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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

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

For the Quarterly period ended March 31, 2003.

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 No. 000-31101

APPLIED MOLECULAR EVOLUTION, INC.




(Exact name of registrant as specified in its charter)


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

3520 Dunhill Street

San Diego, California 92121





(Address of principal executive offices and zip code)


(858) 597-4990




(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 [   ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

YES [X]   NO [   ]

20,817,735 shares of the Registrants Common Stock were outstanding as of
May 1, 2003.





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|                           |                                                                                               |                                            |  |  |  |  |  | 
|-------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|                           |                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                           |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS     
|                           |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                           |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                           | ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                           |                                                                                               | RISK FACTORS                              
|                           | ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                           | ITEM 4: CONTROLS AND PROCEDURES                                                              
|PART II: OTHER INFORMATION
|                           | ITEM 1: LEGAL PROCEEDINGS                                                                    
|                           | ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                           | ITEM 3: DEFAULTS UPON SENIOR SECURITIES                                                      
|                           | ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                           | ITEM 5: OTHER INFORMATION                                                                    
|                           | ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                
|CERTIFICATIONS            
|EXHIBIT 99.1              
|EXHIBIT 99.2              



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APPLIED MOLECULAR EVOLUTION, INC.
FORM 10-Q INDEX

|                              |                                                                                               |                                                                                                      |    |      |    | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                              |                                                                                               |                                                                                                      |    | PAGE
|                              |                                                                                               |                                                                                                      |    |     
|PART I: FINANCIAL INFORMATION |                                                                                               |                                                                                                      |    |     
|                              | ITEM 1: Financial Statements                                                                  |                                                                                                      |    | 3    |   
|                              |                                                                                               | Consolidated Balance Sheets at March 31, 2003 (unaudited), and December 31, 2002                     |    |      | 3  | 
|                              |                                                                                               | Consolidated Statements of Operations for the three months ended March 31, 2003
and 2002 (unaudited) |    |      | 4  | 
|                              |                                                                                               | Consolidated Statements of Cash Flows for the three months ended March 31, 2003
and 2002 (unaudited) |    |      | 5  | 
|                              |                                                                                               | Notes to Consolidated Financial Statements (unaudited)                                               |    |      | 6  | 
|                              | ITEM 2: Managements Discussion and Analysis of Financial Condition and Results of Operations |                                                                                                      |    | 8    |   
|                              |                                                                                               | Risk Factors                                                                                         |    |      | 12 | 
|                              | ITEM 3: Quantitative and Qualitative Disclosures About Market
Risk                            |                                                                                                      |    | 15   |   
|                              | ITEM 4: Controls and
Procedures                                                               |                                                                                                      |    | 15   |   
|PART II: OTHER INFORMATION    |                                                                                               |                                                                                                      |    |     
|                              | ITEM 1: Legal Proceedings                                                                     |                                                                                                      |    | 16   |   
|                              | ITEM 2: Changes in Securities and Use of Proceeds                                             |                                                                                                      |    | 16   |   
|                              | ITEM 3: Defaults Upon Senior Securities                                                       |                                                                                                      |    | 17   |   
|                              | ITEM 4: Submission of Matters to a Vote of Security Holders                                   |                                                                                                      |    | 17   |   
|                              | ITEM 5: Other Information                                                                     |                                                                                                      |    | 17   |   
|                              | ITEM 6: Exhibits and Reports on Form 8-K                                                      |                                                                                                      |    | 17   |   
|SIGNATURES                    |                                                                                               |                                                                                                      | 18 |     
|CERTIFICATIONS                |                                                                                               |                                                                                                      | 19 |     
|EXHIBITS                      |                                                                                               |                                                                                                      | 21 |     

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APPLIED MOLECULAR EVOLUTION, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

|                                     |                                                                                                                                                             |  |                                            |         |             |        |              |         |   |        | 
|------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------ | ------- | ----------- | ------ | ------------ | ------- | - | ------ | 
|                                     |                                                                                                                                                             |  |                                            |         | MARCH 31,   |        | DECEMBER 31,
|                                     |                                                                                                                                                             |  |                                            |         | 2003        |        | 2002        
|                                     |                                                                                                                                                             |  |                                            |         |             |        |             
|                                     |                                                                                                                                                             |  |                                            |         | (UNAUDITED) |        | (AUDITED)   
|ASSETS                               |                                                                                                                                                             |  |                                            |         |             |        |              |        
|Current assets:                      |                                                                                                                                                             |  |                                            |         |             |        |              |        
|                                     | Cash and cash equivalents                                                                                                                                   |  | $                                          | 5,174   |             |        | $            | 6,336   |  
|                                     | Short-term investments                                                                                                                                      |  |                                            | 42,559  |             |        |              | 44,783  |  
|                                     | Prepaid expenses                                                                                                                                            |  |                                            | 605     |             |        |              | 448     |  
|                                     | Other current assets                                                                                                                                        |  |                                            | 794     |             |        |              | 922     |  
|                                     |                                                                                                                                                             |  |                                            |         |             |        |              |         |  
|                                     |                                                                                                                                                             |  | Total current assets                       |         |             | 49,132 |              |         |   | 52,489 | 
|Restricted cash                      |                                                                                                                                                             |  | 10,500                                     |         |             |        | 10,500       |        
|Property and equipment, net          |                                                                                                                                                             |  | 14,934                                     |         |             |        | 14,490       |        
|Patents, net                         |                                                                                                                                                             |  | 1,989                                      |         |             |        | 1,985        |        
|Other assets                         |                                                                                                                                                             |  | 574                                        |         |             |        | 507          |        
|                                     |                                                                                                                                                             |  |                                            |         |             |        |              |         |  
|                                     |                                                                                                                                                             |  | Total assets                               |         | $           | 77,129 |              |         | $ | 79,971 | 
|                                     |                                                                                                                                                             |  |                                            |         |             |        |              |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY |                                                                                                                                                             |  |                                            |         |             |        |              |        
|Current liabilities:                 |                                                                                                                                                             |  |                                            |         |             |        |              |        
|                                     | Accounts payable                                                                                                                                            |  | $                                          | 669     |             |        | $            | 958     |  
|                                     | Accrued liabilities                                                                                                                                         |  |                                            | 2,196   |             |        |              | 1,613   |  
|                                     | Current portion of deferred revenue                                                                                                                         |  |                                            | 686     |             |        |              | 1,214   |  
|                                     |                                                                                                                                                             |  |                                            |         |             |        |              |         |  
|                                     |                                                                                                                                                             |  | Total current liabilities                  |         |             | 3,551  |              |         |   | 3,785  | 
|Deferred revenue                     |                                                                                                                                                             |  | 99                                         |         |             |        | 158          |        
|Deferred rent                        |                                                                                                                                                             |  | 132                                        |         |             |        | 86           |        
|Long-term obligation                 |                                                                                                                                                             |  | 10,000                                     |         |             |        | 10,000       |        
|Minority interest                    |                                                                                                                                                             |  |                                           |         |             |        |             |        
|Stockholders equity:                |                                                                                                                                                             |  |                                            |         |             |        |              |        
|                                     | Preferred stock, $.001 par value, 5,000,000 shares authorized, none issued                                                                                  |  |                                            |        |             |        |              |        |  
|                                     | Common stock, $.001 par value, 45,000,000 shares authorized, 23,890,846
and 23,661,477 shares issued at March 31, 2003, and December 31, 2002,
respectively |  |                                            | 24      |             |        |              | 24      |  
|                                     | Additional paid-in capital                                                                                                                                  |  |                                            | 161,074 |             |        |              | 160,588 |  
|                                     | Deferred compensation                                                                                                                                       |  |                                            | (767    | )           |        |              | (1,213  | )
|                                     | Notes receivable from employees                                                                                                                             |  |                                            | (958    | )           |        |              | (941    | )
|                                     | Accumulated other comprehensive income                                                                                                                      |  |                                            | 535     |             |        |              | 761     |  
|                                     | Accumulated deficit                                                                                                                                         |  |                                            | (74,875 | )           |        |              | (71,591 | )
|                                     | Less: Treasury stock at cost - 3,073,111 shares                                                                                                             |  |                                            | (21,686 | )           |        |              | (21,686 | )
|                                     |                                                                                                                                                             |  |                                            |         |             |        |              |         |  
|                                     |                                                                                                                                                             |  | Total stockholders equity                 |         |             | 63,347 |              |         |   | 65,942 | 
|                                     |                                                                                                                                                             |  |                                            |         |             |        |              |         |  
|                                     |                                                                                                                                                             |  | Total liabilities and stockholders equity |         | $           | 77,129 |              |         | $ | 79,971 | 
|                                     |                                                                                                                                                             |  |                                            |         |             |        |              |         |  

See accompanying notes.

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APPLIED MOLECULAR EVOLUTION, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

|                                                       |                                      |   |                    |       |      |   |        |       | 
|------------------------------------------------------ | ------------------------------------ | - | ------------------ | ----- | ---- | - | ------ | ----- | 
|                                                       |                                      |   | THREE MONTHS ENDED
|                                                       |                                      |   | MARCH 31,         
|                                                       |                                      |   | 2003               |       | 2002
|                                                       |                                      |   |                    |       |     
|Revenues:                                              |                                      |   |                    |       |      |   |        |      
|                                                       | Contract revenue from collaborations |   | $                  | 2,328 |      |   | $      | 1,956 | 
|                                                       | Other revenue                        |   |                    | 835   |      |   |        | 659   | 
|                                                       |                                      |   |                    |       |      |   |        |      
|                                                       | Total revenues                       |   |                    | 3,163 |      |   |        | 2,615 | 
|                                                       |                                      |   |                    |       |      |   |        |      
|Operating expenses:                                    |                                      |   |                    |       |      |   |        |      
|                                                       | Research and development             |   |                    | 4,599 |      |   |        | 3,366 | 
|                                                       | General and administrative           |   |                    | 2,328 |      |   |        | 2,804 | 
|                                                       | Stock-based compensation             |   |                    | 449   |      |   |        | 1,039 | 
|                                                       |                                      |   |                    |       |      |   |        |      
|                                                       | Total operating expenses             |   |                    | 7,376 |      |   |        | 7,209 | 
|                                                       |                                      |   |                    |       |      |   |        |      
|Loss from operations                                   |                                      |   | (4,213             | )     |      |   | (4,594 | )    
|Minority interest                                      |                                      |   | 344                |       |      |   |       |      
|Interest income, net                                   |                                      |   | 585                |       |      |   | 924    |      
|                                                       |                                      |   |                    |       |      |   |        |      
|Net loss                                               |                                      | $ | (3,284             | )     |      | $ | (3,670 | )    
|                                                       |                                      |   |                    |       |      |   |        |       | 
|Net loss per share, basic and diluted                  |                                      | $ | (0.16              | )     |      | $ | (0.17  | )    
|Weighted average shares outstanding, basic and diluted |                                      |   | 20,480             |       |      |   | 21,842 |      

See accompanying notes.

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APPLIED MOLECULAR EVOLUTION, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

|                                                                                          |                                                     |   |                    |      |      |   |         |       |  
|----------------------------------------------------------------------------------------- | --------------------------------------------------- | - | ------------------ | ---- | ---- | - | ------- | ----- | -
|                                                                                          |                                                     |   | THREE MONTHS ENDED
|                                                                                          |                                                     |   | MARCH 31,         
|                                                                                          |                                                     |   | 2003               |      | 2002
|                                                                                          |                                                     |   |                    |      |     
|OPERATING ACTIVITIES                                                                      |                                                     |   |                    |      |      |   |         |      
|Net loss                                                                                  |                                                     | $ | (3,284             | )    |      | $ | (3,670  | )    
|Adjustments to reconcile net loss to net cash provided by
(used in) operating activities: |                                                     |   |                    |      |      |   |         |      
|                                                                                          | Depreciation and amortization                       |   |                    | 334  |      |   |         | 335   |  
|                                                                                          | Amortization of stock-based compensation            |   |                    | 446  |      |   |         | 1,024 |  
|                                                                                          | Compensation related to consultant stock options    |   |                    | 3    |      |   |         | 15    |  
|                                                                                          | Deferred revenue                                    |   |                    | (587 | )    |   |         | (751  | )
|                                                                                          | Deferred rent                                       |   |                    | 46   |      |   |         | (8    | )
|                                                                                          | Minority interest                                   |   |                    | (344 | )    |   |         |      |  
|                                                                                          | Realized gain on short-term investments             |   |                    | (221 | )    |   |         | (136  | )
|                                                                                          | Accrued interest on notes receivable from employees |   |                    | (17  | )    |   |         | (15   | )
|Changes in operating assets and liabilities:                                              |                                                     |   |                    |      |      |   |         |      
|                                                                                          | Prepaid expenses and other assets                   |   |                    | (96  | )    |   |         | 2,953 |  
|                                                                                          | Accounts payable and accrued expenses               |   |                    | 294  |      |   |         | 706   |  
|                                                                                          |                                                     |   |                    |      |      |   |         |      
|Net cash provided by (used in) operating activities                                       |                                                     |   | (3,426             | )    |      |   | 453     |      
|                                                                                          |                                                     |   |                    |      |      |   |         |      
|INVESTING ACTIVITIES                                                                      |                                                     |   |                    |      |      |   |         |      
|Restricted cash                                                                           |                                                     |   |                   |      |      |   | (11,990 | )    
|Purchase of property and equipment                                                        |                                                     |   | (737               | )    |      |   | (9,754  | )    
|Purchase of short-term investments                                                        |                                                     |   | (12,564            | )    |      |   | (19,929 | )    
|Proceeds from sale of short-term investments                                              |                                                     |   | 14,783             |      |      |   | 20,512  |      
|Patents                                                                                   |                                                     |   | (45                | )    |      |   | (74     | )    
|                                                                                          |                                                     |   |                    |      |      |   |         |      
|Net cash provided by (used in) investing activities                                       |                                                     |   | 1,437              |      |      |   | (21,235 | )    
|                                                                                          |                                                     |   |                    |      |      |   |         |      
|FINANCING ACTIVITIES                                                                      |                                                     |   |                    |      |      |   |         |      
|Proceeds from long-term obligations                                                       |                                                     |   |                   |      |      |   | 10,000  |      
|Proceeds from short term loan                                                             |                                                     |   |                   |      |      |   | 56      |      
|Issuance of common stock                                                                  |                                                     |   | 79                 |      |      |   | 102     |      
|Investment in subsidiary by minority investor, net                                        |                                                     |   | 748                |      |      |   |        |      
|                                                                                          |                                                     |   |                    |      |      |   |         |      
|Net cash provided by financing activities                                                 |                                                     |   | 827                |      |      |   | 10,158  |      
|                                                                                          |                                                     |   |                    |      |      |   |         |      
|Net decrease in cash and cash equivalents                                                 |                                                     |   | (1,162             | )    |      |   | (10,624 | )    
|Cash and cash equivalents at the beginning of the period                                  |                                                     |   | 6,336              |      |      |   | 25,927  |      
|                                                                                          |                                                     |   |                    |      |      |   |         |      
|Cash and cash equivalents at the end of the period                                        |                                                     | $ | 5,174              |      |      | $ | 15,303  |      
|                                                                                          |                                                     |   |                    |      |      |   |         |      

See accompanying notes.

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APPLIED MOLECULAR EVOLUTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



|1. |  | Organization and Business
|-- |  | -------------------------

Applied Molecular Evolution, Inc. (the Company or AME), a Delaware
corporation, was incorporated on August 14, 1989. The Company has a broad
technology platform termed AMEsystem, which the Companys management
believes will provide AME with a valuable and efficient solution to
optimizing proteins with commercial potential. To date, the Company has
announced that it has successfully utilized its proprietary technology to
optimize proteins from all major classes of therapeutic proteins for
corporate collaborators and the Companys internal development projects.
AMEs majority owned subsidiary, Novasite Pharmaceuticals, Inc.
(Novasite), applies directed molecular evolution to small-molecule drug
discovery and optimization.



|2. |  | Basis of Presentation
|-- |  | ---------------------

The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all the
information and disclosures required by generally accepted accounting
principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. The
results of operations for the interim period are not necessarily
indicative of results to be expected for any other interim period or for
the year as a whole. These unaudited consolidated financial statements and
disclosures thereto should be read in conjunction with the audited
financial statements and disclosures thereto contained in the Companys
annual report on Form 10-K for the year ended December 31, 2002.

The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the consolidated financial
statements and related disclosures. Changes in the estimates may affect
amounts reported in future periods.

The consolidated financial statements include the accounts of the Company
and its majority owned subsidiaries, Novasite and AME Torrey View, LLC
(Torrey View). Novasite and Torrey View are 54% and 99% owned by AME,
respectively, as of March 31, 2003. All significant intercompany accounts
and transactions have been eliminated.



|3. |  | Commitments
|-- |  | -----------

On August 17, 2001, the Company entered into an Operating Agreement with
Torrey View Phase II, L.P., to establish Torrey View. On March 4, 2002,
Torrey View purchased a 10.73-acre parcel of undeveloped land in San Diego
County from a third party at a cost of approximately $8.0 million. The
Company may develop this property over the next few years as its corporate
headquarters. The Company could also seek alternative uses for the
property or sell the property if development would be inconsistent with
the Companys liquidity and cash resource needs.

In connection with the purchase, the Company borrowed approximately $10.0
million, under a $15.0 million credit facility, from Merrill
Lynch Business Financial Services to fund the purchase price and certain development costs, and as of
March 31, 2003, we had approximately $5.0 million available for future
financing needs under this credit facility. As of March 31, 2003, restricted cash of approximately $10.5 million
collateralized the outstanding loan balance. The Company also entered into
a $3.0 million loan and a development and management agreement with a
group, that is not affiliated with the Company, but that is affiliated
with the 1% owner of Torrey View, who may assist the Company with the
development of the project. The $3.0 million loan from the Company to the
group is collateralized by a perfected security interest in the 1% owners
membership rights in Torrey View and is due in 2004. Torrey View also
entered into an engagement letter and compensation agreement with a third
party to act as a broker and co-development manager, on behalf of Torrey
View, in connection with the purchase and development of the land.

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On July 25, 2002, a petition was filed in the Superior Court of the State
of California, County of San Diego, by the Torrey Hills Community
Coalition, et al. against the City of San Diego, et al. seeking to compel
the City of San Diego to revoke the approval which was previously issued
with respect to the development of our corporate headquarters. A petition
was also filed by the Del Mar Union School District on October 25, 2002,
seeking a similar legal remedy. These petitions assert that the City of
San Diego failed to comply with or violated various legal requirements in
connection with its approval of that development, but they do not seek
monetary relief from the Company. We understand that the City of San Diego
believes that it has complied with all legal requirements for this project
and therefore intends to vigorously oppose these petitions. The Company is
named as a real party in interest, and we also intend to vigorously oppose
these petitions and believe that they will not have a material adverse
effect on our business.



|4. |  | Comprehensive Loss
|-- |  | ------------------

Total comprehensive loss was $3,510,000 for the three months ended March
31, 2003, and $4,296,000 for the three months ended March 31, 2002. The
difference between net loss and comprehensive loss is primarily due to the
difference between the market value and the cost basis of the Companys
short-term marketable securities.



|5. |  | Computation of Net Loss Per Share
|-- |  | ---------------------------------

Basic and diluted net loss per share are presented in conformity with
Statement of Financial Accounting Standards No. 128, Earnings per Share
(SFAS No. 128). In accordance with SFAS No. 128, basic and diluted net
loss per share has been computed using the weighted average number of
shares of common stock outstanding during the period, less shares subject
to repurchase. To the extent common stock equivalents (stock options) are
dilutive, they would be included in diluted per share amounts.



|6. |  | Stock-based Compensation
|-- |  | ------------------------

The Company has in effect several stock-based plans under which
nonqualified and incentive stock options have been granted to employees,
consultants and directors. As required by SFAS No. 123, Accounting for
Stock-Based Compensationand SFAS No. 148, Accounting for Stock-Based
Compensation Transition and Disclosure,the proforma effects of
stock-based compensation on net income (loss) and net earnings (loss) per common
share are estimated at the date of grant using the Black-Scholes
option-pricing model. For purposes of pro forma disclosures, the
estimated fair value of the options is amortized to expense over the
options vesting period. The Companys pro forma net loss information is
as follows (in thousands, except per share amounts):

|                                                          |  |                            |        |             |  |   |        |  
|--------------------------------------------------------- |  | -------------------------- | ------ | ----------- |  | - | ------ | -
|                                                          |  | For the Three Months Ended
|                                                          |  | March 31,                 
|                                                          |  | 2003                       |        | 2002       
|                                                          |  |                            |        |            
|                                                          |  | (Unaudited)                |        | (Unaudited)
|                                                          |  |                            |        |            
|Net loss attributable to common stockholders, as
reported |  | $                          | (3,284 | )           |  | $ | (3,670 | )
|Net loss attributable to common stockholders, pro
forma   |  | $                          | (4,386 | )           |  | $ | (4,623 | )
|Basic and diluted net loss per share, as reported         |  | $                          | (0.16  | )           |  | $ | (0.17  | )
|Basic and diluted net loss per share, pro forma           |  | $                          | (0.21  | )           |  | $ | (0.21  | )



|7. |  | Novasite Financing
|-- |  | ------------------

In January 2003, the Companys subsidiary, Novasite, received $750,000 as
consideration for the issuance of 750,000 shares of preferred stock to
Crabtree Ventures, L.P. John F. Richards, one of our directors, is the
President of Crabtree Ventures, L.L.C., the general partner of Crabtree
Ventures, L.P., a minority investor in Novasite. In April 2003, Novasite
received $250,000 as consideration for the issuance of 250,000 shares of
preferred stock to Crabtree Ventures, L.P.

In January 2002, Novasite received $200,000 from a private placement of
10% convertible notes with AME and Crabtree Ventures, L.P. These notes,
which did not have a material beneficial conversion feature or include
warrants, were converted into preferred stock of Novasite in connection
with the financing which closed on September 30, 2002.

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In addition, in August 2002, Novasite received $350,000 from a private
placement of 10% convertible notes with Crabtree Ventures, L.P. The notes
plus accrued interest were converted at a discounted price into preferred
stock of Novasite in connection with the financing which closed on
September 30, 2002. Novasite recorded a debt discount of $477,000 related
to the beneficial conversion feature of the notes, and the full amount of
the debt discount was recorded as other financing charges as of September
30, 2002. In connection with the issuance of the August 2002 convertible
notes, Novasite issued warrants to purchase 350,000 shares of preferred
stock. The warrants are fully vested and expire in August 2006. Novasite
recorded a debt discount related to the warrants of $127,000 based upon a
Black-Scholes valuation, which was recorded as other financing charges as
of September 30, 2002, when the notes were converted. In addition to the
conversion of notes held by Crabtree Ventures, L.P. and AME and related
accrued interest as of September 30, 2002, which totaled $554,041,
Novasite received cash proceeds of $500,000 and issued 1,430,304 shares of
preferred stock. In November 2002, Novasite received an additional
$250,000 as consideration for the issuance of 250,000 shares of preferred
stock to Crabtree Ventures, L.P.




ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The statements in this quarterly report that are not descriptions of
historical facts may be forward-looking statements that are subject to
risks and uncertainties. Actual results could differ materially from those
currently anticipated due to a number of factors, including those
identified below and in our other publicly available documents. We are
under no obligation to update any of these forward-looking statements
after the filing of this quarterly report to reflect actual results or
changes in our expectations.

The following information should be read in conjunction with the
consolidated financial statements and the notes thereto included in Item 1
of this quarterly report. We also urge readers to review and consider our
disclosures describing various factors that affect our business, including
the disclosures under Managements Discussion and Analysis of Financial
Condition and Results of Operations and Risk Factors and the audited
financial statements and notes thereto contained in our annual report on
Form 10-K for the year ended December 31, 2002.

OVERVIEW

We are a leader in the application of directed molecular evolution to the
optimization and development of human biotherapeutics. Directed molecular
evolution is a process by which genes and proteins are optimized for
specific commercial purposes. Our technology has been validated by, among
other things, the ongoing clinical trials of Vitaxin, a humanized and
optimized therapeutic monoclonal antibody candidate, that AME licensed to
MedImmune, Inc. (MedImmune), the successful creation of Numax
candidates by optimizing Synagis® for MedImmune and the engineering of
product candidates AME-527 and AME-133, optimized versions of the
FDA-approved, currently marketed monoclonal antibodies Remicade® and
Rituxan®, respectively. We use our proprietary AMEsystem technology
to rapidly create improvements in proteins that would be less efficient
and more expensive to achieve through conventional methods. Since our
inception, our principal focus has been on applying our technology to
human biotherapeutics, the largest and most profitable target market for
directed molecular evolution. We plan to use our directed molecular
evolution technology to develop improved versions of FDA-approved,
currently marketed biopharmaceuticals as well as novel human
biotherapeutics. AMEs majority owned subsidiary, Novasite,
applies directed molecular evolution to small-molecule drug discovery and
optimization.

Since our formation, we have expended considerable resources on the
development of our AMEsystem technology and the development of
Vitaxin, a product candidate engineered from an antibody we licensed
from The Scripps Research Institute. Much of our research and development
from 1995 to 1999 was allocated to preclinical development and initial
clinical trials of Vitaxin. In 1999, we licensed Vitaxin to MedImmune,
Inc. (MedImmune), which is responsible for future clinical development
expenses and commercialization.

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

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Research funding from
corporate collaborators and government grants is recognized as revenue
when the services are rendered.

We have incurred losses since our inception. As of March 31, 2003, we had
an accumulated deficit of $74.9 million. The losses and this accumulated
deficit resulted from the significant costs incurred in the development of
our technology platform, our internal development projects and the
preclinical and clinical development of Vitaxin. We expect these losses to
increase as we continue to invest in our AMEsystem technology and internal
development projects.

On August 17, 2001, the Company entered into an Operating Agreement with
Torrey View Phase II, L.P., to establish AME Torrey View, LLC (Torrey
View), a 99% owned subsidiary of the Company, which is consolidated in
our financial statements. On March 4, 2002, Torrey View purchased a
10.73-acre parcel of undeveloped land in San Diego County from a third
party at a cost of approximately $8.0 million. The Company may develop
this property over the next few years as its corporate headquarters. The
Company could also seek alternative uses for the property or sell the
property if development would be inconsistent with the Companys liquidity
and cash resource needs.

In connection with the purchase, the Company borrowed approximately $10.0
million, under a $15.0 million credit facility, from Merrill Lynch
Business Financial Services to fund the purchase price and certain
development costs, and as of March 31, 2003, we had approximately $5.0
million available for future financing needs under this credit facility.
As of March 31, 2003, restricted cash of approximately $10.5 million
collateralized the outstanding loan balance. The Company also entered into
a $3.0 million loan and a development and management agreement with a
group, that is not affiliated with the Company, but that is affiliated
with the 1% owner of Torrey View, who may assist the Company with the
development of the project. The $3.0 million loan from the Company to the
group is collateralized by a perfected security interest in the 1% owners
membership rights in Torrey View and is due in 2004. Torrey View also
entered into an engagement letter and compensation agreement with a third
party to act as a broker and co-development manager, on behalf of Torrey
View, in connection with the purchase and development of the land.

On July 25, 2002, a petition was filed in the Superior Court of the State
of California, County of San Diego, by the Torrey Hills Community
Coalition, et al. against the City of San Diego, et al. seeking to compel
the City of San Diego to revoke the approval which was previously issued
with respect to the development of our corporate headquarters. A petition
was also filed by the Del Mar Union School District on October 25, 2002,
seeking a similar legal remedy. These petitions assert that the City of
San Diego failed to comply with or violated various legal requirements in
connection with its approval of that development, but they do not seek
monetary relief from the Company. We understand that the City of San Diego
believes that it has complied with all legal requirements for this project
and therefore intends to vigorously oppose these petitions. The Company is
named as a real party in interest, and we also intend to vigorously oppose
these petitions and believe that they will not have a material adverse
effect on our business.

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

On January 6, 2003, we announced a report and recommendation from the
magistrate judge in the United States District Court for the District of
Massachusetts to the district judge in our legal action against MorphoSys
AG and its wholly owned subsidiary MorphoSys USA, Inc. that MorphoSys
motion for summary judgment of non-infringement be allowed and that AMEs
motion for partial summary judgment of infringement be denied and all
other motions be dismissed as moot. We have filed objections to the
magistrate judges report and recommendation. The district judge may
adopt, reject or modify the magistrate judges recommendation or instruct
the magistrate judge to reconsider the recommendation.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of
operations are based upon the Companys consolidated financial statements,
which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues, expenses and
related disclosure of contingent assets and liabilities. On an ongoing
basis, we evaluate our estimates, including those related to revenue
recognition, patent costs and income taxes. We base our
estimates on historical experience and on various other assumptions that
are believed to be reasonable under the

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circumstances, the results of
which form the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions
or conditions.

We believe that the following critical accounting policies affect the
significant judgments and estimates used in the preparation of our
consolidated financial statements.

Revenue recognition

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

Patent costs

We capitalize the costs incurred to file patent applications. These costs
are amortized over a six-year estimated useful life from the date of patent issuance.
At March 31, 2003, capitalized costs related to issued patents totaled
approximately $467,000 (net of accumulated amortization) and approximately
$1.5 million related to unissued patents. Our results of operations could
be materially impacted when we begin amortizing the costs related to
unissued patents. In addition, we expense all costs related to abandoned
patent applications. If we elect to abandon any of our currently issued or
unissued patents, the related expense could be material to our results of
operations for the period of the abandonment.

Income taxes

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

RESULTS OF OPERATIONS

Three Months Ended March 31, 2003, Compared to Three Months Ended March 31, 2002

Revenues. Our revenues increased to $3.2 million for the quarter ended
March 31, 2003, from $2.6 million for the same period in 2002, an increase
of approximately $600,000. The increase was primarily due to contract
revenue recognized under our corporate collaborations.

Research and development. Research and development expenses increased to
$4.6 million for the quarter ended March 31, 2003, from $3.4 million for
the same period in 2002, an increase of approximately $1.2 million. The
increase was primarily due to increased scientific staffing and the
expansion of scientific activities in support of our internal development
projects and corporate collaborations.

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General and administrative. General and administrative expenses decreased
to $2.3 million for the quarter ended March 31, 2003, from $2.8 million
for the same period in 2002, a decrease of approximately $500,000. The
decrease was primarily due to the decrease in legal expenses incurred in
our litigation against MorphoSys.

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

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

For the three months ended March 31, 2003, we recorded non-cash,
stock-based compensation of $449,000 ($145,000 and $304,000 related to
research and development and general and administrative, respectively),
compared to approximately $1.0 million ($336,000 and $702,000 related to
research and development and general and administrative, respectively) for
the same period in 2002.

Interest income, net. Net interest income decreased to $585,000 for the
quarter ended March 31, 2003 from $924,000 for the same period in 2002, a
decrease of approximately $339,000. The decrease was primarily due to
lower interest rates and lower cash, cash equivalent and short-term
investment balances in 2003.

LIQUIDITY AND CAPITAL RESOURCES

In July 2000, we sold 5.3 million shares of Common Stock in an initial
public offering resulting in net proceeds to the Company of approximately
$94.5 million (excluding offering expenses). Prior to the initial public
offering, we had financed our operations primarily through private
placements of equity securities, with aggregate net proceeds of
approximately $39.9 million. In addition, we have generated $26.7 million
of cash from corporate collaborations through March 31, 2003.

As of March 31, 2003, we had approximately $47.7 million in unrestricted
cash, cash equivalents and short-term investments, compared to $51.1
million of unrestricted cash, cash equivalents and short-term investments
as of December 31, 2002. In addition, we had restricted cash of $10.5
million as of March 31, 2003 and March 31, 2002, which has been pledged as
collateral for the $10.0 million credit facility from Merrill Lynch.

For the three months ended March 31, 2003, we used cash of approximately
$3.4 million in operating activities, net of non-cash charges for
depreciation and patent amortization totaling $334,000 million, non-cash,
stock based compensation totaling $449,000, a decrease in deferred revenue
of $587,000 and changes in operating assets and liabilities of $198,000.

For the three months ended March 31, 2003, we generated cash of
approximately $1.4 million from investing activities. Our investing
activities consisted primarily of purchases and sales of short-term
investments and capital expenditures for property and equipment. We expect
to continue to make investments in our infrastructure, including
purchasing property and equipment to support our operations.

For the three months ended March 31, 2003, we generated cash of
approximately $827,000 from financing activities. Our financing activities
consisted primarily of an investment by a minority investor in our
subsidiary, Novasite.

We expect our cash requirements to increase in 2003 as we continue our
research and development efforts, hire additional personnel, and
accommodate our future facility needs. These facility needs include leased
space at our current facilities, and may include the development of the
property purchased by Torrey View, the Companys 99% owned subsidiary. The
Company may develop this property as its corporate headquarters over the
next few years, which could involve a substantial commitment. The Company
could also seek alternative uses for the property or sell the property if
development would be inconsistent with the Companys liquidity and cash
resource needs. We believe that our current cash, cash equivalents and short-term
investments and interest earned thereon, together with funding received
from collaborators and government grants will be

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sufficient to satisfy our anticipated cash needs for working capital and
capital expenditures for at least the next two years. However, it is
possible that we will seek additional financing within this timeframe. We
may raise additional funds through public or private financing,
collaborative relationships or other arrangements. We cannot guarantee
that additional funding, if sought, will be available on terms favorable
to us. Further, any additional equity financing may be dilutive to
stockholders, and debt financing, if available, may involve restrictive
covenants. Our failure to raise capital when needed may harm our business
and operating results.

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

On January 6, 2003, we announced a report and recommendation from the
magistrate judge in the United States District Court for the District of
Massachusetts to the district judge in our legal action against MorphoSys
AG and its wholly owned subsidiary MorphoSys USA, Inc. that MorphoSys
motion for summary judgment of non-infringement be allowed and that AMEs
motion for partial summary judgment of infringement be denied and all
other motions be dismissed as moot. We have filed objections to the
magistrate judges report and recommendation. The district judge may
adopt, reject or modify the magistrate judges recommendation or instruct
the magistrate judge to reconsider the recommendation.




RISK FACTORS

We have not achieved profitability and may never become profitable.

We are at an early stage of development. We incurred a net loss of $3.3
million for the three months ended March 31, 2003, and our revenue for the
same period was $3.2 million. Additionally, we have had net losses each
year since inception and as of March 31, 2003, had an accumulated deficit
of $74.9 million. We expect to report a net loss for fiscal year 2003, and
we expect to report increasing net losses for the foreseeable future. We
may never achieve profitability. The size of our net losses will depend,
in part, on the rate of growth, if any, in our contract revenue and on the
level of our expenses. To date, we have derived most of our revenue from
corporate collaborations and expect to continue to do so for the
foreseeable future. Revenue from corporate collaborations is uncertain
because our ability to secure future agreements will depend upon our
ability to address the needs of our potential collaborators. We expect to
spend significant amounts to fund research and development and enhance our
AMEsystem technology. We expect that our operating expenses will increase
significantly in the near term, and consequently, we will need to generate
significant additional revenue to achieve profitability. Even if we do
achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis.

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

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



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

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

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

While we have met with initial success in applying our AMEsystem
technology, to prove its commercial value, we or our collaborators will
need to commercialize biotherapeutic candidates that we have optimized.
Successful commercialization of biotherapeutic candidates requires:
preclinical testing, clinical trials, regulatory approval and commercial
manufacturing. It will take us or our collaborators many years to complete
these steps for any biotherapeutic candidate. If we or our collaborators
do not undertake and successfully complete these activities, then our
AMEsystem technology will be of little commercial value, and our ability
to generate revenue will be limited. Currently, there is one product
candidate, Vitaxin, in clinical trials that has been optimized using our
technology.

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

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

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

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

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

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

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

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

We also rely upon trade secrets, technical know-how, and continuing
inventions to develop and maintain our competitive position. Others may
independently develop substantially equivalent proprietary information and
techniques or otherwise

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gain access to our trade secrets or disclose our technology, and we may
not be able to meaningfully protect our trade secrets or be capable of
protecting our rights to our trade secrets.

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

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

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

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

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

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

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

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

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

We may be sued for product liability and other claims if our technology or
products developed from our technology are alleged to have caused harm. We
may not be able to avoid significant liability exposure. We maintain
product liability insurance, but we may not have sufficient coverage. If
we are sued for any injury caused by our product candidates and found

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liable, our financial condition, reputation and ability to find

collaborators may be harmed.

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

Future sales of our common stock by our stockholders under Rule 144 of the
Securities Act of 1933 (Securities Act), or through the exercise of
outstanding registration rights or otherwise could have an adverse effect
on the price of our common stock. Shares of our common stock which are not
held by our affiliates are eligible for sale in the public market in
reliance on Rule 144(k) or Rule 701 under the Securities Act without any
volume restrictions. Additionally, we registered a total of 7,622,625
shares of common stock reserved for issuance under our stock plans. Some
of our existing stockholders have rights to require us to register their
shares for future sale.

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

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

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

As of March 31, 2003, our officers and directors and their affiliates, in
the aggregate, owned beneficially approximately 27% of our outstanding
shares of common stock. As a result, these stockholders, acting together,
would be able to effectively control most matters requiring approval by
our stockholders, including the election of a majority of the directors.
If your interests as a stockholder are different from their interests as
both managers and stockholders, you may not agree with their decisions.




ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities
that we invest in may have market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment
to fluctuate. For example, if we hold a security that was issued with a
fixed interest rate at the then-prevailing rate, and the prevailing
interest rate later rises, the market value of our investment will
probably decline. To minimize this risk in the future, we intend to
maintain our portfolio of cash equivalents and short-term investments in a
variety of securities, including commercial paper, money market funds and
government and non-government debt securities. The average duration of all
of our investments as of March 31, 2003, was less than two years. Due to
the short-term nature of these investments, we believe that we have no
material exposure to interest rates arising from our investments. A
hypothetical 100 basis point adverse move in interest rates along the
entire interest rate yield curve would not materially affect the fair
value of our interest sensitive financial instruments. Declines in
interest rates over time will, however, reduce our investment income,
while increases in interest rates over time will increase our interest
expense.




ITEM 4: CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.

Within the 90-day period prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the
participation of the Companys management, including the Companys Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Companys disclosure controls and procedures
pursuant to Rule 13a-14 of the Securities Exchange Act of 1934 (Exchange
Act). Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Companys disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required
to be included in the Companys Exchange Act filings.

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Changes in Internal Controls.

There have been no significant changes in the Companys internal controls
or in other factors that could significantly affect internal controls
subsequent to the date the Company carried out its evaluation.




PART II: OTHER INFORMATION




ITEM 1: LEGAL PROCEEDINGS

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

On January 6, 2003, we announced a report and recommendation from the
magistrate judge in the United States District Court for the District of
Massachusetts to the district judge in our legal action against MorphoSys
AG and its wholly owned subsidiary MorphoSys USA, Inc. that MorphoSys
motion for summary judgment of non-infringement be allowed and that AMEs
motion for partial summary judgment of infringement be denied and all
other motions be dismissed as moot. We have filed objections to the
magistrate judges report and recommendation. The district judge may
adopt, reject or modify the magistrate judges recommendation or instruct
the magistrate judge to reconsider the recommendation.

On July 25, 2002, a petition was filed in the Superior Court of the State
of California, County of San Diego, by the Torrey Hills Community
Coalition, et al. against the City of San Diego, et al. seeking to compel
the City of San Diego to revoke the approval which was previously issued
with respect to the development of our corporate headquarters. A petition
was also filed by the Del Mar Union School District on October 25, 2002,
seeking a similar legal remedy. These petitions assert that the City of
San Diego failed to comply with or violated various legal requirements in
connection with its approval of that development, but they do not seek
monetary relief from the Company. We understand that the City of San

Diego believes that it has complied with all legal requirements for this
project and therefore intends to vigorously oppose these petitions. The
Company is named as a real party in interest, and we also intend to
vigorously oppose these petitions and believe that they will not have a
material adverse effect on our business.




ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS

(a)      Not applicable.

(b)      Not applicable.

(c)      Not applicable.

(d)      The effective date of our first registration statement, filed on Form
S-1 under the Securities Act of 1933 (No. 333-36830) relating to our
initial public offering of common stock, was July 26, 2000. A total of
5,347,500 shares of our common stock were sold at a price of $19.00 per
share to an underwriting syndicate led by CIBC World Markets, UBS
PaineWebber Incorporated, formerly known as PaineWebber Incorporated, and
SG Cowen. Of these 5,347,500 shares, 697,500 shares were issued upon
exercise of the underwriters over-allotment option. The offering
commenced on July 27, 2000, and closed on August 2, 2000. The initial
public offering resulted in gross proceeds of $101.6 million, $7.1 million
of which was applied toward the underwriting discount. Expenses related to
the offering totaled approximately $1.6 million. No direct or indirect
payments were made to any directors, officers, owners of ten percent or
more of any class of our equity securities or other affiliates of the
Company other than for reimbursement of expenses. Net proceeds to us,
after deducting these expenses, were approximately $92.9 million. We have
used approximately $10.9 million of the net offering proceeds for a
portion of the repurchase of approximately 3.1 million shares of our stock
for $21.7 million, $7.0 million for purchases of property and equipment
and approximately $22.6 million to fund our net losses. The balance of the
proceeds was applied towards the purchase of temporary investments
consisting of U.S. government agencies obligations, corporate bonds,
asset-backed securities and cash and cash equivalents.

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ITEM 3: DEFAULTS UPON SENIOR SECURITIES

Not applicable.




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

None.




ITEM 5: OTHER INFORMATION

None.




ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K



|(a) |  | Exhibits                                                                                                                                   
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | 99.1 Certification Pursuant to Section 1350 of Chapter 63 of 18
U.S.C. as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
|   
|    |  | 99.2 Certification Pursuant to Section 1350 of Chapter 63 of 18
U.S.C. as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002

None



|(b) |  | Reports on Form 8-K during the first quarter
|--- |  | --------------------------------------------

None

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##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.

|                  |  |     |  |                                                             
|----------------- |  | --- |  | ------------------------------------------------------------
|Date: May 6, 2003 |  | By: |  | /s/ William D. Huse, M.D., Ph.D.                            
|                  |  |     |  |                                                             
|                  |  |     |  | William D. Huse, M.D., Ph.D.                                
|                  |  |     |  | President, Chief Executive Officer and Chairman of the Board
|                  |  |     |  |                                                             
|Date: May 6, 2003 |  | By: |  | /s/ Lawrence E. Bloch, M.D., J.D.                           
|                  |  |     |  |                                                             
|                  |  |     |  | Lawrence E. Bloch, M.D., J.D.                               
|                  |  |     |  | Chief Financial Officer and Secretary                       

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##### Table of Contents






CERTIFICATIONS

I, William D. Huse, M.D., Ph.D., certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Applied Molecular
Evolution, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;

b) evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5.     The registrants other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal
controls; and

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.

|                  |                                                              |     |  |                                 
|----------------- | ------------------------------------------------------------ | --- |  | --------------------------------
|Date: May 6, 2003 |                                                              | By: |  | /s/ William D. Huse, M.D., Ph.D.
|                  |                                                              |     |  |                                 
|                  |                                                              |     |  | William D. Huse, M.D., Ph.D.    
|                  | President, Chief Executive Officer and Chairman of the Board

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##### Table of Contents



I, Lawrence E. Bloch, M.D., J.D., certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Applied Molecular
Evolution, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact

necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;

b) evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5.     The registrants other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal
controls; and

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.

|                 |  |     |  |                                      
|---------------- |  | --- |  | -------------------------------------
|Date May 6, 2003 |  | By: |  | /s/ Lawrence E. Bloch, M.D., J.D.    
|                 |  |     |  |                                      
|                 |  |     |  | Lawrence E. Bloch, M.D., J.D.        
|                 |  |     |  | Chief Financial Officer and Secretary

20