<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 June 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 August 8, 2001, the registrant had 10,728,469 shares of common stock, par
value $0.01 par value per share, outstanding.
<PAGE>

                             ARTIFICIAL LIFE, INC.


                               TABLE OF CONTENTS
                               -----------------
<TABLE>
<CAPTION>


PART I:                      FINANCIAL INFORMATION                    PAGE NO.
           ---------------------------------------------------------  --------
<S>        <C>                                                        <C>

ITEM 1.    UNAUDITED FINANCIAL STATEMENTS:

           Condensed Consolidated Balance Sheets - December 31, 2000
           and June 30, 2001........................................         1

           Condensed Consolidated Statements of Operations for
           the Three and Six Months Ended June 30, 2000 and 2001....         2

           Condensed Consolidated Statements of Stockholders'
           Equity (Deficit) for the Six Months Ended June 30,
           2000 and 2001............................................         3

           Condensed Consolidated Statements of Cash Flows for
           the Six Months Ended June 30, 2000 and 2001..............         4

           Notes to Unaudited Condensed Consolidated Financial
           Statements...............................................         5

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
           CONDITION AND RESULTS OF OPERATIONS......................         9

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
           MARKET RISK..............................................        14

PART II    OTHER INFORMATION

ITEM 1     LEGAL PROCEEDINGS........................................        14

ITEM 2     CHANGE IN SECURITIES.....................................        15

ITEM 3     DEFAULTS UPON SENIOR SECURITIES..........................        15

ITEM 4     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......        15

ITEM 5     OTHER INFORMATION........................................        15

ITEM 6     EXHIBITS AND REPORTS ON FORM 8-K.........................        15

</TABLE>
<PAGE>

PART I   FINANCIAL INFORMATION


ITEM 1.  FINANCIAL STATEMENTS
------------------------------
                             ARTIFICIAL LIFE, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (UNAUDITED)

                                     ASSETS
<TABLE>
<CAPTION>

                                                                                         December 31,          June 30,
                                                                                             2000                2001
                                                                                        ----------------    ---------------
<S>                                                                                           <C>                 <C>
Current assets:
    Cash and cash equivalents                                                               $   729,696        $    29,993
    Accounts receivable, trade, net of allowance for doubtful
         accounts of $2,152,070 in 2000 and $1,924,690 in 2001                                1,315,074             48,300
    Accounts receivable, affiliate                                                              207,766                  -
    Due from officer/stockholder                                                                 53,773                  -
    Refundable foreign taxes                                                                     81,949                  -
    Prepaid expenses and other current assets                                                   287,381             36,454
                                                                                        ----------------    ---------------

              Total current assets                                                            2,675,639            114,747
                                                                                        ----------------    ---------------

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            259,820
                                                                                        ----------------    ---------------

                                                                                              3,421,854            357,367
                                                                                        ----------------    ---------------

Other assets:
    Costs in excess of fair value of net assets acquired, net of accumulated
         amortization of $33,493 in 2000 and $47,823 in 2001                                     52,482             38,153
    Capitalized software development costs, net of accumulated
         amortization of $964,140 in 2000 and $1,051,105 in 2001                                500,984            187,270
    Investments in unconsolidated subsidiaries                                                  250,000            250,000
    Deposits and other assets                                                                    62,046             12,038
                                                                                        ----------------    ---------------

                                                                                                865,512            487,461
                                                                                        ----------------    ---------------

    TOTAL ASSETS                                                                            $ 6,963,005        $   959,575
                                                                                        ================    ===============

                      LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
    Accounts payable                                                                        $ 2,169,086       $  1,664,084
    Advances from stockholder                                                                         -          1,085,000
    Due to officer/stockholder                                                                        -            106,924
    Deferred revenue                                                                            289,554            232,475
    Accrued expenses                                                                          1,087,587            565,015
                                                                                        ----------------    ---------------

              Total current liabilities                                                       3,546,227          3,653,498
                                                                                        ----------------    ---------------

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         26,157,394
    Notes receivable from stockholders                                                         (198,301)          (107,613)
    Accumulated deficit                                                                     (21,493,775)       (28,850,989)
    Accumulated other comprehensive loss                                                       (373,719)                 -
                                                                                        ----------------    ---------------

              Total stockholders' equity (deficit)                                            3,416,778         (2,693,923)
                                                                                        ----------------    ---------------

    TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)                                    $ 6,963,005       $    959,575
                                                                                        ================    ===============
</TABLE>


See accompanying notes to unaudited condensed consolidated financial statements.

                                       1
<PAGE>

                             ARTIFICIAL LIFE, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)


<TABLE>
<CAPTION>


                                                            Three-months ended June 30,              Six-months ended June 30,
                                                         ------------------------------------   ------------------------------------
                                                              2000                2001               2000                2001
                                                         ----------------    ----------------   ----------------    ----------------
<S>                                                       <C>                 <C>              <C>                   <C>
Revenues:
      Software license agreements                           $  1,092,027        $     69,000       $  1,885,887        $    294,381
      Application services and other                           1,730,087             189,445          2,457,431           1,405,107
                                                         ----------------    ----------------   ----------------    ----------------

                                                               2,822,114             258,445          4,343,318           1,699,488
                                                         ----------------    ----------------   ----------------    ----------------

Operating expenses:
      General and administrative                               2,000,357           1,650,362          3,416,564           3,623,926
      Engineering and cost of sales                            2,284,762             909,910          4,008,174           3,153,057
      Research and development                                   302,545              84,356            512,553             235,639
      Sales and marketing                                        930,174             449,592          1,726,183           1,527,547
      Provision for doubtful accounts                                  -               8,723                  -              40,670
      Net restructuring charges                                        -             395,676                  -             395,676
                                                         ----------------    ----------------   ----------------    ----------------

                Total operating expenses                       5,517,838           3,498,619          9,663,474           8,976,515
                                                         ----------------    ----------------   ----------------    ----------------

                Loss from operations                          (2,695,724)         (3,240,174)        (5,320,156)         (7,277,027)

Other income (expenses):
      Foreign exchange loss                                       (1,186)                290            (41,536)            (17,401)
      Equity in loss of joint venture                           (325,426)                  -           (565,569)                  -
      Interest income                                             64,699               2,034             92,836               9,312
      Interest expense                                           (16,604)            (55,570)           (31,151)            (72,098)
                                                         ----------------    ----------------   ----------------    ----------------

                Loss before provision for income taxes        (2,974,241)         (3,293,420)        (5,865,576)         (7,357,214)

Provision for income taxes                                             -                   -                  -                   -
                                                         ----------------    ----------------   ----------------    ----------------

                Net loss                                    $ (2,974,241)       $ (3,293,420)      $ (5,865,576)       $ (7,357,214)
                                                         ================    ================   ================    ================

Basic and diluted net loss per share                        $      (0.29)       $      (0.32)      $      (0.58)       $      (0.71)

Weighted average shares outstanding
      used in per share calculation                           10,286,020          10,332,865         10,132,233          10,327,226

</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.

                                       2
<PAGE>

                             ARTIFICIAL LIFE, INC.

      CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                  (UNAUDITED)


<TABLE>
<CAPTION>

                                       Comprehensive
                                          Income                 Preferred Stock                    Common Stock
                                                          -----------------------------    ----------------------------------
                                          (Loss)            Shares          Amount              Shares            Amount
                                      ----------------    -----------    --------------    -----------------   --------------

<S>                                     <C>                <C>            <C>                  <C>                <C>
Balance at December 31, 1999                                       -         $       -            9,863,415          $98,634

Issuance of common stock                                           -                 -              427,865            4,279

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

Stock options issued for services
    rendered                                                       -                 -                    -                -

Comprehensive loss:
    Net loss                             $ (5,865,576)
    Foreign currency translation
        adjustment                            (65,062)             -         $       -                    -                -
                                      ----------------    -----------    --------------    -----------------   --------------
            Total comprehensive loss     $ (5,930,638)
                                      ================

Balance at June 30, 2000                                           -         $       -           10,291,280         $102,913
                                                          ===========    ==============    =================   ==============

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

Issuance of common stock                                           -         $       -              425,000            4,250

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

Stock options and warrants issued
    for services rendered                                          -                 -                    -                -

Comprehensive loss:
    Net loss                             $ (7,357,214)
    Foreign currency translation
        adjustment                            373,719              -                 -                    -                -
                                      ----------------    -----------    --------------    -----------------   --------------
            Total comprehensive loss     $ (6,983,495)
                                      ================

Balance at June 30, 2001                                           -         $       -           10,728,469         $107,285
                                                          ===========    ==============    =================   ==============

</TABLE>


See accompanying notes to unaudited condensed consolidated financial statements.


<TABLE>
<CAPTION>

                                                                                                 Accumulated
                                        Additional                                                  Other             Total
                                         Paid-in             Notes             Accumulated      Comprehensive     Stockholders'
                                         Capital           Receivable            Deficit            Loss         Equity (Deficit)
                                      ---------------    ---------------    ----------------    -------------    ----------------

<S>                                     <C>                <C>            <C>                  <C>                <C>
Balance at December 31, 1999             $15,563,784       $   (749,981)       $ (8,905,480)       $ (85,908)        $ 5,921,049

Issuance of common stock                   9,549,745         (5,145,000)                  -                -           4,409,024

Repayment of notes receivable
    from stockholders net of
    increases for accrued interest                 -          5,710,164                   -                -           5,710,164

Stock options issued for services
    rendered                                  76,190                  -                   -                -              76,190

Comprehensive loss:
    Net loss                                       -                  -          (5,865,576)               -          (5,865,576)
    Foreign currency translation
        adjustment                                 -                  -                   -          (65,062)            (65,062)
                                      ---------------    ---------------    ----------------    -------------    ----------------
            Total comprehensive loss


Balance at June 30, 2000                 $25,189,719       $   (184,817)       $(14,771,056)       $(150,970)        $10,185,789
                                      ===============    ===============    ================    =============    ================

Balance at December 31, 2000             $25,379,538       $   (198,301)       $(21,493,775)       $(373,719)        $ 3,416,778

Issuance of common stock                     385,750                  -                   -                -             390,000

Repayment of notes receivable
    from stockholders net of
    increases for accrued interest                 -             90,688                   -                -              90,688

Stock options and warrants issued
    for services rendered                    392,106                  -                   -                -             392,106

Comprehensive loss:
    Net loss                                       -                  -          (7,357,214)               -          (7,357,214)
    Foreign currency translation
        adjustment                                 -                  -                   -          373,719             373,719
                                      ---------------    ---------------    ----------------    -------------    ----------------
            Total comprehensive loss


Balance at June 30, 2001                 $26,157,394       $   (107,613)       $(28,850,989)       $       -         $(2,693,923)
                                      ===============    ===============    ================    =============    ================
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.

                                       3
<PAGE>

                             ARTIFICIAL LIFE, INC.

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)


<TABLE>
<CAPTION>

                                                                                        Six-months ended June 30,
                                                                                  -------------------------------------
                                                                                        2000                2001
                                                                                  -----------------   -----------------

<S>                                                                                   <C>                 <C>
Cash flows from operating activities:
      Net loss                                                                        $ (5,865,576)       $ (7,357,214)
      Adjustments to reconcile net loss to net cash
           used by operating activities:
                Depreciation and amortization                                              738,367             888,698
                Equity in loss of joint venture                                            565,569                   -
                Intercompany profit elimination                                             28,504                   -
                Net restructuring charges                                                        -             395,676
                Interest income accrued on notes receivable from stockholders               (8,910)             (9,312)
                Stock options issued for services rendered                                  76,190             392,106
                Decrease in accounts receivable, affiliates                                335,229             159,050
                (Increase) decrease in accounts receivable, trade                       (1,942,765)            977,434
                Increase (decrease) in prepaid expenses and other assets                  (101,549)             13,673
                Increase in accounts payable and other current liabilities                 633,782           1,671,499
                (Increase) decrease in due to/from officer/stockholder                     (83,176)            160,552
                                                                                  -----------------   -----------------

                Net cash used by operating activities                                   (5,624,335)         (2,707,838)
                                                                                  -----------------   -----------------

Cash flows from investing activities:
      Purchases of property and equipment                                               (1,415,730)            (58,193)
      Proceeds from sales of property and equipment                                              -              76,500
      Expenditures for capitalized software development costs                              (96,678)                  -
      Cash of subsidiaries sold or in bankruptcy                                                 -             (93,177)
      Investment in joint venture                                                         (909,900)                  -
                                                                                  -----------------   -----------------

                Net cash used by investing activities                                   (2,422,308)            (74,870)
                                                                                  -----------------   -----------------

Cash flows from financing activities:
      Proceeds from notes receivable from stockholders                                   5,719,074             100,000
      Repayment of note payable to officer/stockholder                                    (500,000)                  -
      Proceeds from advances from officer/stockholder                                             -          1,085,000
      Proceeds from bank credit lines                                                            -           1,006,671
      Proceeds from issuance of common stock                                             4,409,024             250,000
                                                                                  -----------------   -----------------

                Net cash provided by financing activities                                9,628,098           2,441,671
                                                                                  -----------------   -----------------

Effect of exchange rate changes on cash                                                    (13,696)           (358,666)
                                                                                  -----------------   -----------------

                Net increase (decrease) in cash and cash equivalents                     1,567,759            (699,703)

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

Cash and cash equivalents at end of period                                            $  4,160,147        $     29,993
                                                                                  =================   =================

Supplemental disclosure of cash flow information:
      Interest paid                                                                   $     31,151        $     43,797
      Note receivable received upon exercise of stock options                              113,750                   -
      Note receivable received and stock subscriptions from issuance of
           common stock and warrants                                                     5,031,250                   -
      Proceeds from exercise of stock options applied as a reduction
           of accrued consulting expenses                                                        -             140,000
</TABLE>


See accompanying notes to unaudited condensed consolidated financial statements.

                                       4
<PAGE>

                              ARTIFICIAL LIFE, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

                    THREE AND SIX MONTHS ENDED JUNE 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 Six Months Ended June 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 has 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 intention to maintain
stringent cost controls, the Company anticipates achieving profitability in the
second half of 2001, however, there can be no assurances of such results. 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)
                                                    ==========

                                       5
<PAGE>

  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 $100,000 with respect to Artificial Life Asia and is currently
negotiating the settlement of claims for unpaid wages and vacation pay of
$165,000 with respect to its operations in the United States. Furthermore, the
Company has not paid its Chief Executive Officer his salary earned to date in
2001 of $147,434. Without obtaining additional financing or capital, the Company
will not have sufficient resources to fund its operations through 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. The Company intends to file a registration statement on Form S-1
pursuant to the terms of this agreement. Once this registration statement is
declared effective by the Securities and Exchange Commission, the Company will
be able to sell shares of its common stock to Bluefire to obtain additional
funding. The Company does not currently meet certain of the listing requirements
of the Nasdaq National Market ("Nasdaq"). The Company has met with
representatives of Nasdaq and has requested a 90 day grace period until October
18, 2001 to comply with the Nasdaq's listing requirements. The ability to meet
these requirements may affect the Company's ability to obtain funding under the
Bluefire equity financing. 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.


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 six month periods ended June 30,
2000 and 2001. Basic and diluted net loss per share are the same, 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
                                       6
<PAGE>

(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.


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 advanced funds
bear interest at 10%, are unsecured and are due on demand. Interest expense on
this advance amounted to $28,301 for the six month period ended June 30, 2001,
and is included in due to officer/stockholder at June 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 six month period ended June 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 Six Months Ended June 30, 2001.

Other financial data for the six month period ended June 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                          $ 1,020,645   $   171,436    $       -   $ 507,407   $       -    $         -   $ 1,699,488

Intersegment revenue                    97,613        68,790      567,988     163,447           -       (897,838)            -
Interest income                         96,990           164            -       1,788           -        (89,630)        9,312
Interest expense                        28,858        49,791          546      82,533           -        (89,630)       72,098
Depreciation and amortization
   Expense                             255,022       132,352       84,656      87,330       1,295              -       560,655
Net restructuring charges             (355,544)      (50,341)    (377,027)    387,236           -              -      (395,676)
Income tax expense                           -             -            -           -           -              -             -
Net loss                            (4,386,458)   (1,321,185)    (794,037)   (604,902)   (236,303)       (14,329)   (7,357,214)
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                  3,107,536             -            -           -      27,155     (2,175,116)      959,575

</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

                                       7
<PAGE>

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.

  The Company is currently negotiating a settlement with Copley Place Associates
with respect to a claim for early lease termination and unpaid back rent for its
Boston, Massachusetts corporate headquarters. At June 30, 2001, the Company has
accrued $100,000 in connection with this matter. To the Company's knowledge, as
of August 13, 2001, no suit has been filed.

  In connection with claims for unpaid wages and vacation pay made by former
employees of its U.S. operations, the Company has accrued $165,000. 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
August 13, 2001, no suits have been filed.

8.  SUBSEQUENT EVENT

  On August 6, 2001, the Company entered into a license agreement with an
existing client, a European Bank. The agreement provides for an additional
license to the Company's Portfolio Manager Software, as well as the transfer
from the Company to the client of certain, restricted ownership rights in
certain custom software which the Company had previously developed for the
client. The purchase price was $1,000,000 payable in cash at closing. The
transaction closed on August 10, 2001.

                                       8
<PAGE>

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

OVERVIEW

  The Company was established in 1997 pursuant to a management buyout from its
former parent company, Neurotec International Corp., a German multimedia and
internet solutions company.  The Company's initial business plan focused on the
provision of software consulting services.  The Company subsequently shifted its
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.

  The Company has continued to incur losses in the first and second quarter of
2001. Based upon the substantial restructuring of the Company in the second
quarter of 2001 and the Company's intention to maintain stringent cost controls,
the Company anticipates achieving profitability in the second half of 2001,
however, there can be no assurances of such results. The Company's continued net
losses have severely impacted the Company's liquidity and cash position which,
in turn, have impeded the Company's ability to fund its operations.
Consequently, in connection with the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2000, the Company's independent accountants
expressed an opinion doubting the Company's ability to continue as a going
concern. As of June 30, 2001, the Company had cash and cash equivalents of
approximately $30,000 and accounts payable in excess of $1.6 million. On April
6, 2001 the Company received a letter from the Nasdaq National Market ("Nasdaq")
stating that the Company does not comply with certain listing requirements. On
July 12, 2001, a panel hearing was held by the Nasdaq to discuss the Company's
plans and ability to comply with the listing requirements. The Company
subsequently presented a detailed plan to the panel and requested a 90 day grace
period to comply with the requirements. As of August 13, 2001, no decision has
been announced by the Nasdaq panel. If the Company is unable to remain listed on
Nasdaq, this would materially impair the ability of stockholders to buy and sell
shares of the Company's stock, and trading would be 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, 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.

  During the first half of 2001, the Company re-evaluated its business and
decided to shift its focus to the marketing and sales of its products and to
reserve product development efforts primarily for individual clients that
contract for such development.  Consequently, the Company anticipates devoting
fewer resources to engineering and research and development activities in the
future. The Company laid off nearly all of its engineering and research and
development employees during the first half of 2001 and plans to subcontract
these services as needed. As a result, the Company significantly reduced its
engineering and research and development costs in the first half of 2001. In
connection with this restructuring, the Company sold all of its stock in
Artificial Life Rus on May 25, 2001. The Company has therefore been relieved of
all tax assessment liability associated with the operations of Artificial Life
Rus. Also, the Company 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, the Company implemented a significant cost reduction program
during the first half of 2001.  The Company has taken drastic steps to reduce
its U.S. operations, including a major reduction of office facilities, the
relocation of its headquarters from Boston, Massachusetts to New York, New York,
the termination of its lease for its former headquarters in Boston,
Massachusetts and the negotiation of a settlement with the landlord, and the
termination of most of its staff.  Also, the Company has reduced its marketing
activities, website development, technology, and operating infrastructure
development budgets.  Furthermore, the Company is currently reviewing plans to
consolidate the operations of Artificial Life USA, Artificial Life Mobile, and
Artificial Life Ventures into the Company to minimize overhead costs and
expenses.  The Company is seeking a long-term lease contract for its new
headquarters in New York and is currently occupying a temporary office for a
period of three months.  Lease obligations from this temporary office are less
than $10,000 per month.

  Although the Company realized significant software license revenues in 1999
and 2000, and software license revenues as a percentage of overall revenues
increased from 1999 to 2000, software license revenues decreased significantly
in the first half of 2001 as compared to the same period 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, the Company's inability to obtain additional
financing to fund its operations, the cessation of the Company's European
operations, the cessation of the Company's Russian operations, and the
significant downsizing and restructuring of the Company's U.S. operations.

  In the near term, the Company has shifted its business focus to the marketing,
sales, and support of its existing products, including the sale of non-exclusive
source code licenses. The Company will continue limited product development of
its financial product packages and individual client contracted projects. The
Company believes, however, that it will continue to generate negative cash flows
from operations until the second half of 2001. The Company's continued losses
have severely impacted the Company's liquidity and cash position. To the extent
that the Company's marketing and sales of its existing products and limited
product development efforts do not result in commercially successful products
that generate significant net revenues, the Company will be materially adversely
affected. There can be no assurance that the Company will ever generate
sufficient revenues from the sale of its products or associated services to
achieve and maintain profitability.

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

  In addition to its restructuring efforts, the Company is also seeking
additional financing to increase its liquidity and capital resources.  If the
Company is unable to obtain additional financing, this would have a material
adverse effect on its business.

                                       9
<PAGE>

RESULTS OF OPERATIONS

  In fiscal year 2000, license revenues increased in the aggregate and as a
percentage of overall revenues and the Company's client base expanded.  In the
six month period ended June 30, 2001, license revenues and other revenues
decreased in comparison to the first six months of 2000, due to global market
conditions, cessation of operations in Europe and substantial downsizing of the
Company's United States operations. The Company's current strategy is to
maintain stringent cost controls while focusing its efforts on the sale and
support of its existing products, including the sale of non-exclusive source
code licenses.

                                       10
<PAGE>

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

REVENUES:  Revenues for the quarter ended June 30, 2001 were $258,445 as
compared to $2,822,114 for the quarter ended June 30, 2000. The decrease of
$2,563,669 or 91% was due primarily to a general major downturn of the global
Internet markets, the general negative business climate, and the Company's
inability to obtain necessary funding and the Company's restructuring and
dramatic downsizing of its 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 the Company derives its revenues. Engineering
expenses for the quarter ended June 30, 2001 were $909,910 as compared to
$2,284,762 for the quarter ended June 30,2000. The decrease of $1,374,852 or 60%
was primarily due to the downsizing and lay off of personnel during the quarter.

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 June 30, 2001 were $84,356 as compared to
$302,545 for the quarter ended June 30, 2000. The decrease of $218,189 or 72% is
due primarily to the shut down of the Russian R&D operations and the lay-off of
its staff.

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 June, 30, 2001
were $1,650,362 as compared to $2,000,357 for the quarter ended June 30, 2000.
The decrease of $349,995 or 17.5% was due primarily to the general downsizing of
the Company and the associated lay-off of staff.

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
June 30, 2001 were $449,592 compared to $930,174 for the quarter ended June 30,
2000. The decrease of $480,582 or 52% was primarily due to the general
downsizing of the Company and the reduction of marketing expenses.

NET LOSS:  Net Loss for the quarter ended June 30, 2001 was $3,293,420 as
compared to $2,974,241 for the quarter ended June 30, 2000. This increase of
$319,179 or 11% was due to a substantial decrease in revenues offset by the
execution of the Company's global cost cutting program and downsizing and the
one time expenses related to the net restructuring charges in connection with
the cessation of operations in Europe and the downsizing of operations in the
United States.


SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000

REVENUES: Revenues for the six months ended June 30, 2001 were $1,699,488 as
compared to $4,343,318 for the six months ended June 30, 2000. The decrease of
$2,643,830 or 61% was due to the general downturn of the global Internet markets
during the period, the general negative business climate, the Company's
inability to obtain necessary funding, and the Company's restructuring and
dramatic downsizing of its 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 the Company derives its revenues.  Engineering
expenses for the six months ended June 30, 2001 were $3,153,057 as compared to
$4,008,174 for the six months ended June 30, 2000.  The decrease of $855,117 or
21.3% is primarily attributable to the effects of the Company's global cost
cutting program

                                       11
<PAGE>

and the lay-off of staff. Major components of engineering and cost of sales
include payroll and related costs of $1,993,653, travel and lodging expenses of
$94,938, occupancy expense of $254,224, the amortization of previously
capitalized software development costs of $313,713, depreciation of $281,498,
and consulting expense of $174,818.

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 six months ended June
30, 2001 were $235,639 as compared to $512,553 for the six months ended June 30,
2000. The decrease of $276,914 or 54% is primarily attributable to a decrease of
payroll and related costs of $190,045 associated with the shut down of the
Company's Russian research and development facility. 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 six
months ended June 30, 2001 were $3,623,926 as compared to $3,416,564 for the six
months ended June 30, 2000. The increase of $207,362 or 6% is primarily
attributable to the establishment of the Company's international administrative
infrastructure in the first quarter offset by reductions due to the lay-off of
staff, global downsizing in the second quarter. Significant expenses include
payroll and related costs of $1,107,246, recruiting and other professional fees
of $150,789, travel and entertainment expense of $209,798, communications
expense of $126,942, rent expense of $228,043, and legal and accounting expenses
of $532,688.

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 six months ended June 30, 2001 were
$1,527,547 as compared to $1,726,183 for the six months ended June 30, 2000. The
decrease of $198,636 or 11.5% is primarily attributable to the reduction of
general marketing expenses in both the United States and Europe in connection
with the Company's restructuring. Significant expenses include payroll and
related costs of $715,558, consulting expense of $216,553, trade shows expense
of $119,630, public relations expense of $104,785, travel and entertainment
expense of $92,026, rent expense of $74,548, and advertising expense of $32,399.

NET LOSS: Net loss for the six months ended June 30, 2001 was $7,357,214
compared to a net loss of $5,865,576 for the six months ended June 30, 2000.
This increase of $1,491,638 or 25% is primarily due to the substantial reduction
in revenues due to the downturn of the global internet markets and the Company's
dramatic downsizing offset, in part, by a reduction in costs as a result of the
Company's restructuring.


LIQUIDITY AND CAPITAL RESOURCES

Overview

  From inception through July 3, 1997, the Company funded its operations
primarily through initial equity investments in 1994 and 1995 totaling $500,000
and net income from operations. Subsequent to July 3, 1997, the Company incurred
operating losses in connection with its 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 the Company 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, the Company received $9,302,773 net proceeds from its initial public
offering. During 1999, option holders of the Company exercised options netting
the Company approximately $1,300,000, which was received in 1999 and the first
quarter of 2000. In February 2000, the Company 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 $2,562,500 to the Company in exchange for
102,500 common shares; the second transaction netted $1,550,000 to the Company
in exchange for 50,000 common shares. In March 2000, the Company 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 $4,856,250 to the
Company in exchange for 150,000 common shares and 75,000 warrants. In January
2001, the Company issued 25,000 common shares to a private individual in
connection with a private placement. The total proceeds to the Company amounted
to $250,000.  Costs related to these transactions were immaterial. The Company's
future requirements for additional capital will depend on many factors,
including but not limited to, the

                                       12
<PAGE>

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 the Company's suites of products.

  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 has continued to incur losses in the first
and second quarter of 2001. Based upon the substantial restructuring of the
Company in the second quarter of 2001 and the Company's intention to maintain
stringent cost controls, the Company anticipates achieving profitability in the
second half of 2001, however, there can be no assurances of such results. The
Company's continued losses have severely impacted the Company's liquidity and
cash position. In order to fund its cash needs for 2001, the Company borrowed
$485,000 from its Chief Executive Officer during the first quarter and an
additional $600,000 during the second quarter for a total of $1,085,000. The
advances are expected to be converted into an interest-bearing term loan and, in
part, may be converted into equity, subject to approval of the Company's
stockholders. Without obtaining additional financing or capital, the Company
will not have sufficient resources to fund its operations through 2001. To that
end, the Company has entered into an irrevocable stock purchase agreement with
Bluefire on March 22, 2001, to provide the Company with equity financing. The
Company believes that the financing that will become available from this equity
facility upon the effectiveness of its registration statement will be sufficient
(based on the volume and share price calculation determining the draw down
amounts) to fund its operations through 2001and 2002. However, the Company is
continuing to pursue other 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 come from the outcome of this uncertainty.


OTHER

  On April 6, 2001 the Company received a letter from the Nasdaq National Market
("Nasdaq") stating that the Company does not comply with certain listing
requirements. On July 12, 2001, a panel hearing was held by the Nasdaq to
discuss the Company's plans and ability to comply with the listing requirements.
The Company subsequently presented a detailed plan to the panel and requested a
90 days grace period to comply with the requirements. As of the date of this
filing, no decision has been made by the Nasdaq panel. If the Company were to be
delisted from Nasdaq, the Company's ability to obtain future financing could be
materially impaired.

  On May 25, 2001, the Company sold all its stock in Artificial Life Rus for a
nominal amount. The Company has therefore been relieved of all tax assessment
liability associated with the operations of Artificial Life Rus. See Item 1.
Legal Proceedings.

  The Company has entered into an employment agreement with its new Global Chief
Financial Officer, Phaik Chin Lim as an employee of Artificial Life Asia on June
1, 2001 with a base salary of $16,667 per month, paid on a 12 month basis, with
the cash salary convertible to stock or stock options by mutual agreement. The
Company has also issued to Phaik Chin Lim an option to purchase 300,000 shares
and a warrant to purchase an additional 200,000 shares of the Company's common
stock, each at an exercise price of $0.35 per share.


                                       13
<PAGE>

  The Company has 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.

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 the Company's 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 Company's current liquidity and cash position and ability to
raise additional financing or capital; limited revenues generated by the
Company; the Company's failure to successfully complete the restructuring of its
operations; the Company's failure to successfully complete its cost reduction
program; the Company's dependence on the growth in demand for agent-based
software products, such as the Company's suite of SmartBot products; competition
with more established software companies; market acceptance of the Company's
software robot products; the Company's ability to regain compliance with
applicable listing requirements on Nasdaq; the Company's ability to minimize
design defects, software errors, misuse of the Company's products, incorrect
data from external sources and other potential problems which may be out of the
Company's control; the Company's ability to remain competitive through limited
product development and individual contracted products; the Company's ability to
generate revenues from sales of its intellectual property for direct use into
third party systems; the Company's decision not to create new products and
technologies for the foreseeable future; the ability of the Company to retain
its key employees; the Company's dependence on third party contractors to
complete portions of its development work; certain risks associated with sales
in foreign markets, including political and economic instability, restrictive
trade policies of foreign governments, local economic conditions in foreign
markets, potentially adverse tax consequences and the burdens on customers of
complying with a variety of applicable laws; the Company's dependence on
continued growth of the Internet and online commerce; the Company's ability to
protect its intellectual property and other proprietary rights; the Company's
ability to establish and maintain brand identity; the management of the
Company's foreign operations; the success by the Company in identifying and
licensing third party voice recognition software which will be compatible with
its products; the impact of government regulations; and general economic
conditions.


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

   The Company maintains its cash and cash equivalents in checking, savings, and
money market accounts.  Approximately 76% of these deposits are denominated in
U.S. dollars. At June 30, 2001, approximately 24% 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, the Company's 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. The
Company believes that a hypothetical 10% increase or decrease in either interest
or exchange rates, however, would not have a material adverse effect on its
financial condition. The Company does not hold derivative financial instruments,
derivative commodity investments or other financial investments or engage in
foreign currency hedging or other transactions that expose it 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 rented by the Company on behalf of certain foreign
employees were settled for an aggregate settlement of $40,000 to be paid by the
Company by August 14, 2001.

  The Company is also currently negotiating a settlement with Copley Place
Associates for early lease termination and settlement of unpaid back rent for
its former Boston, Massachusetts corporate headquarters; damages are estimated
at $100,000. To the Company's knowledge, as of August 13, 2001, no suit has been
filed by Copley Place Associates. An unfavorable resolution of this negotiation
could have a material adverse effect on the Company's business, results of
operations, and financial condition.

  During 2000, Artificial Life Rus, the Company's 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 for a nominal
amount. The Company has therefore been relieved of all tax assessment liability
associated with the operations of Artificial Life Rus.

  On June 8, 2001, the Company filed for bankruptcy protection for Artificial
Life Deutschland in the Insolvenzgerant Frankfurt. An unfavorable resolution of
this administrative proceeding could have a material adverse effect on the
Company's business, results of operations, or financial condition.

  On June 29, 2001, the Company filed for bankruptcy protection for Artificial
Life Schweiz in the bankruptcy court of Kanton Nidwalden, Switzerland. An
unfavorable resolution of this administrative proceeding could have a material
adverse effect on the Company's business, results of operations, or financial
condition.

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

                                       14
<PAGE>

ITEM 2.  CHANGE IN SECURITIES
-----------------------------

  On April 27, 2001 and June 7, 2001, the Company issued to Robert Duggan, in
consideration of consulting services rendered to the Company in connection with
the Company's consideration and preparation of documents related to various
financing alternatives, a warrant to purchase 35,000 shares of the Company's
common stock at an exercise price of $0.50 per share and a warrant to purchase
350,000 shares of the Company's common stock at an exercise price of $0.10 per
share, respectively.  Each warrant is immediately exercisable for a term of four
(4) years.

  On June 4, 2001, the Company's issue to Phaik Chin Lim, the Company's Global
Chief Financial Officer a warrant to purchase 200,000 shares of the Company's
common stock at an exercise price of $0.35 per share. This warrant was
immediately exerciseable for a term of four (4) years.

  No person acted as an underwriter with respect to the above described
transactions between the Company and each of Mr. Duggan and Ms. Lim. In each
transaction, the Company relied on Section 4(2) of the Securities Act of 1933,
as amended.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
-----------------------------------------

  On June 8, 2001, the Company filed for bankruptcy protection for Artificial
Life Deutschland in the Insolvenzgerieht Frankfurt. See Item 1. Legal
Proceedings of this Form 10-Q for further discussion. As of the date of the
bankruptcy filing, Artificial Life Deutschland owed $543,010 obtained pursuant
to a bank overdraft line.

  On June 29, 2001, the Company filed for bankruptcy protection for Artificial
Life Schweiz in the bankruptcy court of Kanton Nidwalden, Switzerland. See Item
1. Legal Proceedings of this Form 10-Q for further discussion. As of the date of
the bankruptcy filing, Artificial Life Schweiz owed $463,661 obtained pursuant
to a bank overdraft credit line.


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

None.


ITEM 5.  OTHER INFORMATION
--------------------------

  The Private Securities Litigation Reform Act of 1995 provides a safe harbor
for forward-looking statements made by or on behalf of the Company. Certain
statements contained in Management's Discussion and Analysis and in other
Company filings are forward-looking statements. These statements discuss, among
other things, expected growth, future revenues, future cash flows and future
performance. The forward-looking statements are subject to risks and
uncertainties including but not limited to the cost of goods, competitive
pressures, inflation, consumer debt levels, currency exchange fluctuations,
trade restrictions, changes in tariff and freight rates, interest rate
fluctuations and other capital market conditions, and other risks indicated in
the Company's filings with the United States Securities and Exchange Commission.
Actual results may materially differ from anticipated results described in these
statements.

  During the second quarter of the current fiscal year, Messrs. Felix Widmer,
Gerhard Zink and Rolf Levenhagen resigned from the Company's Board of Directors
to pursue other opportunities.  Subsequently, in July 2001, Messrs. Frank
Namyslik, Hartmut Meyer and Dr. Gert Hensel were each appointed to the Company's
Board of Directors.

  In May 2001, Robert Pantano resigned his position as the Company's Chief
Financial Officer. On June 1, 2001, Ms. Lim replaced Mr. Pantano as the
Company's Global Chief Financial Officer.

  In connection with a claim for unpaid wages and vacation pay in the aggregate
amount of $62,895 made by Mr. Pantano, the Company's former Chief Financial
Officer, the Company has reached a settlement with Mr. Pantano pursuant to which
the Company has agreed to pay Mr. Pantano the sum of $31,477 in exchange for the
release of all current and potential claims of Mr. Pantano against the Company.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K
------------------------------------------

(a)  Exhibits

      3.1 Amended and Restated Certificate of Incorporation of the Company.
          Filed as Exhibit 3.1 to the Company's Registration Statement on Form
          S-1 (File No. 333-64619) and incorporated herein by reference.

      3.2  Restated Bylaws of the Company. Filed as Exhibit 3.2 to the Company's
           Registration Statement on Form S-1 (File No. 333-64619) and
           incorporated herein by reference.

      4.1  Specimen Common Stock Certificate for share of Common Stock of the
           Company. Filed as Exhibit 4.1 to the Company's Registration Statement
           on Form S-1 (File No. 333-64619) and incorporated herein by
           reference.

      4.2  Form of Representatives' Warrant issued by the Company to
           underwriters New York Broker, Inc. and New York Broker Deutschland AG
           upon consummation of the Company's initial public offering. Filed as
           Exhibit 4.2 to the Company's Registration Statement on Form S-1 (File
           No. 333-64619) and incorporated herein by reference.

     10.1  License Agreement by and among Artificial Life, Inc., [             ]
           and Escrow Europe (Switzerland) AG, dated August 6, 2001

     10.2  Employment Agreement between Artificial Life Asia, Ltd. and Phaik
           Chin Lim dated June 1, 2001.

     99    Forward-looking Information

(b)  Reports on Form 8-K

  On June 1, 2001, the Company filed a Current Report on Form 8-K with the
Securities and Exchange Commission announcing that (i) it cut staff cuts and
initiated corporate restructuring, including shutting down its

                                       15
<PAGE>

Russian operations, (ii) it planned to file for bankruptcy with respect to the
Registrant's German and Swiss subsidiaries, (iii) its Chief Financial Officer
had resigned and it appointed his replacement, (iv) it had received notice from
Nasdaq that it no longer was in compliance with Nasdaq listing requirements, (v)
it planned to relocate its headquarters and (vi) that it was engaged in merger
and financing discussions.

                                       16
<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 August, 14,
2001.


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

                                         By:  /s/ Eberhard Schoneburg
                                              ----------------------------
                                              Eberhard Schoneburg
                                              Chairman, President &
                                              Chief Executive Officer
                                              (Principal Executive Officer)

                                         By:  /s/ Phaik Chin Lim
                                              ----------------------------
                                              Phaik Chin Lim
                                              Chief Financial Officer
                                              (Principal Financial Officer)

                                       17
<PAGE>

EXHIBIT INDEX

Exhibit

 *3.1 Amended and Restated Certificate of Incorporation of the Company. Filed as
      Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No.
      333-64619) and incorporated herein by reference.

 *3.2 Restated Bylaws of the Company. Filed as Exhibit 3.2 to the Company's
      Registration Statement on Form S-1 (File No. 333-64619) and incorporated
      herein by reference.

 *4.1 Specimen Common Stock Certificate for share of Common Stock of the
      Company. Filed as Exhibit 4.1 to the Company's Registration Statement on
      Form S-1 (File No. 333-64619) and incorporated herein by reference.

 *4.2 Form of Representatives' Warrant issued by the Company to underwriters New
      York Broker, Inc. and New York Broker Deutschland AG upon consummation of
      the Company's initial public offering. Filed as Exhibit 4.2 to the
      Company's Registration Statement on Form S-1 (File No. 333-64619) and
      incorporated herein by reference.

+10.1 License Agreement by and among Artificial Life, Inc., [_________], and
      Escrow Europe (Switzerland) AG dated August 6, 2001.

 10.2 Employment Agreement between Artificial Life Asia, Ltd. and Phaik Chin Lim
      dated June 1, 2001.

 99   Forward-looking Information


* Previously filed.

+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the commission.

                                       18