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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------

                                   FORM 10-K
                            ------------------------

(MARK ONE)

     [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
           EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

                                       OR

     [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
           EXCHANGE ACT OF 1934

                       COMMISSION FILE NUMBER: 000-31101

                       APPLIED MOLECULAR EVOLUTION, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S>                                            <C>
                  DELAWARE                                      33-0374014
       (STATE OR OTHER JURISDICTION OF                       (I.R.S. EMPLOYER
       INCORPORATION OR ORGANIZATION)                       IDENTIFICATION NO.)
</TABLE>

                              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 [X]  NO [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [ ]

     The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $148,256,526 as of March 9, 2001, 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 23,592,727 shares of the registrant's Common Stock issued and
outstanding as of March 9, 2001.

                      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
2001 Annual Meeting of Stockholders to be held on May 31, 2001, is incorporated
by reference in Part III, Items 10, 11, 12 and 13 on this Form 10-K.
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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 evolution to the development of biotherapeutics.
Directed evolution is a process for optimizing genes and proteins for specific
commercial purposes. Our technology has been validated by, among other things,
our recent success in optimizing Synagis(R) for MedImmune, Inc. ("MedImmune").
We use our proprietary AMEsystem(TM) 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 evolution. We plan to use our directed
evolution technology to develop improved versions of currently marketed,
FDA-approved biopharmaceuticals as well as novel human biotherapeutics.

BACKGROUND

                        DNA, CODONS, GENES AND PROTEINS

                   [DNA, CODONS, GENES AND PROTEINS GRAPHIC]

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

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     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 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
about 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.

     Proteins are composed of combinations of 20 different sub-units 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 dramatic 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 purposes:

     - It is extremely slow, requiring the passage of thousands and even
       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, which is the study of all the genetic information of a species
and its relationship to disease, is transforming biotechnology. Recent
technological advances in molecular biology and in scientific instrumentation
have greatly increased the ability of researchers to identify genes and
subsequently determine their
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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 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
evolved for commercial purposes, and typically yield proteins that may be
deficient with respect to characteristics such as potency, stability,
availability in the body, side effect profile and manufacturing cost.

     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. Empiric evidence
suggests that random mutagenesis offers a low probability of improving a protein
and usually results in detrimental changes to 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 EVOLUTION AND LIMITATIONS OF COMPETING APPROACHES

     The goal of directed evolution is to optimize proteins for 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 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 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
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 evaluating, or screening, 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 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 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 evolution represents a significant step forward in the
optimization of proteins. There are currently a number of different competing
approaches for conducting directed evolution, including gene shuffling. We
believe that these competing approaches do not take full advantage of the
potential of directed 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 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
       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 efficacy, potency and
       side effect profile 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 evolution and address the limitations of
alternative directed evolution approaches. There are three components to our
AMEsystem technology:

     - DirectAME(TM): DirectAME is a patented gene synthesis process that
       enables us to rapidly produce a library of diverse genes altered from the
       initial gene.

     - ExpressAME(TM): ExpressAME consists of several gene expression systems
       that efficiently produce proteins from the genes produced using
       DirectAME.

     - SelectAME(TM): 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 generated using
       ExpressAME.

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                                [AMEsystem Logo]

  Step One: DirectAME

     Our patented DirectAME technology addresses the limitations of competing
directed evolution approaches by generating the appropriate amount of genetic
diversity in a rapid and precise fashion, thereby dramatically increasing the
probability of creating and identifying the most functionally-improved proteins.
In contrast to alternative directed evolution approaches, our DirectAME approach
has the following strengths:

     - Completeness of diversity. When optimizing the function of a protein by
       applying directed evolution technology, it is critical that all 20
       possible 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 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.

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     - 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 amino acids, the
      crucial sites on an antibody that determine its 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 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 evolution
technology to virtually any protein, including those that cannot be produced 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 evolution in a broad spectrum of host
organisms, including both bacterial and mammalian cells. As a result, we can now
rapidly optimize many biotherapeutics which were previously not amenable to
directed 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 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 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 can 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 evolution. We believe that the level of technological
sophistication and precision required to improve currently marketed,
FDA-approved biopharmaceuticals as well as to
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develop novel biotherapeutics is significantly greater than that required by
other potential target markets for directed evolution technologies. Since our
inception, we have focused on developing and optimizing our AMEsystem technology
to address these multi-billion dollar market opportunities.

  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.
Protein pharmaceutical products such as erythropoietin, which had worldwide
sales of approximately $3.8 billion in 1998, represent some of the world's
highest revenue pharmaceutical products. The biotherapeutic market encompasses a
wide variety 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 eight
       therapeutic antibodies, six of them in the last three years, with total
       sales in 1999 of approximately $1.0 billion, including $227 million for
       Synagis. The major obstacles to be overcome in antibody engineering
       include unfavorable side effect profile, inadequate affinity for the
       target, instability, manufacturing cost and potency.

      As demonstrated through collaborations with our corporate partners, our
      proprietary AMEsystem technology enables us to optimize human antibodies
      with respect to potency, affinity, side effect profile, stability and
      manufacturing cost. To date, we have optimized 10 different 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.
       G-CSF attained worldwide sales of over $1.6 billion in 1998 and is one of
       the world's highest revenue pharmaceutical products. Worldwide sales of
       cytokines totaled almost $8.0 billion in 1997.

     - Hormones: Hormones are proteins that are critical to the daily function
       and normal growth and development of the human body. 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. Many of the most debilitating and chronic human
       diseases are due to hormone deficiencies. Sales of human growth hormone
       totaled more than $1.5 billion in 1998.

     - Serum Proteins: Serum proteins are proteins that are found in the plasma
       or serum portion of human blood. Hemophilia is one example of a disease
       due to deficiencies in serum proteins. In this disease, a deficiency in
       one or more of the plasma proteins needed to form a blood clot results in
       a bleeding disorder. The treatment for hemophilia involves the
       administration of the missing serum protein. The total worldwide market
       for serum proteins for hemophiliacs in 1999 was approximately $1.0
       billion.

     - 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 the only treatment available to these
       patients. Worldwide sales of Cerezyme totaled approximately $470 million
       in 1999.

     - Growth Factors: Growth factors represent an emerging class of
       biotherapeutic compounds that show great promise in treating a host of
       different diseases. For example, vascular endothelial growth factor,
       commonly known as VEGF, is a protein that is secreted by oxygen-deprived
       tissues. It acts by binding to specific receptors on blood vessels to
       stimulate the formation of new blood vessels, a process known
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       as angiogenesis. Patients who suffer from coronary artery disease and who
       are not candidates for angioplasty or bypass surgery may benefit from the
       administration of this growth factor. This class of biotherapeutics may
       have a very large patient population. Given that the majority of these
       proteins are still in the very early stages of development, they
       represent attractive candidates for optimization using our AMEsystem
       technology.

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 Cell Matrix, Inc. ("Cell Matrix").

  Expanded Market Opportunity and 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 evolution technology, we created several new drug candidates for
MedImmune that have been shown in animal models to be at least 10 times more
potent than Synagis. MedImmune is expected to take one of these candidates
through clinical trials, and if successful, market it as Numax(TM). If Numax's
significantly increased potency is confirmed in human clinical trials expected
to begin in 2001, MedImmune could develop Numax for new markets including the
elderly, reduce production costs, and pursue various delivery forms to broaden
the product's use.

  Increased Potency and Decreased Manufacturing Costs

     MedImmune encountered a significant problem while attempting to
commercialize Vitaxin(TM), a monoclonal antibody product candidate designed to
treat various cancers 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 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 Phase I clinical trials
with MedImmune during the first quarter of 2001.

  Reduced Side Effects and Improved Affinity

     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 over a two-year period to improve its anti-CD40 antibody by
applying rational design techniques. Through the application of our AMEsystem
technology, we optimized the antibody in just four months, 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 expected to enter
Phase I clinical trials with anti-CD40 in 2001.

  Expanded Therapeutic Potential

     Seattle Genetics' BR96 is an antibody in development for treating 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.

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  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, 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.

BUSINESS STRATEGY

     We are a leader in applying directed evolution to the development and
commercialization of human biotherapeutics. We have selected biotherapeutics as
our primary target industry because it is the largest and highest margin market
for directed 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.

     - Develop Novel Biotherapeutics. We plan to access and develop novel human
       biotherapeutics from a wide variety of sources. We plan to continue our
       collaborations with leading pharmaceutical and biotechnology companies
       that are facing technical challenges to the development and
       commercialization of their therapeutic proteins. We also expect genomics
       and the sequencing of the human genome to yield an expanding number of
       novel proteins to optimize and commercially develop. Finally, we will
       continue to license additional biotherapeutic product candidates from
       leading academic institutions.

     - Leverage Strategic Collaborations. We plan to continue to leverage
       strategic collaborations to expand our product pipeline. 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. Collaborators provide financial support for research and
       development, and pay milestones and royalties on any product sales.

     - Invest in Selected Internal Development Projects. We plan to select a
       limited number of promising projects for internal development. We plan to
       focus on projects that we believe have lower development risks and target
       large, highly profitable markets such as 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 strong
       intellectual property portfolio. 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 strategic
collaborations will continue to be an important element of our business
strategy. Unless specifically mentioned, we do not have commercialization rights
to

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<PAGE>   11

the intellectual property 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 strategic collaboration
with MedImmune, a leader in the commercial development of therapeutic
antibodies. The agreement covers the licensing of Vitaxin to MedImmune as well
as the optimization of three additional antibodies, including Synagis. Licenses
granted under this agreement are exclusive and worldwide covering the right to
research, develop, sell and sublicense. The business terms of the agreement
include potential royalties which may last the life of the applicable patents as
well as other payments of up to $45.0 million including an aggregate of $750,000
in research and development support, $40.5 million in potential milestone
payments, and an equity investment. Under the terms of the agreement portions of
the milestone payments may be creditable against royalties. We have received
$7.4 million from MedImmune through December 31, 2000. The duration of the
research and development aspect of this agreement has been extended through
February 2003, although it may be terminated by MedImmune on 90 days notice or
by us in the event of a default by MedImmune.

     Synagis, MedImmune's flagship product, is currently the only FDA-approved
monoclonal antibody for the prevention of Respiratory Syncytial Virus infection.
Cost constraints and the requirement for intramuscular administration have
limited the drug's use to treating only high-risk infants. By applying our
AMEsystem technology, we created several new drug candidates for treating this
serious lung infection that have been demonstrated in animal models to be at
least 10 times more potent than Synagis. MedImmune is expected to take one of
these candidates through clinical trials, and if successful, market it as Numax.
This more potent version of Synagis, which is expected to enter clinical trials
in 2001, 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
oncology, rheumatoid arthritis, diabetic retinopathy, and macular degeneration.
We originally licensed 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
focusing on 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 decreased manufacturing costs. During the first quarter of
2001, MedImmune initiated Phase I clinical trials with second generation
Vitaxin.

  Bristol-Myers Squibb

     We have entered into two separate agreements with Bristol-Myers Squibb, one
of the largest pharmaceutical companies in the world. We have completed our
optimization work under these agreements and have received over $27 million
through December 31, 2000, and will potentially receive future royalties, as
well as up to $3,850,000 in potential milestones. Under the terms of the
agreement, portions of the milestone payments may be creditable against
royalties.

     In June 1993, we entered into the initial strategic 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 being developed by 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 autoimmune disease, which has now been completed. Bristol-Myers Squibb
is expected to begin Phase I clinical trials with its anti-CD40 antibody in
2001.

  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 from Bristol-Myers
                                        10
<PAGE>   12

Squibb and is continuing to develop this antibody. Under our original agreement
with Bristol-Myers Squibb and an agreement among Bristol-Myers Squibb, Seattle
Genetics, and AME, we may receive milestones and royalties from this product.

  Cell Matrix

     In November 1999, we entered into a strategic collaboration covering up to
four novel antibody therapeutics with Cell Matrix, a private biotechnology
company developing anti-angiogenic antibodies for the treatment of cancer.
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 potential royalties relating to
the two optimized compounds, which may last up to 10 years from the date of the
first commercial sale of a product developed from this collaboration.
Additionally, we may receive up to $8.5 million in research funding and
potential milestone payments. We have received a total of $1.0 million through
December 31, 2000, and we received an additional $500,000 in January 2001.

  Biosynexus

     In December 2000, we entered into a strategic collaboration covering the
optimization of a therapeutic antibody, HU96-110, with Biosynexus, Inc.
("Biosynexus"), a private biotechnology company developing antibodies for the
treatment of infectious disease. HU96-110 is being developed for the treatment
of staphlycoccal bacterial infection. The business terms of the agreement
include research and development support, potential milestone payments and
potential royalties on the sale of approved products. AME is currently
optimizing HU96-110.

INTERNAL DEVELOPMENT PROGRAMS

     We are using our AMEsystem technology to develop both improved versions of
currently marketed biopharmaceuticals and novel human therapeutics. We are
working on improving multiple currently marketed, 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 million in 2001. We are also
developing a number of product candidates based upon versions of a therapeutic
enzyme we licensed from the University of Nebraska Medical Center in March 2000
and the Mayo Clinic in January 2001. We are optimizing versions of this enzyme
for attractive markets including cancer, and plan to take 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
evolution with an extensive portfolio that includes 17 issued U.S. patents
related to our proprietary directed evolution technology. Thirty-four
counterpart patents to these U.S. patents are issued in other major
industrialized countries. We have an additional 22 pending U.S. patent
applications and 33 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 evolution. They claim methods for introducing changes at the
       codon level to generate genetic diversity.

     - ExpressAME: ExpressAME is a system used for conducting directed evolution
       in both bacterial and mammalian cells. This system enables the expression
       of many therapeutic proteins in their functional,
                                        11
<PAGE>   13

       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.

     - 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 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.

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

COMPETITION

     We are a leader in the application of directed evolution to the 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
drugs we have optimized.

     One of the product candidates with respect to which we have a collaboration
is currently in human clinical trials. MedImmune commenced a Phase I human
clinical trial with second generation Vitaxin in the first quarter of 2001 and
is expected to commence Phase II clinical trials with second generation Vitaxin
later in 2001. MedImmune is also expected to commence Phase I clinical trials
with Numax in 2001. Bristol-Myers Squibb is expected to enter a Phase I clinical
trial with anti-CD40 in 2001. Seattle Genetics is now in preclinical development
with hBR96 and Cell Matrix is in preclinical development with the
anti-angiogenic antibodies, HUI77 and HUIV26.

                                        12
<PAGE>   14

     Our corporate collaborators will control all aspects of the clinical
testing of these product candidates, and we do not have any results from
completed trials for these current product candidates. We also do not have any
product candidates of our own in preclinical or clinical development.

     Any products 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 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, multi-center, 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, IND, which the FDA must review and allow before human clinical trials
can start. 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 ultimately decide that the
application does not satisfy its criteria for approval or require additional
preclinical or clinical studies. 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

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<PAGE>   15

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
products 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.

EMPLOYEES

     As of December 31, 2000, we had 47 full-time employees, 21 of whom hold
advanced degrees. Thirty two of our full-time employees were engaged in research
and development and 15 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 $13.6
million for the year ended December 31, 2000, and our revenue for 2000 was $2.7
million. Additionally, we have had net losses each year since inception and as
of December 31, 2000, had an accumulated deficit of $40.9 million. We expect to
report a net loss for fiscal year 2001, 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 collaborations and expect to continue to do so in the
foreseeable future. Revenue from collaborations are 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
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 only 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

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<PAGE>   16

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

WE HAVE OPTIMIZED ONLY ONE TYPE OF PROTEIN AND MAY NOT BE ABLE TO OPTIMIZE
OTHERS, THEREBY LIMITING OUR MARKET POTENTIAL.

     To date we have optimized only antibodies for corporate collaborators. 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
products. 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 products under
their respective agreements. Moreover, some of our collaborators are also
researching competing technologies and products 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 products 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 products arising out of our collaborative arrangements
or not to devote sufficient resources to develop, manufacture, market or sell
these products.

IF PRODUCT CANDIDATES WE OPTIMIZE DO NOT RECEIVE REGULATORY APPROVAL, NEITHER WE
NOR OUR COLLABORATORS WILL BE ABLE TO COMMERCIALIZE THESE PRODUCTS.

     The U.S. Food and Drug Administration must approve any therapeutic product
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
drugs we have optimized.

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<PAGE>   17

IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGY, OUR
COMPETITIVE POSITION COULD BE HURT.

     The patent positions of biopharmaceutical 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.

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 products. 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 products 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 products 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 products through the
application of our directed 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 products we develop cannot be marketed as a
result, we would lose our core business.

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<PAGE>   18

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 maintain product
liability insurance, but we may not have sufficient coverage. If we are sued for
any injury caused by our products 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
5,450,000 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 31.4% 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.

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<PAGE>   19

                                   MANAGEMENT

EXECUTIVE OFFICERS

     Our executive officers and key employees, and their ages and positions as
of March 9, 2001, are:

<TABLE>
<CAPTION>
                   NAME                     AGE                         POSITION
                   ----                     ---                         --------
<S>                                         <C>    <C>
William D. Huse, M.D., Ph.D. .............  46     Chief Executive Officer, President and Director
Lawrence E. Bloch, M.D., J.D. ............  35     Chief Financial Officer, Vice President of
                                                   Business Development and Secretary
Jeffry D. Watkins, Ph.D. .................  39     Vice President of Research
</TABLE>

     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 post-doctoral work at Cold
Spring Harbor Laboratory.

     LAWRENCE E. BLOCH, M.D. has been our Vice President of Business Development
since July 1999, our Chief Financial Officer since March 2000 and our Secretary
since April 2000. From 1998 to 1999, he served as a consultant to several
private biotechnology companies, including U.S. Genomics, Inc. In 1995, Dr.
Bloch co-founded CareCom, Inc., a developer of patient-oriented bioinformatics
applications, and served as its President from 1995 to 1999. Dr. Bloch holds a
J.D. from Harvard Law School, an M.D. from Harvard Medical School, and an MBA
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 Vice President of Research since June
1998. 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 focusing on diagnostics. Dr. Watkins holds a Ph.D.
in biochemistry from Purdue University. He completed his post-doctoral 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, was named
inventor on seven directed evolution patents and has been the principal
investigator on multiple federal grants.

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 for the foreseeable
future.

ITEM 3. LEGAL PROCEEDINGS.

     Not applicable.

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

     Not applicable.

                                        18
<PAGE>   20

                                    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:

<TABLE>
<CAPTION>
                                                              HIGH      LOW
                                                             ------    ------
<S>                                                          <C>       <C>
Third Quarter (from July 27, 2000).........................  $40.25    $24.19
Fourth Quarter.............................................  $39.88    $11.75
</TABLE>

     On March 9, 2001, the last reported sale price of our common stock on the
Nasdaq National Market was $11.19 per share. On March 9, 2001, there were
approximately 1,200 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, 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.

                                        19
<PAGE>   21

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 are not
intended to replace the consolidated financial statements.

<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                  ------------------------------------------------
                                                  2000(1)    1999(1)    1998      1997      1996
                                                  --------   -------   -------   -------   -------
                                                       (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                               <C>        <C>       <C>       <C>       <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue.........................................  $  2,693   $ 2,592   $ 2,590   $ 3,329   $ 3,145
Operating expenses:
  Research and development......................     4,462     4,408     2,583     2,992     4,709
  General and administrative....................     2,834     1,363     1,975     2,637     2,614
  Amortization of deferred compensation ($3,882
     and $78 related to research and development
     and $8,343 and $377 related to general and
     administrative for the years ended December
     31, 2000 and 1999, respectively)...........    12,225       455        --        --        --
                                                  --------   -------   -------   -------   -------
          Total operating expenses..............    19,521     6,226     4,558     5,629     7,323
                                                  --------   -------   -------   -------   -------
Loss from operations............................   (16,828)   (3,634)   (1,968)   (2,300)   (4,178)
Minority interest...............................       127        45        --        --        --
Interest income, net............................     3,142       213       101        79         4
                                                  --------   -------   -------   -------   -------
Net loss........................................   (13,559)   (3,376)   (1,867)   (2,221)   (4,174)
Deemed dividend on Series F preferred stock.....   (10,100)       --        --        --        --
                                                  --------   -------   -------   -------   -------
Net loss applicable to common stockholders......  $(23,659)  $(3,376)  $(1,867)  $(2,221)  $(4,174)
                                                  ========   =======   =======   =======   =======
Basic and diluted net loss per common share.....  $  (2.17)  $ (1.39)  $ (1.13)  $ (1.43)  $ (3.14)
                                                  ========   =======   =======   =======   =======
Net loss per share..............................  $  (1.24)  $ (1.39)  $ (1.13)  $ (1.43)  $ (3.14)
                                                  ========   =======   =======   =======   =======
Weighted average shares outstanding.............    10,910     2,429     1,659     1,551     1,328
Pro forma net loss per share....................  $  (0.76)  $ (0.24)
                                                  ========   =======
Pro forma weighted average shares outstanding...    17,947    14,070
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
  investments...................................  $ 89,550   $ 3,498   $   824   $ 3,920   $ 3,089
Working capital.................................    90,565     3,225       313     1,052      (274)
Total assets....................................    94,874     5,938     2,752     5,717     5,384
Long-term obligations...........................        --        17        --        17        83
Minority interest...............................       372       225        --        --        --
Stockholders' equity............................    91,917     3,830       725     2,592     1,741
</TABLE>

---------------
(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).

                                        20
<PAGE>   22

QUARTERLY RESULTS OF OPERATIONS

     The following is a summary of the unaudited quarterly results of operations
for the years ended December 31, 2000 and 1999 (in thousands, except per share
data):

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31, 2000           YEAR ENDED DECEMBER 31, 1999
                                                  --------------------------------------   ----------------------------------
                                                    Q1         Q2        Q3        Q4        Q1        Q2       Q3       Q4
                                                  -------   --------   -------   -------   -------   ------   ------   ------
<S>                                               <C>       <C>        <C>       <C>       <C>       <C>      <C>      <C>
Revenue.........................................  $   831   $    377   $   668   $   817   $   147   $  318   $1,575   $  552
Operating expenses..............................    2,270      5,560     5,507     6,184     1,192    1,225    2,324    1,485
                                                  -------   --------   -------   -------   -------   ------   ------   ------
Loss from operations............................   (1,439)    (5,183)   (4,839)   (5,367)   (1,045)    (907)    (749)    (933)
Minority interest...............................       43         35        12        37        --       --       --       45
Interest income, net............................       38         84     1,265     1,755        31       66       56       60
                                                  -------   --------   -------   -------   -------   ------   ------   ------
Net loss........................................   (1,358)    (5,064)   (3,562)   (3,575)   (1,014)    (841)    (693)    (828)
Deemed dividend on Series F preferred stock.....       --    (10,100)       --        --        --       --       --       --
                                                  -------   --------   -------   -------   -------   ------   ------   ------
Net loss applicable to common stockholders......  $(1,358)  $(15,164)  $(3,562)  $(3,575)  $(1,014)  $ (841)  $ (693)  $ (828)
                                                  =======   ========   =======   =======   =======   ======   ======   ======
Basic and diluted net loss per common share.....  $ (0.53)  $  (5.73)  $ (0.22)  $ (0.16)  $ (0.42)  $(0.33)  $(0.27)  $(0.32)
                                                  =======   ========   =======   =======   =======   ======   ======   ======
Weighted average shares outstanding, basic
  and diluted...................................    2,577      2,648    16,435    21,862     2,429    2,568    2,569    2,570
Pro forma basic and diluted net loss per
  common share..................................  $ (0.10)  $  (0.33)  $ (0.17)  $ (0.16)  $ (0.07)  $(0.06)  $(0.05)  $(0.06)
                                                  =======   ========   =======   =======   =======   ======   ======   ======
Weighted average pro forma shares outstanding...   14,217     15,194    20,510    21,862    13,643   14,208   14,209   14,210
</TABLE>

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 evolution to the development
of biotherapeutics. Directed 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 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 - 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 the first quarter of 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 research collaborations, product and
technology licenses, pre-paid royalties and government grants. We have strategic
collaborations with MedImmune, Bristol-Myers Squibb, Seattle Genetics, Cell
Matrix, and Biosynexus. We have licensed intellectual property to Biosite
Diagnostics, Inc. in exchange for a non-refundable, 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.

                                        21
<PAGE>   23

     We have incurred losses since our inception. As of December 31, 2000, we
had an accumulated deficit of $40.9 million. These losses and this accumulated
deficit resulted from the significant costs incurred in the development of our
technology platform and the clinical development of Vitaxin. We expect these
losses to increase as we continue to invest in our AMEsystem technology and
internal development projects.

     We have capitalized 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, 2000, we had capitalized costs related to issued
patents totaling approximately $380,000 (net of accumulated amortization) and
approximately $1,152,000 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.

RESULTS OF OPERATIONS

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 one
time 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 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 Financial Accounting Standards Board (FASB)
Interpretation No. 28 over the vesting periods of the related options, which is
generally 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 mil-

                                        22
<PAGE>   24

lion 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.

YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998

     Revenue. Revenue was $2.6 million for both years ended December 31, 1999
and 1998. Revenue in 1999 was generated primarily from our collaboration with
MedImmune ($2.0 million), while 1998 revenue was generated primarily from our
collaboration with Bristol-Myers Squibb ($2.4 million).

     Research and development. Research and development expenses increased to
$4.4 million for the year ended December 31, 1999, from $2.6 million for the
year ended December 31, 1998, an increase of $1.8 million. The increase was
related primarily to an increase in the clinical development costs of Vitaxin
incurred in 1999.

     General and administrative. General and administrative expenses decreased
to $1.4 million for the year ended December 31, 1999, from $2.0 million for the
year ended December 31, 1998, a decrease of $600,000. The decrease was due
primarily to a reduction in administrative support personnel.

     Stock-based compensation. We recorded deferred stock-based compensation of
$1.1 million during the year ended December 31, 1999, of which $455,000 ($78,000
and $377,000 related to research and development and general and administrative,
respectively) was expensed in 1999.

     Interest income, net. Net interest income increased to $213,000 for the
year ended December 31, 1999, from $101,000 for the year ended December 31,
1998, an increase of $112,000. The increase was due primarily to our higher
average cash and investment balances during 1999 as a result of licensing
Vitaxin and selling common stock to MedImmune in February 1999 and from the
private placement of equity securities of our subsidiary, Novasite
Pharmaceuticals, Inc., in November 1999.

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 $17.1 million of cash from research collaborations
through December 31, 2000.

     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, 2000, we had approximately $89.6 million in cash, cash
equivalents and short-term investments, compared to $3.5 million of cash, cash
equivalents and short-term investments as of December 31, 1999.

     For the year ended December 31, 2000, we used cash of approximately $2.9
million in operating activities primarily to fund our net losses of $13.6
million, offset by non-cash charges for stock-based compensation

                                        23
<PAGE>   25

totaling $12.2 million, and changes in operating assets and liabilities of $1.3
million. We used approximately $3.2 million of cash for operations in 1999 and
$2.6 million in 1998.

     For the year ended December 31, 2000, we used cash of approximately $51.8
million in investing activities compared to the use of cash of approximately
$1.9 million for the year ended December 31, 1999. For the year ended December
31, 1998, we generated cash of $2.3 million from 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, 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. In 1998, we used cash of $66,000 for financing
activities, primarily for the payments on long-term equipment financing.

     Novasite Pharmaceuticals, Inc., our majority-owned subsidiary, was
incorporated in July 1999. Novasite has a proprietary technology platform for
discovering and optimizing small molecule drug candidates. In December 2000, AME
contributed $400,000 in cash in a private placement of Novasite's preferred
stock, and minority investors contributed $600,000 in gross cash proceeds,
resulting in a reduction in AME's ownership percentage in Novasite from 78% to
72%.

     We expect our cash requirements to increase significantly in 2001 as we
continue our research and development efforts, hire additional personnel, grow
our administrative support activities and expand our facilities. 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.

INCOME TAXES

     We incurred net operating losses in 2000, 1999 and 1998, and consequently
we did not pay any federal or state income taxes. At December 31, 2000, we had
federal net operating loss carryforwards of approximately $22 million, which
begin to expire in 2005. The net operating loss carryforwards for state tax
purposes were approximately $1.5 million, which began to expire in 1999. We also
had federal and state research and development tax credit carryforwards of
$518,000 and $279,000, respectively, which begin to expire in 2005.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In March 2000, the Financial Accounting Standards Board issued Financial
Interpretation No. 44, (FIN 44), Accounting for Certain Transactions Involving
Stock Compensation -- an interpretation of APB Opinion No. 25. FIN 44 clarifies
the definition of employee for purposes of applying Accounting Practice Board
Opinion No. 25, Accounting for Stock Issued to Employees, 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 became effective on July 1, 2000, but certain
conclusions in FIN 44 cover specific events that occur after either December 15,
1998, or January 12, 2000. The adoption of FIN 44 had no effect on our financial
position or results of operations.

                                        24
<PAGE>   26

     The Financial Accounting Standards Board has issued SFAS No. 133 Accounting
for Derivative Instruments and Hedging Activities, which became effective for
the Company on January 1, 2001. SFAS 133 establishes accounting and reporting
standards requiring that every derivative instrument, including certain
derivative instruments embedded in other contracts, be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS 133 also
requires that changes in the derivative's fair value be recognized in earnings
unless specific hedge accounting criteria are met. We believe that adoption of
SFAS 133 will not have a material effect on our financial statements, since we
currently do not hold derivative instruments or engage in hedging activities.

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 non government debt securities. The average duration
of all of our investments in 2000 was less than one year. 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.

                                        25
<PAGE>   27

                                    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."

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, 2000.

                                        26
<PAGE>   28

     (c) Exhibits

<TABLE>
<CAPTION>
    EXHIBIT
    NUMBER                         DESCRIPTION OF DOCUMENT
    -------                        -----------------------
    <C>          <S>
      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       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.
    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      Lease Agreement for 11095 Flintkote Avenue, San Diego,
                 California dated as of November 20, 2000.
      10.17      Amendment dated as of March 8, 2001 to Selection Agreement
                 with MedImmune, Inc.
      21.1       Subsidiaries of Applied Molecular Evolution, Inc.
      23.1       Consent of Ernst & Young LLP, Independent Auditors.
      24.1       Power of Attorney (see page 28).
</TABLE>

---------------
(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.

 +  The Company has received confidential treatment of certain portions of these
    agreements.

                                        27
<PAGE>   29

                                   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 nineteenth day of March, 2001.

                                          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., 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.

<TABLE>
<CAPTION>
                        NAME                                        TITLE                    DATE
                        ----                                        -----                    ----
<C>                                                    <C>                              <S>

          /s/ WILLIAM D. HUSE, M.D., PH.D.              President and Chief Executive   March 19, 2001
-----------------------------------------------------   Officer (Principal Executive
            William D. Huse, M.D., Ph.D.                    Officer) and Director

             /s/ LAWRENCE E. BLOCH, M.D.                   Chief Financial Officer      March 19, 2001
-----------------------------------------------------     (Principal Financial and
               Lawrence E. Bloch, M.D.                       Accounting Officer)

          /s/ COSTA G. SEVASTOPOULOS, PH.D.                 Chairman of the Board       March 16, 2001
-----------------------------------------------------
            Costa G. Sevastopoulos, Ph.D.

              /s/ PETER K. HILAL, M.D.                            Director              March 16, 2001
-----------------------------------------------------
                Peter K. Hilal, M.D.

                /s/ JOHN F. RICHARDS                              Director              March 16, 2001
-----------------------------------------------------
                  John F. Richards

               /s/ JAMES J. BOCHNOWSKI                            Director              March 16, 2001
-----------------------------------------------------
                 James J. Bochnowski
</TABLE>

                                        28
<PAGE>   30

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Report of Ernst & Young LLP, Independent Auditors...........  F-2
Consolidated Balance Sheets as of December 31, 2000 and
  1999......................................................  F-3
Consolidated Statements of Operations for the years ended
  December 31, 2000, 1999 and 1998..........................  F-4
Consolidated Statements of Stockholders' Equity for the
  years ended December 31, 2000, 1999 and 1998..............  F-5
Consolidated Statements of Cash Flows for the years ended
  December 31, 2000, 1999 and 1998..........................  F-6
Notes to Consolidated Financial Statements..................  F-7
</TABLE>

                                       F-1
<PAGE>   31

               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, 2000 and 1999, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2000. 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, 2000 and 1999, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States.

                                          /s/ ERNST & YOUNG LLP

San Diego, California
February 23, 2001,
except for the second paragraph of Note 6,
as to which the date is
March 8, 2001

                                       F-2
<PAGE>   32

                       APPLIED MOLECULAR EVOLUTION, INC.

                          CONSOLIDATED BALANCE SHEETS
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

                                     ASSETS

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                2000        1999
                                                              --------    --------
<S>                                                           <C>         <C>
Current assets:
  Cash and cash equivalents.................................  $ 36,865    $  1,974
  Short-term investments....................................    52,685       1,524
  Prepaid expenses..........................................       552         205
  Other current assets......................................     2,317         406
                                                              --------    --------
Total current assets........................................    92,419       4,109
Property and equipment, net.................................       851         442
Patents, net................................................     1,532       1,344
Other assets................................................        72          43
                                                              --------    --------
Total assets................................................  $ 94,874    $  5,938
                                                              ========    ========

                       LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable and accrued expenses.....................  $  1,579    $    629
  Current portion of deferred revenue.......................       258         237
  Current portion of long-term obligations..................        17          18
                                                              --------    --------
Total current liabilities...................................     1,854         884
Deferred revenue............................................       631         868
Deferred rent...............................................       100         114
Long-term obligations, less current portion.................        --          17
Minority interest...........................................       372         225
Commitments (Note 4)
Stockholders' equity:
  Preferred stock, $0.001 par value:
     Authorized shares -- 5,000,000 at December 31, 2000
     Issued and outstanding shares -- none at December 31,
      2000 and 11,640,124 at December 31, 1999 Liquidation
      value -- $24,551 at December 31, 1999.................        --          12
  Common stock, $0.001 par value:
     Authorized shares -- 45,000,000 at December 31, 2000
     Issued and outstanding shares -- 23,592,264 and
      2,569,846 at December 31, 2000 and 1999,
      respectively..........................................        24           3
  Additional paid-in capital................................   158,776      31,831
  Deferred compensation.....................................   (10,918)       (649)
  Notes receivable from employees...........................      (827)         --
  Accumulated other comprehensive income (loss).............       180          (8)
  Accumulated deficit.......................................   (40,918)    (27,359)
  Less: Treasury stock at cost -- 1,200,000 shares at
     December 31, 2000......................................   (14,400)         --
                                                              --------    --------
Total stockholders' equity..................................    91,917       3,830
                                                              --------    --------
Total liabilities and stockholders' equity..................  $ 94,874    $  5,938
                                                              ========    ========
</TABLE>

                            See accompanying notes.

                                       F-3
<PAGE>   33

                       APPLIED MOLECULAR EVOLUTION, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                              ------------------------------
                                                                2000       1999       1998
                                                              --------    -------    -------
<S>                                                           <C>         <C>        <C>
Revenue:
  Contract revenue (from related party in 1998).............  $  1,539    $ 2,008    $ 2,438
  Other revenue.............................................     1,154        584        152
                                                              --------    -------    -------
Total revenue...............................................     2,693      2,592      2,590
Operating expenses:
  Research and development..................................     4,462      4,408      2,583
  General and administrative................................     2,834      1,363      1,975
  Non-cash, stock based compensation ($3,882 and $78 related
     to research and development and $8,343 and $377 related
     to general and administrative for the years ended
     December 31, 2000 and 1999, respectively)..............    12,225        455         --
                                                              --------    -------    -------
Total operating expenses....................................    19,521      6,226      4,558
                                                              --------    -------    -------
Loss from operations........................................   (16,828)    (3,634)    (1,968)
Minority interest...........................................       127         45         --
Interest income, net........................................     3,142        213        101
                                                              --------    -------    -------
Net loss....................................................   (13,559)    (3,376)    (1,867)
Deemed dividend on Series F preferred stock.................   (10,100)        --         --
                                                              --------    -------    -------
Net loss applicable to common stockholders..................  $(23,659)   $(3,376)   $(1,867)
                                                              ========    =======    =======
Basic and diluted net loss per common share.................  $  (2.17)   $ (1.39)   $ (1.13)
                                                              ========    =======    =======
Weighted average shares outstanding used in computing basic
  and diluted loss per common share.........................    10,910      2,429      1,659
</TABLE>

                            See accompanying notes.

                                       F-4
<PAGE>   34

                       APPLIED MOLECULAR EVOLUTION, INC.

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                       (IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>

                                                                                                                         NOTES
                                                PREFERRED STOCK         COMMON STOCK       ADDITIONAL                  RECEIVABLE
                                              --------------------   -------------------    PAID-IN       DEFERRED        FROM
                                                SHARES      AMOUNT     SHARES     AMOUNT    CAPITAL     COMPENSATION   EMPLOYEES
                                              -----------   ------   ----------   ------   ----------   ------------   ----------
<S>                                           <C>           <C>      <C>          <C>      <C>          <C>            <C>
BALANCE AT DECEMBER 31, 1997................   11,640,124    $ 12     1,659,228    $ 2      $ 24,695      $     --       $  --
 Issuance of common stock...................           --      --           250     --            --            --          --
 Net loss and comprehensive loss............           --      --            --     --            --            --          --
                                              -----------    ----    ----------    ---      --------      --------       -----
BALANCE AT DECEMBER 31, 1998................   11,640,124      12     1,659,478      2        24,695            --          --
 Issuance of common stock, net..............           --      --       907,143      1         5,109            --          --
 Exercise of stock options for cash.........           --      --         3,225     --             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          --
 Minority investor's investment in
   Novasite.................................           --      --            --     --           922            --          --
 Unrealized loss on short-term
   investments..............................           --      --            --     --            --            --          --
 Net loss...................................           --      --            --     --            --            --          --
 Comprehensive loss.........................           --      --            --     --            --            --          --
                                              -----------    ----    ----------    ---      --------      --------       -----
BALANCE AT DECEMBER 31, 1999................   11,640,124      12     2,569,846      3        31,831          (649)         --
 Exercise of stock options for cash and
   notes receivable.........................           --      --     1,735,335      2         1,228            --        (799)
 Deferred compensation......................           --      --            --     --        21,220       (21,220)         --
 Amortization of deferred compensation......           --      --            --     --            --        10,948          --
 Issuance of stock options to consultants...           --      --            --     --             4            (4)         --
 Compensation related to consultant stock
   options..................................           --      --            --     --         1,270             7          --
 Interest on notes receivable...............           --      --            --     --            --            --         (28)
 Issuance of Series F preferred stock, net
   of issuance costs........................    2,244,444       2            --     --        10,006            --          --
 Issuance of common stock at IPO, net of
   issuance costs...........................           --      --     5,347,500      5        92,909            --          --
 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            --          --
 Purchase of treasury stock.................           --      --            --     --            --            --          --
 Unrealized gain on short-term
   investments..............................           --      --            --     --            --            --          --
 Net loss...................................           --      --            --     --            --            --          --
 Comprehensive loss.........................           --      --            --     --            --            --          --
                                              -----------    ----    ----------    ---      --------      --------       -----
BALANCE AT DECEMBER 31, 2000................           --    $ --    23,592,264    $24      $158,776      $(10,918)      $(827)
                                              ===========    ====    ==========    ===      ========      ========       =====

<CAPTION>
                                               ACCUMULATED
                                                  OTHER                        TREASURY STOCK
                                              COMPREHENSIVE                        AT COST              TOTAL
                                                 INCOME       ACCUMULATED   ---------------------   STOCKHOLDERS'
                                                 (LOSS)         DEFICIT       SHARES      AMOUNT       EQUITY
                                              -------------   -----------   ----------   --------   -------------
<S>                                           <C>             <C>           <C>          <C>        <C>
BALANCE AT DECEMBER 31, 1997................      $ --         $(22,117)            --   $     --     $  2,592
 Issuance of common stock...................        --               --             --         --           --
 Net loss and comprehensive loss............        --           (1,867)            --         --       (1,867)
                                                  ----         --------     ----------   --------     --------
BALANCE AT DECEMBER 31, 1998................        --          (23,984)            --         --          725
 Issuance of common stock, net..............        --               --             --         --        5,110
 Exercise of stock options for cash.........        --               --             --         --            1
 Deferred compensation......................        --               --             --         --           --
 Amortization of deferred compensation......        --               --             --         --          435
 Issuance of stock options to consultants...        --               --             --         --           --
 Compensation related to consultant stock
   options..................................        --               --             --         --           20
 Minority investor's investment in
   Novasite.................................        --               --             --         --          922
 Unrealized loss on short-term
   investments..............................        (8)              --             --         --           (8)
 Net loss...................................        --           (3,375)            --         --       (3,375)
                                                                                                      --------
 Comprehensive loss.........................        --               --             --         --       (3,383)
                                                  ----         --------     ----------   --------     --------
BALANCE AT DECEMBER 31, 1999................        (8)         (27,359)            --         --        3,830
 Exercise of stock options for cash and
   notes receivable.........................        --               --             --         --          431
 Deferred compensation......................        --               --             --         --           --
 Amortization of deferred compensation......        --               --             --         --       10,948
 Issuance of stock options to consultants...        --               --             --         --           --
 Compensation related to consultant stock
   options..................................        --               --             --         --        1,277
 Interest on notes receivable...............        --               --             --         --          (28)
 Issuance of Series F preferred stock, net
   of issuance costs........................        --               --             --         --       10,008
 Issuance of common stock at IPO, net of
   issuance costs...........................        --               --             --         --       92,914
 Issuance of common stock for conversion of
   preferred stock upon IPO.................        --               --             --         --           --
 Issuance of common stock for exercise of
   warrants.................................        --               --             --         --           --
 Minority investor's investment in
   Novasite.................................        --               --             --         --          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................      $180         $(40,918)    (1,200,000)  $(14,400)    $ 91,917
                                                  ====         ========     ==========   ========     ========
</TABLE>

                            See accompanying notes.

                                       F-5
<PAGE>   35

                       APPLIED MOLECULAR EVOLUTION, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                  YEAR ENDED DECEMBER 31,
                                                              -------------------------------
                                                                2000        1999       1998
                                                              ---------    -------    -------
<S>                                                           <C>          <C>        <C>
OPERATING ACTIVITIES
Net loss....................................................  $ (13,559)   $(3,376)   $(1,867)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation and amortization.............................        264        244        398
  Amortization of deferred compensation.....................     10,948        435         --
  Compensation related to consultant stock options..........      1,277         20         --
  Deferred revenue..........................................       (216)      (237)    (1,097)
  Deferred rent.............................................        (14)        (7)        --
  Minority interest.........................................       (127)       (45)        --
  Realized gain on short-term investments...................       (124)        --         --
  Accrued interest on notes receivable from employees.......        (28)        --         --
  Write-off of abandoned patents............................         49          3         --
  Changes in operating assets and liabilities:
     Prepaid expenses and other assets......................     (2,287)      (308)      (135)
     Accounts payable and accrued expenses..................        950         83         63
                                                              ---------    -------    -------
Net cash flows used in operations...........................     (2,867)    (3,188)    (2,638)
INVESTING ACTIVITIES
Purchase of property and equipment..........................       (565)      (182)        (9)
Purchase of short-term investments..........................   (109,078)    (3,906)        --
Proceeds from sale of short-term investments................     58,228      2,375      2,740
Patents.....................................................       (345)      (225)      (383)
                                                              ---------    -------    -------
Net cash flows provided by (used in) investing activities...    (51,760)    (1,938)     2,348
FINANCING ACTIVITIES
Payments on long-term obligations...........................        (18)       (27)       (66)
Issuance of common stock, net...............................     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 (used in) financing activities...     89,518      6,276        (66)
                                                              ---------    -------    -------
Increase (decrease) in cash and cash equivalents............     34,891      1,150       (356)
Cash and cash equivalents at the beginning of the year......      1,974        824      1,180
                                                              ---------    -------    -------
Cash and cash equivalents at the end of the year............  $  36,865    $ 1,974    $   824
                                                              =========    =======    =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest......................................  $       2    $     2    $     6
                                                              =========    =======    =======
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...................................................  $     827    $    --    $    --
                                                              =========    =======    =======
</TABLE>

                            See accompanying notes.

                                       F-6
<PAGE>   36

                       APPLIED MOLECULAR EVOLUTION, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               DECEMBER 31, 2000

 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 monoclonal antibodies for pharmaceutical and
biotechnology companies.

PRINCIPLES OF CONSOLIDATION

     The consolidated financial statements include the accounts of the Company
and Novasite Pharmaceuticals, Inc. ("Novasite"), which was incorporated in 1999.
At December 31, 2000, AME's ownership interest in Novasite was 72%. Prior to
December 2000, AME had a 78% ownership interest in Novasite. All significant
intercompany accounts and transactions have been eliminated. Minority interest
at December 31, 2000, represents the minority stockholders' proportionate share
of the net assets of Novasite at such date.

     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, using both its own employees and certain employees of the
Company on a contract services basis. The net loss of Novasite ($567,000 and
$205,000 in 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.

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 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
<PAGE>   37
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

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 on a straight-line basis 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, 2000.

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

                                       F-8
<PAGE>   38
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

losses on investments, shall be reported, net of their related tax effect, to
arrive at comprehensive income or loss.

NET LOSS PER SHARE

     Basic and diluted net loss per common share are presented in conformity
with SFAS No. 128, Earnings per Share, and Staff Accounting Bulletin 98 (SAB 98)
issued by the Securities and Exchange Commission, for all periods presented.
Under the provisions of SAB 98, common stock and preferred stock that has been
issued or granted for nominal consideration prior to the anticipated effective
date of the initial public offering must be included in the calculation of basic
and diluted net loss per common share as if these shares had been outstanding
for all periods presented. To date, the Company has not issued or granted shares
for nominal consideration.

     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. Pro forma
basic and diluted net loss per common share, as presented below, has been
computed for the years ended December 31, 2000 and 1999, as described above, and
also gives effect to the conversion of preferred stock which automatically
converted to common stock immediately prior to the completion of the Company's
initial public offering (using the "as if converted" method) from the original
date of issuance.

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

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31,
                                                       ------------------------------
                                                         2000       1999       1998
                                                       --------    -------    -------
<S>                                                    <C>         <C>        <C>
Net loss applicable to common stockholders...........  $(23,659)   $(3,376)   $(1,867)
                                                       ========    =======    =======
Weighted average shares used in computing net loss
  per share, basic and diluted.......................    10,910      2,429      1,659
                                                       ========    =======    =======
Net loss per common share, basic and diluted.........  $  (2.17)   $ (1.39)   $ (1.13)
                                                       ========    =======    =======
Pro forma net loss per share:
Net loss applicable to common stockholders...........  $(23,659)   $(3,376)
Less: deemed dividend on Series F preferred stock....    10,100         --
                                                       --------    -------
Pro forma net loss...................................  $(13,559)   $(3,376)
                                                       ========    =======
Weighted average shares used in computing net loss
  per share, basic and diluted.......................    10,910      2,429
Pro forma adjustment to reflect weighted average
  effect of assumed conversion of preferred stock
  (unaudited)........................................     7,037     11,641
                                                       --------    -------
Shares used in computing pro forma net loss per
  share, basic and diluted (unaudited)...............    17,947     14,070
                                                       ========    -------
Pro forma net loss per share, basic and diluted
  (unaudited)........................................  $  (0.76)   $ (0.24)
                                                       ========    =======
</TABLE>

     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 application of the treasury stock method for
options and warrants, was 2,509,716, 13,008,863 and 12,928,966 for the years
ended December 31, 2000, 1999 and 1998, respectively. Such securities, had they
been dilutive, would have been included in the computation of diluted net loss
per share.

                                       F-9
<PAGE>   39
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

REVENUE RECOGNITION

     Contract revenue in 2000 includes amounts received under collaborative
agreements with MedImmune, Inc. ("MedImmune") and Cell Matrix, Inc. ("Cell
Matrix") (Note 6), and 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.

     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 by
MedImmune, which occurred in August 1999. Contract revenue from related party in
1998 consists of amounts received under collaborative agreements with
Bristol-Myers Squibb Company ("Bristol-Myers Squibb") (Note 6), and was
recognized as services were performed under the contract.

     Other revenue consists principally of research grants and a non-refundable,
prepaid royalty fee received from Biosite Diagnostics, Inc. ("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. Accordingly,
amounts received under multiple-element arrangements requiring on-going 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 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 7), 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.

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

                                       F-10
<PAGE>   40
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

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.

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

RECLASSIFICATIONS

     Certain amounts in the prior year financial statements have been
reclassified to conform to the current year presentation.

RECENTLY ISSUED ACCOUNTING STANDARDS

     The Financial Accounting Standards Board has issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, which the Company
will adopt effective January 1, 2001. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. Management does not
believe the adoption of SFAS No. 133 will impact the financial statements as the
Company currently does not invest in derivative instruments or engage in hedging
activities.

     In March 2000, the Financial Accounting Standards Board issued Financial
Interpretation No. 44, or FIN 44, Accounting for Certain Transactions Involving
Stock Compensation -- an interpretation of APB Opinion No. 25. FIN 44 clarifies
the definition of employee for purposes of applying Accounting Practice Board
Opinion No. 25, Accounting for Stock Issued to Employees, 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 became effective on July 1, 2000, but certain
conclusions in FIN 44 cover specific events that occur after either December 15,
1998 or January 12, 2000. The adoption of FIN 44 had no effect on our financial
position or results of operations.

                                       F-11
<PAGE>   41
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

 2. BALANCE SHEET DETAILS

SHORT-TERM INVESTMENTS

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

<TABLE>
<CAPTION>
                                                      AMORTIZED    MARKET     UNREALIZED
                                                        COST        VALUE     GAIN (LOSS)
                                                      ---------    -------    -----------
<S>                                                   <C>          <C>        <C>
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
                                                       =======     =======       ====
</TABLE>

     At December 31, 1999, short-term investments consisted of the following (in
thousands):

<TABLE>
<CAPTION>
                                                       AMORTIZED    MARKET    UNREALIZED
                                                         COST       VALUE     GAIN (LOSS)
                                                       ---------    ------    -----------
<S>                                                    <C>          <C>       <C>
Obligations of U.S. government agencies..............   $1,195      $1,187        $(8)
Corporate debt securities............................      337         337         --
                                                        ------      ------        ---
                                                        $1,532      $1,524        $(8)
                                                        ======      ======        ===
</TABLE>

     Short-term investments by contractual maturity at December 31, 2000, are as
follows (in thousands):

<TABLE>
<S>                                                          <C>
Due in one year or less....................................  $10,754
Due after one year through two years.......................   27,810
Greater than two years.....................................   14,121
                                                             -------
                                                             $52,685
                                                             =======
</TABLE>

OTHER CURRENT ASSETS

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

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                           ------------------
                                                            2000       1999
                                                           -------    -------
<S>                                                        <C>        <C>
Interest income receivable...............................  $ 1,195    $    --
Contract and grant research receivable...................    1,072        374
Other....................................................       50         32
                                                           -------    -------
                                                           $ 2,317    $   406
                                                           =======    =======
</TABLE>

PROPERTY AND EQUIPMENT

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

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                           ------------------
                                                            2000       1999
                                                           -------    -------
<S>                                                        <C>        <C>
Laboratory equipment.....................................  $ 2,069    $ 1,678
Computers, office furniture and equipment................      740        580
Leasehold improvements...................................      483        469
                                                           -------    -------
                                                             3,292      2,727
Accumulated depreciation.................................   (2,441)    (2,285)
                                                           -------    -------
                                                           $   851    $   442
                                                           =======    =======
</TABLE>

                                       F-12
<PAGE>   42
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

PATENT COSTS

     Patent costs consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                           ------------------
                                                            2000       1999
                                                           -------    -------
<S>                                                        <C>        <C>
Issued patent costs......................................  $   685    $   662
Accumulated amortization.................................     (305)      (197)
                                                           -------    -------
                                                               380        465
Unissued patent costs....................................    1,152        879
                                                           -------    -------
                                                           $ 1,532    $ 1,344
                                                           =======    =======
</TABLE>

 3. STOCKHOLDERS' EQUITY

PREFERRED STOCK

     On May 3, 2000, the Company sold 1,133,333 shares of Series F preferred
stock at $4.50 per share for gross proceeds of $5.1 million. On June 15, 2000,
the Company sold an additional 1,111,111 shares of Series F preferred stock at
$4.50 per share for gross proceeds of $5.0 million. The Series F preferred stock
was sold primarily to the affiliates of an independent accredited investor,
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.

     Also, concurrent with the close of the Company's initial public offering,
the Company's articles of incorporation were amended to authorize 5,000,000
shares of undesignated preferred stock, none of which are issued or outstanding.
The Company's board of directors is authorized to fix the designation, powers,
preferences, and rights of any such series.

COMMON STOCK

     Concurrent with the close of the Company's initial public offering, the
Company's articles of incorporation were amended to increase the authorized
number of shares of common stock to 45,000,000 shares.

     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.

                                       F-13
<PAGE>   43
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

STOCK OPTION PLANS

     The Company's 1992 Stock Plan has authorized the grant of options for up to
3,100,000 shares of common stock to employees, directors and consultants. All
options granted have ten year terms and generally vest ratably over four years
of continued employment. In April 2000, the Company adopted the 2000 Stock Plan,
authorizing the issuance of 1,600,000 stock options. These options vest over
seven years but vesting may accelerate if the aggregate public market value of
the Company exceeds specified levels on specified dates. Shares issued pursuant
to the exercise of an unvested option are subject to the Company's right of
repurchase which lapses over the vesting period of the original option.

     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 stock options because, as
discussed below, the alternative fair value accounting provided for under SFAS
No. 123, Accounting for Stock-Based Compensation, requires use of option
valuation models which the Company believes were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.

     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 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 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 and 1998 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 2000, 1999 and 1998
were $0.67, $0.03, and $0.11, 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):

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31,
                                                       ------------------------------
                                                         2000       1999       1998
                                                       --------    -------    -------
<S>                                                    <C>         <C>        <C>
Net loss attributable to common stockholders, as
  reported...........................................  $(23,659)   $(3,376)   $(1,867)
Net loss attributable to common stockholders, pro
  forma..............................................  $(23,802)   $(3,407)   $(1,873)
Basic and diluted net loss per share, as reported....  $  (2.17)   $ (1.39)   $ (1.13)
Basic and diluted net loss per share, pro forma......  $  (2.18)   $ (1.40)   $ (1.13)
</TABLE>

                                       F-14
<PAGE>   44
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

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

<TABLE>
<CAPTION>
                                                                      WEIGHTED
                                                      NUMBER OF       AVERAGE
                                                       SHARES      EXERCISE PRICE
                                                      ---------    --------------
<S>                                                   <C>          <C>
Balance at December 31, 1997........................      732          $0.37
  Granted...........................................      641          $0.45
  Exercised.........................................       --             --
  Canceled..........................................     (151)         $0.44
                                                       ------
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
                                                       ======
</TABLE>

     At December 31, 2000, options to purchase 781,045 shares were exercisable
and 557,662 shares and 640,000 shares were available for future grant under the
1992 and the 2000 Plans, respectively. At December 31, 2000, 1,235,872 shares of
common stock were reserved for issuance upon exercise of outstanding options.

     Exercise prices and the weighted average remaining contractual life for
options outstanding as of December 31, 2000, are as follows (shares in
thousands):

<TABLE>
<CAPTION>
                                             WEIGHTED       WEIGHTED                 WEIGHTED
                                             AVERAGE        AVERAGE                  AVERAGE
                             NUMBER         REMAINING       EXERCISE     NUMBER      EXERCISE
RANGE OF EXERCISE PRICES   OUTSTANDING   CONTRACTUAL LIFE    PRICE     EXERCISABLE    PRICE
------------------------   -----------   ----------------   --------   -----------   --------
<S>                        <C>           <C>                <C>        <C>           <C>
    $ 0.25 - $ 0.45             813            6.24          $ 0.40        608        $0.38
    $ 0.75 - $ 1.25             353            9.24          $ 0.81        173        $0.76
    $ 6.50 - $13.50               6            9.55          $ 8.41         --           --
    $21.00 - $38.50              64            9.83          $24.84         --           --
                              -----                                        ---
    $ 0.25 - $38.50           1,236            7.30          $ 1.82        781        $0.46
</TABLE>

     At December 31, 2000, 1,273,844 shares of common stock issued upon the
exercise of options were subject to repurchase at a weighted-average price of
$0.79.

     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, 2000
and 1999, the Company recorded amortization of deferred stock compensation
expense of approximately $12.2 million and $435,000, respectively.

                                       F-15
<PAGE>   45
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

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
commencing in 2001. No shares have been issued to date under the ESPP.

COMMON STOCK SOLD TO MEDIMMUNE

     In conjunction with a collaborative research and development agreement
entered into with MedImmune in February 1999 (Note 7), 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. The Company considered available objective evidence related to the
value of the other two elements of the agreement, including (i) offers made in
late 1998 by another company to acquire a license to Vitaxin without a
contemporaneous equity investment in the company, and (ii) offers made in late
1998 by another company to acquire the Company. The Company also considered that
(i) there had been no other sales of common stock to independent outside
investors in 1998 or 1999, (ii) the limited number of offers received for either
a Vitaxin license or an acquisition of the Company, and (iii) the persuasiveness
of the amounts in these offers given that the transactions were not ultimately
consummated. Ultimately, while the Company believes a significant portion of the
proceeds related 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.

 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 $415,000 for each of the three years in the
period ended December 31, 2000. At December 31, 2000 and 1999, equipment
recorded under capital leases totaled approximately $45,000 less accumulated
amortization of $13,000 and $5,000, respectively.

                                       F-16
<PAGE>   46
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

     Annual future minimum lease payments as of December 31, 2000, are as
follows (in thousands):

<TABLE>
<CAPTION>
                                                            OPERATING    CAPITAL
                                                             LEASES      LEASES
                                                            ---------    -------
<S>                                                         <C>          <C>
2001......................................................   $  574        $17
2002......................................................      543         --
2003......................................................      561         --
2004......................................................       23         --
2005......................................................        9         --
                                                             ------        ---
Total minimum lease payments..............................   $1,710         17
                                                             ======
Less amount representing interest.........................                  --
                                                                           ---
Present value of capital lease obligations................                  17
Less current portion......................................                  17
                                                                           ---
Capital lease obligations, non-current....................                 $--
                                                                           ===
</TABLE>

     The Company subleases a portion of its facilities under a sublease expiring
in June 2002. Sublease income was approximately $86,000, $10,000 and $10,000 for
the years ended December 31, 2000, 1999 and 1998, respectively. Future minimum
sublease income to be received under non-cancelable subleases as of December 31,
2000 is approximately $112,000 and $76,000 for the years ended December 31, 2001
and 2002, respectively.

 5. INCOME TAXES

     At December 31, 2000, the Company had federal and California tax net
operating loss carryforwards of approximately $22 million and $1.5 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 50% limitation of California
loss carryforwards. The federal tax loss carryforwards will begin expiring in
2005, unless previously utilized. Approximately $16,000 of the California tax
loss carryforward expired during 2000, and the related deferred tax asset and
tax loss carryforward amounts have been reduced accordingly. The remaining
California tax loss carryforward will begin expiring in 2001 unless previously
utilized. The Company also has federal and California research and development
tax credit carryforwards totaling $518,000 and $279,000, 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 which occurred
during 1993. However, the Company believes that the limitation will not have a
material impact on the utilization of the carryforwards.

                                       F-17
<PAGE>   47
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

     Significant components of the Company's deferred tax assets as of December
31, 2000 and 1999 are shown below. A valuation allowance of $8.9 million, has
been recognized to offset the deferred tax assets as realization of such assets
is uncertain.

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                           ------------------
                                                            2000       1999
                                                           -------    -------
                                                             (IN THOUSANDS)
<S>                                                        <C>        <C>
Deferred tax assets:
  Net operating loss carryforwards.......................  $ 7,793    $ 7,267
  Research and development credits.......................      699        826
  Capitalized research expense...........................      388        969
  Deferred revenue.......................................      362        450
  Other..................................................      258        273
                                                           -------    -------
Total deferred tax assets................................    9,500      9,785
  Valuation allowance for deferred tax assets............   (8,911)    (9,248)
                                                           -------    -------
Net deferred tax assets..................................      589        537
Deferred tax liabilities:
     Patent expenses.....................................     (589)      (537)
                                                           -------    -------
Net deferred taxes.......................................  $    --    $    --
                                                           =======    =======
</TABLE>

 6. COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS

BRISTOL-MYERS SQUIBB

     During 1993 and 1995, the Company entered into two collaborative agreements
with Bristol-Myers Squibb to discover and develop certain antibodies for use in
human cancer therapy. The Company was required to provide a specified level of
scientific research through September 1998. Included in the statements of
operations are contract revenues from a related party in connection with this
agreement of $2.4 million for the year ended December 31, 1998. As of December
31, 1998, the Company had received all contract revenue payments specified under
the agreement and had completed all its performance obligations. The agreements
also provide that Bristol-Myers Squibb 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 does not anticipate any future contract
revenue under this agreement.

MEDIMMUNE

     In February 1999, the Company entered into a collaboration agreement with
MedImmune to produce optimized antibodies. Pursuant to the terms of the research
program under the collaboration agreement, MedImmune agreed to fund three
research programs for a stated number of full-time employees, dedicated to the
specified research, each for a period of six months, extendable up to 24 months.
The first research program began in February 1999, and was completed in March
2000. The term of the collaboration agreement was extended on March 8, 2001, to
provide for the remaining two research programs to be selected by February 24,
2003. In addition, 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% recorded as deferred
royalty revenue. Additionally, if MedImmune makes the milestone payment through
an equity purchase, 20% of the

                                       F-18
<PAGE>   48
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

amount will be recorded as deferred royalty revenue. During the year ended
December 31, 2000, the Company recorded revenue of approximately $200,000
related to research activities performed under the agreement.

CELL MATRIX

     In November 1999, the Company entered into a collaboration agreement with
Cell Matrix to humanize and optimize candidate molecules and to perform some
preclinical development. Pursuant to the terms of the agreement, Cell Matrix
paid the Company for the humanization and 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. 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 Incorporated ("Biosynexus") to optimize a candidate molecule and
perform certain preclinical development. The research and development aspect of
this collaboration is 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.

 7. LICENSE AGREEMENTS

MEDIMMUNE

     Vitaxin, the Company's angiogenesis inhibitor, was exclusively licensed to
MedImmune in return for an equity investment, milestone payments and royalties.
Under the agreement, MedImmune is responsible for all future clinical
development, manufacturing and commercialization of Vitaxin. MedImmune made a
$5.15 million equity investment in the Company in February 1999 (Note 3), and
pursuant to the terms of the agreement and will pay milestones and royalties
related to the development and commercialization of any resulting products.

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
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 upfront, non-refundable royalty fee of $1.5 million. The Company
is recognizing the royalty fee as revenue over the estimated lives of the
related patents. As of December 31, 2000, 1999 and 1998, approximately $868,000,
$1.1 million and $1.3 million, respectively, of the amount originally received
is included in deferred revenue.

                                       F-19
<PAGE>   49
                       APPLIED MOLECULAR EVOLUTION, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                               DECEMBER 31, 2000

 8. NIH GRANT

     In September 2000, the National Institutes of Health ("NIH") awarded a
grant to Novasite which provides $3.2 million over three years for research to
develop Novasite's proprietary technology platform. Revenue related to this
grant of approximately $748,000 is included in other revenue for the year ended
December 31, 2000.

 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. Through December 31, 2000, there have
been no Company contributions under the plan.

                                       F-20