<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

                                   (Mark One)

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended September 30, 2001

OR

|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ____ to ____.

                         COMMISSION FILE NUMBER 0-25075
                         ------------------------------

                              ARTIFICIAL LIFE, INC.
                              ---------------------
             (Exact name of Registrant as specified in its charter)

                   DELAWARE                                04-3253298
       ------------------------------------------------------------------
       (State or other jurisdiction of                 (I.R.S. Employer
        incorporation or organization)                Identification No.)

             885 THIRD AVENUE, SUITE 2921
                  NEW YORK, NEW YORK                         10022
       ------------------------------------------------------------------
        (Address of principal executive offices)           (Zip Code)

                                 (212) 829-4386
                                 --------------
              (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such

filing requirements for the past 90 days. Yes |X| No |_|

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

As of November 5, 2001, the registrant had 10,728,469 shares of common stock,
$0.01 par value per share, outstanding.
<PAGE>

                              ARTIFICIAL LIFE, INC.

                                TABLE OF CONTENTS

PART I:                      FINANCIAL INFORMATION                      PAGE NO.
                                                                        --------
ITEM 1.   UNAUDITED FINANCIAL STATEMENTS:

          Condensed Consolidated Balance Sheets - December 31, 2000
          and September 30, 2001........................................       2

          Condensed Consolidated Statements of Operations for
          the Three and Nine Months Ended  September 30, 2000 and 2001..       3

          Condensed Consolidated Statements of Stockholders'
          Equity (Deficit) for the Nine Months Ended  September 30,
          2000 and 2001.................................................       4

          Condensed Consolidated Statements of Cash Flows for
          the Nine Months Ended September 30, 2000 and 2001.............       5

          Notes to Unaudited Condensed Consolidated Financial
          Statements....................................................       6

ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
          CONDITION AND RESULTS OF OPERATIONS...........................       8

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
          MARKET RISK...................................................      12

PART II                         OTHER INFORMATION

ITEM 1    LEGAL PROCEEDINGS.............................................      12

ITEM 2    CHANGE IN SECURITIES AND USE OF PROCEEDS......................      12

ITEM 3    DEFAULTS UPON SENIOR SECURITIES...............................      12

ITEM 4    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........      12

ITEM 5    OTHER INFORMATION.............................................      12

ITEM 6    EXHIBITS AND REPORTS ON FORM 8-K..............................      13
<PAGE>

                              ARTIFICIAL LIFE, INC.

                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)

                                     ASSETS

<TABLE>
<CAPTION>
                                                                             December 31,    September 30,
                                                                                 2000            2001
                                                                             ------------    -------------
<S>                                                                          <C>             <C>
Current assets:
  Cash and cash equivalents                                                  $    729,696    $     78,068
  Accounts receivable, trade, net of allowance for doubtful
    accounts of $2,152,070 in 2000 and $1,924,690 in 2001                       1,315,074              --
  Accounts receivable, affiliate                                                  207,766              --
  Due from officer/stockholder                                                     53,773          41,840
  Refundable foreign taxes                                                         81,949              --
  Prepaid expenses and other current assets                                       287,381         100,648
                                                                             ------------    ------------

      Total current assets                                                      2,675,639         220,556
                                                                             ------------    ------------

Property and equipment:
  Computer equipment                                                            3,290,916         615,186
  Furniture and fixtures                                                          806,885              --
  Leasehold improvements                                                          642,445              --
  Office equipment                                                                401,602           2,001
                                                                             ------------    ------------

                                                                                5,141,848         617,187
  Less accumulated depreciation and amortization                                1,719,994         310,946
                                                                             ------------    ------------

                                                                                3,421,854         306,241
                                                                             ------------    ------------

Other assets:
  Costs in excess of fair value of net assets acquired, net of accumulated
    amortization of $33,493 in 2000 and $62,152 in 2001                            52,482          23,824
  Capitalized software development costs, net of accumulated
    amortization of $964,140 in 2000 and $1,134,373 in 2001                       500,984         104,002
  Investments in unconsolidated subsidiaries                                      250,000         250,000
  Deposits and other assets                                                        62,046          25,904
                                                                             ------------    ------------

                                                                                  865,512         403,730
                                                                             ------------    ------------

  TOTAL ASSETS                                                               $  6,963,005    $    930,527
                                                                             ============    ============

                 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
  Accounts payable                                                           $  2,169,086    $  1,249,056
  Advances from stockholder                                                            --       1,045,000
  Deferred revenue                                                                289,554         228,725
  Accrued expenses                                                              1,087,587         792,518
                                                                             ------------    ------------

      Total current liabilities                                                 3,546,227       3,315,299
                                                                             ------------    ------------

Commitments and contingencies Stockholders' equity (deficit):
  Preferred stock, $.01 par value; 5,000,000 shares
    authorized, no shares issued and outstanding                                       --              --
  Common stock, $.01 par value; 30,000,000 shares authorized,
    10,303,469 shares issued and outstanding in 2000 and 10,728,469
    shares issued and outstanding in 2001                                         103,035         107,285
  Additional paid-in capital                                                   25,379,538      26,200,894
  Notes receivable from stockholders                                             (198,301)       (111,649)
  Accumulated deficit                                                         (21,493,775)    (28,581,302)
  Accumulated other comprehensive loss                                           (373,719)             --
                                                                             ------------    ------------

      Total stockholders' equity (deficit)                                      3,416,778      (2,384,772)
                                                                             ------------    ------------

  TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)                       $  6,963,005    $    930,527
                                                                             ============    ============
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.


                                       2
<PAGE>

                              ARTIFICIAL LIFE, INC.

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                            Three-month periods            Nine-month periods
                                                            ended September 30,            ended September 30,
                                                       ----------------------------    ----------------------------
                                                           2000            2001            2000            2001
                                                       ------------    ------------    ------------    ------------
<S>                                                    <C>             <C>             <C>             <C>
Revenues:
  Software license agreements                          $  1,945,556    $  1,029,000    $  3,831,443    $  1,323,381
  Application services and other                          2,704,792          56,500       5,162,223       1,461,607
                                                       ------------    ------------    ------------    ------------

                                                          4,650,348       1,085,500       8,993,666       2,784,988
                                                       ------------    ------------    ------------    ------------

Operating expenses:
  General and administrative                              2,336,979         581,478       5,753,543       4,205,404
  Engineering and cost of sales                           2,292,016         143,556       6,300,190       3,296,613
  Research and development                                  390,172           3,734         902,725         239,373
  Sales and marketing                                       679,970          64,740       2,406,153       1,592,287
  Provision for doubtful accounts                                --              --              --          40,670
  Net restructuring charges                                      --              --              --         395,676
                                                       ------------    ------------    ------------    ------------

     Total operating expenses                             5,699,137         793,508      15,362,611       9,770,023
                                                       ------------    ------------    ------------    ------------

     Income (loss) from operations                       (1,048,789)        291,992      (6,368,945)     (6,985,035)

Other income (expenses):
  Foreign exchange gain (loss)                               15,415              --         (26,121)        (17,401)
  Equity in loss of joint venture                          (188,499)             --        (754,068)             --
  Interest income                                            33,068           4,035         125,904          13,347
  Interest expense                                             (816)        (26,340)        (31,967)        (98,438)
                                                       ------------    ------------    ------------    ------------

     Income (loss) before provision for income taxes     (1,189,621)        269,687      (7,055,197)     (7,087,527)

Provision for income tax                                         --              --              --              --
                                                       ------------    ------------    ------------    ------------

     Net income (loss)                                 $ (1,189,621)   $    269,687    $ (7,055,197)   $ (7,087,527)
                                                       ============    ============    ============    ============

Net earnings (loss) per share:
  Basic                                                $      (0.12)   $       0.03    $      (0.69)   $      (0.68)
  Diluted                                                     (0.12)           0.02           (0.69)          (0.68)

Weighted average shares outstanding
  used in per share calculation:
  Basic                                                  10,293,071      10,728,469      10,186,237      10,462,444
  Diluted                                                10,293,071      11,924,302      10,186,237      10,462,444
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.


                                       3
<PAGE>

                              ARTIFICIAL LIFE, INC.

            CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                   (Unaudited)

<TABLE>
<CAPTION>

                                    Comprehensive       Preferred Stock              Common Stock        Additional
                                       Income       -------------------------   ---------------------     Paid-in
                                       (Loss)         Shares        Amount        Shares      Amount      Capital
                                    ------------    ----------   ------------   ----------   --------   -----------
<S>                                 <C>                     <C>  <C>            <C>          <C>        <C>
Balance at December 31, 1999                                --   $         --    9,863,415   $ 98,634   $15,563,784

Issuance of common stock                                    --             --      461,842      4,619     9,711,905

Repayment of notes receivable
  from stockholders net of
  increases for accrued interest                            --             --           --         --            --

Stock options issued for services
  rendered                                                  --             --           --         --       114,285

Comprehensive loss:
  Net loss                          $ (7,055,197)           --             --           --         --            --
  Foreign currency translation
    adjustment                          (210,661)           --             --           --         --            --
                                    ------------    ----------   ------------   ----------   --------   -----------
      Total comprehensive loss      $ (7,265,858)
                                    ============

Balance at September 30, 2000                               --   $         --   10,325,257   $103,253   $25,389,974
                                                    ==========   ============   ==========   ========   ===========

Balance at December 31, 2000                                --   $         --   10,303,469   $103,035   $25,379,538

Issuance of common stock                                    --             --      425,000      4,250       385,750

Repayment of notes receivable
  from stockholders net of
  increases for accrued interest                            --             --           --         --            --

Stock options issued for services
  rendered                                                  --             --           --         --       435,606

Comprehensive loss:
  Net loss                          $ (7,087,527)           --             --           --         --            --
  Foreign currency translation
    adjustment                           373,719            --             --           --         --            --
                                    ------------    ----------   ------------   ----------   --------   -----------
      Total comprehensive loss      $ (6,713,808)
                                    ============

Balance at September 30, 2001                               --   $         --   10,728,469   $107,285   $26,200,894
                                                    ==========   ============   ==========   ========   ===========

<CAPTION>
                                                                 Accumulated
                                                                    Other           Total
                                      Notes       Accumulated    Comprehensive   Stockholders'
                                    Receivable      Deficit          Loss           Equity
                                    ----------   ------------    -------------   -------------
<S>                                 <C>          <C>               <C>            <C>
Balance at December 31, 1999        $(749,981)   $ (8,905,480)     $ (85,908)     $ 5,921,049

Issuance of common stock             (337,500)             --             --        9,379,024

Repayment of notes receivable
  from stockholders net of
  increases for accrued interest      734,376              --             --          734,376

Stock options issued for services
  rendered                                 --              --             --          114,285

Comprehensive loss:
  Net loss                                 --      (7,055,197)            --       (7,055,197)
  Foreign currency translation
    adjustment                             --              --       (210,661)        (210,661)
                                    ---------    ------------      ---------      -----------
      Total comprehensive loss

Balance at September 30, 2000       $(353,105)   $(15,960,677)     $(296,569)     $ 8,882,876
                                    =========    ============      =========      ===========

Balance at December 31, 2000        $(198,301)   $(21,493,775)     $(373,719)     $ 3,416,778

Issuance of common stock                   --              --             --          390,000

Repayment of notes receivable
  from stockholders net of
  increases for accrued interest       86,652              --             --           86,652

Stock options issued for services
  rendered                                 --              --             --          435,606

Comprehensive loss:
  Net loss                                 --      (7,087,527)            --       (7,087,527)
  Foreign currency translation
    adjustment                             --              --        373,719          373,719
                                    ---------    ------------      ---------      -----------
      Total comprehensive loss

Balance at September 30, 2001       $(111,649)   $(28,581,302)     $      --      $(2,384,772)
                                    =========    ============      =========      ===========
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.


                                       4
<PAGE>

                              ARTIFICIAL LIFE, INC.

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                          Nine-month periods
                                                                          ended September 30,
                                                                      --------------------------
                                                                          2000           2001
                                                                      -----------    -----------
<S>                                                                   <C>            <C>
Cash flows from operating activities:
  Net loss                                                            $(7,055,197)   $(7,087,527)
  Adjustments to reconcile net loss to net cash
    used by operating activities:
      Depreciation and amortization                                     1,213,765      1,037,421
      Equity in loss of joint venture                                     754,068             --
      Intercompany profit elimination                                      (9,421)            --
      Net restructuring charges                                                --        395,676
      Interest income accrued on notes receivable from stockholders       (15,889)       (13,348)
      Stock options issued for services rendered                          114,285        435,606
      Decrease in accounts receivable, affiliates                         331,832        159,050
      (Increase) decrease in accounts receivable, trade                (3,864,543)     1,025,734
      Increase in prepaid expenses and other assets                      (303,309)       (64,387)
      Increase in accounts payable and other current liabilities        1,364,737      1,480,224
      (Increase) decrease in due to/from officer/stockholder             (118,301)        11,788
                                                                      -----------    -----------

      Net cash used by operating activities                            (7,587,973)    (2,619,763)
                                                                      -----------    -----------

Cash flows from investing activities:
  Purchases of property and equipment                                  (2,253,449)       (58,193)
  Proceeds from sales of property and equipment                                --         76,500
  Expenditures for capitalized software development costs                (100,783)            --
  Cash of subsidiaries sold or in bankruptcy                                   --        (93,177)
  Investment in joint venture                                            (909,900)            --
                                                                      -----------    -----------

      Net cash used by investing activities                            (3,264,132)       (74,870)
                                                                      -----------    -----------

Cash flows from financing activities:
  Proceeds from notes receivable from stockholders                        718,487        100,000
  Repayment of note payable and advances from stockholder                (500,000)       (40,000)
  Proceeds from advances from stockholder                                      --      1,085,000
  Proceeds from bank credit lines                                              --      1,006,671
  Proceeds from issuance of common stock                                9,410,802        250,000
                                                                      -----------    -----------

      Net cash provided by financing activities                         9,629,289      2,401,671
                                                                      -----------    -----------

Effect of exchange rate changes on cash                                   (32,580)      (358,666)
                                                                      -----------    -----------

      Net decrease in cash and cash equivalents                        (1,255,396)      (651,628)

Cash and cash equivalents at beginning of period                        2,592,388        729,696
                                                                      -----------    -----------

Cash and cash equivalents at end of period                            $ 1,336,992    $    78,068
                                                                      ===========    ===========

Supplemental disclosure of cash flow information:
  Interest paid                                                       $    31,967    $    43,797
  Note receivable received upon exercise of stock options                 337,500             --
  Proceeds from exercise of stock options applied as a reduction
    of accrued consulting expense                                              --        140,000
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.


                                       5
<PAGE>

                              ARTIFICIAL LIFE, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

                 THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of
Artificial Life, Inc. (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-
X. Accordingly, they do not include all information and footnotes required by
generally accepted accounting principles for complete financial statement
presentation. The consolidated financial statements include the accounts of
Artificial Life, Inc., and its wholly-owned subsidiaries: Artificial Life
Schweiz AG ("Artificial Life Schweiz"), Artificial Life Deutschland AG
("Artificial Life Deutschland"), Artificial Life Ventures, Inc. ("Artificial
Life Ventures"), Artificial Life USA, Inc. ("Artificial Life USA"), Artificial
Life Mobile Computing, Inc. ("Artificial Life Mobile Computing"), Artificial
Life Asia Limited ("Artificial Life Asia"), and Artificial Life Rus Ltd., the
wholly-owned subsidiary of Artifical Life Schweiz ("Artificial Life Rus"). All
significant intercompany balances and transactions have been eliminated in
consolidation. Artificial Life Schweiz and Artificial Life Deutschland ceased
operations in May 2001 and entered into bankruptcy and dissolution proceedings
in June 2001. As of the dates of the bankruptcy filings, Artificial Life Schweiz
and Artificial Life Deutschland were excluded from consolidation in the
Company's financial statements, and the stockholder equity or deficit of each of
the subsidiaries at that time were recorded as an increase or decrease to the
net restructuring charges recorded in the quarter ended June 30, 2001. See Note
2 to Notes to Condensed Consolidated Financial Statements (Unaudited) for the
Three and Nine Months Ended September 30, 2001. Artificial Life Rus ceased
operations in May 2001 and its stock was sold to an unrelated third party.

The financial information included in this report has been prepared in
conformity with the accounting policies reflected in the financial statements
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission.

2. CORPORATE RESTRUCTURING AND NEED FOR ADDITIONAL FINANCING

In 2000, the Company continued to incur losses from operations, and had
partially funded these losses through three private placements of Common Stock
totaling $8.9 million. The Company continued to incur losses in the first and
second quarter of 2001. Based on the substantial restructuring of the Company in
the second quarter of 2001 and the Company's stringent cost controls, the
Company achieved profitability in the third quarter of 2001, however, there can
be no assurances such results will continue in future quarters. The Company's
continued losses have severely impacted the Company's liquidity and cash
position. For this reason, the Company restructured its operations, implemented
a significant cost reduction program, and began efforts to sell intellectual
property for direct use into third-party systems. In connection with the
Company's restructuring, the Company shut down and sold all of the stock of
Artificial Life Rus for a nominal value on May 25, 2001, and the buyer assumed
all outstanding liabilities of Artificial Life Rus as part of the transaction.
In addition, the Company ceased operations of Artificial Life Deutschland and
Artificial Life Schweiz in May 2001 and bankruptcy and dissolution proceedings
were commenced in June 2001 for both entities. The Company has also taken
drastic steps to reduce its U.S. operations, including a major reduction of
office facilities, the relocation of its offices to temporary offices in New
York, New York, and the termination of most of its staff. The Company did not
provide any termination benefits to terminated employees. The Company intends
to use subcontractors to meet its staffing needs in the immediate future, while
focusing its efforts on the sale and support of its existing products including
the sale of non-exclusive source code licenses.

As a result of these restructuring efforts, the Company incurred net
restructuring charges in the quarter ended June 30, 2001 of $395,676. Components
of the net restructuring charges are as follows:

Loss on sale of Artificial Life Rus                      ($377,026)
Loss on disposal of property and equipment                (367,666)
Loss on elimination of stockholder's equity of
Artificial Life Schweiz                                    (50,342)
Gain on elimination of stockholder's deficit of
Artificial Life Deutschland                                399,358
                                                         ---------

    Net restructuring charges                            ($395,676)
                                                         =========

In 2001, the Company's Chief Executive Officer advanced $485,000 to the Company
during the first quarter and an additional $600,000 during the second quarter
for a total of $1,085,000. The advances are being converted into an interest
bearing term loan and, in part or in total, may be converted into equity at a
later date, subject to the approval of the Company's stockholders. Currently,
the Company has been unable to pay its past due payroll liabilities of
approximately $128,000 with respect to Artificial Life Asia and is currently
negotiating the settlement of claims for unpaid wages and vacation pay of
approximately $150,000, representing the maximum amount of damages claimed with
respect to this matter, in connection with its operations in the United States.
Furthermore, the Company has not paid its Chief Executive Officer his salary
earned to date in 2001 of $227,435. Even though the Company significantly
reduced its operating expenses during the first nine months of 2001, it may not
have sufficient resources to fund its operations through the end of 2001. To
that end, the Company entered into an irrevocable stock purchase agreement with
Bluefire Capital, Inc., a Cayman Island Corporation ("Bluefire"), on March 22,
2001, to provide the Company with equity financing. Bluefire has committed to
purchase up to $13,000,000 of shares of the Company's common stock over the
course of three years, and such amount may increase if certain conditions are
met. The ability to raise funds through this equity facility and the number and
amount of each equity transaction available under the facility are subject to
certain conditions at the time of each sale of the Company's common stock to
Bluefire. As a result of the current market conditions, the Company has deferred
the filing of a registration statement on Form S-1 pursuant to the terms of the
agreement. Once market


                                       6
<PAGE>

conditions improve, the Company intends to file the registration statement which
will allow the sale of common stock to Bluefire. The Company is continuing to
pursue short-term borrowings and other direct share placement opportunities to
meet its anticipated liquidity shortfalls. The Company cannot assure that it
will be able to complete this or any other financing or that such financings
will be adequate to meet the Company's needs.

These factors create a substantial doubt about the Company's ability to continue
as a going concern. The accompanying financial statements do not include any
adjustments that might result from the outcome of this uncertainty.

The Company does not currently meet certain of the listing requirements of the
Nasdaq National Market ("Nasdaq"). The Company met with representatives of
Nasdaq and requested a 90 day grace period until October 18, 2001 to comply with
the Nasdaq's listing requirements. On August 20, 2001, the Company received a
letter from the Nasdaq Listings Qualification Panel notifying the Company of its
de-listing from the Nasdaq stock exchange. The Company's common stock is now
traded on the Over The Counter Bulletin Board (OTC BB).

3. NET LOSS PER SHARE

Basic net loss per share is calculated based on the weighted average number of
common shares outstanding for the three and nine month periods ended September
30, 2000 and 2001. Diluted earnings per share reflects additional common shares
that would have been outstanding if dilutive potential common shares had been
issued, as well as any adjustment to income that would result from the assumed
issuance. Potential common shares that may be issued by the Company relate to
outstanding stock options and warrants, and are determined using the treasury
stock method. The effect of dilutive options and warrants was to increase
weighted average shares outstanding by 1,195,833 for the quarter ended September
30, 2001. Basic and diluted net loss per share are the same for all other
periods presented, since the effect of inclusion of all common stock equivalents
would be anti-dilutive.

4. COMMON STOCK

On April 27, 2001 the Company issued to Robert Duggan, the Company's Secretary:
(i) a warrant to purchase 35,000 shares of the Company's common stock at an
exercise price of $0.50 per share in consideration of consulting services
rendered to the Company by Mr. Duggan in connection with the Company's
consideration and preparation of documents related to various financing
alternatives, and (ii) an option to purchase 65,000 shares of the Company's
common stock at an exercise price of $0.50 per share in consideration of
consulting services rendered to the Company by Mr. Duggan in connection with the
Company's other legal matters.

On June 7, 2001 the Company issued to Phaik Chin Lim, the Company's Global Chief
Financial Officer, (i) a warrant to purchase 200,000 shares of the Company's
common at an exercise price of $0.35 per share, and (ii) an option to purchase
300,000 shares of the Company's common stock at an exercise price of $0.35 per
share, in connection with the execution of an employment agreement.

On June 7, 2001 the Company issued to Robert Duggan (i) a warrant to purchase
350,000 shares of the Company's common stock at an exercise price of $0.10 per
share in consideration of consulting services rendered to the Company by Mr.
Duggan in connection with the Company's consideration and preparation of
documents related to various financing alternatives, and (ii) an option to
purchase 150,000 shares of the Company's common stock at an exercise price of
$0.10 per share in consideration of consulting services rendered to the Company
by Mr. Duggan in connection with the Company's other legal matters.

On June 20, 2001, the Company granted to: (i) Frank Namyslik an option to
purchase 200,000 shares of common stock at an exercise price of $0.35 per share
in connection with Mr. Namyslik assuming a position on the Company's Board of
Directors, (ii) Hartmut Meyer an option to purchase 50,000 shares of common
stock at an exercise price of $0.35 per share in connection with Mr. Meyer
assuming a position on the Company's Board of Directors, (iii) Eric Egnet an
option to purchase 50,000 shares of common stock at an exercise price of $0.50
per share in connection with Mr. Egnet assuming a position on the Company's
Advisory Board, and (iv) Dr. Gert Hensel an option to purchase 50,000 shares of
common stock at an exercise price of $0.35 per share in connection with Dr.
Hensel assuming a position on the Company's Board of Directors.

On June 30, 2001 the Company granted to (i) Richard Bonn an option to purchase
200,000 shares of the Company's common stock at an exercise price of $0.35 per
share in connection with Mr. Bonn assuming the position of the Company's Chief
Information Officer, (ii) Klaus Kater, the Company's former Chief Technology
Officer, an option to purchase 100,000 shares of the Company's common stock at
an exercise price of $0.35 per share in satisfaction of services rendered by
him, and (iii) Rolf Levenhagen, the Company's former President - Sales and
Marketing and a former member of the Company's Board of Directors, an option to
purchase 300,000 shares of the Company's common stock at an exercise price of
$0.35 per share in satisfaction of services rendered by him. Additionally,
Messrs. Levenhagen and Kater each exercised their options to purchase 300,000
and 100,000 shares of common stock, respectively, on June 30, 2001. Amounts
received on exercise totaling $140,000 were applied as a reduction of consulting
fees to these individuals.

In connection with the above issuances of stock options and warrants in the
quarter ended June 30, 2001, the Company recognized compensation expense in the
amount of $334,000.

On August 17, 2001, the Company granted an option to purchase 50,000 shares of
common stock at an exercise price of $1.01 per share to John Perry Barlow in
consideration of consulting services rendered to the Company.

On August 22, 2001, the Company granted an option to purchase 50,000 shares of
common stock at an exercise price of $1.00 per share to Ms. Claudia Alsdorf in
connection with Ms. Alsdorf's newly adopted role as a member of the Company's
Board of Directors.

In connection with the above issuances of stock options in the quarter ended
September 30, 2001, the Company recognized compensation expense in the amount of
$43,500.


                                       7
<PAGE>

5. ADVANCES FROM STOCKHOLDER

In the first quarter of 2001, the Company's Chief Executive Officer, a major
stockholder of the Company, advanced $485,000 to the Company. Furthermore, the
Company's Chief Executive Officer advanced an additional $600,000 to the Company
during the second quarter of 2001 for a total of $1,085,000. The Company repaid
$40,000 of this amount in the third quarter of 2001. The advanced funds bear
interest at 10%, are unsecured and are due on demand. Interest expense on these
advances amounted to $54,641 for the nine month period ended September 30, 2001,
and is netted in due from officer/stockholder at September 30, 2001.

6. SEGMENT INFORMATION

The Company, whose operations consist of a single line of business, markets and
supports "intelligent software robots," software programs, and related
intellectual property, that the Company has designed to automate and simplify
time-consuming and complex business-related Internet functions.

During the nine month period ended September 30, 2001, the Company had
operations located outside of the United States in Switzerland, Russia, Germany
and Hong Kong. See Note 2 to the Notes to Condensed Consolidated Financial
Statements (Unaudited) for the Three and Nine Months Ended September 30, 2001.

Other financial data for the nine month period ended September 30, 2001, is as
follows:

<TABLE>
<CAPTION>
                                    United                      Russian
                                    States      Switzerland    Federation    Germany       Asia       Eliminations      Total
                                    ------      -----------    ----------    -------       ----       ------------      -----
<S>                              <C>            <C>            <C>          <C>          <C>          <C>            <C>
Revenues from external
customers                        $ 2,106,145    $   171,436    $      --    $ 507,407    $      --    $        --    $ 2,784,988

Intersegment revenue                  97,613         68,790      567,988      163,447           --       (897,838)            --
Interest income                      101,025            164           --        1,788           --        (89,630)        13,347
Interest expense                      55,198         49,791          546       82,533           --        (89,630)        98,438
Depreciation and amortization
  expense                            305,653        132,352       84,656       87,330        1,759             --        611,750
Net restructuring charges           (355,544)       (50,341)    (377,027)     387,236           --             --       (395,676)
Income tax expense                        --             --           --           --           --             --             --
Net loss                          (4,053,650)    (1,321,185)    (794,037)    (604,902)    (299,424)       (14,329)    (7,087,527)
Investment in unconsolidated
  subsidiary                         250,000             --           --           --           --             --        250,000

Expenditures for property
  and equipment                           --         24,224       12,605       12,038        9,326             --         58,193
Identifiable assets                2,939,329             --           --           --       14,623     (2,023,425)       930,527
</TABLE>

7. CONTINGENCY

In June 2001, Artificial Life Schweiz and Artificial Life Deutschland entered
into bankruptcy and dissolution proceedings. The Company believes that no
further liabilities will be incurred by the Parent company in connection with
its subsidiaries' bankruptcy filings. However, the ultimate outcome of these
filings cannot be determined at this time. No provision has been made for any
additional liabilities which may be incurred.

During 2000, Artificial Life Rus, the Company's former Russian research and
development arm, was assessed approximately $440,000 by the Tax Inspection for
the Central Region of St. Petersburg (TICRP), in connection with additional
value added and profit taxes. Artificial Life Rus appealed the assessment to the
St. Petersburg Court, and on February 26, 2001 received a favorable decision
from the Court. On March 16, 2001 the TICRP appealed the Court's decision. The
Company was notified on April 26, 2001, that it had prevailed in the appeal.
There is one remaining avenue of appeal for the TICRP. In March 2001, Artificial
Life Rus received notice that the TICRP intends to make an additional assessment
of approximately $163,500 for additional value added and profit taxes. On May
25, 2001, the Company sold all its stock in Artificial Life Rus and the buyer
assumed all liabilities. Therefore, no provision for any additional taxes
incurred as a result of this matter have been provided for in the Company's
financial statements.

On September 5, 2001 Copley Place Associates filed suit against the Company
alleging that the Company breached its commercial lease by vacating its former
Boston, Massachusetts corporate headquarters prior to the expiration of the
lease term. Copley Place Associates has alleged damages of approximately
$585,000. The Company is vigorously defending the lawsuit. At September 30,
2001, the Company had accrued $100,000 in connection with all costs related to
this matter.

In connection with claims for unpaid wages and vacation pay made by former
employees of its U.S. operations, the Company has accrued $150,000 representing
the maximum amount of damages claimed with respect to this matter. The Company
is currently negotiating settlements with certain of these employees. Although
certain of these employees of the Company's U.S. operations have filed claims
for unpaid wages and vacation pay with the Office of the Attorney General of the
Commonwealth of Massachusetts, to the Company's knowledge, as of November 1,
2001 no suits had been filed.

                                       8
<PAGE>

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

RESULTS OF OPERATIONS

OVERVIEW

We were established in 1997 pursuant to a management buyout from our former
parent company, Neurotec International Corp., a German multimedia and internet
solutions company. Our initial business plan focused on the provision of
software consulting services. We subsequently shifted our business focus from
providing software consulting services to the development, marketing and support
of software programs designed to automate and simplify complex business-related
internet functions, such as web navigation, direct sales and marketing, e-mail
automation, user profiling, knowledge management, financial planning and
portfolio management.

We continued to incur losses in the first and second quarter of 2001. Based upon
our substantial restructuring efforts in the second quarter of 2001 and our
efforts to maintain stringent cost controls, we achieved profitability in the
third quarter of 2001, however, there can be no assurances such results will
continue in future quarters. Our continued net losses have severely impacted our
liquidity and cash position which, in turn, have impeded our ability to fund our
operations. Consequently, in connection with our Annual Report on Form 10-K for
the fiscal year ended December 31, 2000, our independent certified public
accountants expressed an opinion doubting our ability to continue as a going
concern. As of September 30, 2001, we had cash and cash equivalents of
approximately $78,000 and accounts payable in excess of $1,200,000. On April 6,
2001 we received a letter from the Nasdaq National Market ("Nasdaq") stating
that we were no longer in compliance with certain listing requirements. On July
12, 2001, a panel hearing was held by Nasdaq to discuss our plans and
ability to comply with the listing requirements. We subsequently presented a
detailed plan to the panel and requested a 90-day grace period to comply with
the requirements. On August 20, 2001, we were de-listed from the Nasdaq stock
exchange. The de-listing may materially impair the ability of stockholders to
buy and sell shares of our stock, and trading is limited primarily to
over-the-counter quotation services, such as the Over-the-Counter Bulletin
Board. For these reasons, during the first half of 2001, we restructured our
operations, implemented a significant cost reduction program, and began efforts
to sell intellectual property for direct use into third-party systems.

During the first half of 2001, we reevaluated our business and shifted our focus
to the marketing and sales of our products and now reserve product development
efforts primarily for individual clients that contract for such development.
Consequently, we continue to anticipate devoting fewer resources to engineering
and research and development activities in the future. We laid off nearly all of
our engineering and research and development employees during the first half of
2001 and plan to subcontract these services as needed. As a result, we
significantly reduced our engineering and research and development costs in the
first half of 2001. Costs for engineering and research and development were kept
at a minimum for the quarter ended September 30, 2001. In connection with this
restructuring, we sold all of our stock in Artificial Life Rus on May 25, 2001.
We have therefore been relieved of all tax assessment liability associated with
the operations of Artificial Life Rus. We also ceased the operations of
Artificial Life Schweiz and Artificial Life Deutschland in May 2001 and
commenced bankruptcy and dissolution proceedings for both entities in June 2001.

In addition, we implemented a significant cost reduction program during the
first half of 2001. Costs for operations were kept to a minimum for the quarter
ended September 30, 2001. We have taken drastic steps to reduce our U.S.
operations, including a major reduction of office facilities, the relocation of
our headquarters from Boston, Massachusetts to New York, New York, the
termination of our lease for our former headquarters in Boston, Massachusetts
and the termination of most of our staff. Also, we have reduced our marketing
activities, website development, technology, and operating infrastructure
development budgets.  Furthermore, we are currently reviewing plans to
consolidate the operations of Artificial Life USA, Artificial Life Mobile, and
Artificial Life Ventures to minimize overhead costs and expenses. We are
seeking a long-term lease contract for our new headquarters in New York and
currently continue to occupy a temporary office. Lease obligations from this
temporary office are less than $10,000 per month.

In the third quarter of 2001, we started a second business division focusing on
life science applications. We believe that the algorithms and methods that we
have developed over the last several years will allow new and innovative
applications in the health care and life science industries. We do not intend to
develop products in this division, but rather, intend to work on a consulting
and project basis with clients and to license our existing intellectual property
for the life science area. However, there can be no guarantee that we will be
successful in this new application of our product line or that this new business
division will generate significant revenues in the future.

Although we realized significant software license revenues in 1999 and 2000, and
although software license revenues as a percentage of overall revenues increased
from 1999 to 2000, software license revenues decreased significantly in the
first nine months of 2001 as compared to the same period in 2000. The decrease
in software license revenues was due to many factors, including but not limited
to, the downturn of the global internet market, the general negative business
climate throughout the world, our inability to obtain additional financing to
fund operations, the cessation of our European and Russian operations, and the
significant downsizing and restructuring of our U.S. operations.

In the near term, we have shifted our business focus to the marketing, sales,
and support of our existing products, including the sale of non-exclusive source
code licenses. We will continue limited product development of our financial
product packages and individual client contracted projects. Our continued losses
have severely impacted our liquidity and cash position. To the extent that our
marketing and sales of existing products and limited product development efforts
do not result in commercially successful products that generate significant net
revenues, we will be materially adversely affected. There can be no assurance
that we will ever generate sufficient revenues from the sale of our products or
associated services to achieve and maintain profitability.

Because we have shifted our primary business focus from software consulting to
licensing developed intellectual property and products, marketing and support
and in light of our current global downsizing, results of operations to date are
not reflective of our business prospects going forward. Moreover, we expect to
experience significant fluctuations in our future operating results due to a
variety of factors. Factors that may affect our operating results include the
recovery of the global Internet markets, the general market acceptance of our
products, our ability to sell and license our intellectual property, the amount
of software consulting we undertake in the future, success in creating and
entering into strategic alliances, our mix of product and service sales, our
response to competitive pressure and our ability to attract and retain qualified
personnel. Gross profit margins will vary from product to product and between
products and services. Although we may have some ability to affect our products
and services mix, our sales mix may vary from period to period and our gross
margins will fluctuate accordingly.

In addition to our restructuring efforts, we are also seeking additional
financing to increase liquidity and capital resources. If we are unable to
obtain additional financing, this will have a material adverse effect on our
business.

                                       9
<PAGE>

RESULTS OF OPERATIONS

In fiscal year 2000, license revenues increased in the aggregate and as a
percentage of overall revenues and our client base expanded. In the nine month
period ended September 30, 2001, license revenues and other revenues decreased
in comparison to the first nine months of 2000, due to global market conditions,
cessation of operations in Europe and substantial downsizing of our United
States operations. Our current strategy is to continue maintaining stringent
cost controls and focus our efforts on the sale and support of our existing
products, including the sale of non-exclusive source code licenses.

THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2000

REVENUES: Revenues for the quarter ended September 30, 2001 were $1,085,500 as
compared to $4,650,348 for the quarter ended September 30, 2000. The decrease of
$3,564,848 or 77% was due primarily to a major downturn of the global Internet
markets, an inhospitable business climate, our inability to obtain necessary
funding, our restructuring and dramatic downsizing of operations.

ENGINEERING AND COST OF SALES: These costs generally consist of salary and
payroll tax expenses, training, consulting, subcontracting and other expenses
incurred to develop and fulfill the engineering (design specifications) of
products and services from which we derive our revenues. Engineering expenses
for the quarter ended September 30, 2001 were $143,556 as compared to $2,292,016
for the quarter ended September 30, 2000. The decrease of $2,148,460 or 94% was
primarily due to our downsizing and lay-off of engineering personnel in the
second quarter of 2001 and the use of outside consultants on an as-needed basis
in the third quarter of 2001.

RESEARCH & DEVELOPMENT: Research and development expenses are similar in nature
to engineering expenses, but they relate to products in their initial stage and
are anticipated to generate revenue at a later date. Research and development
expenses for the quarter ended September 30, 2001 were $3,734 as compared to
$390,172 for the quarter ended September 30, 2000. The decrease of $386,438 or
99% is due primarily to the shut down of the Russian research and development
operations and related staff reductions in the second quarter of 2001 as we
decreased research and development in favor of sales of existing products.

GENERAL AND ADMINISTRATIVE: General and administrative expenses consist of
salary and payroll tax expenses of administrative personnel, rent, professional
fees and costs associated with employee benefits, supplies, communications and
travel. General and administrative expenses for the quarter ended September, 30,
2001 were $581,478 as compared to $2,336,979 for the quarter ended September 30,
2000. The decrease of $1,755,501 or 75% was due primarily to the substantial
consolidation of our operations and associated staff reductions.

SALES AND MARKETING: Sales and marketing expenses consist of salary and payroll
tax expenses of sales and marketing personnel, costs relating to marketing
materials, promotional videos, advertising, trade show related expense and
public relations activities. Sales and marketing expenses for the quarter ended
September 30, 2001 were $64,740 compared to $679,970 for the quarter ended
September 30, 2000. The decrease of $615,230 or 90% was primarily due to our
restructuring, cost cutting measures and the increased efficiency of our
marketing efforts.

NET LOSS/GAIN: The net profit for the quarter ended September 30, 2001 was
$269,687 as compared to a net loss of $1,189,621 for the quarter ended September
30, 2000. This gain is due to a substantial decrease in our cost of operations
as a result of our restructuring and downsizing and, during the second quarter
of 2001, the cessation of our unprofitable operations in Europe.

NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2000

REVENUES: Revenues for the nine months ended September 30, 2001 were $2,784,988
as compared to $8,993,666 for the nine months ended September 30, 2000. The
decrease of $6,208,678 or 69% was due to the general downturn of the global
Internet markets during the period, the general negative business climate, our
inability to obtain necessary funding, and our restructuring and dramatic
downsizing of operations.

ENGINEERING AND COST OF SALES: These costs generally consist of salary and
payroll tax expenses, training, consulting, subcontracting and other expenses
incurred to develop and fulfill the engineering (design specifications) of the
products and services from which we derive our revenues. Engineering expenses
for the nine months ended September 30, 2001 were $3,296,613 as compared to
$6,300,190 for the nine months ended September 30, 2000. The decrease of
$3,003,577 or 48% is primarily attributable to the effects of our continued
global cost cutting program and the lay-off of staff. Major components of the
engineering and cost of sales reduction include payroll and related costs of
$1,592,000, travel and lodging expenses of $375,000, occupancy expense of
$184,000, depreciation of $147,000, and consulting expense of $544,000.

RESEARCH AND DEVELOPMENT EXPENSES: Research and development expenses are similar
in nature to engineering expenses except that they relate to products in their
initial stage. Research and development expenses for the nine months ended
September 30, 2001 were $239,373 as compared to $902,725 for the nine months
ended September 30, 2000. The decrease of $663,352 or 73% is primarily
attributable to a decrease of payroll and related costs of $378,000 associated
with the shut down of our Russian research and development facility and lay-off
of engineering research and development personnel in the United States,
reduction in occupancy costs of $58,000, reduction in travel and lodging expense
of $52,000 and reduction in professional affiliation expense of $80,000. The
research and development expenses for 2000 and 2001 are net of capitalized
software development costs.

GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses consist
of salary and payroll tax expenses of administrative personnel, rent,
professional fees and costs associated with employee benefits, supplies,
communications and travel. General and administrative expenses for the nine
months ended September 30, 2001 were $4,205,404 as compared to $5,753,543 for
the nine months ended September 30, 2000. The decrease of $1,548,139 or 27% is
primarily attributable to our shut down of European operations, the outsourcing
of certain administrative infrastructure, reductions due to the lay-off of staff
and global downsizing during the second quarter of 2001. Significant expense
reductions include payroll and related costs of $834,000, travel and
entertainment expense of $416,000, communications expense of $77,000 and legal
and accounting expenses of $273,000.


                                       10
<PAGE>

SALES AND MARKETING EXPENSES: Sales and marketing expenses consist of salary and
payroll tax expenses of marketing personnel and costs relating to marketing
materials, trade shows, promotional videos, advertising and public relations
activities. Marketing expenses for the nine months ended September 30, 2001 were
$1,592,287 as compared to $2,406,153 for the nine months ended September 30,
2000. The decrease of $813,866 or 34% is primarily attributable to the reduction
of general marketing expenses in both the United States and Europe in connection
with our restructuring. Significant changes include reductions in payroll and
related costs of $108,000, sales conference expense of $227,000, travel and
entertainment expense of $95,000, rent expense of $69,000, and advertising
expense of $323,000 and an increase of consulting expense of $117,000.

NET LOSS: Net loss for the nine months ended September 30, 2001 was $7,087,527
compared to a net loss of $7,055,197 for the nine months ended September 30,
2000. This increase of $32,330 or 0.5% is a result of the substantial reduction
in revenue due to the downturn of the global internet markets and our dramatic
downsizing, as offset by cost savings resulting from our restructuring, cost
reduction programs and cessation of our European operations.

LIQUIDITY AND CAPITAL RESOURCES

Overview

From inception through July 3, 1997, we funded our operations primarily through
initial equity investments in 1994 and 1995 totaling $500,000 and net income
from operations. Subsequent to July 3, 1997, we incurred operating losses in
connection with our transition from software consulting to product development,
marketing and sales. These losses have been funded to date by a private
placement of non-voting common stock of $181,367, the net proceeds of which we
received in June 1998 and a private placement of 824,000 shares of common stock
which raised $3,946,481 in net proceeds. In December 1998, we received
$9,302,773 net proceeds from our initial public offering. During 1999, holders
of options to purchase our common stock exercised their options which netted
approximately $1,300,000, which we received in 1999 and the first quarter of
2000. In February 2000, we concluded two private placements of common stock.
Both transactions occurred at purchase prices that were at a premium to the
average closing price for five days prior to the transaction date. The first
transaction netted us $2,562,500 in exchange for 102,500 our common shares; the
second transaction netted us $1,550,000 in exchange for 50,000 common shares. In
March 2000, we concluded another private placement of common stock. The
transaction occurred at a purchase price that was at a premium to the average
closing price for the five days prior to the transaction date. The transaction
netted us $4,856,250 in exchange for 150,000 common shares and warrants to
purchase 75,000 shares of common stock. In January 2001, we issued 25,000 common
shares to a single individual in a private placement. The total proceeds from
this issuance amounted to $250,000. Costs related to these transactions were
immaterial. Our future requirements for additional capital will depend on many
factors, including but not limited to, the general recovery of the global
Internet markets, sales, marketing and promotional programs and efforts, and the
levels of revenues achieved through the future sales of our suites of products.

In 2000, we continued to incur losses from operations, and had partially funded
these losses through three private placements of our common stock totaling $8.9
million. We continued to incur losses in the first and second quarter of 2001.
Based upon our substantial restructuring in the second quarter of 2001 and our
continued efforts to maintain stringent cost controls, we were able to achieve
profitability in the quarter ended September 30, 2001, however, there can be no
assurances of such results in the future. The losses incurred in the past,
however, have severely impacted our liquidity and cash position.

In order to fund our cash needs for 2001, we borrowed $485,000 from our Chief
Executive Officer during the first quarter, an additional $600,000 during the
second quarter for a total of $1,085,000. We repaid $40,000 of this amount in
the third quarter of 2001. The advanced funds bear interest at 10%, are
unsecured and are due on demand. Without obtaining additional financing or
capital, we will not have sufficient resources to fund our operations through
2001. To that end, we entered into an irrevocable stock purchase agreement with
Bluefire Capital on March 22, 2001 to provide us with equity financing. We are
continuing to pursue other short-term borrowings and other direct share
placement opportunities to meet our anticipated liquidity shortfalls. We cannot
assure that we will be able to complete this or any other financing or that such
financings will be adequate to meet our capital needs.

These factors create a substantial doubt about our ability to continue as a
going concern. The accompanying financial statements do not include any
adjustments that might come from the outcome of this uncertainty.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act that involve risks and uncertainties. Discussions containing forward looking
statements may be found in the material set forth in "Management's Discussion
and Analysis of Financial Condition and Results of Operations" as well as in
this report generally. The words "believe," "expect," "anticipate," and similar
expressions identify forward-looking statements. Such statements are based on
management's current assumptions and expectations and are subject to a number of
factors and uncertainties which could cause actual results or business
conditions to differ materially from those anticipated in the forward-looking
statements. There can be no assurance that actual results will not differ
materially from those described in such statements because of various factors
that may cause or contribute to such differences, including but not limited to,
those risks described in our Annual Report on Form 10-K filed for the fiscal
year ended December 31, 2000. Such factors also include, but are not limited to:
the risk that our current liquidity and cash position and ability to raise
additional financing or capital may further deteriorate; limitations our ability
to generate revenues; the potential that we may fail to successfully complete
the restructuring of our operations and our cost reduction program; the
detrimental effect of our dependence on the growth in demand for agent-based
software products, such as our suite of SmartBot products; the risk from
competition with more established software companies; the potential that market
acceptance of our software robot products will not materialize; limitations on
our ability to minimize design defects, software errors, misuse of our products,
incorrect data from external sources and other potential problems which we may
not be able to control; limitations on our ability to remain competitive
resulting from limited product development and individual contracted products;
our potential inability to generate revenues from sales of our intellectual
property for direct use into third party systems; the potential adverse effects
of our decision not to create new products and technologies for the foreseeable
future; limitations on our ability of to retain key employees; adverse effects
of our dependence on third party contractors to complete portions of our
development work; certain risks associated with sales in foreign markets,
including political and economic instability, restrictive trade policies of
foreign governments, local


                                       11
<PAGE>

economic conditions in foreign markets, potentially adverse tax consequences and
the burdens on customers of complying with a variety of applicable laws;
potential adverse effects of our dependence on continued growth of the internet
and online commerce; our potential inability to protect our intellectual
property and other proprietary rights; our potential inability to establish and
maintain brand identity; the possibility that we will not be successful in
managing our foreign operations; the potential that we will be unsuccessful in
identifying and obtaining third party licenses for voice recognition software
which will be compatible with our products; the potentially adverse impact of
government regulations; and the adverse effects of negative general economic
conditions.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We maintain our cash and cash equivalents in checking, savings, and money market
accounts. Approximately 91% of these deposits are denominated in U.S. dollars.
At September 30, 2001, approximately 9% of these deposits were denominated in
Hong Kong dollars. Deposits in both fixed rate and floating rate interest
accounts carry a degree of interest rate risks. Fixed rate deposits may be
adversely impacted due to a rise in interest rates, while floating rate deposits
may produce less income than expected if interest rates fall. Due in part to
these factors, our future interest income may fall short of expectations due to
changes in interest rates. The cash denominated in non-U.S. currency units is
subject to exchange risks as well as interest rate risks. We believe that a
hypothetical 10% increase or decrease in either interest or exchange rates,
however, would not have a material adverse effect on our financial condition. We
do not hold derivative financial instruments, derivative commodity investments
or other financial investments or engage in foreign currency hedging or other
transactions that would expose us to material market risk.

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On August 8, 2001, four suits filed by AAA Corporate Rentals for nonpayment of
rent for apartments we rented on behalf of certain foreign employees were
settled for an aggregate settlement of $40,000. We satisfied our obligation
under this settlement agreement in August 2001.

On September 5, 2001 Copley Place Associates filed suit against us alleging that
we breached our commercial lease by vacating our former Boston, Massachusetts
corporate headquarters prior to the expiration of the lease term. Copley Place
Associates has alleged damages of approximately $585,000. We are vigorously
defending the lawsuit.

On June 8, 2001, we filed for bankruptcy protection for Artificial Life
Deutschland in the Insolvenzgericht Frankfurt. An unfavorable resolution of this
administrative proceeding could have a material adverse effect on our business,
results of operations, or financial condition. These proceedings are currently
still pending.

On June 29, 2001, we filed for bankruptcy protection for Artificial Life Schweiz
in the bankruptcy court of Kanton Nidwalden, Switzerland. The bankruptcy court
closed the case due to lack of assets on August 20, 2001. As a result, this
entity was dissolved and no further action on our part is required.

In connection with claims for unpaid wages and vacation pay made by former
employees of its U.S. operations, we accrued $150,000 representing the maximum
amount of damages claimed with respect to this matter. We are currently
negotiating settlements with certain of these employees. Although certain
employees of our U.S. operations have filed claims for unpaid wages and vacation
pay with the Office of the Attorney General of the Commonwealth of
Massachusetts, to our knowledge, as of November 1, 2001 no suits had been filed.

It is possible that we may become a party to various legal proceeding arising
from the settlement of our outstanding liabilities.

ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

On June 8, 2001, we filed for bankruptcy protection for Artificial Life
Deutschland in the Insolvenzgericht Frankfurt. As of the date of the bankruptcy
filing, Artificial Life Deutschland owed $543,010 including funds owed to
Dresdner Bank pursuant to a bank overdraft line and funds owed to other
creditors. These proceedings are currently still pending.

On June 29, 2001, we filed for bankruptcy protection for Artificial Life Schweiz
in the bankruptcy court of Kanton Nidwalden, Switzerland. As of the date of the
bankruptcy filing, Artificial Life Schweiz owed $463,661 including funds owed
to UBS Bank pursuant to a bank overdraft credit line and funds owed to other
creditors. The bankruptcy court closed the case due to lack of assets on
August 20, 2001. As a result, this entity was dissolved and no further action
on our part is required.

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

None.

ITEM 5.  OTHER INFORMATION

On April 6, 2001 we received a letter from the Nasdaq National Market ("Nasdaq")
stating that we did not comply with certain listing requirements. On July 12,
2001, a panel hearing was held by the Nasdaq to discuss our plans and ability to
comply with the listing requirements. We subsequently presented a detailed plan
to the panel and requested a 90-day grace period to comply with the
requirements. On August 20, 2001, we were notified by the Nasdaq Listing
Qualifications Panel that we were not granted the requested 90-day grace period
and consequently, we were delisted from the Nasdaq stock exchange. Our shares
are now traded on the Over The Counter Bulletin Board under the same ticker
symbol.


                                       12
<PAGE>

We have incurred losses for income tax purposes for fiscal years 1998, 1999, and
2000. These losses will be available to carry forward and reduce income taxes,
if any, in future periods.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

None.

(b) Reports on Form 8-K

On August 21, 2001, we filed a Current Report on Form 8-K under Items 5 and 7
with the Securities and Exchange Commission announcing that: (i) on August 20,
2001, we had publicly disseminated a press release announcing that our common
stock would no longer be listed on the Nasdaq Stock Market effective with the
open of business on August 20, 2001, and (ii) on August 21, 2001, we had
terminated the employment of our former chief information officer, Richard Bonn,
due to an inability to reach an agreement with Mr. Bonn as to the terms of his
continued employment.


                                       13
<PAGE>

                                   SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, in New York City, New York on November
14, 2001.


                                               ARTIFICIAL LIFE, INC.
                                               ---------------------
                                               (Registrant)

                                               By: /s/ Eberhard Schoeneburg
                                                  ------------------------------

                                                   Eberhard Schoeneburg
                                                   Chairman, President &
                                                   Chief Executive Officer
                                                   (Principal Executive Officer)

                                               By: /s/ Phaik Chin Lim
                                                  ------------------------------

                                                   Phaik Chin Lim
                                                   Chief Financial Officer
                                                   (Principal Financial Officer)