term investments                                           |                                                      |                                       | (60,340 | )     |        |      | (109,078 | )      |        |   | (3,906 | )   
|Proceeds from sale of short-term investments                                 |                                                      |                                       | 59,571  |       |        |      | 58,228   |        |        |   | 2,375  |     
|Patents                                                                      |                                                      |                                       | (455    | )     |        |      | (345     | )      |        |   | (225   | )   
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Net cash flows used in investing activities                                  |                                                      |                                       | (4,404  | )     |        |      | (51,760  | )      |        |   | (1,938 | )   
|                                                                            
|Financing Activities                                                         |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Payments on long-term obligations                                            |                                                      |                                       | (17     | )     |        |      | (18      | )      |        |   | (27    | )   
|Issuance of common stock, net                                                |                                                      |                                       | 88      |       |        |      | 93,345   |        |        |   | 5,111  |     
|Issuance of preferred stock, net                                             |                                                      |                                       |        |       |        |      | 10,008   |        |        |   |       |     
|Purchase of treasury stock                                                   |                                                      |                                       |        |       |        |      | (14,400  | )      |        |   |       |     
|Investment in subsidiary by minority investor, net                           |                                                      |                                       |        |       |        |      | 583      |        |        |   | 1,192  |     
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Net cash flows provided by financing activities                              |                                                      |                                       | 71      |       |        |      | 89,518   |        |        |   | 6,276  |     
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Increase (decrease) in cash and cash
	equivalents                            |                                                      |                                       | (10,938 | )     |        |      | 34,891   |        |        |   | 1,150  |     
|Cash and cash equivalents at the beginning of the
	year                      |                                                      |                                       | 36,865  |       |        |      | 1,974    |        |        |   | 824    |     
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Cash and cash equivalents at the end of the year                             |                                                      | $                                     | 25,927  |       |        | $    | 36,865   |        |        | $ | 1,974  |     
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|                                                                            
|Supplemental Disclosure of Cash Flow
	Information                            |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Cash paid for interest                                                       |                                                      | $                                     | 1       |       |        | $    | 2        |        |        | $ | 2      |     
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|                                                                            
|Supplemental Schedule of Noncash Investing and
	Financing Activities         |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Capital lease obligations entered into for
	equipment                        |                                                      | $                                     |        |       |        | $    |         |        |        | $ | 45     |     
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     
|Exercise of stock options for notes receivable
	and interest thereon         |                                                      | $                                     | 53      |       |        | $    | 827      |        |        | $ |       |     
|                                                                             |                                                      |                                       |         |       |        |      |          |        |        |   |        |     

See accompanying notes.

F-6



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.






NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


December 31, 2001




|   |                                                  
|-- | -------------------------------------------------
|1. | Organization and Significant Accounting
	Policies



| |             
| | ------------
| | Organization

Applied Molecular Evolution, Inc. (the
Company or AME), a Delaware corporation,
was incorporated on August 14, 1989. The Company has a
broad technology platform termed AMEsystem, which the
Companys management believes will provide AME with a
valuable and efficient solution to optimizing proteins with
commercial potential. To date, the Company has successfully
utilized its proprietary technology to optimize proteins from
the classes of antibodies and enzymes for corporate
collaborators and the Companys internal development
projects.



| |                            
| | ---------------------------
| | Principles of Consolidation

The consolidated financial statements include the
accounts of the Company and its majority owned subsidiaries,
Novasite Pharmaceuticals, Inc. (Novasite), and AME
Torrey View, LLC (Torrey View). All significant
intercompany accounts and transactions have been eliminated.

At December 31, 2001 and 2000, AMEs
ownership interest in Novasite was 72%. Prior to December 2000,
AME had a 78% ownership interest in Novasite. The Company
initially contributed the rights to two patents with a carrying
value of approximately $38,000, and the minority investor
contributed $1,250,000 in gross cash proceeds to Novasite. In
December 2000, AME contributed an additional $400,000 in cash,
and minority investors contributed $600,000 in gross cash
proceeds. Novasite is performing research and development
related to the patented technology. The net loss of Novasite
($1,522,000, $567,000 and $205,000 in 2001, 2000 and 1999,
respectively) is allocated to the minority interests based on
their ownership percentage of Novasite. The amounts ($308,000
and $922,000 in 2000 and 1999, respectively) by which AMEs
ownership interest in Novasites equity exceeded AMEs
cost basis in its investment has been recorded as additional
paid-in capital of AME.

On August 17, 2001, the Company entered into
an Operating Agreement with Torrey View Phase II, L.P., to
establish AME Torrey View, LLC (Torrey View). Torrey
View is a 99% owned subsidiary and is consolidated in the
Companys financial statements.



| |                                                   
| | --------------------------------------------------
| | Cash, Cash Equivalents and Short-Term
	Investments

Cash and cash equivalents consist primarily of
highly liquid investments with original maturities of
90 days or less when purchased. Short-term investments
consist of debt securities with maturities in excess of
90 days when purchased.

In accordance with Financial Accounting Standards
Board (FASB) Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for
Certain Investments in Debt and Equity Securities,management determines the appropriate classification of
short-term investment securities at the time of purchase and
reevaluates such designation as of each balance sheet date. All
securities have been classified as available-for-sale and are
carried at fair value, with unrealized gains and losses, if any,
reported in comprehensive income (loss). Realized gains and
losses on available-for-sale securities are included in interest
income. The cost of securities sold is based on the specific
identification method.



| |                                     
| | ------------------------------------
| | Fair Value of Financial
	Instruments

Cash and cash equivalents, accounts payable and
accrued liabilities, are carried at cost, which management
believes approximates fair value due to the short-term maturity
of these instruments. Short-term investments are carried at fair
value.

F-7



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                             
| | ----------------------------
| | Concentration of Credit Risk

Financial instruments which potentially subject
the Company to concentrations of credit risk consist primarily
of cash and cash equivalents. The Company limits its exposure to
credit loss by placing its cash with high credit quality
financial institutions.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost and
depreciated over the estimated useful lives of the assets
(3 to 10 years) using the straight-line method.
Leasehold improvements and assets under capital leases are
stated at cost and amortized over the shorter of the estimated
useful lives of the assets or the lease term.



| |                  
| | -----------------
| | Long-Lived Assets

In accordance with SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of,if indicators of
impairment exist, the Company assesses the recoverability of the
affected long-lived assets by determining whether the carrying
value of such assets can be recovered through the undiscounted
future operating cash flows. If impairment is indicated, the
Company measures the amount of such impairment by comparing the
carrying value of the asset to the present value of the expected
future cash flows associated with the use of the asset. While
the Companys current and historical operating and cash
flow losses are indicators of impairment, the Company believes
the future cash flows to be received from the long-lived assets
will exceed the assets carrying value, and accordingly the
Company has not recognized any impairment losses through
December 31, 2001.



| |             
| | ------------
| | Patent Costs

Legal costs incurred in filing patent
applications have been capitalized and, upon patent issuance,
are amortized over the six-year estimated useful lives of the
patents. Costs related to abandoned patent applications are
expensed at the time of abandonment.



| |             
| | ------------
| | Income Taxes

In accordance with SFAS No. 109,
Accounting for Income Taxes,a deferred tax asset or
liability is determined based on the difference between the
financial statement and tax basis of assets and liabilities as
measured by the enacted tax rates which will be in effect when
these differences reverse. The Company has provided a full
valuation allowance against any deferred tax assets.



| |              
| | -------------
| | Deferred Rent

Rent expense is recorded on a straight-line basis
over the term of the lease. The difference between rent expense
and amounts paid under the lease agreements is recorded as
deferred rent in the accompanying consolidated balance sheets.



| |                            
| | ---------------------------
| | Comprehensive Income (Loss)

In accordance with SFAS No. 130,
Reporting Comprehensive Income,all components of
comprehensive income or loss, including net income or loss, are
reported in the financial statements in the period in which they
are recognized. Comprehensive income or loss is defined as the
change in equity during a period from transactions and other
events and circumstances from non-owner sources. Net income or
loss and other comprehensive income or loss, including foreign
currency translation adjustments and unrealized gains and losses
on investments, shall be reported, net of their related tax
effect, to arrive at comprehensive income or loss.

F-8



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                   
| | ------------------
| | Net Loss per Share

Basic and diluted net loss per common share are
presented in conformity with SFAS No. 128, Earnings per
Share. In accordance with SFAS No. 128, basic and
diluted net loss per share has been computed using the weighted
average number of shares of common stock outstanding during the
period, less shares subject to repurchase.

The following table presents the calculation of
net loss per share (in thousands, except per share data):

|                                                                                 |  |                          |         |      |  |      |         |   |  |   |        |  
|-------------------------------------------------------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | ------- | - |  | - | ------ | -
|                                                                                 |  |                         
|                                                                                 |  | Years Ended December 31,
|                                                                                 |  |                         
|                                                                                 |  | 2001                     |         | 2000 |  | 1999
|                                                                                 |  |                          |         |      |  |     
|Net loss applicable to common stockholders                                       |  | $                        | (13,230 | )    |  | $    | (23,659 | ) |  | $ | (3,376 | )
|                                                                                 |  |                          |         |      |  |      |         |   |  |   |        |  
|Weighted average shares used in computing net
	loss per share, basic and diluted |  |                          | 21,394  |      |  |      | 10,910  |   |  |   | 2,429  |  
|                                                                                 |  |                          |         |      |  |      |         |   |  |   |        |  
|Net loss per common share, basic and diluted                                     |  | $                        | (0.62   | )    |  | $    | (2.17   | ) |  | $ | (1.39  | )
|                                                                                 |  |                          |         |      |  |      |         |   |  |   |        |  

The Company has excluded all preferred stock,
outstanding stock options and warrants, and shares subject to
repurchase from the calculation of diluted loss per common share
because all such securities are antidilutive for all periods
presented. The total number of shares excluded from the
calculation of diluted net loss per share, prior to the
application of the treasury stock method for options and
warrants, was 3,097,273, 2,509,716 and 13,008,863 for the years
ended December 31, 2001, 2000 and 1999, respectively.



| |                    
| | -------------------
| | Revenue Recognition

Contract revenue is recognized either
(i) ratably over the term of the agreement, which
approximates the performance of services, for contracts
specifying payment for services over a given period, or
(ii) as services are performed under the agreement, for
contracts specifying payment on a per-full-time employee basis.
Contract revenue in 2001 includes amounts received under
collaborative agreements with Eli Lilly and Company
(Lilly), MedImmune, Inc. (MedImmune),
Biosynexus Incorporated (Biosynexus) and Aventis
Pharmaceuticals, Inc. (Note 6). Contract revenue in 2000
includes amounts received under collaborative agreements with
MedImmune and CancerVax, Inc. (CancerVax) (Note 6).

Revenue from the sale of a specified quantity of
Vitaxin to MedImmune (Note 3) is included in contract revenue in
1999, and was recorded upon the shipment of the specified
quantity of Vitaxin and the acceptance of the product candidates
by MedImmune, which occurred in August 1999.

Other revenue consists principally of research
grants and a nonrefundable, prepaid royalty fee received from
Biosite Incorporated (Biosite), which is being
recognized ratably over the estimated useful lives of the
related patents (Note 7). Grant revenue is recognized as
the research expenses related to the grants are incurred. All
amounts received under the collaborative research agreements or
research grants are not refundable, regardless of the success of
the underlying research.

Revenue earned related to up-front product and
technology license fees is recognized in accordance with Staff
Accounting Bulletin 101 issued by the Securities and Exchange
Commission, and effective in 2001. Accordingly, amounts received
under multiple-element arrangements requiring ongoing services
or performance by the Company are recognized over the period of
such services or performance.

Revenue from milestones are recognized when
earned, as evidenced by written acknowledgement from the
collaborator, provided that (i) the milestone event is
substantive and its achievability was not reasonably assured at
the inception of the agreement, and (ii) the Companys
performance obligations after the milestone achievement will
continue to be funded by the collaborator at a comparable level
to before the milestone achievement. If both of these criteria
are not met, the milestone payment would be recognized over the

F-9



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

remaining minimum period of the Companys
performance obligations under the arrangement. Royalties, if
any, will be recognized as earned. Under the Companys
research agreement with MedImmune (Note 6), MedImmune may make
milestone payments in the form of either cash payment or a
purchase of equity at a specified premium to the then-current
fair value of the Companys stock, and a portion of such
milestones are creditable against future royalties. Upon receipt
of a cash milestone payment, the amount creditable against
future royalties will be recorded as deferred royalty revenue
and recognized as royalties would otherwise be due to the
Company. Upon receipt of an equity milestone payment, the
specified premium will be recorded as deferred royalty revenue
and recognized as royalties would otherwise be due to the
Company. In the event the Company is notified by MedImmune that
MedImmune is terminating the development of all products for
which royalties could be due to the Company, any amount then
recorded as deferred royalty revenue will be recognized in full.

Amounts received in excess of revenue recognized
are recorded as deferred revenue.



| |                                
| | -------------------------------
| | Research and Development
	Costs

Research and development costs are expensed as
incurred. Such costs include: personnel expenses, contractor
fees, laboratory supplies, facilities and allocation of
corporate costs. These expenses are incurred during research and
development activities for our internal development projects and
our corporate collaborations and grants.



| |                         
| | ------------------------
| | Stock-Based Compensation

The Company has elected to follow Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees(APB 25) and related
Interpretations, in accounting for its employee and director
stock options. Under APB 25, when the purchase price of
restricted stock or the exercise price of the Companys
employee stock options equals or exceeds the fair value of the
underlying stock on the date of issuance or grant, no
compensation expense is recognized.

In March 2000, the FASB issued
Interpretation No. 44, (FIN 44),
Accounting for Certain Transactions Involving Stock
Compensation  An Interpretation of APB 25.This interpretation clarifies the definition of employee for
purpose of applying APB 25, the criteria for determining
whether a plan qualifies as a non-compensatory plan, the
accounting consequence of various modifications to the terms of
a previously fixed stock option or award, and the accounting for
an exchange of stock compensation awards in a business
combination. FIN 44 was effective and the Company adopted
the interpretation on July 1, 2000. The adoption did not
have a material impact on the Companys consolidated
results of operations.

Options or stock awards issued to non-employees
are recorded at their fair value as determined in accordance
with SFAS No. 123, Accounting for Stock-Based
Compensation, and the Emerging Issues Task Forces
(EITF) 96-18, Accounting for Equity
Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or
Services, and recognized over the related service period.



| |                  
| | -----------------
| | Segment Reporting

SFAS No. 131, Disclosures About Segments
of an Enterprise and Related Information,requires the use
of a management approach in identifying segments of an
enterprise. Management has determined that the Company operates
in one business segment, which is scientific research and
development activities.



| |                 
| | ----------------
| | 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 of recorded assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements and the

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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

recorded amounts of revenues and expenses during
the reporting period. Actual results could differ from the
estimates.



| |                                      
| | -------------------------------------
| | Recently Issued Accounting
	Standards

In June 2001, the FASB issued SFAS No. 141,
Business Combinations,and No. 142, Goodwill and
Other Intangible Assets.SFAS No. 141 requires all
business combinations initiated after June 30, 2001, to be
accounted for by the purchase method. Under SFAS No. 142,
goodwill and intangible assets with indefinite lives are no
longer amortized but are reviewed annually (or more frequently
if impairment indicators arise) for impairment. Separate
intangible assets that are not deemed to have an indefinite life
will continue to be amortized over their useful lives (but with
no maximum life). The amortization provisions of SFAS
No. 142 apply to goodwill and intangible assets acquired
after June 30, 2001. With respect to goodwill and
intangible assets acquired prior to July 1, 2001, the
Company is required to adopt SFAS No. 142 effective
January 1, 2002. The Company does not expect the adoption
of these pronouncements to have an effect on the consolidated
financial statements as the Company has not recorded any
goodwill or other intangible assets as a result of a business
combination.

In October 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, which establishes one accounting model to
be used for long-lived assets to be disposed of by sale and
broadens the presentation of discontinued operations to include
more disposal transactions. SFAS No. 144 supercedes SFAS
No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30.
While earlier application is encouraged, SFAS No. 144 is
effective for fiscal years beginning after December 15,
2001. The Company does not believe the adoption of SFAS
No. 144 will have a material impact on its financial
statements.

2.     Balance Sheet
Details



| |                       
| | ----------------------
| | Short-Term Investments

At December 31, 2001, short-term investments
consisted of the following (in thousands):

|                                        |  |           |        |        |  |             |        |  |  |   |     | 
|--------------------------------------- |  | --------- | ------ | ------ |  | ----------- | ------ |  |  | - | --- | 
|                                        |  | Amortized |        | Market |  | Unrealized 
|                                        |  | Cost      |        | Value  |  | Gain (Loss)
|                                        |  |           |        |        |  |            
|Obligations of U.S. government agencies |  | $         | 3,707  |        |  | $           | 3,808  |  |  | $ | 101 | 
|Corporate debt securities               |  |           | 42,211 |        |  |             | 42,614 |  |  |   | 403 | 
|Asset-backed securities                 |  |           | 7,764  |        |  |             | 7,847  |  |  |   | 83  | 
|                                        |  |           |        |        |  |             |        |  |  |   |     | 
|                                        |  | $         | 53,682 |        |  | $           | 54,269 |  |  | $ | 587 | 
|                                        |  |           |        |        |  |             |        |  |  |   |     | 

At December 31, 2000, short-term investments
consisted of the following (in thousands):

|                                        |  |           |        |        |  |             |        |  |  |   |     | 
|--------------------------------------- |  | --------- | ------ | ------ |  | ----------- | ------ |  |  | - | --- | 
|                                        |  | Amortized |        | Market |  | Unrealized 
|                                        |  | Cost      |        | Value  |  | Gain (Loss)
|                                        |  |           |        |        |  |            
|Obligations of U.S. government agencies |  | $         | 9,033  |        |  | $           | 9,109  |  |  | $ | 76  | 
|Corporate debt securities               |  |           | 27,930 |        |  |             | 27,954 |  |  |   | 24  | 
|Asset-backed securities                 |  |           | 15,542 |        |  |             | 15,622 |  |  |   | 80  | 
|                                        |  |           |        |        |  |             |        |  |  |   |     | 
|                                        |  | $         | 52,505 |        |  | $           | 52,685 |  |  | $ | 180 | 
|                                        |  |           |        |        |  |             |        |  |  |   |     | 

F-11



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Short-term investments by contractual maturity at
December 31, 2001, are as follows (in thousands):

|                                     |  |   |        | 
|------------------------------------ |  | - | ------ | 
|Due in one year or less              |  | $ | 25,281 | 
|Due after one year through two years |  |   | 18,116 | 
|Due after two years                  |  |   | 10,872 | 
|                                     |  |   |        | 
|                                     |  | $ | 54,269 | 
|                                     |  |   |        | 



| |                     
| | --------------------
| | Other Current Assets

Other current assets consist of the following (in
thousands):

|                                       |  |              |       |      |  |   |       | 
|-------------------------------------- |  | ------------ | ----- | ---- |  | - | ----- | 
|                                       |  |             
|                                       |  | December 31,
|                                       |  |             
|                                       |  | 2001         |       | 2000
|                                       |  |              |       |     
|Interest income receivable             |  | $            | 1,143 |      |  | $ | 1,195 | 
|Contract and grant research receivable |  |              | 2,094 |      |  |   | 1,072 | 
|Other                                  |  |              | 148   |      |  |   | 50    | 
|                                       |  |              |       |      |  |   |       | 
|                                       |  | $            | 3,385 |      |  | $ | 2,317 | 
|                                       |  |              |       |      |  |   |       | 



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment consist of the following
(in thousands):

|                                          |  |              |        |      |  |   |        |  
|----------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | -
|                                          |  |             
|                                          |  | December 31,
|                                          |  |             
|                                          |  | 2001         |        | 2000
|                                          |  |              |        |     
|Laboratory equipment                      |  | $            | 2,825  |      |  | $ | 2,069  |  
|Computers, office furniture and equipment |  |              | 1,527  |      |  |   | 740    |  
|Leasehold improvements                    |  |              | 2,120  |      |  |   | 483    |  
|                                          |  |              |        |      |  |   |        |  
|                                          |  |              | 6,472  |      |  |   | 3,292  |  
|Accumulated depreciation                  |  |              | (3,249 | )    |  |   | (2,441 | )
|                                          |  |              |        |      |  |   |        |  
|                                          |  | $            | 3,223  |      |  | $ | 851    |  
|                                          |  |              |        |      |  |   |        |  



| |             
| | ------------
| | Patent Costs

Patent costs consist of the following (in
thousands):

|                         |  |              |       |      |  |   |       |  
|------------------------ |  | ------------ | ----- | ---- |  | - | ----- | -
|                         |  |             
|                         |  | December 31,
|                         |  |             
|                         |  | 2001         |       | 2000
|                         |  |              |       |     
|Issued patents           |  | $            | 954   |      |  | $ | 685   |  
|Accumulated amortization |  |              | (427  | )    |  |   | (305  | )
|                         |  |              |       |      |  |   |       |  
|                         |  |              | 527   |      |  |   | 380   |  
|Unissued patents         |  |              | 1,338 |      |  |   | 1,152 |  
|                         |  |              |       |      |  |   |       |  
|                         |  | $            | 1,865 |      |  | $ | 1,532 |  
|                         |  |              |       |      |  |   |       |  

F-12



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

3.     Stockholders
Equity



| |                
| | ---------------
| | Preferred Stock

Prior to the completion of the Companys
initial public offering, the Series F preferred stock was
sold primarily to the affiliates of an independent accredited
investor at $4.50 per share, however the price was substantially
below the Companys initial public offering price.
Accordingly, pursuant to EITF 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features,
the Company recognized a deemed dividend on the Series F
preferred stock of $10.1 million.

In July 2000, the Company completed its initial
public offering of common stock under the Securities Act of
1933, resulting in gross proceeds of $101.6 million and net
proceeds (less the underwriters discount and offering
expenses) of $92.9 million. Upon completion of the initial
public offering, all of the Companys convertible preferred
stock and series A, B, C, D, E and F preferred stock outstanding
converted into 13,884,568 shares of common stock.



| |             
| | ------------
| | Common Stock

In December 2000, the Company repurchased
1.2 million shares of its common stock at a price of $12
per share.



| |         
| | --------
| | Warrants

During 1996 and 1997, in connection with a
short-term loan and security agreements, the Company issued
warrants to purchase 26,667 shares and 40,000 shares,
respectively, of Series E preferred stock at an exercise
price of $5.625 per share. In September 2000, these warrants
were converted, in accordance with the warrant agreements, into
55,015 shares of the Companys common stock.



| |                   
| | ------------------
| | Stock Option Plans

The Company has in effect several stock-based
plans under which nonqualified and incentive stock options have
been granted to employees, consultants and directors. At
December 31, 2001, approximately 2.5 million stock
options were outstanding and approximately 500,000 shares were
available for future grant under these plans.

The Board of Directors has designated committees
that determine eligibility, vesting schedules and exercise
prices for options granted under these plans. Options and other
stock awards expire not more than ten years from the date of
grant and are either exercisable immediately after the date of
grant and subject to certain repurchase rights by the Company
until such ownership rights have vested or are exercisable upon
vesting. Vesting generally occurs over three or four years. At
December 31, 2001 and 2000, 616,812 and 1,273,844 shares of
common stock, respectively, were subject to repurchase at a
weighted-average price of $0.79. Options are granted at prices
at least equal to the fair value of the Companys common
stock on the date of grant.

Pro forma net loss information is required to be
disclosed by SFAS No. 123 and has been determined as if the
Company has accounted for its employee stock options under the
fair value method prescribed in that statement.

The fair value for the 2001 options was estimated
at the date of grant, using the Black-Scholes option pricing
model with the following assumptions: risk-free interest rate of
5%; dividend yield of 0%; a weighted-average expected life of
the option of five years; and a volatility factor of 115%. The
fair value for the 2000 options granted after the Company filed
its initial registration statement relating to the IPO was
estimated at the date of grant, using the Black-Scholes option
pricing model with the following assumptions: risk-free interest
rate of 5.5%; dividend yield of 0%; a weighted-average expected
life of the option of two years; and a

F-13



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

volatility factor of 136%. The fair value for the
2000 options granted before the Company filed its initial
registration statement relating to the IPO and the fair value
for the 1999 options was estimated at the date of grant, using
the minimum value pricing model with the following weighted
average assumptions: risk-free interest rate of 6%; dividend
yield of 0%; and a weighted-average expected life of the option
of two years for 1999 and four years for 1998.

The weighted average fair values of options
granted in 2001, 2000 and 1999 were $8.35, $0.67 and $0.03,
respectively.

The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded
options, which 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 employee
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 employee 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
net loss information is as follows (in thousands, except per
share amounts):

|                                                           |  |                          |         |      |  |      |         |   |  |   |        |  
|---------------------------------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | ------- | - |  | - | ------ | -
|                                                           |  |                         
|                                                           |  | Years Ended December 31,
|                                                           |  |                         
|                                                           |  | 2001                     |         | 2000 |  | 1999
|                                                           |  |                          |         |      |  |     
|Net loss attributable to common stockholders, as
	reported |  | $                        | (13,230 | )    |  | $    | (23,659 | ) |  | $ | (3,376 | )
|Net loss attributable to common stockholders, pro
	forma   |  | $                        | (14,831 | )    |  | $    | (23,802 | ) |  | $ | (3,407 | )
|Basic and diluted net loss per share, as reported          |  | $                        | (0.62   | )    |  | $    | (2.17   | ) |  | $ | (1.39  | )
|Basic and diluted net loss per share, pro forma            |  | $                        | (0.69   | )    |  | $    | (2.18   | ) |  | $ | (1.40  | )

The following table summarizes stock option
activity (shares in thousands):

|                             |           |           |       |                |   |   |      |       | 
|---------------------------- | --------- | --------- | ----- | -------------- | - | - | ---- | ----- | 
|                             |           |           |       | Weighted      
|                             |           | Number of |       | Average       
|                             |           | Shares    |       | Exercise Price
|                             |           |           |       |               
|Balance at December 31, 1998 |           |           | 1,222 |                |   | $ | 0.37 |      
|                             | Granted   |           |       | 207            |   |   | $    | 0.45  | 
|                             | Exercised |           |       | (3             | ) |   | $    | 0.33  | 
|                             | Canceled  |           |       | (124           | ) |   | $    | 0.45  | 
|                             |           |           |       |                |   |   |      |      
|Balance at December 31, 1999 |           |           | 1,302 |                |   | $ | 0.41 |      
|                             | Granted   |           |       | 1,772          |   |   | $    | 1.69  | 
|                             | Exercised |           |       | (1,735         | ) |   | $    | 0.71  | 
|                             | Canceled  |           |       | (103           | ) |   | $    | 0.45  | 
|                             |           |           |       |                |   |   |      |      
|Balance at December 31, 2000 |           |           | 1,236 |                |   | $ | 1.82 |      
|                             | Granted   |           |       | 1,315          |   |   | $    | 9.71  | 
|                             | Exercised |           |       | (10            | ) |   | $    | 1.45  | 
|                             | Canceled  |           |       | (60            | ) |   | $    | 11.77 | 
|                             |           |           |       |                |   |   |      |      
|Balance at December 31, 2001 |           |           | 2,481 |                |   | $ | 5.76 |      
|                             |           |           |       |                |   |   |      |      

F-14



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Exercise prices and the weighted average
remaining contractual life for options outstanding as of
December 31, 2001, are as follows (shares in thousands):

|                         |                |             |  |                  |       |          |  |             |      |          |  |   |       |  |  |  |       |  |  |   |       | 
|------------------------ | -------------- | ----------- |  | ---------------- | ----- | -------- |  | ----------- | ---- | -------- |  | - | ----- |  |  |  | ----- |  |  | - | ----- | 
|                         |                |             |  | Weighted         |       | Weighted |  |             |      | Weighted
|                         |                |             |  | Average          |       | Average  |  |             |      | Average 
|                         |                | Number      |  | Remaining        |       | Exercise |  | Number      |      | Exercise
|Range of Exercise Prices |                | Outstanding |  | Contractual Life |       | Price    |  | Exercisable |      | Price   
|                         |                |             |  |                  |       |          |  |             |      |         
|$                        | 0.25 - $ 0.45  |             |  |                  | 805   |          |  |             | 5.23 |          |  | $ | 0.40  |  |  |  | 805   |  |  | $ | 0.40  | 
|$                        | 0.75 - $ 1.25  |             |  |                  | 346   |          |  |             | 8.23 |          |  | $ | 0.80  |  |  |  | 346   |  |  | $ | 0.80  | 
|$                        | 7.00 - $12.90  |             |  |                  | 1,122 |          |  |             | 9.89 |          |  | $ | 8.91  |  |  |  | 22    |  |  | $ | 9.76  | 
|$                        | 13.54 - $15.50 |             |  |                  | 148   |          |  |             | 9.10 |          |  | $ | 14.92 |  |  |  | 31    |  |  | $ | 15.17 | 
|$                        | 21.00 - $38.50 |             |  |                  | 60    |          |  |             | 8.82 |          |  | $ | 25.00 |  |  |  | 18    |  |  | $ | 25.06 | 
|                         |                |             |  |                  |       |          |  |             |      |          |  |   |       |  |  |  |       |  |  |   |       | 
|$                        | 0.25 - $38.50  |             |  |                  | 2,481 |          |  |             | 8.00 |          |  | $ | 5.76  |  |  |  | 1,222 |  |  | $ | 0.45  | 
|                         |                |             |  |                  |       |          |  |             |      |          |  |   |       |  |  |  |       |  |  |   |       | 

During the years ended December 31, 2000 and
1999, in connection with the grant of certain stock options to
employees, the Company recorded deferred stock compensation
totaling approximately $21.2 million and $1.1 million,
respectively, representing the difference between the exercise
price and the estimated fair value of the Companys common
stock on the date such stock options were granted. Deferred
compensation is included as a reduction of stockholders
equity and is being amortized to expense over the vesting period
of the options in accordance with FASB Interpretation
No. 28, which permits an accelerated amortization
methodology. During the years ended December 31, 2001, 2000
and 1999, the Company recorded amortization of deferred stock
compensation expense of approximately $6.5 million,
$10.9 million and $435,000, respectively.

Employee
Stock Purchase Plan

The Companys 2000 Employee Stock Purchase
Plan (ESPP) was adopted by the board of directors on
June 20, 2000, and was subsequently approved by the
stockholders. The ESPP permits eligible employees to purchase
common stock through payroll deductions at 85% of fair market
value. The initial offering period commenced on January 1,
2001. The Company has reserved 750,000 shares of common stock
for issuance under the ESPP. The number of shares reserved for
issuance under the ESPP may be increased on the first day of
each fiscal year. At December 31, 2001, 7,036 shares had
been issued under the ESPP, and 742,964 shares were available
for future issuance.

Common Stock
Sold to MedImmune

In conjunction with a collaborative research and
development agreement entered into with MedImmune in February
1999 (Note 6), MedImmune paid the Company an aggregate of
$6,350,000, before expenses of $40,000, for (i) 907,143
shares of common stock, (ii) a specified quantity of
Vitaxin, and (iii) an exclusive license to Vitaxin. At
MedImmunes request the agreement did not allocate the
total proceeds among the three elements of the agreement. Of the
aggregate proceeds of $6,350,000, $1,200,000 was refundable if
the Company did not deliver the specified quantity of Vitaxin.
This amount approximates the Companys actual cost to
acquire the specified quantity of Vitaxin from a third-party
manufacturer and provide it to MedImmune. Accordingly, the
Company allocated such amount to the specified quantity of
Vitaxin and recognized it as revenue in August 1999 when the
Vitaxin was delivered to and accepted by MedImmune. While the
Company believes a significant portion of the proceeds relate to
the value of the license to Vitaxin, the Company concluded that
the available objective evidence was not persuasive enough to
support an allocation of the remaining proceeds ($5,110,000)
between the license and equity elements of the agreement, and
accordingly the entire remaining proceeds were allocated to
common stock.

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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Common Shares
Reserved for Future Issuance

At December 31, 2001, the following shares
of common stock were reserved for issuance upon the exercise of
equity instruments (in thousands):

|                    |                              |  |       |       | 
|------------------- | ---------------------------- |  | ----- | ----- | 
|Stock options:      |                              |  |       |      
|                    | Issued and outstanding       |  |       | 2,481 | 
|                    | Authorized for future grants |  |       | 445   | 
|Stock purchase plan |                              |  | 743   |      
|                    |                              |  |       |      
|                    |                              |  | 3,669 |      
|                    |                              |  |       |      

4.     Lease
Commitments

The Company leases its facilities under operating
leases, which expire in 2003. The leases provide for escalating
rent payments during the term. For financial reporting purposes,
rent expense is recognized on a straight-line basis over the
terms of the leases. Accordingly, rent expense recognized in
excess of rent paid is reflected as deferred rent. Under the
lease agreements, the Company is required to pay a percentage of
operating expenses relating to the building. Rent expense was
approximately $519,000, $415,000 and $415,000 for the three
years ended December 31, 2001, 2000 and 1999, respectively.

The Company also leases some of its office
equipment under operating leases, which expire in 2005.

Annual future minimum lease payments as of
December 31, 2001, are as follows (in thousands):

|                             |  |   |       | 
|---------------------------- |  | - | ----- | 
|2002                         |  | $ | 541   | 
|2003                         |  |   | 559   | 
|2004                         |  |   | 23    | 
|2005                         |  |   | 9     | 
|2006                         |  |   |      | 
|                             |  |   |       | 
|Total minimum lease payments |  | $ | 1,132 | 
|                             |  |   |       | 

The Company subleases a portion of its facilities
under a sublease expiring in June 2002. Sublease income was
approximately $78,000, $86,000 and $10,000 for the years ended
December 31, 2001, 2000 and 1999, respectively. Future
minimum sublease income to be received under non-cancelable
subleases as of December 31, 2001, is approximately $75,000
for the year ending December 31, 2002.

5.     Income
Taxes

At December 31, 2001, the Company had
federal and California tax net operating loss carryforwards of
approximately $26.0 million and $6.1 million,
respectively. The difference between the tax loss carryforwards
for federal and California purposes is primarily attributable to
the capitalization of research and development expenses for
California and the 55% limitation of California loss
carryforwards. The federal tax loss carryforwards will begin
expiring in 2005, unless previously utilized. The California tax
loss carryforwards will continue to expire in 2002, unless
previously utilized. The Company also has federal and California
research and development tax credit carryforwards totaling
$821,000 and $493,000, respectively, which will expire beginning
in 2005, unless previously utilized.

Pursuant to Internal Revenue Code
Section 382 and 383, use of the Companys net
operating loss and tax credit carryforwards will be limited as a
result of certain cumulative changes in the Companys stock
ownership that occurred during 1993. However, the Company
believes that the limitation will not have a material impact on
the utilization of the carryforwards.

F-16



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##### Table of Contents



APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Significant components of the Companys
deferred tax assets as of December 31, 2001 and 2000, are shown
below. A valuation allowance of $19.4 million has been
recognized to offset the deferred tax assets as realization of
such assets is uncertain.

|                          |                                             |                |        |         |   |   |       |        |  
|------------------------- | ------------------------------------------- | -------------- | ------ | ------- | - | - | ----- | ------ | -
|                          |                                             |               
|                          |                                             | December 31,  
|                          |                                             |               
|                          |                                             | 2001           |        | 2000   
|                          |                                             |                |        |        
|                          |                                             |               
|                          |                                             | (In thousands)
|Deferred tax assets:      |                                             |                |        |         |   |   |       |       
|                          | Net operating loss carryforwards            |                | $      | 9,489   |   |   | $     | 7,793  |  
|                          | Research and development credits            |                |        | 1,142   |   |   |       | 699    |  
|                          | Capitalized research expense                |                |        | 636     |   |   |       | 388    |  
|                          | Deferred compensation                       |                |        | 7,223   |   |   |       |       |  
|                          | Deferred revenue                            |                |        | 938     |   |   |       | 362    |  
|                          | Other                                       |                |        | 400     |   |   |       | 258    |  
|                          |                                             |                |        |         |   |   |       |       
|Total deferred tax assets |                                             |                | 19,828 |         |   |   | 9,500 |       
|                          | Valuation allowance for deferred tax assets |                |        | (19,416 | ) |   |       | (8,911 | )
|                          |                                             |                |        |         |   |   |       |       
|Net deferred tax assets   |                                             |                | 412    |         |   |   | 589   |       
|Deferred tax liabilities: |                                             |                |        |         |   |   |       |       
|                          | Patent expenses                             |                |        | (412    | ) |   |       | (589   | )
|                          |                                             |                |        |         |   |   |       |       
|Net deferred taxes        |                                             | $              |       |         |   | $ |      |       
|                          |                                             |                |        |         |   |   |       |       

6.     Collaborative
Research and Development Agreements

MedImmune

In February 1999, the Company entered into a
collaboration agreement with MedImmune to produce optimized
antibodies. In addition, Vitaxin, the Companys
angiogenesis inhibitor, was exclusively licensed to MedImmune in
return for an equity investment, milestone payments and
royalties related to the development and commercialization of
resulting products. Pursuant to the terms of the research
program under the collaboration agreement, MedImmune agreed to
fund three research programs, each for a period of six months,
extendable up to 24 months. In addition to program funding,
MedImmune will pay royalties to AME on net sales of products
developed. The agreement also provides that MedImmune will make
additional payments, either through cash payments or equity
purchases at a specified premium to then-current fair value, to
the Company upon the achievement of certain milestones. Under
the terms of the agreement, MedImmune has the option to credit
up to 65% of cash payments and 20% of equity purchases against
future royalty payments. At the time of a cash payment, 35% of
the payment will be recognized as milestone revenue, and the
remaining 65% will be recorded as deferred royalty revenue.
Additionally, if MedImmune makes the milestone payment through
an equity purchase, 20% of the amount will be recorded as
deferred royalty revenue. During the years ended
December 31, 2001 and 2000, the Company recorded revenue of
approximately $585,000 and $200,000, respectively, related to
research activities performed under the agreement.

Eli Lilly and
Company

In December 2001, the Company entered into a
collaboration agreement with Eli Lilly and Company
(Lilly) to create optimized versions of an antibody
as well as a non-antibody protein therapeutic. Pursuant to the
terms of the research program under the collaboration agreement,
Lilly agreed to fund two research programs, one for a period of
up to one year and the other for a period of six months,
extendable by mutual

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APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

consent. In addition to program funding, the
agreement also provides that Lilly will make additional payments
to the Company upon the achievement of certain milestones and
pay royalties on its net sales of products developed. During the
year ended December 31, 2001, the Company recorded revenue
of $60,000 related to program funding under this agreement. In
February 2002, an additional agreement was entered into by AME
and Lilly for the optimization of an additional antibody.

Chiron

In December 2001, the Company entered into a
research agreement with Chiron Corporation (Chiron)
to optimize a non-antibody protein therapeutic. The research
program of this agreement is for six months, extendable upon
mutual written consent. In addition to program funding, the
agreement also provides that Chiron will make additional
payments to the Company upon the achievement of certain
milestones and pay royalties on its net sales of products
developed. The Company did not record any revenue under this
agreement during the year ended December 31, 2001.

CancerVax

In November 1999, the Company entered into a
collaboration agreement with Cell-Matrix, Inc., which was
acquired by CancerVax in January 2002, to optimize candidate
molecules and to perform some preclinical development. Pursuant
to the terms of the agreement, Cell-Matrix paid the Company for
the optimization of each of the two candidate molecules, which
was completed in 2000. In addition, Cell-Matrix made milestone
payments to AME for each enhanced antibody. The agreement also
provides that Cell-Matrix will make additional payments to the
Company upon the achievement of certain milestones and pay
royalties on its net sales of products developed. No revenue was
recorded under this agreement during the year ended
December 31, 2001. During the year ended December 31,
2000, the Company recorded revenue of approximately $1.3 million
related to research activities performed under the agreement.

Biosynexus

In December 2000, the Company entered into a
collaboration agreement with Biosynexus to optimize a candidate
molecule and perform certain preclinical development. The
research and development aspect of this collaboration was for
six months. In addition to research and development funding, the
agreement also provides that Biosynexus will make additional
payments to the Company upon the achievement of certain
milestones and pay royalties on its net sales of products
developed. During the year ended December 31, 2001, the
Company recorded revenue of $750,000 related to research
activities performed under this agreement.

Aventis
Pharmaceuticals, Inc.

In July 2001, Novasite entered into an agreement
with Aventis Pharmaceuticals, Inc., to conduct a pilot-screening
project using Novasites proprietary technology platform.
During the year ended December 31, 2001, the Company
recorded revenue of $50,000 related to this agreement.

7.     License
Agreements

TSRI

During 1994, the Company entered into a license
agreement with The Scripps Research Institute of California
(TSRI). TSRI granted the Company exclusive rights to
certain technology relating to a murine monoclonal antibody and
the use of the antibody as an inhibitor of angiogenesis. In
exchange, the Company paid TSRI $100,000 and issued TSRI 20,000
shares of AME common stock. The Company also agreed to provide
TSRI additional payments based on the completion of certain
clinical and approval milestones. In addition, the Company has
agreed to reimburse TSRI for a portion of its past and future
patent costs related to

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APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the licensed technology and pay royalties to TSRI
on net sales of each licensed product. The exclusive license
will expire 10 years after the date of the first commercial
sale of such licensed product.

Biosite

During 1998, the Company entered into a license
agreement with Biosite. The Company granted Biosite
non-exclusive rights to certain AME patent technology in
exchange for an up-front, nonrefundable royalty fee of
approximately $1.5 million. The Company is recognizing the
royalty fee as revenue over the estimated lives of the related
patents. As of December 31, 2001, 2000 and 1999,
approximately $631,000, $868,000 and $1.1 million,
respectively, of the amount originally received are included in
deferred revenue.

8.     NIH
Grants

In September 2000, the NIH awarded a grant to
Novasite that provides $3.2 million over three years for
research to develop Novasites proprietary technology
platform. Other revenue includes approximately $1.6 million and
$748,000 related to this grant for the years ended December 31,
2001 and 2000, respectively.

In September 2001, the NIH awarded a
grant to AME which provides $1.0 million to support the
preclinical development of a therapeutic enzyme optimized by
AMEs proprietary directed molecular evolution technology.
Other revenue includes approximately $258,000 related to this
grant for the year ended December 31, 2001.

9.     401(k)
Plan

The Company maintains a 401(k) plan which allows
substantially all employees to contribute up to 15% of their
salary, subject to annual limitations and requirements set by
the Company. The board of directors may, at its sole discretion,
approve Company contributions. During the year ended
December 31, 2001, the Company contributed approximately
$73,000 under the plan.

10.     Quarterly
Results of Operations (unaudited)

The following is a summary of the unaudited
quarterly results of operations for the years ended
December 31, 2001 and 2000 (in thousands, except per share
data):

|                                                        |  |                              |        |                              |  |    |        |    |  |    |        |    |  |    |        |    |  |   |        |   |  |   |         |   |  |   |        |   |  |   |        |  
|------------------------------------------------------- |  | ---------------------------- | ------ | ---------------------------- |  | -- | ------ | -- |  | -- | ------ | -- |  | -- | ------ | -- |  | - | ------ | - |  | - | ------- | - |  | - | ------ | - |  | - | ------ | -
|                                                        |  |                              |        |                             
|                                                        |  | Year Ended December 31, 2001 |        | Year Ended December 31, 2000
|                                                        |  |                              |        |                             
|                                                        |  | Q1                           |        | Q2                           |  | Q3 |        | Q4 |  | Q1 |        | Q2 |  | Q3 |        | Q4
|                                                        |  |                              |        |                              |  |    |        |    |  |    |        |    |  |    |        |   
|Revenue                                                 |  | $                            | 852    |                              |  | $  | 764    |    |  | $  | 872    |    |  | $  | 1,125  |    |  | $ | 831    |   |  | $ | 377     |   |  | $ | 668    |   |  | $ | 817    |  
|Operating expenses                                      |  |                              | 5,657  |                              |  |    | 5,507  |    |  |    | 5,452  |    |  |    | 5,485  |    |  |   | 2,270  |   |  |   | 5,560   |   |  |   | 5,507  |   |  |   | 6,184  |  
|                                                        |  |                              |        |                              |  |    |        |    |  |    |        |    |  |    |        |    |  |   |        |   |  |   |         |   |  |   |        |   |  |   |        |  
|Loss from operations                                    |  |                              | (4,805 | )                            |  |    | (4,743 | )  |  |    | (4,580 | )  |  |    | (4,360 | )  |  |   | (1,439 | ) |  |   | (5,183  | ) |  |   | (4,839 | ) |  |   | (5,367 | )
|Minority interest                                       |  |                              | (13    | )                            |  |    | 147    |    |  |    | 180    |    |  |    | 58     |    |  |   | 43     |   |  |   | 35      |   |  |   | 12     |   |  |   | 37     |  
|Interest income, net                                    |  |                              | 1,516  |                              |  |    | 1,239  |    |  |    | 1,263  |    |  |    | 868    |    |  |   | 38     |   |  |   | 84      |   |  |   | 1,265  |   |  |   | 1,755  |  
|                                                        |  |                              |        |                              |  |    |        |    |  |    |        |    |  |    |        |    |  |   |        |   |  |   |         |   |  |   |        |   |  |   |        |  
|Net loss                                                |  |                              | (3,302 | )                            |  |    | (3,357 | )  |  |    | (3,137 | )  |  |    | (3,434 | )  |  |   | (1,358 | ) |  |   | (5,064  | ) |  |   | (3,562 | ) |  |   | (3,575 | )
|Deemed dividend on Series F preferred stock             |  |                              |       |                              |  |    |       |    |  |    |       |    |  |    |       |    |  |   |       |   |  |   | (10,100 | ) |  |   |       |   |  |   |       |  
|                                                        |  |                              |        |                              |  |    |        |    |  |    |        |    |  |    |        |    |  |   |        |   |  |   |         |   |  |   |        |   |  |   |        |  
|Net loss applicable to common stockholders              |  | $                            | (3,302 | )                            |  | $  | (3,357 | )  |  | $  | (3,137 | )  |  | $  | (3,434 | )  |  | $ | (1,358 | ) |  | $ | (15,164 | ) |  | $ | (3,562 | ) |  | $ | (3,575 | )
|                                                        |  |                              |        |                              |  |    |        |    |  |    |        |    |  |    |        |    |  |   |        |   |  |   |         |   |  |   |        |   |  |   |        |  
|Basic and diluted net loss per common share             |  | $                            | (0.16  | )                            |  | $  | (0.16  | )  |  | $  | (0.15  | )  |  | $  | (0.16  | )  |  | $ | (0.53  | ) |  | $ | (5.73   | ) |  | $ | (0.22  | ) |  | $ | (0.16  | )
|                                                        |  |                              |        |                              |  |    |        |    |  |    |        |    |  |    |        |    |  |   |        |   |  |   |         |   |  |   |        |   |  |   |        |  
|Weighted average shares outstanding, basic and
	diluted |  |                              | 21,125 |                              |  |    | 21,355 |    |  |    | 21,440 |    |  |    | 21,652 |    |  |   | 2,577  |   |  |   | 2,648   |   |  |   | 16,435 |   |  |   | 21,862 |  

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APPLIED MOLECULAR EVOLUTION, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

11.     Subsequent
Events

On March 4, 2002, AME Torrey View, LLC
(Torrey View), a 99% owned subsidiary of the
Company, which is consolidated in the Companys financial
statements, purchased a 10.73 acre parcel of undeveloped land in
San Diego County from a third party at a cost of approximately
$8.0 million. The Company intends to develop this property
over the next few years as its corporate headquarters.

In connection with the purchase, the Company
borrowed approximately $10.0 million, under a $15.0 million
collateralized credit facility, from Merrill Lynch Bank USA to
fund the purchase price and certain development costs. The
Company expects to borrow the remaining $5.0 million under
the credit facility during 2002. The Company also entered into a
$3.0 million loan and a development and management
agreement with a group, that is not affiliated with the Company,
but that is affiliated with the 1% owner of Torrey View, who
will assist the Company with the development of the project. The
$3.0 million loan from the Company to the group is
collateralized by a perfected security interest in the 1%
owners membership rights in Torrey View and is due in 2004.

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