SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB


              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                  For the fiscal year ended September 30, 2000

                         Commission File Number: 1-14559
                         -------------------------------

                             MUSE TECHNOLOGIES, INC.
                             -----------------------
             (Exact name of registrant as specified in its charter)


                    Delaware                             85-0437001
       (State or other jurisdiction of                (I.R.S. Employer
        incorporation or organization)              Identification Number)

   300 Fifth Avenue, Waltham, Massachusetts                 02154
   (Address of principal executive offices)               (Zip Code)


                    Issuer's telephone number: (781) 890-4300

          SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT:

                                  Common Stock
                                  ------------
                                (Title of Class)

                Class A Redeemable Common Stock Purchase Warrants
                -------------------------------------------------
                                (Title of Class)

          SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT:

                                  Common Stock
                                  ------------
                                (Title of Class)

                Class A Redeemable Common Stock Purchase Warrants
                -------------------------------------------------
                                (Title of Class)




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Check whether the issuer (1) 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 [ ]       No  [X]

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained is this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. Yes [ ]  No [X]

State issuer's revenues for its most recent fiscal year: $6,069,592

As of January 26, 2001, there were outstanding 12,866,808 shares of common
stock, $.015 par value (the "Common Stock"), and Class A Redeemable Common Stock
Purchase Warrants (the "Warrants") to purchase 2,705,954 shares of Common Stock.
Based on the closing prices of the Common Stock and the Warrants on that date,
$0.9688 and $0.13, respectively, the approximate aggregate market value of the
Common Stock and the Warrants held by non-affiliates was $9,408,900 and
$221,774, respectively.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's 2001 Definitive Proxy Statement, which statement
will be filed not later than 120 days after the end of the fiscal year covered
by this Report, are incorporated by reference in Part III hereof.

Certain exhibits are incorporated by reference to certain of the Registrant's
registration statements and the amendments thereto and certain of the
Registrant's periodic reports, as listed in response to Item 13(a)(2).

Transitional Small Business Disclosure Format (check one):

         Yes [ ]      No [X]


              [The remainder of this page is intentionally blank.]


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This Report contains certain forward-looking statements and information relating
to the Company that are based on the beliefs of management as well as
assumptions made by, and information currently available to, the Company. When
used in this Report, the words "anticipate," "believe," "estimate," "expect,"
"will," "could," "may" and similar expressions, are intended to identify
forward-looking statements, but the absence of any such words does not mean that
the statement is not forward-looking. Such statements reflect the current views
of management with respect to future events and are subject to certain risks,
uncertainties and assumptions, including those described under "Factors
Affecting Operating Results and Market Price of Stock" and elsewhere in this
Report. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results may vary
materially from those described herein. In addition to the other information in
this Report, the above factors should be carefully considered in evaluating the
Company and its business.

ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL

         MUSE Technologies, Inc. has recently determined to conduct business
under the name Advanced Visual Systems. Together with our subsidiaries, we
develop and market data visualization software products that are designed to
enhance a computer user's ability to integrate, present, analyze and better
understand many different types of data. We also provide our customers with
comprehensive software solutions, systems integration, and training and support
services using data visualization and other methods of advanced computer
graphics.

         Data visualization is the process of displaying conventional numeric
and text-based data in the form of 2D or 3D colors and shapes. By presenting
data in a graphical form, many computer users find it easier to digest large
quantities of data and reach meaningful conclusions about the data faster and
more efficiently. Perceptual computing extends the principles of data
visualization by engaging multiple senses and cognitive skills of a computer
user at the same time (such as sight, sound and touch) to create a sensory-rich
computer-based "environment" in which the user can perceive the data in a highly
intuitive manner. For purposes of this report, the words "data visualization"
are intended to include perceptual computing.

         We develop and market several data visualization software products as
well as provide a wide range of professional services to our customers, who are
commonly engineers, scientists, analysts, researchers, government personnel and
general business users. The services we provide include the creation of
customized software products based upon our proprietary software (and sometimes
that of other companies), as well as selling (on a limited basis) computer
hardware to use with our software and custom solutions. We also provide
training, technical support and integration services to our customers.

         Our Company was incorporated in Delaware on October 24, 1995 and
commenced conducting business under the name Advanced Visual Systems on January
1, 2001. Our executive offices are now located at 300 Fifth Avenue, Third Floor,
Waltham, MA 02154. Our telephone number is (781) 890-4300.

RECENT DEVELOPMENTS

         On November 16, 1999, we acquired all of the outstanding stock of
Virtual Presence, Ltd., a 10-year-old U.K. company that creates sophisticated 3D
graphics solutions using proprietary and third party software and hardware.
Virtual Presence (also know as MUSE Virtual Presence) is a wholly-owned
subsidiary that operates offices in London and Manchester, U.K., and is the
majority shareholder of


<PAGE>

SimTeam SARL, a French company that provides products and services similar to
those of MUSE Virtual Presence in France.

         On March 17, 2000, through MUSE Virtual Presence, we acquired all of
the outstanding stock of Simulation Solutions, Ltd., a U.K. company involved in
providing advanced solutions to the manufacturing industry using proprietary and
third-party software and hardware. Simulation Solutions (also known as MUSE
Simulation Solutions) operates from the Manchester, U.K. offices of MUSE Virtual
Presence.

         On March 28, 2000, through MUSE Virtual Presence, we completed an asset
acquisiton of theVRsource.com (also known as MUSE VRsource), an e-commerce Web
site that is a reseller of our hardware and software and that of other companies
that are used in advanced computer graphics, virtual reality and data
visualization.

         On June 1, 2000, we entered into an equity line agreement with
Kingsbridge Capital Limited, which entitles us to sell and obligates Kingsbridge
to purchase, from time to time, up to $18,000,000 of our common stock. Our
ability to require Kingsbridge to purchase our common stock is subject to
certain limitations based on the market price and trading volume of our common
stock. Pursuant to the terms of the equity line agreement, we also issued to
Kingsbridge warrants to purchase 200,000 shares of MUSE common which are
exercisable at $3.76 per share through November 27, 2004. Additionally, on
August 7, 2000, we sold to Kingsbridge a convertible note in the principal
amount of $1,000,000 with interest at the annual rate of 10%. The note is
convertible into shares of our common stock after August 7, 2001 at the per
share rate of the lower of $2.375 or 88% of the average closing bid price for
the five trading days prior to conversion. In connection with the sale of the
convertible note, we also issued to Kingsbridge warrants to purchase 75,000
shares of our common stock which is exercisable at $2.6125 per share over the
four year period commencing on August 7, 2001.

         On November 9, 2000 we completed the acquisition of Advanced Visual
Systems Inc. (AVS) through a merger, and AVS became a wholly-owned subsidiary of
MUSE Technologies, Inc. AVS is an internationally recognized provider of data
visualization software and solutions that markets its products and services
through a direct sales force in North America and Europe and through indirect
channels such as distributors and independent software vendors worldwide. Kubota
Corporation, a Japanese company, has distribution rights in Japan to AVS
products through its KGT subsidiary. As a result of the merger, the stockholders
of AVS received an aggregate of 1,929,579 shares of our common stock in exchange
for all outstanding shares of AVS capital stock.

         On December 12, 2000 we appointed BlueStone Capital Partners, L.P. as
our financial and investment banking advisors. Under the terms of a
non-exclusive agreement, Bluestone is to be paid a one-time retainer of $50,000
in addition to monthly fees, plus a commission at the closing of the sale of
securities, if any, to certain institutional, accredited individual or strategic
investors.

         On December 26, 2000 we entered into an agreement with Prevail With
Vision, Inc. (PVW) to assist us in identifying between $3,500,000 and
$10,000,000 in loan or credit facilities. Under the terms of this agreement, PVW
was paid a retainer fee of $25,000 and will receive a 6% placement fee on any
funds raised by PVW.

         On January 1, 2001 we transferred our interest in two products (MIST
and VIST) and one customer contract of MUSE Virtual Presence to Mentice AB, a
Swedish company. Under the terms of our agreement with Mentice, we are entitled
to purchase shares representing 5% of the company that develops and markets the
former MUSE Virtual Presence products transferred to Mentice. We will also be
entitled to a 20% royalty in 2001 and a 10% royalty in 2002 of the profits
derived from the MIST


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product, and a 5% royalty in 2001 and 2002 of all profits derived from the VIST
product and our former contract with Guidant Corporation.

         On January 2, 2001, we retained The Wall Street Group, Inc. as
financial relations advisors. Under the terms of an agreement, The Wall Street
Group will receive $7,000 per month in consulting fees and warrants to purchase
100,000 shares of our common stock at a price of $0.52 per share. The agreement
is for a term of one year and can be cancelled by either party upon 90 days
written notice, at which time The Wall Street Group will forfeit a prorated
portion of the warrants.

         On January 22, 2001, we received a letter from the Nasdaq Stock Market
indicating that, as a result of the failure to timely file our annual report,
our common stock would be delisted from the Nasdaq Stock Market as of January
30, 2001 unless our annual report was field by January 29, 2001. We have
complied with this request and are confident that no such delisting shall occur.

ORGANIZATION

Since the acquisition of AVS, we are organized into two operating groups:

     o    Data visualization software and services. The "Data Visualization
          Group" creates and sells software products directly to customers
          through an international sales force and through value added resellers
          (VARs) and independent software vendors (ISVs). In addition, the Data
          Visualization Group provides training, support and professional
          services to our customers to facilitate their use of our software. The
          Data Visualization Group encompasses the operations of MUSE
          Technologies, Inc., AVS and MUSE Federal Systems Group, Inc., and
          employs approximately 99 full-time personnel from offices in Waltham,
          MA; Albuquerque, NM; San Jose, CA; Huntington Beach, CA; Arlington,
          VA, Herndon, VA; Surrey, UK; Paris, France; Milan, Italy; Holte,
          Denmark; and Frankfurt, Germany.

     o    Advanced visualization solutions. The "Advanced Visualization Group"
          provides highly customized software-based solutions; systems
          integration, training and consulting services; and computer hardware
          and accessories to a predominately European customer base. The
          solutions created by the Advanced Visualization group do not commonly
          integrate software products from our Data Visualization Group, as the
          solutions tend to solve computer graphics-related challenges that are
          in specialized fields that exist in the periphery of the general data
          visualization marketplace. The Advanced Visualization group
          encompasses the operations of MUSE Virtual Presence, MUSE Simulation
          Solutions, MUSE VRsource and SimTeam, and employs 40 full-time
          personnel from offices in London, UK; Manchester, UK and Paris,
          France.

PRODUCTS AND SERVICES

     Our Data Visualization group has developed and is currently marketing the
following products and services:

     o    OpenViz(R)is a software development product that enables any type of
          business data to be expressed in highly interactive 2D and 3D
          presentations that can be easily distributed via the Web, embedded in
          popular office suite documents or built into powerful runtime
          applications. Using OpenViz, large volumes of business information (in
          multiple formats and from different sources) can be delivered on
          demand to any Windows, Unix, Linux or Apple computer. A client-side
          plug-in architecture enables fully interactive, lightweight ActiveX
          controls and Java applets to bring interactivity and dynamic graphics
          to all types of business information. Data from non-Web enabled
          business and financial applications can be viewed in a standard Web
          browser with


<PAGE>

          OpenViz, which enables corporate MIS departments and software vendors
          developing content delivery solutions to integrate advanced
          visualization graphics into customized software applications. OpenViz
          was developed by AVS over a two-year period and is based upon many
          years of experience dealing with computer graphics and data
          visualization challenges in the complex scientific and engineering
          industries. We believe that OpenViz has a superior architecture and
          greater functionality than any other data visualization product
          serving the general business and financial industries, and that it's
          embrace of multiple platforms and standards, ability to embrace any
          data format, Web-centric design and robust graphics capabilities will
          enable OpenViz to attain broad acceptance in the large and potentially
          lucrative "business desktop" marketplace.

     o    VizWorks(TM)is an entry-level data visualization product that is based
          upon the OpenViz architecture. Where OpenViz is designed to be
          utilized by ISV's, sophisticated application developers and our own
          professional services personnel to create custom data visualization
          applications, VizWorks is designed to be used by low-level programmers
          and corporate MIS departments to create highly interactive charts and
          graphs and publish them on the Web in a matter hours. VizWorks
          consists of pre-packaged 2D and 3D "scenes" that are customizable
          charts and graphs that are ready to be deployed with a minimum of
          programming experience. VizWorks scenes are sold in "collections" that
          are designed to serve the particular needs of a specific business or
          vertical market sector. The first collection (which was released in
          November 2000) was VizWorks Charts and is designed for basic business
          charting and graphing. VizWorks collections sell for approximately
          $300 per user or can be licensed for server-based deployment starting
          at $1,500 per server. VizWorks scenes are fully scalable to the
          OpenViz development platform, where they can be enhanced or adapted to
          more sophisticated applications. Upon migration to the OpenViz
          platform, OpenViz pricing prevails for software and licensing.
          Management believes that VizWorks will attract a large number of
          business and financial users searching for a low-cost, entry-level
          approach to data visualization. We also believe that many of these
          users will choose to broadly deploy their VizWorks applications and
          eventually adopt OpenViz to serve their advanced visualization and
          content delivery requirements.

     o    MuSE(R)(Multi-dimensional user oriented Synthetic Environment) is a
          software development toolkit that is used by skilled computer
          programmers to create software applications for end-users that can be
          installed on different computing platforms (Windows and UNIX) and take
          advantage of different physical or logical input and output devices
          (keyboards, mice, voice recognition, speech synthesis, etc.). MuSE was
          first developed at Sandia National Laboratories in 1991 and licensed
          to us in 1995. Since being licensed to us, we have made numerous
          enhancements to the MUSE software and added extensive capabilities and
          functionalities beyond those of the core software licensed from Sandia
          Corporation (see page "The MuSE License Agreement"). Multiple users
          can employ MuSE to share the same MuSE-based software application and
          collaborate from remote locations over computer networks. We believe
          MUSE represents a new approach to computer interaction by facilitating
          the integration of diverse types of data into a single presentation
          environment and by presenting this data using sight, sound and other
          methods of representation in a manner that enhances an end-user's
          ability to analyze and understand this data. This process is known as
          "perceptual computing" because it engages multiple senses and
          leverages the perceptual skills of computer users.

     o    AVS/Express(TM)is offered in a Developer Edition and Visualization
          Edition. The Developer Edition is a multi-platform (Windows, Unix,
          Linux), component-based software environment for visualizing complex
          data and for building applications with interactive visualization and
          graphics functions. Users of the Developer Edition have access to a
          wealth of fine-grain visual programming objects that provide a
          complete development environment. Extremely advanced


<PAGE>

          features of the Developer Edition permit software developer to
          reconfigure any aspect of the system and build powerful applications
          that can be licensed for distribution. The Visualization Edition of
          AVS/Express offers end users (such as scientists, researchers, and
          other technical professionals) an advanced and comprehensive suite of
          data visualization and analysis capabilities. It provides end users
          with state-of-the-art technology for advanced graphics, imaging, data
          visualization, and presentation. The Visualization Edition's visual
          programming environment makes it easy for users to quickly and
          interactively visualize their data.

     o    AVS5(TM)is AVS' original visual programming and data visualization
          product. AVS5 consists of a comprehensive suite of data visualization
          and analysis techniques that incorporate both traditional
          visualization tools such as 2D plots and graphs and image processing,
          as well as advanced tools for 3D interactive rendering and volume
          visualization. AVS5 provides intuitive, easy-to-learn interfaces to
          the most frequently used visualization techniques. These interfaces,
          or "viewers", help users explore their data immediately--even before
          building a customized application. For the developer who builds custom
          applications, AVS5 provides a visual programming environment that is
          designed to accelerate the process of progressing from a prototype
          application to a tuned, deliverable application. AVS5 currently
          operates on all of the major UNIX workstations and supports the full
          range of graphics hardware available on these platforms.

     o    Gsharp(TM)is a Windows and Unix-based software product that generates
          technical charts and graphs. It enables analysts, researchers and
          other computer users to choose from a large gallery of 2D and 3D
          graphs and select standard layouts or create custom graphs by
          combining, overlaying, or projecting any graph type. Only a minimum
          amount of information and experience is required for graph creation.
          Toolbars, custom features, popup "wizards" and other aids make it
          relatively simple to create sophisticated graphs and then select,
          view, and modify any graph attribute. A built-in data manager module
          makes it easy to read data from a vast selection of file formats and
          sources, including SQL databases. Gsharp produces high-resolution
          printed output and permits charts and graphs to be easily published
          over the Internet.

     o    Toolmaster(TM)is a comprehensive graphics library for programmers that
          is used to create 2D and 3D charts and graphs and presentation-quality
          hardcopy output on the UNIX, OpenVMS and Windows platforms. Toolmaster
          supports a wide range of data formats and chart types, permitting
          software developers with no previous X or Windows programming
          experience to quickly add sophisticated graphics to their
          applications. Toolmaster can be integrated with Motif and Windows
          graphical user interface builders, enabling a reduction in application
          development time. Toolmaster provides precise control over chart
          layout and appearance with a comprehensive set of graph and attribute
          setting functions that satisfy even the most demanding layout
          requirements.

     o    Professional services represent a significant portion of revenue for
          the Data Visualization Group. Many of our customers request and pay
          for our computer programmers to utilize our software products to
          create a computer program or complete software solution that is
          entirely unique to a very particular problem that the customer is
          attempting to solve. Despite the fact that many of our customers have
          skilled programmers on their staff, they often turn to us for
          extremely advanced application development projects. Custom
          applications can be produced for use by a single user at the client
          company, or, when used by multiple users, can sometimes produce
          additional royalty or licensing revenue. Often, these custom
          applications (or portions thereof) can be reutilized in other custom
          applications for future customers, or added to our software as new
          features or capabilities.

Our Advanced Visualization group has developed the following technologies and
provides the following services, products and technologies:


<PAGE>

     o    Customized application development and related professional services
          represent a significant portion of revenue for the Advanced
          Visualization group and is a particular strength of that segment of
          our business. A majority of the software projects for which the
          Advanced Visualization group is engaged involves the creation of a
          very specific and customized product for the client. Custom
          applications are most commonly produced for use by a single user or
          small group of users at the client company, however sometimes can be
          created for large groups of users. Often, these custom applications
          (or portions thereof) can be reutilized in other custom applications
          for future customers.

     o    Synthetic training systems are PC-based simulators that permit
          students to experience a computerized re-creation of complex
          equipment, facilities or systems (such as jet fighter cockpits or
          nuclear power plant control rooms), and to interact with the features
          and complexities of these systems in a lifelike manner. The advantage
          of synthetic training systems is that they can be far less costly than
          traditional simulators or physical mockups, have been demonstrated to
          be far more effective in terms of training speed and efficiency than
          traditional systems, and minimize the requirement for
          high-demand/high-cost equipment (such as actual aircraft) to be
          removed from service for training purposes. The Advanced Visualization
          group has developed an advanced synthetic trainer for the Royal Air
          Force that now serves as the validation and successful model for
          similar systems to be sold into the military, industrial and
          commercial markets. Synthetic training systems can range from $150,000
          to over $1 million each, which may include the cost of hardware to
          operate the system. Annual maintenance and support are additional
          costs.

     o    Advanced graphics and virtual reality hardware includes highly
          advanced Unix computers; personal computers of varying sophistication;
          computer display screens and projection systems; peripheral devices
          such as joysticks, head tracking devices, haptic feedback units,
          stereoscopic glasses; or any other piece of hardware that a customer
          might desire or require to take advantage of our software or services,
          or those provided by other companies. We offer these products to our
          customers because in many cases they are an integral part of advanced
          3D graphics. None of the hardware products offered to our customers
          are manufactured directly by us, and we do not inventory any products.
          Upon receipt of a signed purchase order from a customer we place an
          order with a third party manufacturer and collect payment from the
          customer upon delivery and/or installation of the part. We represent
          approximately 50 manufacturers and offer approximately 200 different
          products. Only the Advanced Visualization group of our company offers
          these hardware products and accessories.

     o    Visualization facilities are rooms or theaters that are specifically
          designed to present information using data visualization software and
          hardware to groups of decision makers. Advanced computers and
          projection systems can be used to produce extremely high resolution
          images with clarity and real time performance that are ideal for
          digital prototype presentation, high resolution mapping, command and
          control of processes and corporate planning and briefing applications.
          Visualization facilities have gained acceptance in the manufacturing,
          digital prototyping, engineering, process plant design and oil/gas
          exploration & production industries. Because of our expertise in the
          field of data visualization and advanced graphics, we have begun
          specifying hardware and software to be utilized in these industries
          that have embraced large-scale data visualization. None of the
          hardware products offered to our customers are manufactured directly
          by us, and we do not inventory any products. Upon receipt of a signed
          purchase order from a customer we place an order with a third party
          manufacturer and collect payment from the customer upon delivery
          and/or installation of the part. We represent approximately 5
          manufacturers of large-scale visualization facilities and offer
          approximately 35 different


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          equipment. The Advanced Visualization group are the sole resellers of
          visualization facilities, however other operating units can refer
          interested customers to the primary reselling units.

     o    Systems integration, systems maintenance and support services are
          provided by the Advanced Visualization group to customers with varying
          types advanced graphics hardware and software systems. Many customers
          require technical assistance in configuring, installing and
          maintaining advanced equipment, as well as training on new systems and
          performing routine service on sophisticated hardware.

INDUSTRY OVERVIEW

     Our software products and consulting services have been oriented towards
meeting the needs of the multiple sectors of the industrial, scientific,
research and general business and financial industries. Each of these market
sectors has been affected by several trends that have influenced our strategy
and direction:

     o    Corporations, government agencies and individual computer users are
          dealing with increasingly larger and more complex quantities of
          information, most of which is in the form of computer-based data.
          Making sense of this information is becoming more and more difficult,
          and the disparity of data formats commonly prevents such information
          from being integrated into a single computing environment in which a
          user can observe, analyze, and interact with the information.

     o    Advances in multiprocessing chip technology and enhanced graphics card
          capabilities have empowered Windows platform computers and
          workstations to match the performance of several UNIX class machines,
          which until recently had been the standard of sophisticated computing
          tasks in many industries. The decreasing cost of Windows hardware and
          the large number of installed Windows operating systems has created a
          large and growing population of computer users who are capable of
          taking advantage of new software technologies.

     o    Wide adoption of the Internet in nearly every business sector has
          afforded new possibilities and demands for remote collaboration,
          content delivery, data presentation and remote data access.

     o    Advances in 3D graphics software and technology have created a
          paradigm of "visual computing" in several industries, most notable of
          which are the design, engineering, manufacturing and military sectors.
          Visual computing is used to create and manipulate true-color,
          three-dimensional objects representing complex data with extreme
          precision and speed, thereby enhancing understanding. In visual
          computing, a three-dimensional full color image replaces the
          two-dimensional screen image. The use of visually rich images makes it
          possible to represent complex data more understandably as well as to
          simulate real-world characteristics.

     We believe that these trends have created a unique and significant
opportunity and that data visualization-related software and professional
services will continue to grow in demand from both established and emerging
markets. As these markets expand, customers will likely turn to companies such
as ours, which have proven experience with software, solutions, hardware,
installation, support, maintenance and training.

STRATEGY

         Our company is generally focused on providing customers with data
visualization and advanced computer graphics solutions in the form of:


<PAGE>

     o    Data visualization software products that our customers can use to
          create software solutions on their own;
     o    Turn-key data visualization and advanced computer graphics solutions
          that help a customer solve a particular problem;
     o    Training and support for our software products and solutions;
     o    Computing hardware and accessories that are used in data visualization
          and advanced computer graphics; and
     o    Professional installation, maintenance, training and support services.

         We believe that our ability to provide such a sweeping range of
products and services to multiple international market segments is a distinct
advantage over companies that provide only limited aspects of our capabilities.
As the market for our products and services grows, we believe that we will be
poised to capture a significant share of such market and establish an
international brand reflecting our position as a leader in data visualization
and advanced computer graphics software and solutions.

         From the beginning of our 1999 fiscal year until the second quarter of
our 2000 fiscal year, the primary sales strategy for MUSE Technologies and MUSE
Federal Systems Group was to distribute its software products and services
through a network of resellers that had extensive vertical market expertise.
Because the MuSE software product is intended to serve the unique needs of many
different industries, MUSE management believed that it would be more efficient
to identify resellers, distributors, service providers and other experts in a
select few industries to sell MuSE software to their existing and potential
customers. That distribution strategy, known as the Strategic Reselling Partner
(SRP) program, has produced lower than expected results to date and management
concluded in early fiscal 2000 that establishing a direct sales relationship
with potential customers will shorten the sales cycle and ensure that MuSE
software is effectively introduced into our target markets. The wholly-owned
subsidiaries of our Advanced Visualization group historically sold products only
using their own direct sales force, without any dependence on resellers or third
party representatives.

         AVS also has relied primarily on a direct sales force to sell its
products and services, although it has entered into several Independent Software
Vendor (ISV) relationships in which third-party companies embed AVS technology
in their software products.

         Our current strategy is to focus primarily on direct sales by our own
sales staff to customers and ISVs and to develop ISV relationships in which our
data visualization software products are utilized and/or embedded in third-party
products, thereby producing ongoing licensing revenue.

         In addition, we have elected to place extremely limited emphasis on the
sale of professional services to agencies of the US federal government, after
concluding that our resources would be better applied to higher profit margin
customer relationships in the commercial sectors of business and industry.
Despite the fact that MUSE Technologies has historically conducted a substantial
portion of its business with US federal agencies, management has determined that
such activities were not as profitable as expected, however, they did produce
extensive validation of the MuSE software product as well as valuable insight as
to how to best exploit that technology. Accordingly, we have reduced the size of
our MUSE Federal Systems Group subsidiary and may transfer any future government
sales activity to our other Data Visualization group subsidiaries. We plan on
continuing to sell our data visualization software toolkits and related licensed
products to federal agencies on a direct basis as well as through reseller and
ISV channels, and may selectively offer professional services to federal
agencies and contractors. Certain subsidiaries of the Advanced Visualization
group will continue to sell professional services to European government
agencies and bodies.


<PAGE>

         We have also eliminated the sale of medical training hardware and
related software products from our Advanced Visualization group. On January 1,
2001 we transferred our interest in two products and one customer contract of
MUSE Virtual Presence to Mentice AB, a Swedish company. Under the terms of our
agreement with Mentice, we are entitled to purchase shares representing 5% of
the company that develops and markets the former MUSE Virtual Presence products;
and we will receive a 20% royalty in 2001 and a 10% royalty in 2002 of the
profits derived from the MIST product, and a 5% royalty in 2001 and 2002 of all
profits derived from the VIST product and our former contract with Guidant
Corporation. We believe that this action will permit us to focus on core
competencies and more developed market opportunities and eliminate a substantial
investment that would be required to continue developing these products.

         Each of our operating groups is focused on generating revenue from
well-defined vertical and horizontal industry sectors. The primary markets we
are either currently or plan to serve include:

     o    Data Visualization group: Business intelligence, data mining, decision
          support, education/Research, engineering, entertainment,
          manufacturing, ISV, oil & gas, scientific telecommunications,
          transportation and utilities;

     o    Advanced Visualization group: Education/research, engineering,
          entertainment, government, manufacturing, telecommunications,
          synthetic training, transportation, and large-scale visualization
          facilities.

         We believe that these industries and our product/service offerings
provide the greatest opportunity for revenue generation and growth potential.
The majority of our targeted industries have already embraced various aspects of
data visualization or advanced computer graphics or are exhibiting strong trends
of adoption. We anticipate expanding into additional markets as opportunity and
financial resources permit.

         Our current plan is for the Data Visualization group to sell its
software and services in the U.S. and internationally and for the Advanced
Visualization group to conduct its sales activities primarily in Europe.

SALES AND MARKETING

         Our current sales and marketing staff consists of 29 full-time
employees; 11 salespersons serving the Data Visualization group; 7 salespersons
serving the Advanced Visualization group; and 10 marketing personnel who provide
marketing, public relations, graphic and Web design activities to both operating
units. Our sales and marketing operations are overseen by a Senior Vice
President, Vice President of International Operations and Vice President of
Professional Services. In addition, we have a Vice President of Business
Development and most of our top executives participate in sales activities with
major corporate and ISV accounts.

         We are presently in the process of interviewing additional sales and
marketing personnel and, subject to sufficient financial resources, plan on
expanding our sales and marketing force in calendar 2001.

         The different operating groups and subsidiaries of our company have
marketed our products and services using multiple tactics that best serve our
targeted industries. In general, we have relied on the following channels of
promotion:


<PAGE>

     o    Strategic media relations. We promote our products by obtaining
          product articles, customer testimonials and success stories in
          targeted trade and business publications. This practice has produced
          international visibility for our products and has served as a
          cost-effective means of promotion.

     o    Attending trade shows and professional conferences. We participate
          numerous market-specific trade shows at which large groups of
          potential customers congregate to see the latest developments in their
          industry. Trade shows permit us to demonstrate our software and
          services and directly meet with potential customers to discuss their
          needs. The cost of trade shows is extremely expensive, however, and we
          attempt to mitigate the cost of selected shows by appearing in the
          exhibition booth of promotional partners to reduce the size and cost
          of our participation.

     o    Solicitation of potential customers by direct phone and mail contact.
          We generate a substantial amount of repeat business with customers
          through a direct phone marketing program, and also identify potential
          new customers through this process, which is extremely cost-effective.
          We also send product brochures and promotional pieces via targeted
          postal mail and customer response, the cost of which can be
          considerable.

     o    Joint promotions with strategic partners. We routinely engage in
          non-exclusive joint promotions with hardware and software companies
          whose products we use, advocate the use of, or sell through our
          Advanced Visualization group. Joint promotions can take the shape of
          trade shows, customer visits, printed brochures and/or Web-based
          promotions.

     o    Print and online advertising. Historically, we have conducted very
          little advertising due to its high cost. Subject to sufficient
          financial resources and budget allocations, however, we plan on
          advertising selected products and services in targeted print
          publications and at targeted Internet sites.

CUSTOMERS

         Including our recently acquired AVS subsidiary, we have provided our
software and services to approximately 2,500 international customers, the bulk
of which come from AVS. Approximately 12,000 user licenses have been issued for
AVS software products. Generally, our customers are large or mid-sized
corporations with complex problems that they wish to better understand or solve,
and software vendors who use our technology to add visualization capabilities to
their own products.

         A partial list of customers of the Data Visualization Group includes:
Agilent; Arthur Andersen; Blue Martini Software; British Petroleum; Computer
Associates; Con Edison; General Electric; Deutsche Telekom; Geoquest; Goodyear
Tire & Rubber; JP Morgan; Los Alamos National Laboratory; Motorola; NASA
(multiple facilities and programs); Sagetree; Sandia National Laboratories;
Schlumberger; U.S. Air Force; U.S. Department of Transportation; U.S. Joint
Chiefs of Staff; U.S. Navy (multiple facilities and programs); and Vodafone,

         A partial list of customers of our Advanced Visualization group
includes: Alenia-Marconi; Bombardier; British Aerospace; British Telecom; DERA;
Diageo; Electricite de France; European Union; Fluor Daniel; French Army; Lever
Brothers; Lloyds Bank; Nestle U.K.; Procter & Gamble; Renault; Rolls Royce;
Royal Air Force; Unilever; Severn Trent Water; and Vickers Defense.


<PAGE>

STRATEGIC RESELLING PARTNERS AND INDEPENDENT SOFTWARE VENDORS

         MUSE Technologies developed its Strategic Reselling Partner (SRP)
program in 1998 and relied almost exclusively upon this business model through
early fiscal 2000. AVS has historically relied predominately on direct sales of
its software to a mix of both corporate customers and Independent Software
Vendors (ISVs), producing much more dynamic sales results. The SRP program has
produced lower than expected results to date and management concluded in early
fiscal 2000 that establishing a direct sales relationship with potential
customers would shorten the sales cycle and ensure that MuSE software is
effectively introduced into our target markets.
We are no longer actively engaged in SRP activity.

         ISVs and SRPs can produce revenue for our company by:

     o    Generating revenue opportunities through the licensing and resale of
          our software;
     o    Producing ongoing revenues through the licensing and sale of product
          upgrades and through service, support and maintenance agreements;
     o    Creating additional revenues through the development of specialized
          applications appropriate to the specific vertical market(s) of the
          distributor; and
     o    Producing new product development initiatives that result from
          customer feedback and product modification requests.

         Under the former SRP program, resellers could secure territorial or
vertical market exclusivity by paying an up-front fee to us, or enter into a
non-exclusive commitment for representation of MuSE software in selected
markets. Both exclusive and non-exclusive SRP agreements established an
anticipated revenue goal for the reseller over the multi-year period of their
agreement. The relative value of each vertical market or territory was
established by mutual agreement between us and the SRP. The valuation was based
upon third-party data and market projection analysis that are obtained from one
or more industry experts. In some cases, we were entitled to a percentage of
sales or profits that the SRP derived from products that included our MuSE
software. To date, no SRP has met its anticipated revenue goal or otherwise
produced significant revenue for us.

         Under the AVS ISV program, distributors do not generally secure
territorial or vertical market exclusivity, however, in some cases they may pay
an up-front licensing fee with minimum annual re-licensing fees that are either
flat-rate or determined by a percentage of sales of selected products. A unit of
KGT, a subsidiary of Kubota Corporation, is the sole exclusive ISV of AVS, with
the right to distribute AVS software products in Japan. AVS' ISVs have
historically proven to be reliable sources of revenue and generally performed to
the expectation of AVS management.

         We have entered into the following SRP relationships:

     o    In June 1998, we entered into a strategic reselling partner agreement
          with Continuum Resources International, ASA, a Norwegian company, with
          respect to distribution of our products and services in the oil and
          gas industry worldwide. In exchange for such exclusive rights,
          Continuum Resources paid us a non-refundable license fee of
          $5,000,000. Minimum sales commitments totaling $12,000,000 through
          2001 were modified in June 2000 due to significant pricing reductions
          in the cost of our products and to enable Continuum Resources to
          implement its business plan. The modified agreement requires Continuum
          Resources to generate minimum revenues of $250,000 during the next
          fiscal year with minimum requirements for succeeding years to be
          established by mutual agreement. We are currently discussing a
          comprehensive settlement of all issues with respect to our
          relationship with Continuum Resources. See "Management's Discussion
          and Analysis of Financial Condition and Results of Operations."


<PAGE>

     o    In December 1998, we entered into a non-exclusive strategic reselling
          partner agreement with Intergraph Corp., an automated business
          solutions company with customers worldwide in a variety of commercial
          sectors and government. The agreement with Intergraph provides
          Intergraph with the non-exclusive right to resell our products and
          services worldwide in exchange for minimum annual sales commitments
          aggregating $4 million through 2001. To date, Intergraph has not
          produced any material revenue through this agreement.

     o    In February 1999, we entered into non-exclusive reseller agreements
          under our strategic reselling partner program with Analytical
          Mechanics Associates (AMA), a technical consulting firm, and Federal
          Data Corporation (FDC), an information technology provider serving
          primarily the federal government. Each agreement is for a term of
          three years with minimum sales commitments of $3 million over the term
          of the agreement. To date, neither AMA nor FDC have produced any
          material revenue through these agreements.

     o    In March 2000, we entered into a non-exclusive reseller agreement
          under our SRP partner program with Pentagon Engineering, a "Best of
          Class" reseller of Hewlett-Packard hardware and the premier
          "Co-Create" software VAR in the U.S., as well as a developer of custom
          solutions for the engineering and automotive industries. Under the
          terms of a three-year non-exclusive agreement, Pentagon Engineering
          has committed to $1,000,000 over the term of the agreement. To date,
          Pentagon has not produced any revenue through this agreement.

     o    In July 2000, we entered into a non-exclusive reseller agreement under
          our SRP program with Science Applications International Corporation
          (SAIC), a diversified high-technology research and engineering company
          that offers a broad range of expertise in analysis, computer system
          development and integration, technical support services, and computer
          hardware and software products. Under the terms of the agreement, SAIC
          plans to offer MuSE products and services within the U.S. to all
          federal agencies and companies that are qualified to perform work for
          a federal agency. International orders must be pre-approved by MUSE
          Federal Systems Group. The term of the agreement is through May 30,
          2003. The agreement requires minimum sales commitments over the term
          aggregating $2 million. To date, SAIC has not produced material
          revenue through this agreement.

         Although our existing SRP agreements provide for minimum annual sales
commitments, failure to satisfy such commitments will only permit us to
terminate such strategic reselling partner agreement. Accordingly, we cannot
assure you that the threat of termination of any strategic reselling partner
agreement will be an effective deterrent against any breach of that strategic
reselling partner agreement or that such minimum sales commitments will be
realized.

         Our current strategy is to expand our sales force and convert all
operating groups to a primarily direct sales model, where ISVs are identified
and serviced in the same manner as other commercial accounts. For MUSE
Technologies, this represents a material departure from our original business
plan of dependence on SRPs and a change from our former belief that the company
would primarily serve the needs of resellers and place significantly less
emphasis on direct customer sales activity.

         To date, the migration of MUSE Technologies from a SRP revenue model to
one of direct sales has been slow and only moderately productive.

         Since the completion of the merger with AVS, we have commenced planning
a unified direct sales effort for the software products and services of both
MUSE Technologies and AVS, however, our plan has not yet been fully implemented
and we have seen only limited results. We still believe that long-


<PAGE>

term revenue can be generated from the ISV channel and plan on continuing to
attract ISV business activity in concert with a direct sales program.

MATERIAL CONTRACTS WITH CUSTOMERS

We have entered into the following material contracts with customers:

     o    In April 1999, we entered into a three-year agreement with The
          Goodyear Tire & Rubber Company to develop applications using our
          advanced visualization and network collaboration software. We agreed
          to provide software, system design, consulting, and technical support
          services to Goodyear on a project-by-project basis. The agreement
          includes a three-year renewal option and provides exclusivity for
          consulting or application design services within the tire and rubber
          manufacturing business throughout its term, provided that they satisfy
          the minimum annual project commitments. Sales activities in the tire
          and rubber manufacturing industry by our SRP's are not affected by
          this agreement. In December 2000, Goodyear advised us that they wished
          to terminate the agreement due to budgetary cutbacks. Although we are
          in continuing discussions with Goodyear about the future of our
          business relationship, it is likely that we will not see significant
          revenue from this customer in the future.

     o    In January 2000, MUSE Virtual Presence entered into an agreement with
          Guidant Corporation to provide a sophisticated cardiology training
          simulator to Guidant's European headquarters in Belgium. Under the
          terms of a contract valued at approximately $500,000, MUSE Virtual
          Presence will undertake custom software development work to adapt the
          company's existing IST (Interventional radiology/cardiology
          Simulation-based Trainer) system. On January 1, 2001 we transferred
          our interest in this contract to Mentice. Under the terms of our
          agreement with Mentice, we are entitled to purchase shares
          representing 5% of the company that develops and markets the
          cardiology trainer; and we will receive a 20% royalty in 2001 and a
          10% royalty in 2002 of the profits derived from the MIST product, and
          a 5% royalty in 2001 and 2002 of all profits derived from the VIST
          product and our former contract with Guidant Corporation.

     o    In April 2000, MUSE Virtual Presence was awarded a major contract with
          the Manchester Visualization Centre to provide hardware, software and
          services at one of the world's most sophisticated facilities for
          advanced research and development, interactive computer graphics,
          multimedia, image processing and visualization. The contract, valued
          at approximately $1,000,000, provides for MUSE Virtual Presence to
          perform extensive work at the Manchester Visualization Centre, which
          is located at the University of Manchester in the United Kingdom. The
          project will transform computational systems into high-performance
          visual computing platforms for researchers, students and commercial
          users to project real-time graphics in a three-screen theater.
          Included in the project is the installation of MuSE and FrameSet
          software.

COMPETITION

         We believe that the current market for our data visualization and
advanced graphics products and services is relatively small and fragmented.
However, based upon publicly available and commissioned market research, we
believe that this market will grow rapidly over the next five years. We believe
that no single company dominates the market at the present time; however, a
number of emerging companies are aggressively pursuing opportunities in the same
market areas as us. Many of the companies with whom we compete or expect to
compete have substantially greater financial resources, research and development
capabilities, sales and marketing staffs and distribution channels and are
better known than we.


<PAGE>

         We believe that the principal factors affecting our ability to compete
are the capabilities, functionality and architecture of our products; our
ability to provide expert professional services; the ease of use of our software
and solutions by end-users; the performance and functionality of software
applications developed and marketed by us and our resellers; and the reputation
of our subsidiaries within their respective markets.

         Other companies develop and market software that competes with certain
features of each product we offer. Many of these companies have economic and
marketing resources that are far greater than ours. Because the market for data
visualization and advanced graphics software is just beginning to take on formal
dimensions and because some of our competitors have product lines that offer
more that just data visualization software and have longstanding relationships
with leading corporations and government agencies, we may not be able to compete
with these companies despite what we believe are superior features and
capabilities of our products.

         The following companies engage in the sales of competitive software
and/or services with our Data Visualization group:

     o    Division, a unit of Parametric Technologies
     o    iLog
     o    Khoral Research
     o    Multigen-Paradigm, a unit of Computer Associates
     o    Numerical Algorithms Group
     o    Research Systems, a unit of Kodak Corporation
     o    Sense8, a unit of Engineering Animation
     o    Template Graphics
     o    Visual Numerics
     o    Visual Insights
     o    Visual Mining

         Each of these companies offers a data visualization software product
and/or a solutions capability that directly competes with us. We believe,
however, that none of these companies offers the comprehensive range of data
visualization products that we do and that our experience working with a wide
range of visualization challenges is equal to or superior to that of our
competitors. As the demand for data visualization software and solutions grows,
more companies are likely to develop products that will compete with us. If we
are unable to spend sufficient amounts on marketing, promotion and the expansion
of our sales force, these companies may quickly dominate the markets in which we
conduct business and prevent us from achieving our sales objectives.

         Two solutions providers are competitors to our Advanced Visualization
group, both of which have marketing budgets, reputations, personnel resources
and other capabilities that are significantly greater than ours. These include
SGI and EDS. Both of these companies are large and have international
dimensions, while our Advanced Visualization group operates primarily in two
European countries only. We believe that our competitive strength over these
companies is an 11 year reputation for developing quality solutions as well as
our small size and agility. As the market for advanced computer graphics grows,
additional competitors of all sizes may enter the marketplace and present new
competitive challenges.

         The market for advanced data visualization facilities and related
         equipment is large and extremely competitive. In many instances, we
         compete directly with manufacturers that have independent sales forces
         as well as many other distributors of their products. Manufacturers and
         large


<PAGE>

         resellers also have a greater ability to reduce the cost of their
         products to customers. We do not have any exclusive reseller agreements
         with manufacturers and in some cases we have a limited geographic
         territory in which we can sell certain products.

         As the data visualization and advanced computer graphics markets grow,
new software and hardware products will inevitably become available and
additional hardware vendors will emerge as competitors. We cannot be assured
that we will be able to compete with these companies or that our existing
customers will not turn to our competitors for products and services.

ACQUISITION STRATEGY

         In 1999 we commenced an acquisition strategy that was designed to
achieve the following goals:

         o   Add new products, services and capabilities to our business;

         o   Create an international presence, primarily in Europe;

         o   Add new industries to our target markets;

         o   Add qualified technical personnel to our ranks;

         o   Add revenue and other forms of economic opportunity from existing
             or imminent projects or products; and o Build an international
             brand that is synonymous with perceptual computing software and
             solutions.

         Our acquisition strategy was motivated by an awareness that data
visualization and advanced computer graphics were beginning to transcend their
"emerging industry" status and a belief that a company with a broad array of
products, services and offices could better serve a host of customers in an
array of industries.

         We believe that our acquisition efforts to date, including the
acquisition of AVS, will significantly reposition us as a major contender for
data visualization market leadership and will provide us with a majority of the
benefits set forth above.

         On November 16, 1999, we purchased all of the outstanding stock of
Virtual Presence, Ltd., a 10 year old United Kingdom company that creates
sophisticated 3D graphics solutions using proprietary and third party software
and hardware. MUSE Virtual Presence operates offices in London and Manchester,
United Kingdom, and is the majority shareholder of SimTeam SARL, a French
company that provides products and services similar to those of MUSE Virtual
Presence in France.

         On March 17, 2000, we purchased all of the outstanding stock of
Simulation Solutions, Ltd., a U.K. company involved in providing advanced
solutions to the manufacturing industry using proprietary and third-party
software and hardware. MUSE Simulation Solutions operates from the Manchester,
U.K. offices of MUSE Virtual Presence.

         On March 28, 2000, we completed an asset purchase of theVRsource.com,
an e-commerce Web site that is a reseller of our hardware and software and that
of other companies that is used in virtual reality, data visualization and
perceptual computing.

         On November 9, 2000 we completed the acquisition of AVS, an
internationally recognized provider of data visualization software and solutions
that markets its products and services through a direct sales force in North
America and Europe and through indirect channels such as distributors and ISVs
worldwide.


<PAGE>

         At present, management continues to analyze acquisition opportunities,
however, our ability to enter into any acquisition transactions is limited by a
lack of current financial resources. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations".

THE MUSE LICENSE AGREEMENT

         Pursuant to the license agreement with Sandia Corporation, we received
(i) a limited exclusive worldwide license to use and reproduce the MuSE
software, (ii) a license to create derivative works of MuSE software and (iii)
the right to distribute and sublicense the MuSE software. The license agreement
provides us with a ten-year exclusive license with respect to the MuSE software,
and thereafter provides a non-exclusive right through 2015. After the end of the
exclusive ten-year period, we may request that Sandia Corporation extend the
exclusivity through 2015, which determination shall be made in Sandia
Corporation's sole discretion and subject to continued royalty payments under
the license agreement. If the license agreement continues in force for a total
of 20 years, our rights under the license agreement convert to a paid-up
non-exclusive license.

         We are required to pay royalties (with an annual minimum royalty of
$20,000) for the term of the license agreement, based on our gross revenues,
less cost of goods sold and certain other expenses, from the sale of products
utilizing MuSE. Additionally, we paid a one-time license fee of $400,000 in
connection with the acquisition of the license agreement from Viga Technologies
Corporation in 1995. We are also required to retain the services of key
personnel capable of supporting the MuSE software. The license agreement is
terminable by Sandia Corporation in the event of a breach thereunder by us
(including, without limitation, due to failure to pay minimum royalties in the
annual amount of $20,000), or in Sandia Corporation's discretion, in the event
of any breach of the license agreement, Sandia Corporation may convert the
license into a non-exclusive license or otherwise reduce our rights thereunder.

         As part of the license agreement, we have agreed to grant Sandia
Corporation an irrevocable non-exclusive license to use the MuSE software (and
all enhancements, modifications and corrections made by us) and to develop
derivative works based on the MuSE software for internal use at Sandia
Corporation.

         Under the license agreement, we bear the risk that the information and
technology licensed from Sandia Corporation and incorporated in the MuSE
software may infringe the rights of third parties and must indemnify Sandia
Corporation in respect of any claims for copyright infringement brought against
them and arising from the development and distribution of the programs
incorporated in the MuSE software. We have agreed to treat the originally
licensed MuSE software as proprietary to Sandia Corporation. However,
enhancements and modifications to such original software, which have been
extensive, are considered proprietary to us.

INTELLECTUAL PROPERTY RIGHTS

         We have been advised that Sandia Corporation has filed patent
applications for aspects of the MuSE software and holds copyrights to the MuSE
software. We depend on Sandia Corporation for the protection of the intellectual
property covered by the license agreement. We cannot assure you that Sandia
Corporation will be able to patent other inventions present in the MuSE software
or otherwise protect the proprietary intellectual property covered by the
license agreement.

         We have filed and are in the process of filing patent applications for
Continuum and related technologies, and also filed trademark and logo
applications.


<PAGE>

         We will generally rely on a combination of trade secret, copyright,
trademark and patent law to protect our proprietary rights in the intellectual
property developed by us. Although we intend to provide products utilizing the
MuSE software to its customers primarily in object code form, we cannot assure
you that unauthorized third parties will not be able to copy the software. In
addition, we cannot assure you that our competitors will not independently
utilize existing technologies to develop products that are substantially
equivalent or superior to our software. We could incur substantial costs in
defending itself or our licensees in litigation brought by third parties, or in
seeking a determination of the scope and validity of the proprietary rights of
others.

RESEARCH AND PRODUCT DEVELOPMENT

         We believe that our future success depends in large part upon
consistent enhancements to our existing software products and the development of
new software products. We are currently developing new software products
relating to information management with broad applications in the commercial,
government and education markets and enhancing existing products to improve
price and performance, expand product capabilities, simplify user interfaces,
help define and support emerging industry standards, and develop
interoperability with most products and devices commonly used in our targeted
markets. Our data visualization products operate on a broad range of platforms
and with a variety of display and input/output devices. We also believe that it
is beneficial to work with third parties to accomplish these goals and have, in
the past, received funding from outside sources, such as grants from government
organizations, to develop products and applications. We intend to continue to
pursue such external research and development funding sources, however plan on
becoming less reliant on them.

         For fiscal 2000, fiscal 1999 and fiscal 1998, our research and
development expense was approximately $2,993,000, $2,303,000 and $957,000,
respectively. We sponsored all research and development expenses except for
payments derived from Small Business Innovative Research grants from the Federal
government of approximately $341,000 which were included in revenue in fiscal
1998 and related to development of certain applications of our MuSE software
product.

EMPLOYEES

         As of September 30, 2000, we had 70 full-time employees. As of January
26, 2001, subsequent to completion of our acquisition of AVS, our full-time
employment increased to 159. We believe that our relationships with our
employees are satisfactory. We have no history of any work stoppages and none of
our employees are currently represented by a union.

ITEM 2.  DESCRIPTION OF PROPERTY

         We lease 8,762 square feet of office and laboratory space in
Albuquerque, New Mexico and by amendment of our lease, have leased an additional
8,787 square feet of space at our Albuquerque headquarters. The lease, as
amended, provides for base rental payments of approximately $10,600 per month.
The amended lease extends the termination date until January 31, 2002.

         We lease 2,342 square feet of office space and demonstration facilities
in Arlington, VA. This lease provides for rental payments of $4,977 per month
and terminates on January 31, 2003.

         MUSE Virtual Presence leases approximately 3,500 square feet of space
in London at a rental of $4,500 per month on a lease expiring in 2023.
Additionally, MUSE Virtual Presence leases a 5,000 square foot central
development facility outside of Manchester (U.K.) at a rental of $3,500 per
month on a lease expiring in June 2003. MUSE SimTeam leases approximately 1,800
square feet of space in Paris for a rental of $2,750 per month on a lease
expiring in May 2001.


<PAGE>

         AVS's executive and corporate offices comprise 14,429 square feet of a
facility at 300 Fifth Avenue, Waltham, Massachusetts under lease agreements that
expire on December 31, 2002. In addition, AVS has a lease for and has subleased
10,770 square feet of the Waltham facility to two other companies. AVS also
maintains a total of eight leased sales offices in the following locations:
United Kingdom, France, Germany, Italy, Denmark, California and Virginia. AVS
believes that its facilities are adequate for its current operations.

         We believe that all such properties are adequate and are for their
intended purposes.

ITEM 3.  LEGAL PROCEEDINGS

         From time to time, we or our subsidiaries may be involved in litigation
relating to claims arising in the normal course of business. We do not believe
that any such litigation, if decided adversely to us or our subsidiaries, would
have a material adverse effect on our results of operations or financial
condition.

         Notwithstanding the foregoing, on November 25, 2000, John Hough, former
Managing Director of Virtual Presence and a current director of MUSE
Technologies, filed a Notice of Originating Application with the Employment
Tribunals in the UK alleging unfair dismissal of his positions with Virtual
Presence. Virtual Presence, through its attorneys, responded to Mr. Hough's
allegations on December 21, 2000. Virtual Presence believes that Mr. Hough's
claims are without merit and intends to vigorously defend itself in this
proceeding. Management believes that the ultimate outcome of this proceeding
will not have a material adverse effect on our results of operations or
financial condition.

         We are also a party to two arbitration proceedings with respect to
claims by two former employees, one of whom was an executive officer, alleging
wrongful dismissal. The former employees are seeking unspecified damages in
amounts in excess of $100,000. We do not believe that the final outcome of these
proceedings will have an adverse effect on our results of operations or
financial condition.

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

         The Company did not submit any matters to a vote of its stockholders,
through the solicitation of proxies or otherwise, during the fourth quarter of
fiscal 2000.

PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCK-HOLDER MATTERS

Our Common Stock and Warrants are traded on the Nasdaq SmallCap (Trademark)
Market ("Nasdaq") under the symbol "MUZE" and "MUZEW", respectively, and on the
Boston Stock Exchange ("BSE") under the symbols "MZE" and "MZEW", respectively.
The following table sets forth, for the periods indicated, the range of high and
low bid prices of the Common Stock and the Warrants as reported by Nasdaq and
the BSE. These quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not necessarily represent actual transactions.

Common Stock                                             High     Low
------------                                             ----     ---

From November 17, 1998 (first trade date)               $14.00   $8.50
through December 31, 1998
Quarter ended March 31, 1999                            $10.50   $3.88




<PAGE>

Quarter ended June 30, 1999                             $ 8.13   $3.88
Quarter ended September 30, 1999                        $ 6.25   $3.25
Quarter ended December 31, 1999                         $ 4.063  $2.625
Quarter ended March 31, 2000                            $ 6.25   $2.719
Quarter ended June 30, 2000                             $ 5.375  $2.00
Quarter ended September 30, 2000                        $ 3.375  $1.813

Warrants
--------

From November 17, 1998 (first trade date)               $ 4.18   $1.25
through December 31, 1998
Quarter ended March 31, 1999                            $ 3.50   $1.25
Quarter ended June 30, 1999                             $ 1.75   $1.13
Quarter ended September 30, 1999                        $ 1.63   $0.75
Quarter ended December 31, 1999                         $ 1.313  $0.50
Quarter ended March 31, 2000                            $ 1.44   $0.13
Quarter ended June 30, 2000                             $ 1.50   $0.63
Quarter ended September 30, 2000                        $ 0.81   $0.19


The approximate number of record holders of our common stock at January 22, 2001
was 676, not including beneficial owners whose shares are held by banks, brokers
and other nominees.

We have not paid any dividends. We do not expect to pay cash dividends on our
common stock in the foreseeable future as any earnings are expected to be
retained to finance our operations. Declaration of dividends in the future will
remain within the discretion of our Board of Directors.


<PAGE>



ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATION

The following presentation of management's discussion and analysis of the
Company's financial condition and results of operations should be read in
conjunction with the Company's Consolidated Financial Statements, the
accompanying notes thereto and other financial information appearing elsewhere
in this Report. This section and other parts of this Report contain forward-
looking statements that involve risks and uncertainties. The Company's actual
results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operation--Factors
Affecting Operating Results and Market Price of Stock" commencing on page 28.
Additionally, this section does not include the comparative financial results of
AVS since the acquisition of AVS occurred subsequent to the fiscal year end.
However, certain pro forma financial information appearing in the Company's
Consolidated Financial Statements is briefly discussed.

OPERATIONAL OVERVIEW

         We receive revenue from the sale and licensing of our software
products, the sale of third-party manufactured hardware and software, and by
providing consulting, training, support and maintenance services.

         From the beginning of our 1999 fiscal year until the second quarter of
our 2000 fiscal year, the primary sales strategy for MUSE Technologies and MUSE
Federal Systems Group was to distribute our software products and services
through a network of resellers that had extensive vertical market expertise.
Because the MuSE software product was designed to serve the unique needs of many
different industries, management believed that it would be more efficient to
identify resellers, distributors, service providers and other experts in a
select few industries to sell MuSE software to their existing and potential
customers. That distribution strategy, known as the Strategic Reselling Partner
(SRP) program, has produced lower than expected results to date, and while
several SRP distributors continue to promote and offer the MuSE software product
and services, management believes that establishing a direct sales relationship
with potential customers will shorten the sales cycle, optimize profitability,
and ensure that MuSE software is effectively introduced into our target markets.
AVS has historically sold products through its own direct sales force and
through ISVs.

         Our current strategy is to expand our sales force and convert all
operating units to a primarily direct sales model where a combination of
products and services are offered to our customers. For MUSE Technologies and
MUSE Federal Systems Group this represents a material departure from our
original business plan of dependence on SRPs and a belief that the company would
take on the primary dimensions of a "software publisher" with revenue being
generated from software licensing and royalty income. Management still believes
that long-term revenue can be generated from conventional royalty/licensing
publishing practices by resellers and directly by us; however, as a means of
creating a larger installed base of users, we believe that the current sales
strategy of all of our subsidiaries and operating groups should be focused on
direct contact with customers that have complex data integration and data
analysis challenges and large populations of users. We believe that select
target markets can benefit from an integrated deployment of our software and
professional services, and that a direct sales effort will produce faster and
more significant revenues.

         Revenue is generated through a direct sales process as well as by
authorized resellers. As a result of significant lead time necessary to market
and consummate such direct sales and reseller agreements, our quarterly results
are expected to fluctuate significantly depending on the timing of completion of
such arrangements and any up front fees and sales commitments associated
therewith. Accordingly, results in


<PAGE>

any one quarter are not indicative of results to be expected in subsequent
quarters. Currently, our SRP program has been requiring a greater than
anticipated sales cycle and, therefore, sales attributable to resellers for the
period ended September 30, 2000 were not significant.

         Although our existing reseller agreements provide for minimum annual
sales commitments, failure to satisfy those commitments merely permit us to
terminate that agreement. Accordingly, we cannot provide assurance that the
threat of terminating any strategic reselling partner agreement is an effective
deterrent against a breach of the agreement that the minimum sales commitments
have not been realized.

         In June 1998, we entered into a strategic reselling partner agreement
with Continuum Resources International, ASA, a Norwegian company, with respect
to distribution of our products and services in the oil and gas industry
worldwide. In exchange for such exclusive rights, Continuum Resources paid us a
non-refundable license fee of $5,000,000. Minimum sales commitments totaling
$12,000,000 through 2001 were modified in June 2000 due to significant pricing
reductions in the cost of our products and to enable Continuum Resources to
implement its business plan. The modified agreement requires Continuum Resources
to generate minimum revenues of $250,000 during the next fiscal year with
minimum requirements for succeeding years to be established by mutual agreement
by December 31, 2000. We have entered into discussions with Continuum Resources
to achieve a comprehensive solution to all issues, including payment to us of
certain notes receivable.

         In December 1998, we entered into a non-exclusive strategic reselling
partner agreement with Intergraph Corp., an automated business solutions company
with customers worldwide in a variety of commercial sectors and government. Our
agreement with Intergraph provides it with the non-exclusive right to resell our
products and services worldwide in exchange for minimum annual sales commitments
aggregating $4 million through 2001. As of September 30, 2000, Intergraph has
not yet generated any sales of our software under the agreement.

         In February 1999, we entered into non-exclusive reseller agreements
under our SRP program with Analytical Mechanics Associates (AMA), a technical
consulting firm, and Federal Data Corporation (FDC), an information technology
provider serving primarily the Federal government. Each agreement is for a term
of three years with minimum sales commitments of $3 million over the term of the
agreement. As of September 30, 2000, AMA has not yet generated any sales of our
software and FDC has produced approximately $50,000 in sales of our software.

         In March 2000, we entered into a non-exclusive reseller agreement under
our SRP program with Pentagon Engineering, a "Best of Class" reseller of
Hewlett-Packard hardware and the premier Co-Create software VAR in the U.S., as
well as a developer of custom solutions for the engineering and automotive
industries. Under the terms of a three-year non-exclusive agreement, Pentagon
Engineering has committed to $1,000,000 over the term of the agreement under
this agreement. There have been no revenues produced to date under this
agreement.

         In July 2000, we entered into a non-exclusive reseller agreement under
our SRP program with Science Applications International Corporation (SAIC), a
diversified high-technology research and engineering company that offers a broad
range of expertise in analysis, computer system development and integration,
technical support services, and computer hardware and software products. Under
the terms of the agreement, SAIC plans to offer certain of our products and
services within the U.S. to all federal agencies and companies that are
qualified to perform work for a federal agency. International orders must be
pre-approved by MUSE Federal Systems Group. The term of the agreement is through
May 30, 2003. The agreement requires minimum sales commitments over the term
aggregating $2 million. There have been no revenues produced to date under this
agreement.


<PAGE>

         In April 1999, we entered into a three-year agreement with Goodyear
Tire & Rubber Company to develop applications using our advanced visualization
and network collaboration software. We will provide software, system design,
consulting, and technical support services to Goodyear on a project-by-project
basis. The agreement includes a three-year renewal option and provides Goodyear
with exclusivity for consulting or application design services within the tire
and rubber manufacturing business throughout its term, provided that minimum
annual project commitments are satisfied. Sales activities in the tire and
rubber manufacturing industry by our SRP are not affected by this agreement. In
December 2000, Goodyear advised us that they were terminating the agreement
effective as of December 31, 2000 due to budgetary cutbacks. Although dialog
with Goodyear is continuing, it is unlikely that we will receive significant
revenues from Goodyear in the future.

         In January 2000, MUSE Virtual Presence entered into an agreement with
Guidant Corporation to provide a sophisticated cardiology training simulator to
Guidant's European headquarters in Belgium. Under the terms of a contract valued
at approximately $500,000, MUSE Virtual Presence was to undertake custom
software development work to adapt the company's existing IST (Interventional
radiology/cardiology Simulation-based Trainer) system. However, on January 1,
2001, our interest in this contract was transferred to Mentice AB, a Swedish
company. Under the terms of our agreement with Mentice, we are entitled to
purchase shares representing 5% of the company that will develop and market the
former MUSE Virtual Presence products. We will also be entitled to a 20% royalty
in 2001 and a 10% royalty in 2002 of the profits derived from the MIST product;
and a 5% royalty in 2001 and 2002 of all profits derived the VIST product and
our former contract with Guidant Corporation.

         In April 2000, MUSE Virtual Presence was awarded a major contract with
the Manchester Visualization Centre to provide hardware, software and services
at one of the world's most sophisticated facilities for advanced research and
development, interactive computer graphics, multimedia, image processing and
visualization. The contract, valued at $1,000,000, provides for MUSE Virtual
Presence to perform extensive work at the Manchester Visualization Centre, which
is located at the University of Manchester in the United Kingdom. The project
will transform computational systems into high-performance visual computing
platforms for researchers, students and commercial users to project real-time
graphics in a three-screen theater. Included in the project is the installation
of MuSE and FrameSet software.

         In 1999, we formed MUSE Federal Systems Group, Inc., a wholly owned
subsidiary that provides software and consulting services exclusively to federal
agencies and government contractors. During fiscal 2000, we have determined to
place extremely limited emphasis on the sale of professional services to
agencies of the US federal government, after concluding that our resources would
be better applied to higher profit margin customer relationships in the
commercial sectors of business and industry. Despite the fact that MUSE
Technologies has historically conducted a substantial portion of its business
with US federal agencies, management has determined that such activities were
not as profitable as expected, however, they did produce extensive validation of
the MuSE software product as well as valuable insight as to how to best exploit
that technology. Accordingly, we have reduced the size of our MUSE Federal
Systems Group subsidiary and may transfer any future government sales activity
to our other Data Visualization group subsidiaries. We plan on continuing to
sell our data visualization software toolkits and related licensed products to
federal agencies on a direct basis as well as through reseller and ISV channels,
and may selectively offer professional services to federal agencies and
contractors. Certain subsidiaries of the Advanced Visualization group will
continue to sell professional services to European government agencies and
bodies.

         On November 16, 1999, we completed the acquisition of Virtual Presence
Ltd., a provider of interactive visualization solutions for companies in the
European defense, medical and manufacturing industries. We acquired Virtual
Presence for a total of $300,000 in cash at the closing, $300,000 in notes


<PAGE>

payable over a nine-month period and 430,839 shares of our common stock, subject
to certain restrictions. Of those shares, 205,522 were subject to adjustment in
the event that the price of the common stock over the twenty trading days prior
to November 15, 2000 is less than $4.41 per share. Accordingly, an additional
246,906 shares of our common stock will be issued in connection with this
transaction.

         On March 17, 2000, we acquired Simulation Solutions, Ltd., a U.K.
company that provides advanced software and consulting services in the field of
plant and equipment manufacturing simulation. We acquired Simulation Solutions
for a total of $117,333 in cash and 44,895 shares of our common stock.
Simulation Solutions has been incorporated into our existing European operation.
The contribution to revenues as a result of this acquisition has not been
significant to date.

         On March 28, 2000, we purchased theVRsource.com, a prominent e-commerce
site for advanced visualization and virtual reality hardware, from theVRSource,
Inc., a Colorado corporation, for $400,000 in cash and notes. TheVRsource.com
website offers high performance peripheral devices from leading hardware
manufacturers including Polhemus, Ascension, FakeSpace, Virtual Technologies,
Sony and Virtual Research Corporation. The contribution to revenues as a result
of this acquisition has not been significant to date.

         On May 4, 2000, our CEO and Chairman resigned. As a result of certain
severance arrangements and repurchase of stock options to purchase 750,000
shares of our common stock in connection with his resignation, we incurred a
charge to earnings in the third fiscal quarter of approximately $990,000. As
part of the resignation arrangement, we will make certain of these payments over
a two-year period.

         On November 9, 2000 we completed the acquisition of AVS through a
merger, and AVS has become a wholly owned subsidiary of MUSE Technologies, Inc.
AVS is an internationally recognized provider of data visualization software and
solutions that markets its products and services through a direct sales force in
North America and Europe and through indirect channels such as distributors and
independent software vendors worldwide. Kubota Corporation has distribution
rights in Japan to AVS products through its KGT subsidiary. As a result of the
merger, the stockholders of AVS received an aggregate of 1,929,579 shares of our
common stock in exchange for all outstanding shares of AVS capital stock.

         On January 22, 2001, we received a letter from the Nasdaq Stock Market
indicating that, as a result of the failure to timely file our annual report,
our common stock would be delisted from the Nasdaq Stock Market as of January
30, 2001 unless our annual report was field by January 29, 2001. We have
complied with this request and are confident that no such delisting shall occur.

RESULTS OF OPERATIONS FOR FISCAL 2000 AND FISCAL 1999

         Revenue for the fiscal year ended September 30, 2000 ("fiscal 2000")
was $6,069,592 as compared to revenue of $1,723,267 for the fiscal year ended
September 30, 1999 ("fiscal 1999"). The increase of $4,346,325 or 352% for the
twelve-month period is primarily attributable to sales generated by Virtual
Presence, which was acquired in November 1999, together with increases in
product and contract sales during fiscal 2000.

         Total operating expense for fiscal 2000 was $17,814,231 compared to
total operating expense of $6,970,963 for fiscal 1999. The increase of
$10,843,269 or 256% for fiscal 2000 is primarily attributable to incorporating
the expenses of Virtual Presence and Simulation Solutions operations, including
$3,396,238 in costs of products sold, an increase in selling, general and
administrative expenses as a result of increases in engineering and
administrative personnel, as well as one-time charges of $994,062 for severance
and other costs in conjunction with the resignation of an executive officer in
May 2000,


<PAGE>

merger and acquisition costs of $596,709 associated with the acquisition of AVS,
and a write-down of goodwill associated with the disposition of the medical
products of Virtual Presence.

         Total other expenses for fiscal 2000 was $350,637 as compared to other
income of $134,747 for fiscal 1999. The net drop in other income of $485,384 for
fiscal 2000 as compared to fiscal 1999 is primarily attributable to an
unrealized loss on investments of $687,625, and increase in interest expense of
$44,533, and a reduction in interest income of $316,862. Fiscal 1999 included a
one-time charge of $563,685 of costs in excess of market value of repurchased
stock.

         Accordingly, the net loss for fiscal 2000 of $12,095,276 as compared to
the net loss of $5,112,948 for fiscal 1999, reflected the significant increases
in revenue and costs associated with the Virtual Presence acquisition, the
hiring of additional personnel, one-time charges for severance costs and other
acquisition costs and an unrealized loss on investments.

LIQUIDITY AND CAPITAL RESOURCES

         Historically, our capital requirements have been funded through a
series of debt and equity financings and revenues received through the strategic
reselling partner program. During fiscal 2000, revenues generated from direct
sales activities have also funded portions of our capital needs.

         In July 1998, we sold 1,000,000 shares of common stock and warrants to
purchase 1,000,000 shares of common stock to Continuum Resources for an
aggregate purchase price of $8,000,000. In October 1998, we loaned $1,000,000 to
a subsidiary of Continuum Resources for the establishment of a Houston facility.
The loan is payable on demand and bears interest at the rate of 12% per annum. A
balance of $1,000,000 plus accrued interest of $34,414 remains outstanding on
the loan as of the date hereof. We are currently in discussions with Continuum
Resources to formalize a further payment strategy. Pursuant to a written
agreement with Continuum Resources dated June 2000, Continuum Resources has
acknowledged its payment obligations on the loan. In the event we cannot reach
agreement on payment terms or such payment is not made upon demand, we will be
entitled to terminate the reseller agreement and Continuum Resources' exclusive
distribution rights for MuSE software in the oil and gas industry. Accordingly,
a reserve of $250,000 has been taken against the value of the loan.

         On November 19, 1998, we consummated an initial public offering through
the sale of 1,200,000 shares of common stock and Class A Warrants to purchase
600,000 shares of common stock and received gross proceeds of $9,600,000.
Additionally, on December 2, 1998, the underwriter of our initial public
offering exercised its over-allotment option in full and we received gross
proceeds of $1,440,000. Total net proceeds to us from the initial public
offering were approximately $9,200,000.

         On November 16, 1999, we completed the acquisition of Virtual Presence
for a total of $300,000 in cash at the closing, $300,000 in notes payable over a
nine-month period and 430,839 shares of our common stock, subject to certain
restrictions. Of such shares, 205,522 are subject to adjustment in the event
that the average price of our common stock over the twenty day period prior to
November 15, 2000 is less than $4.41 per share.

         In December 1999, we entered into an agreement with Josephthal & Co.,
Inc. for financial advisory services. In connection with this agreement, we paid
$75,000 to Josephthal and granted Josephthal three-year warrants to purchase
82,500 shares of our common stock at $3.90 (representing 120% of the market
price of the common stock on the date of grant). We recorded a charge to
operations of $113,000 in connection with the granting of such warrants.


<PAGE>

         On March 17, 2000, we acquired Simulation Solutions for $117,333 in
cash and 44,895 shares of our common stock. On March 28, 2000, we acquired
theVRsource.com for $400,000 in cash and notes.

         In May 2000, in connection with the letter of intent relating to the
acquisition of AVS, AVS borrowed $1,000,000 from us. The note is payable on
demand and bears interest at the rate of 10% per annum payable monthly in
advance.

         On June 1, 2000, we entered into an equity line agreement with
Kingsbridge Capital Limited. The equity line agreement entitles us to sell and
obligates Kingsbridge to purchase, from time to time, up to $18,000,000 of our
common stock at a discount of 10% or 12% depending on the market price of our
common stock. Our ability to require Kingsbridge to purchase our common stock is
subject to certain limitations based on the market price and trading volume of
our common stock. Additionally, on August 7, 2000, we sold to Kingsbridge a
convertible note in the principal amount of $1,000,000 with interest at the
annual rate of 10%. The note is convertible into shares of our common stock
after the first anniversary of the issuance of such note at the per share rate
of the lower of $2.375 or 88% of the average closing bid price for the five
trading days prior to conversion. We also issued to Kingsbridge warrants to
purchase 200,000 shares of our common stock in connection with the equity line
agreement exercisable at $3.76 per share over the four-year period commencing on
November 28, 2000 and warrants to purchase 75,000 shares of our common stock in
connection with the note issuance exercisable at $2.6125 per share over the four
year period commencing on August 7, 2001.

         On November 9, 2000 we completed the acquisition of AVS through a
merger, and AVS has become a wholly owned subsidiary of MUSE Technologies, Inc.
As a result of the merger, the stockholders of AVS received an aggregate of
1,929,579 shares of our common stock in exchange for all outstanding shares of
AVS capital stock. Additionally, we have exchanged AVS' outstanding stock
options for MUSE stock options and will be required to issue 232,800 shares of
our common stock pursuant to a convertible note to Kubota Corporation.

         On December 12, 2000, we appointed BlueStone Capital Partners, L.P. as
our financial and investment banking advisors. Under the term of a non-exclusive
agreement, Bluestone is to be paid a one-time retainer of $50,000 in addition to
monthly fees, plus a commission at the closing of the sale of securities, if
any, to certain institutional, accredited individual or strategic investors.

         On December 26, 2000, we entered into an agreement with Prevail With
Vision, Inc. (PVW) to assist us in identifying between $3,500,000 and
$10,000,000 in loan or credit facilities. Under the terms of this agreement, PVW
was paid a retainer fee of $25,000 and will receive a 6% placement fee on any
funds raised by PVW.

         On January 2, 2001, we retained The Wall Street Group, Inc. as
financial relations advisors. Under the terms of an agreement, The Wall Street
Group will receive $7,000 per month in consulting fees and warrants to purchase
100,000 shares of our common stock at a price of $0.52 per share. The agreement
is for a term of one year and can be cancelled by either party upon 90 days
written notice, at which time The Wall Street Group will refund a prorated
portion of the warrants.

         For fiscal 2000, there was a net decrease in cash of $11,622,930 as
compared to a net increase in cash of $8,525,331 for fiscal 1999. The decrease
in cash is primarily attributable to the net loss of $12,095,276, the
acquisition of subsidiaries for $1,068,005, the purchase of property and
equipment for $515,232, the purchase of marketable securities for $1,950,228,
capitalization of development costs for $1,628,353, increases in accounts
receivable of $329,451, the issuance of a $1,000,000 note receivable offset by
the funding provided by a $1,000,000 note payable. For fiscal 1999, the increase
in cash was primarily attributable to the receipt of proceeds from our initial
public offering and collection of accounts


<PAGE>

receivable associated with a strategic reselling partner agreement offset in
part by the net loss of $5,112,948.

         In October 1999, we deposited $2,000,000 in an investment account with
a premier investment banking organization. As of September 30, 2000, the value
of such account was approximately $1,300,000. We recently discovered additional
significant losses in this account subsequent to our fiscal year end. We believe
that such losses may be attributable to circumstances other than normal market
fluctuations. The value of the account at December 31, 2000 was approximately
$300,000. We have engaged the services of a law firm and other professionals to
assist in analyzing the prior activity in the account and to recommend
appropriate action based on their findings. We believe that improprieties may
have been committed, and to the extent that we may have valid legal claims
relating to these losses, we intend to prosecute those responsible to the
fullest extent of the law.

         Our capital requirements depend on numerous factors, including the
progress of our product development programs, our ability to enter into
strategic arrangements or other marketing arrangements which result in the
commercialization and distribution of our products, the need to purchase or
lease additional capital equipment and the cost of filing, prosecuting,
defending and enforcing any patent claims and other intellectual property rights
and the anticipated combination of our operations with those of AVS. Based upon
our current plans we believe that current cash resources as well as anticipated
funds to be generated from operations, will be insufficient to satisfy our needs
for the next 12 months. The equity line agreement provides a potential source of
funds, however, under current market conditions, drawing down on the equity line
will be too costly and result in significant dilution to stockholders.
Accordingly, we must obtain additional capital from other sources and there can
be no assurances that additional financing will be available or that the terms
of any financing will be acceptable to us.

         Further, as a result of the merger with AVS on November 9, 2000, it is
anticipated that we will require significant additional funds in order to
complete the effective combination of our operations (including international
operations) and to continue to fund certain projects under development. We
cannot assure you that such funds will be available or that we can effectively
combine our operations with those of AVS as anticipated. The dollar amount
required to successfully market the combined product and service offerings of
MUSE and AVS has not yet been determined, however, we believe that it will be
significant and may not produce immediate results. We plan to develop combined
marketing strategies and operating budgets in the near term to determine the
amount of cash required to integrate existing operations, create a new corporate
identity, launch new products, revitalize existing products, produce new
marketing and promotional materials, expand an international sales force, create
an effective customer and product support organization and invest in new
technology development.

         Although we have engaged the services of investment banking and
financial services firms to assist us in identifying sources of financing, we
can provide no assurance that the amount or structure of any such financings
will be acceptable. In such event, we will be forced to curtail our planned
marketing and growth strategies and possibly certain of our operations. In this
regard, we have been attempting to cut costs where feasible and have
significantly reduced personnel and operating costs in our Albuquerque, NM
office and have moved our principal offices and operations to Waltham,
Massachusetts to take advantage of the synergies available as a result of the
merger with AVS.

         We continually explore strategic, joint venture and acquisition
opportunities both in the United States and abroad. From time to time, we may be
involved in negotiations for strategic reselling partner arrangements, other
strategic relationships, joint ventures, financing arrangements or possible
acquisitions, however, current negotiations, if any, are too preliminary to
warrant disclosure at this time. We will keep investors informed as such
negotiations mature.




<PAGE>

FACTORS AFFECTING OPERATING RESULTS AND MARKET PRICE OF SECURITIES

OUR FUTURE PROFITABILITY IS UNCERTAIN AND WE HAVE A HISTORY OF LOSSES AND
ACCUMULATED DEFICIT WHICH MAY CONTINUE IN THE FUTURE.

         Our revenue to date has not been substantial, and any increase in
revenue will be dependent upon our ability to market our products, either
directly or through distributors or strategic partners. We expect to
substantially increase our operating expenses in anticipation of increased
revenue with no assurance that we will generate sufficient revenue to cover such
expenses. Accordingly, we can not assure you that we will ever be able to
successfully market and commercialize our products or that we will ever achieve
sustained profitable operations.

WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE FOR OPERATIONS AND ACQUISITIONS.

         We have expended, and will need to expend, additional funds in order to
continue our marketing and product development programs and for acquisitions. To
date, we have completed a number of acquisitions and we are in the process of
acquiring AVS. The acquisitions will require cash to fund the purchases and
assimilation of the acquired businesses into our company. Our capital
requirements depend on numerous factors, including:

          o    the progress and strategic direction of our product development,
               marketing and sales programs;
          o    our ability to enter into strategic arrangements or other
               marketing arrangements which result in the commercialization of
               our products;
          o    our need to purchase or lease additional capital equipment; and
          o    the cost of filing, prosecuting, defending and enforcing any
               patent claims and other intellectual property rights.

To date, our principal source of funds has been from the sale of our debt and
equity securities and revenues from sales activities. We have entered into an
equity line agreement with Kingsbridge which allows us to issue and sell and
requires Kingsbridge to purchase up to an aggregate of $18,000,000 of our common
stock, subject to certain limitations based on market price and trading volume
of our common stock and the satisfaction of other conditions. We cannot assure
you that we will meet all of the conditions required to obtain financing under
the equity line agreement. Further, if our current and projected needs change
due to unanticipated events or otherwise, we may be required to obtain
additional capital and there can be no assurance that additional financing will
be available or that the terms of any financing will be acceptable to us. If
adequate funds are not available, we may be required to delay, scale back or
eliminate one or more of our product development programs, including but not
limited to the further development of our software products, or related
products, or we may be forced to obtain funds through entering into arrangements
with collaborative partners or others that may require us to relinquish rights
to our technologies or products that we would not otherwise relinquish.

BECAUSE POTENTIAL CUSTOMERS MAY NOT ACCEPT OUR PRODUCTS WE MAY NEVER ACHIEVE
ENOUGH SALES TO MAKE OUR BUSINESS PROFITABLE.

         The commercial success of our products will be dependent on their
acceptance by potential customers. Our software products are based on technology
that has had extremely limited marketplace acceptance and is subject to the
risks of failure inherent in products based on new technologies. A significant
portion of our resources will be used for research and development and marketing
relating to our software and other products and services. There can be no
assurance that we can or will develop


<PAGE>

marketable products. The failure of our products to achieve market acceptance
would have a material adverse effect on us.

WE HAVE LIMITED SALES AND MARKETING CAPABILITIES.

         Our ability to generate revenue and profits from our software products
is dependent upon our ability to successfully market our products. Our sales
efforts for our software products will be undertaken by a direct sales force as
well as potential strategic partners who can develop and market applications
based on our software products in various industries. Substantial marketing
efforts will be required to increase sales. In addition, we are subject to the
risks inherent in any attempt to commercialize products based on emerging
technology, many of which are not within our control. Our ability to generate
revenue and profits is dependent upon the ability and success of our sales force
and traditional marketing methods. We cannot assure you that we will be
successful in our marketing efforts.

WE ARE DEPENDENT ON STRATEGIC PARTNERS TO HELP MARKET AND COMMERCIALIZE OUR
SOFTWARE PRODUCTS.

         To the extent that we rely upon strategic partners to perform such
functions as marketing or commercialization of applications based on our
software products, we will be dependent upon the ability and willingness of
those strategic partners to perform their obligations in a timely manner. The
amount and timing of the allocation of resources by any strategic partner
pursuant to its arrangement or agreement with us may be affected by numerous
factors not within our control, including, but not limited to:

          o    a change in management or direction by the strategic partner,
          o    the introduction by the strategic partner of products which may
               compete with our products or applications or
          o    the strategic partner's perception of the market for our
               products.

         Conflicts of interest could arise between us and one or more of our
strategic partners which, depending on the nature of the conflict, could have a
material adverse effect upon our business, prospects and financial condition.
Although we will seek to restrict our strategic partners from developing
competitive products we may not be able either to obtain or enforce the
restrictions. Our strategic partners or their affiliates may develop, either
alone or with others, products which are competitive or have applications which
are competitive with our products. Those conflicts could affect the support
provided by the strategic partner for our products which could have a material
adverse effect on us.

         Our ability to enter into arrangements with strategic partners on
acceptable terms may be affected by our financial condition. To the extent that
we are in a position where it requires substantial capital to fund our
operations, it may be necessary for us to grant to strategic partners rights to
our products or technology which we would not otherwise grant. There can be no
assurance that we can or will be able to enter into strategic relationships or
that any agreements or arrangements with strategic partners will generate
revenue or profits for us.

OUR DEPENDENCE ON A LICENSE AGREEMENT COULD HAVE A MATERIAL ADVERSE EFFECT ON
OUR BUSINESS.

         One of our software products, MuSE (Multi-dimensional user oriented
Synthetic Environment), is based on software which is licensed to us by Sandia
Corporation. The license agreement grants us exclusive rights to develop and
commercialize MuSE until October 2005 and thereafter provides a non-exclusive
right through 2015. At the end of the period of exclusivity, we may request that
Sandia extend our exclusivity through 2015, which determination shall be made in
Sandia's sole discretion. Sandia Corporation has the right to terminate the
license or make the license non-exclusive in the event we fail to pay the
required royalties under the license agreement, with an annual minimum royalty
of $20,000


<PAGE>

through the year ending December 31, 2006. Any termination of the license
agreement will have a material adverse effect on us. Furthermore, if and when
the license becomes non-exclusive, other companies may obtain the rights to the
MuSE technology to develop products which may compete with our products.

THE COMPUTER AND SOFTWARE INDUSTRIES ARE SUBJECT TO RAPID CHANGES IN TECHNOLOGY.

         The computer industry in general and the software industry in
particular are subject to rapid changes in technology, which can make our
hardware or software obsolete. Advances in technology create markets for new
products and can change or reduce the market for existing products. There can be
no assurance that future technological developments will not result in
technologies which render our products or applications obsolete. In order for us
to obtain market acceptance of our software and related products, we must be
able to convince our potential customers and strategic partners that we have the
technological capabilities to meet the technological demands of the marketplace.
Furthermore, the willingness of a potential strategic partner to enter into an
agreement or arrangement with us and to devote the financial and personnel
resources to the development of applications using our software may be dependent
on, among other factors, our ability or the ability of the strategic partner to
offer solutions which are competitive with products developed and offered by
others and whether those products can generate an acceptable market share.

WE MAY HAVE DIFFICULTY PROTECTING PATENTS AND OTHER PROPRIETARY RIGHTS TO OUR
TECHNOLOGY AND INTELLECTUAL PROPERTY CLAIMS AGAINST US CAN BE COSTLY AND MAY
RESULT IN THE LOSS OF SIGNIFICANT RIGHTS.

         We believe that patent and other protection of intellectual property
rights is crucial to our business and that our future will depend in part on our
ability to develop proprietary and/or patented products, maintain trade secret
protection and operate without infringing the proprietary rights of others. Our
products are based on patents and other proprietary technology developed by us
and by Sandia Corporation or licensed to us by others. Patents have been issued
separately to us and to Sandia Corporation with respect to various aspects of
MuSE. However, no assurance can be given that the patents will be upheld if
challenged. Any challenge to the validity of our patent or license rights,
regardless of whether we ultimately prevail, could be expensive and could
require us to use a significant portion of our resources for litigation, without
any assurance of success.

         Under our license agreement with Sandia Corporation, Sandia has the
obligation to defend the patents licensed to us against any claim of
infringement or invalidity, as a result of which we will be dependent upon
Sandia's willingness or ability to defend the patents against any claim.

         We cannot assure you that third parties will not challenge the validity
and enforceability of the patent applications or any patents owned or issued in
the future to us, or that the challenges will not be successful. We cannot
assure you that patent infringement claims will not be asserted and found to
have merit, that we will not be enjoined from using MuSE or licensing MuSE, or
that we would not be forced to obtain a license and pay future royalty fees as
well as past damages to the party claiming infringement.

         We will generally rely on a combination of trade secret, copyright,
trademark and patent law to protect our proprietary rights in the intellectual
property developed by us or licensed to us. Although we intend to provide
products utilizing our software to our customers primarily in object code form,
we cannot assure that unauthorized third parties will not be able to duplicate
the software code.


<PAGE>

BECAUSE OUR PRODUCT LIABILITY INSURANCE MAY BE INSUFFICIENT OR MAY NOT BE
AVAILABLE IN THE FUTURE, OUR BUSINESS COULD BE SIGNIFICANTLY AFFECTED.

         The use of our products, including products designed and marketed by a
potential strategic partner, or the distribution of products manufactured by
others, may expose us to liability claims resulting from the use of such
products. We currently maintain limited product liability insurance in the
aggregate amount of $2,000,000 per occurrence with a total aggregate limit of
$5,000,000, and we cannot assure you that the coverage will be adequate.
Furthermore, we cannot assure you that adequate product liability insurance will
be available to us or any of our strategic partners in the future at a
reasonable cost, if at all. Our inability or the inability of any strategic
partner to obtain sufficient coverage at an acceptable cost or to obtain other
protection against potential liability could prevent or inhibit the
commercialization of one or more of our proposed products. A successful product
liability claim or a product recall would have a material adverse effect upon
our business, prospects and financial condition.

OUR DEPENDENCE ON GOVERNMENT CONTRACTS COULD HAVE A MATERIAL ADVERSE EFFECT ON
OUR BUSINESS.

         We maintain several Federal government contracts and receive grants
from the Federal government, all of which are cancelable and subject to
renegotiation at the option of the government for any reason. We derive a
portion of current revenues, and expect to continue to derive a portion of our
revenues in the near future, from government contracts. Accordingly, any
cancellation or renegotiation relating to significant projects could have a
material adverse impact on us.

OUR BUSINESS MAY BE SIGNIFICANTLY AFFECTED BY THE LOSS OF OUR KEY PERSONNEL.

         We are dependent upon the services of Russell G. Barbour, Chief
Executive Officer of AVS and Brian Clark, President and Chief Financial Officer
of MUSE. Given our early stage of development and the shortage of personnel
trained in the application and adaptation of our MuSE product, we are dependent
on our ability to identify, hire, train, retain and motivate high quality
personnel, especially highly skilled engineers involved in the ongoing
developments required to adapt MuSE to specific applications and solutions. Loss
of the services of any of Messrs. Barbour or Clark could have a material adverse
effect on our operations and financial condition. We have entered into
three-year employment agreements with Mr. Clark commencing as of June 1, 1998,
providing for current annual compensation of $172,500. Each agreement provides
for certain bonuses, severance benefits and non-competition covenants and, in
some cases, payments in the event of a change of control.

WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY WHICH MAY ADVERSELY AFFECT OUR
OPERATIONS.

         There are many companies, both public and private, engaged in
developing and marketing products which compete or have applications which
compete with our products. At the present time, AVS and divisions of Parametric
Technologies, Engineering Animation and Computer Associates, among other
companies, market competing products. We believe that the principal factors
affecting our ability to compete include such factors as:

          o    the functionality and architecture of MuSE and other software
               products developed by us,
          o    the performance and benefits of specific applications created
               using our software products, and
          o    the perceived ability of us and/or a strategic partner to support
               and service MuSE after installation.

         Most of the companies with which we compete and are expected to compete
have substantially greater financial resources, research and development
capabilities, sales and marketing staffs and distribution channels. We cannot
assure you that our products and services will achieve sufficient quality,


<PAGE>

functionality or cost-effectiveness to compete with existing or future
alternatives. Additionally, other major software companies may be able to
develop competing products and, if our software products gain market acceptance,
other more established companies may enter our markets.

OUR BUSINESS MAY BE SIGNIFICANTLY AFFECTED BY COST-REDUCTION PROGRAMS OF OUR
CUSTOMERS.

         The pricing of our software products and software products in general
may be affected by the continuing efforts of end-users and information
technology managers to contain or reduce costs through various means, including
curtailment of discretionary spending or reduction in the scope of or
termination of existing projects. We cannot predict the effect that cost
reduction measures or changes in the overall economy may have on our business,
and we cannot assure you that those actions or changes in the economy will not
have a material adverse effect on our business, financial condition and results
of operations. Further, to the extent that those actions or changes have a
material adverse effect upon the business, financial condition and profitability
of other companies that are prospective strategic partners for our products, our
ability to commercialize or distribute our products may be adversely affected.

QUARTERLY FLUCTUATIONS IN OUR BUSINESS COULD ADVERSELY AFFECT REVENUES,
OPERATING RESULTS AND THE MARKET PRICE OF OUR COMMON STOCK.

         Quarterly revenues and operating results will fluctuate as a result of
a variety of factors. These factors, some of which are beyond our control,
include:

          o    the timing of the completion, material reduction or cancellation
               of major projects,
          o    the loss of a major customer or the termination of a relationship
               with a strategic partner,
          o    timing of the receipt of new business,
          o    timing of the hiring or loss of personnel,
          o    changes in the pricing strategies and business focus of us or our
               competitors,
          o    capital expenditures, operating expenses and other costs relating
               to the expansion of operations, and
          o    general economic conditions and acceptance and use of our
               software products.

         Revenues and operating results are difficult to forecast because of
those fluctuations.

         The trading prices of our common stock and warrants are subject to
fluctuation in response to quarterly variations in operating results,
announcements of technological innovations or new products or services by us or
our competitors, as well as other events or factors. In addition, the stock
market has from time to time experienced price and volume fluctuations which
have particularly affected the market price of technology-oriented and computer
software companies, which often have been unrelated to the operating performance
of these companies. These broad market fluctuations may adversely affect the
market price of our common stock and warrants.

THE FAILURE TO ATTRACT OR THE LOSS OF SENIOR MANAGEMENT PERSONNEL COULD
DETRIMENTALLY IMPACT OUR BUSINESS.

         The success of our company depends to a significant extent on the
efforts of our senior management. The loss of one or more of these individuals
could adversely affect us. Our continued success will depend on our ability to
retain existing, and attract additional, qualified senior management personnel.
We may not be successful in doing this.


<PAGE>

MANAGEMENT WILL HAVE BROAD DISCRETION AS TO THE USE OF THE PROCEEDS FROM THE
EQUITY LINE AGREEMENT.

         The net proceeds from the sale of shares to Kingsbridge under the
equity line agreement and the exercise of the warrants will be used for working
capital purposes, including marketing, research and development and other
general corporate purposes. However, unforeseen circumstances, including general
economic and business conditions or material shifts in our strategy or business
plan may result in a reallocation of the intended use of the proceeds.
Accordingly, management will have broad discretion with respect to the
expenditure of the net proceeds.

IF WE CANNOT SUCCESSFULLY INTEGRATE AVS WITH OUR COMPANY, OUR BUSINESS COULD BE
ADVERSELY AFFECTED.

         The AVS merger involves the integration of two companies that have
previously operated independently. To combine AVS with our company, we will need
to integrate and coordinate:

          o    the management and administrative functions,
          o    product offerings and sales,
          o    marketing, and
          o    research and development efforts of each company.

If we cannot successfully integrate our operations, our business and the results
of operations of the combined businesses could be adversely affected.

Combining AVS with our company will present a number of challenges, including:

          o    the management of businesses with different customer bases and
               different approaches to manufacturing, sales and service, and
          o    the integration of a number of geographically separated research
               and development and other facilities.

Whether or not this will succeed will depend largely on our ability to retain
key management, sales and research and development personnel. In addition, our
management will be occupied with integrating AVS operations with our operations
following the merger and this may temporarily distract management from our
day-to-day business. We cannot assure you that AVS will be successfully
integrated with our company.



<PAGE>



ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         See Item 13(a)(1) in Part IV.

ITEM 8.  CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

         Not Applicable

                                    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
         COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

         The following persons are currently serving as directors or have been
selected as director nominees to serve upon their election to the Board at the
upcoming annual meeting of stockholders. Executive officer positions are noted
in the biographical descriptions.

<TABLE>
<CAPTION>
                                          PRESENT PRINCIPAL OCCUPATION
  NAME, BUSINESS                         AND PRINCIPAL OCCUPATION DURING                    DIRECTOR
 ADDRESS AND AGE                        LAST FIVE YEARS; OTHER ACTIVITIES                    SINCE
 ---------------                        ---------------------------------                    -----
<S>                               <C>                                                       <C>
Jack Berenzweig                    Jack C. Berenzweig has been a director of the             1999
Age 57                             Company since May, 1999.  Mr. Berenzweig
                                   currently practices law with the Chicago
                                   intellectual property law firm of Brinks
                                   Hofer Gilson and Lione, which he joined in
                                   1969. He is a graduate of Cornell University,
                                   where he obtained a bachelor's degree in
                                   Electrical Engineering; and American
                                   University Law School where he obtained a
                                   Juris Doctor degree and was a member of the
                                   Law Review. He is presently a director and
                                   Vice Chairman of the Brand Names Educational
                                   Foundation and a former member of the board
                                   of directors of the International Trademark
                                   Association. In addition, he is an ad hoc
                                   member of the Asian Patent Attorneys'
                                   Association Anti-counterfeiting Committee.

Brian R. Clark                     Brian Clark has been a director of the                    1999
Age 43                             Company since December 1999 and Chief
                                   Financial Officer of the Company since
                                   October 1996 and is also the Company's
                                   Treasurer and Secretary. Prior to becoming
                                   associated with the Company, Mr. Clark was an
                                   executive with Optimax Securities
                                   Corporation, a corporation engaged in
                                   investment banking, from 1995 until October
                                   1996; Chief Financial Officer of Softcop
                                   International, a software development
                                   company, from 1993 to 1995; Manager of
                                   Business Development for Royal Insurance
                                   Company of Canada, from 1989 to 1993; and a
                                   Chartered Accountant with Deloitte & Touche
                                   from 1985 to 1989.
</TABLE>


<PAGE>

<TABLE>
<CAPTION>
<S>                               <C>                                                       <C>
Steve Sukman,                      Steve Sukman joined the Company as Director of            1999
Age 42                             Communications in September 1998 after having
                                   served as a public relations consultant to
                                   MUSE for more than one year prior to his
                                   employment with us. He was promoted to Vice
                                   President of Communications in June 1999 and
                                   to Senior Vice President in June 2000. Prior
                                   to joining MUSE, Mr. Sukman engaged in his
                                   own consulting practice where he specialized
                                   in providing corporate communications
                                   services to technology companies with complex
                                   products in emerging and specialized markets.
                                   He formerly served as Vice President of
                                   Potomac West Properties from 1990 through
                                   1992 and Vice President of Los Angeles
                                   Restaurant Group from 1992 through 1994.

John William Poduska, Sr.          John William Poduska, Sr. is currently the                Director
                                   Chairman of the Board of AVS.  Mr. Poduska was            Nominee
                                   Chairman, Chief Executive Officer and founder
                                   of Stardent Computer Inc., a predecessor
                                   company of AVS. Prior to founding Stardent, he
                                   was Chairman and Chief Executive Officer and
                                   President of Apollo Computer, Inc., and
                                   founder and Vice President of Research and
                                   Development of Prime Computer. He was also an
                                   assistant professor of electrical engineering
                                   at Massachusetts Institute of Technology in
                                   Cambridge, Massachusetts. In addition to his
                                   role as Chairman of the Board for AVS since
                                   November, 1991, Mr. Poduska currently sits on
                                   the board of Cambridge Technology Partners,
                                   Safeguard Scientifics, Union Pacific
                                   Resources, Multi Gen Inc., ICE, Exa
                                   Corporation, XL Vision and EVS. Mr. Poduska
                                   received a Bachelor of Science degree, a
                                   Master of Science degree and a Ph.D. in
                                   electrical engineering and computer sciences
                                   from MIT.

Russell G. Barbour,                Russell G. Barbour has been the President and             Director
Age 49                             Chief Executive Officer and a director of AVS             Nominee
                                   since November, 1998. Mr. Barbour was the Vice
                                   President of Product Development for AVS from
                                   April 1997 until November 1998 when he assumed
                                   his current responsibility. Prior to joining
                                   AVS, Mr. Barbour was President of Acuity
                                   Software, a privately held producer of
                                   software development tools. Mr. Barbour was
                                   also a senior software executive at Apollo
                                   Computer Inc. where he held the position of
                                   Vice President of Advanced Technology. Prior
                                   to Apollo, he held management and technical
                                   positions at Prime Computer and Honeywell
                                   Information Systems.

Ian R.G. Edmonds,                  Ian R. G. Edmonds has been a director of AVS              Director
Age 60                             from November, 1991 until July, 1996 and again            Nominee
                                   from January 1999 to present. Mr. Edmonds is
                                   currently
</TABLE>


<PAGE>

<TABLE>
<CAPTION>
<S>                               <C>                                                       <C>
                                   serving as a consultant with AVS. Prior to
                                   that position, Mr. Edmonds was the President
                                   of SRR Solutions, Inc. SRR Solutions provides
                                   enterprise wide client/server credit and
                                   collections solutions to Fortune 2000 clients.
                                   Mr. Edmonds held vice president roles in
                                   engineering, marketing and customer service
                                   with Prime Computer and Stellar Computer. He
                                   also served as President of Stardent Computer
                                   Inc., the UNIRAS Division of AVS Inc. and
                                   Winsbrook Software, Inc.

John Hough,                        John Hough has been a director since January              2000
Age 48                             2000 and will serve until his current term
                                   expires at the next annual meeting of
                                   stockholders. Mr. Hough served as Managing
                                   Director of Virtual Presence Ltd. on behalf of
                                   the Company from November 1999 to November
                                   2000. Mr. Hough no longer holds any other
                                   positions with the Company or its
                                   subsidiaries.
</TABLE>

         During the fiscal year ended September 30, 2000 the Company's Board of
Directors held 21 meetings, which were each attended by 100% of the then current
directors in person or by telephone.

         All directors hold office until the next annual meeting of stockholders
and the election and qualification of their successors. Directors receive
compensation for serving on the Board of Directors as described below. Until
November 15, 2001, HD Brous & Co., Inc. ("Brous"), the underwriter of the
Company's initial public offering, has the right to designate one nominee,
reasonably acceptable to the Company, for election to the Board of Directors.
However, no such acceptable nominee has as yet been designated by Brous.

         The Company has established an Audit Committee composed of Messrs.
Berenzweig and Masi (Mr. Masi's term will expire on the date of the annual
meeting and he will be replaced by [William S. Poduska, Sr. and Ian R.G.
Edmonds]), all non-employee directors, to determine the adequacy of internal
controls and other financial reporting requirements. The Company has established
a Compensation Committee composed of Messrs. Berenzweig and Masi (to be replaced
by Messrs. Poduska and Edmonds) to review general policy matters relating to
compensation and benefits of employees. Officers are elected annually by the
Board of Directors and serve at the discretion of the Board (and in the case of
certain executive officers pursuant to employment agreements as described
below).

         There is no family relationship among any of the directors or executive
officers of the Company.

ITEM 10. EXECUTIVE COMPENSATION

         The following tables set forth the compensation earned by the Company's
Principal Executive Officer and all other executive officers earning in excess
of $100,000 for the fiscal years ended September 30, 2000, 1999 and 1998.


<PAGE>




<TABLE>
<CAPTION>
                                                                                                    LONG TERM
                                                                                                    COMPENSATION
                                                 ANNUAL                                             SECURITIES
                                                 COMPENSATION                                       UNDERLYING
NAME AND PRINCIPAL POSITION              YEAR    SALARY              BONUS          OTHER           OPTIONS
-------------------------------------    -----   ------------        --------       -----------     -------------
<S>                                      <C>     <C>                 <C>            <C>             <C>
Curtiz J. Gangi, (1)                     2000    $136,118            $100,781       $336,130        375,000
Chief Executive Officer and Director     1999    $215,000            $134,375       --              --
                                         1998    $178,846            --             $172,467(2)     466,447

Brian R. Clark,                          2000    $161,250            $ 49,219                       119,500
President, Chief Financial Officer,      1999    $150,000            $ 65,625       --              --
Secretary, Treasurer and Director        1998    $150,000            --             $172,467(2)     150,395

Steve Sukman,                            2000    $137,884            $ 46,313                        97,500
Senior Vice President and Director       1999    $103,462            $  4,000       --               90,000

John Hough (3)                           2000    $126,935            $ 21,631                       180,000
</TABLE>

(1)  Mr. Gangi resigned all positions with the Company effective May 4, 2000.
     Accordingly, salary for fiscal 2000 reflects amounts received through May
     4, 2000 and Other Compensation reflects severance payments received by Mr.
     Gangi through the fiscal year end. Options issued during the year were
     repurchased pursuant to the Termination Agreement.
(2)  Includes amounts received in connection with (i) the Company's distribution
     agreement with CRI (the "CRI Agreement") and (ii) CRI's purchase of
     1,000,000 shares of Common Stock and warrants to purchase an additional
     1,000,000 shares of Common Stock.
(3)  Mr. Hough's employment with Virtual Presence Ltd. Was terminated in
     November 2000. Upon expiration of his current term as director, Mr. Hough
     will hold no other position with the Company or its subsidiaries.

EMPLOYMENT AGREEMENTS

         The Company has entered into employment agreements (each an "Employment
Agreement" and collectively, the "Employment Agreements") with each of Russell
G. Barbour, Brian R. Clark and Steve Sukman (each, an "Executive" and
collectively, the "Executives"). Under the Employment Agreements, each Executive
must devote his full business time and attention to the affairs of the Company.
John Hough's employment with the Company terminated in November 2000.

         Brian R. Clark has entered into a three-year employment agreement with
our company, which commenced as of June 1, 1998, to act as Chief Financial
Officer at an annual base salary of $150,000. Mr. Clark is also entitled to
receive a bonus of up to $65,625 upon the achievement of certain performance
objectives. In connection with his employment agreement, Mr. Clark received
options to purchase 117,500 shares of our common stock at an exercise price of
$7.50 per share, which vests as follows: 30,000 shares on June 1, 1999, 37,500
shares on June 1, 2000 and 50,000 shares on June 1, 2001. Mr. Clark also
received a five year loan in the amount of $75,000 at 5% annual interest in
connection with his relocation to New Mexico. The loan is secured by vested
stock options having a value equal to the principal amount of the loan. Mr.
Clark was promoted to President of the Company in March 2000


<PAGE>

and received a salary increase to $172,500 and additional stock options to
purchase 117,500 shares of common stock at an exercise price of $2.72 per share,
the fair market value on the date of grant).

         Steve Sukman has entered into a one-year employment agreement with our
company, which commenced as of July 12, 2000, to act as Vice-President at an
annual base salary of $110,000. Mr. Sukman is also entitled to receive a bonus
of up to $35,750 upon the achievement of certain performance objectives. In
connection with his employment agreement, Mr. Sukman received options to
purchase 60,000 shares of our common stock at an exercise price of $3.625 per
share, which vests as follows: 30,000 shares on July 12, 2000 and 30,000 shares
on July 12, 2001.

         On November 15, 1999, John Hough entered into a three-year employment
agreement with Virtual Presence Limited, to act as Managing Director at an
annual base salary of $150,000. Mr. Hough is also entitled to receive a bonus
each year of up to $45,000 upon the achievement of certain performance
objectives. Mr. Hough also received a signing bonus of $50,000 on November 15,
1999. In connection with his employment agreement, Mr. Hough received options to
purchase 90,000 shares of our common stock at an exercise price of $3.125 per
share. Mr. Hough's employment agreement with Virtual Presence Limited was
terminated on November 13, 2000.

         Under the Employment Agreements, if the Executive is terminated by the
Company other than "for cause" (as defined in each Employment Agreement), or if
the Executive dies or becomes permanently disabled or terminates for "good
reason" (as defined in each Employment Agreement), all stock options of the
Executive shall immediately vest upon such termination and such Executive shall
receive severance payments in an amount equal to one year's base salary. Each of
the Employment Agreements also contain provisions relating to severance payments
equal to one year's base salary in the event of a change of control (as defined
in the Employment Agreement).

         Each of the Employment Agreements prohibits disclosure of proprietary
and confidential information regarding the Company and its business to anyone
outside the Company both during and subsequent to employment. In addition, each
Executive has agreed, for the duration of his employment with the Company and
for a period of one year thereafter, if the Executive is terminated for any
reason or resigns, not to engage in any competitive business activity; provided,
however, that such non-compete shall be in effect for so long as the Company
continues to pay the Executive's monthly base salary.

         The Employment Agreements provide that the Company will indemnify the
Executive to the fullest extent permitted by the laws of Delaware and in
accordance with the Company's By-Laws and Certificate of Incorporation.

DIRECTORS' COMPENSATION

         The Company pays each non-employee director a fee of $500 for
attendance at each board meeting and reimburses its non-employee directors for
expenses incurred in connection with their attendance at such meetings.
Non-employee directors receive options to purchase 5,000 shares of Common Stock
upon initial election to the Board of Directors and options to purchase 8,000
shares of Common Stock upon re-election at each annual meeting of stockholders,
exercisable after one-year at an exercise price equal to the fair market value
on the date of grant.


ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Insert Rider A


<PAGE>

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Pursuant to their employment agreements, Messrs. Gangi and Clark
received five year loans from the Company in the amounts of $150,000 and
$75,000, respectively, in connection with their relocation to New Mexico. The
loans bear interest at the rate of 5% per annum and are secured by the pledge of
vested stock options having a value equal to the principal amount of the loan.
The loan to Mr. Gangi was exchanged for the cancellation of certain stock
options in connection with his severance arrangement.

         The Company believes that the transactions between the Company and its
officers, directors and employees described above are on terms no less favorable
to the Company than could have been obtained from unaffiliated parties under
similar circumstances.

         From its inception, the Company has maintained and it intends to
continue to maintain at least two independent directors on its Board of
Directors. In connection therewith, any and all material transactions, including
material loans with officers, directors, stockholders holding greater than 5% of
the outstanding shares or affiliates, have been ratified and/or approved and, in
the future, will be ratified and/or approved by a majority of independent
directors who do not have an interest in the transactions, and will be on terms
which are at least as favorable to the Company as those that can be obtained by
unaffiliated third parties, and all such transactions shall be entered into by
the Company for a bona fide purpose. Such independent directors will have full
access, at the Company's expense, to the Company's counsel or other independent
counsel in connection with such ratification or approval of any transaction.

FILING REQUIREMENTS

         The Company believes that all filing requirements under Section 16(a)
of the Securities Exchange Act of 1934, as amended, applicable to its officers,
directors and greater than 10% beneficial owners were complied with during the
fiscal year ended September 30, 2000.

                                     PART IV

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a)      Documents filed as part of this report.


<TABLE>
<CAPTION>
         Page
         ----

        <S>                                                                                                 <C>
         1.       Financial Statements (appearing at end of this report)

                  Independent Auditor's Report                                                                F-1

                  Balance Sheet - September 30, 2000                                                          F-2

                  Statements of Operations - For the years ended
                  September 30, 2000 and 1999                                                                 F-3

                  Statements of Stockholders' Equity -
                  For the years ended September 30, 2000 and 1999                                             F-4
</TABLE>


<PAGE>

<TABLE>
<CAPTION>
        <S>                                                                                                 <C>
                  Statements of Cash Flows - For the years ended
                  September 30, 2000 and 1999                                                                 F-5

                  Notes to Financial Statements                                                               F-6

         2.       Exhibits

                  1.1      Revised Form of Underwriting Agreement.(1)

                  1.2      Revised Form of Underwriter's Unit Purchase
                           Option.(1)

                  3.1      Certificate of Incorporation of the Registrant, as
                           amended.(1)

                  3.2      By-Laws of the Registrant.(1)

                  3.3      Amendment No. 1 to By-Laws of Registrant.(1)

                  4.1      Specimen Stock Certificate.(1)

                  4.2      Revised Form of Warrant Agreement between the
                           Registrant and American Stock Transfer & Trust
                           Company, including the revised form of Class A
                           Redeemable Common Stock Purchase Warrant and the form
                           of Class B Redeemable Common Stock Purchase
                           Warrant.(1)

                  10.1     License Agreement dated October 9, 1995 between the
                           Company and Sandia, as amended.(1)/**

                  10.2     Office Lease dated September 6, 1995 between the
                           Company and Airpark Associates, as amended.(1)

                  10.3     1995 Stock Option Plan.(1)

                  10.4     1996 Stock Option Plan.(1)

                  10.4(a)  Amendment No. 1 to 1996 Stock Option Plan.(1)

                  10.6     Employment Agreement, dated as of August 1, 1998,
                           between Craig Peterson and the Registrant.(1)

                  10.7     Employment Agreement, dated as of June 1, 1998,
                           between Curtiz J. Gangi and the Registrant.(1)

                  10.8     Employment Agreement, dated as of June 1, 1998,
                           between Brian Clark and the Registrant.(1)

                  10.9     Employment Agreement, dated as of June 1, 1998,
                           between Douglas Harless and the Registrant.(1)

                  10.10    Super Value-Added Reseller (S-VAR) Agreement, dated
                           June 19, 1998 between Continuum Resources
                           International ASA and the Registrant.(1)/**
</TABLE>


<PAGE>

<TABLE>
<CAPTION>
                 <S>                                                                                        <C>
                  10.11    Share Purchase Agreement, dated as of November 15,
                           1999, between John Edmund Hough and the
                           Registrant.(2)

                  10.12    Share Purchase Agreement, dated as of November 15,
                           1999, between GLE Development Capital Limited and the
                           Registrant.(2)

                  10.13    Assignment Agreement, dated as of November 16, 1999,
                           among the Registrant, VR Solutions Limited and
                           Intelligent Solutions Limited.(2)

                  10.14    Sixth Amendment to Lease, dated November 18, 1999, by
                           and between Merit Albuquerque Limited Partnership,
                           successor in interest to Airpark Associates, and the
                           Company.(3)

                  10.15    Agreement of Sublease, dated June 15, 1999, by and
                           between Continuum Resources International, Inc. and
                           the Company.(3)

                  10.16    Share Purchase Agreement, dated November 15, 1999
                           between John Edmund Hough and the Company.(4)

                  10.17    Share Purchase Agreement, dated November 15, 1999
                           between the Company and GLE Development Capital
                           Limited.(4)

                  10.18    Assignment Agreement, dated November 16, 1999 among
                           the Company, VR Solutions Limited and Intelligent
                           Systems Solutions Limited. (4)
</TABLE>


<PAGE>

                  10.19    Agreement and Plan of Merger, dated as of July 18,
                           2000, among Advanced Visual Systems Inc., MUSE Merger
                           Sub, Inc. and MUSE Technologies, Inc. (incorporated
                           herein by reference to Exhibit 2.1 of Muse
                           Technologies, Inc.'s registration on FOrm S-4 filed
                           on August 9, 2000 (Commission File No. 333-43384)).

                  10.20    Form of Escrow Agreement among MUSE Technologies,
                           Inc., Russel G. Barbour and John William Poduska,
                           Sr., as representatives of the AVS stockholders,
                           Advanced Visual Systems Inc. and the escrow agent
                           (incorporated herein by reference to Exhibit 2.2 of
                           Muse Technologies, Inc.'s registration statement on
                           Form S-4 filed on August 9, 2000 (Commission File No.
                           333-43384)

                  10.21    Form of Affiliate Agreement of affiliates of Advanced
                           Visual Systems Inc. (incorporated herein by reference
                           to Exhibit 2.3 of Muse Technologies, Inc.'s
                           registration on Form S-4 filed on August 9, 2000
                           (Commission File No. 333-43384)

                  10.22    Private Equity Line Agreement dates as of June 1,
                           2000 by and between Kingsbridge Capital Limited and
                           MUSE Technologies, Inc. (incorporated herein by
                           reference to Exhibit 1 of Muse Technologies, Inc.'s
                           registration statement on Form 8-K, filed on June 8,
                           2000 (Commission File No. 001-14559)).

                  10.23    Registration Rights Agreement dated as of June 1,
                           2000 by and between Kingsbridge Capital Limited and
                           MUSE Technologies, Inc. (incorporated herein by
                           reference to Exhibit 2 of Muse Technologies, Inc.'s
                           registration statement on Form 8-K, filed on June 8,
                           2000 (Commission File No. 001-14559)).

                  10.24    Escrow Agreement dated as of June 1, 2000 among Bank
                           of Albuqerque, N.A., Kingsbridge Capital Limited and
                           MUSE Technologies, Inc. (incorporated herein by
                           reference to Exhibit 3 of Muse Technologies, Inc.'s
                           registration statement on Form 8-K, filed on June 8,
                           2000 (Commission File No. 001-14559)).

                  10.25    Warrant dated as of June 1, (incorporated herein by
                           reference to Exhibit 4 of Muse Technologies, Inc.'s
                           registration statement on Form 8-K, filed on June 8,
                           2000 (Commission File No. 001-14559)).

                  10.26    Purchase Agreement dated as of August 7, 2000 by and
                           between Kingsbridge Capital Limited and MUSE
                           Technologies, Inc. (incorporated herein by reference
                           to Exhibit 1 of Muse Technologies, Inc.'s
                           registration statement on Form 8-K, filed on August
                           10, 2000 (Commission File No. 001-14559)).


<PAGE>

                  10.27    Registration Rights Agreement dated as of August 7,
                           2000 by and between Kingsbridge Capital Limited and
                           MUSE Technologies, Inc. (incorporated herein by
                           reference to Exhibit 2 of Muse Technologies, Inc.'s
                           registration statement on Form 8-K, filed on August
                           10, 2000 (Commission File No. 001-14559)).

                  10.28    Convertible Promissory Note dated as of August 7,
                           2000 (incorporated herein by reference to Exhibit 3
                           of Muse Technologies, Inc.'s registration statement
                           on Form 8-K, filed on August 10, 2000 (Commission
                           File No. 001-14559)).

                  10.29    Warrant dated as of August 7, 2000 (incorporated
                           herein by reference to Exhibit 4 of Muse
                           Technologies, Inc.'s registration statement on Form
                           8-K, filed on August 10, 2000 (Commission File No.
                           001-14559)).

                  10.30    Employment Agreement between Muse Technologies, Inc.
                           and Steve Sukman dated July 12, 2000 (incorporated
                           herein by reference to exhibits to registration
                           statement on Form SB-2, filed November 14, 2000
                           (Commission File No. 333-46152).

                  10.31    Employment Agreement between Virtual Presence Limited
                           and John Edmund Hough dated November 15, 1999
                           (incorporated herein by reference to exhibits to
                           registration statement on Form SB-2, filed November
                           14, 2000 (Commission File No. 333-46152).

                  10.32    Amendment No. 1 to the Private Equity Line Agreement
                           dated as of November 1, 2000 vby and between
                           Kingsbridge Capital Limited and MUSE Technologies,
                           Inc. (incorporated herein by reference to exhibits to
                           registration statement on Form SB-2, filed November
                           14, 2000 (Commission File No. 333-46152).

                  10.33    Amendment No. 1 to the Purchase Agreement dated as of
                           November 1, 2000 by and between Kingsbridge Capital
                           Limited and MUSE Technologies, Inc. (incorporated
                           herein by reference to exhibits to registration
                           statement on Form SB-2, filed November 14, 2000
                           (Commission File No. 333-46152).

                  21       List of Subsidiaries

------------------------
(1)      Incorporated by reference from the Registrant's Registration Statement
         on Form SB-2 (Commission File No. 333-62495).

(2)      Incorporated by reference from the Registrant's Current Report on Form
         8-K filed with the Commission on November 24, 1999.

(3)      Incorporated by reference from the Registrant's Annual Report on Form
         8-KSB for the fiscal year ended September 30, 1999.

(4)      Incorporated by reference from Registrant's Annual Report on Form 8-K
         dated November 24, 1999.

**       Portions of this document have been deleted pursuant to a request for
         confidential treatment.

The Company filed the following Current Reports on Form 8-K during the last
quarter of the period covered by this Report:

(ii)     Current Report on Form 8-K filed on July 25, 2000 reporting the
         execution of merger documents relating to the AVS acquisition.

(iii)    Current Report on Form 8-K filed on August 10, 2000 reporting the sale
         of the convertible note to Kingsbridge.

(iv)     Current Report on Form 8-K filed on November 1, 2000 reporting
         anticipated management changes as a result of the merger with AVS and
         anticipated results for the fourth fiscal quarter.

(v)      Current Report on Form 8-K filed on November 22, 2000 reporting the
         completion of the AVS acquisition.



<PAGE>




                                   SIGNATURES

         In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

                                           MUSE TECHNOLOGIES, INC.

                                           By:      /s/ Brian R. Clark
                                                    Brian R. Clark, President

Dated:   January 29, 2001


                                POWER OF ATTORNEY

Each of the undersigned hereby appoints Brian R. Clark, as his attorney-in-fact
to sign his name, in any and all capacities, to any amendments to this Form
10-KSB and any other documents filed in connection therewith to be filed with
the Securities and Exchange Commission.

In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.

<TABLE>
<CAPTION>
<S>                                          <C>                                              <C>
                  SIGNATURE                                         TITLE                               DATE

         /s/ Brian R. Clark                     President (principal executive officer),       January 29, 2001
         Brian R. Clark                         Chief Financial Officer (principal financial
                                                and accounting officer), Secretary and
                                                Director

         /s/ Steve Sukman                       Senior Vice President and Director             January 29, 2001
         ---------------------------------
         Steve Sukman

         /s/ Jack Berenzweig                    Director                                       January 29, 2001
         Jack Berenzweig

         /s/ Edward A. Masi                     Director                                       January 29, 2001
         --------------------------------
         Edward A. Masi

                                                Director

         John Hough


</TABLE>


<PAGE>

                             MUSE TECHNOLOGIES, INC.

                          INDEX TO FINANCIAL STATEMENTS

                                                                   Page
                                                                   ----
         Independent Auditors' Report                              F-1

         Balance Sheets                                            F-2

         Statements of Operations                                  F-3

         Statement of Stockholders' Equity                         F-4

         Statements of Cash Flows                                  F-5

         Notes to Financial Statements                             F-6-28


<PAGE>



                          INDEPENDENT AUDITORS' REPORT

To the Stockholders and
Board of Directors of
MUSE Technologies, Inc.
Albuquerque, New Mexico

         We have audited the accompanying balance sheet of MUSE Technologies,
Inc. as of September 30, 2000, and the related statements of operations,
stockholders' equity and cash flows, for the years ended September 30, 2000 and
1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of MUSE Technologies,
Inc. as of September 30, 2000, and the results of their operations and their
cash flows, for the years ended September 30, 2000 and 1999 in conformity with
generally accepted accounting principles.

         The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 2 (a) to the
financial statements, the Company has suffered recurring losses and has a net
capital deficiency that raise substantial doubt about its ability to continue as
a going concern. Management's plans in regard to these matters are also
described in Note 2 (a). The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.

                                                  /s/Feldman Sherb & Co., P.C.
                                                  Feldman Sherb & Co., P.C.
                                                  Certified Public Accountants

New York, New York
January 26, 2001

                                      F-1



<PAGE>


                             MUSE TECHNOLOGIES, INC.

                           CONSOLIDATED BALANCE SHEET

                               SEPTEMBER 30, 2000


<TABLE>
<CAPTION>

                                          ASSETS
<S>                                                                         <C>
CURRENT ASSETS:
           Cash and cash equivalents                                        $     441,804
           Marketable securities                                                1,262,603
           Accounts receivable                                                  1,393,088
           Notes receivable-related parties ( net of reserve of $250,000)       1,875,000
           Inventory                                                              109,277
           Other current assets                                                   311,552
                                                                            -------------
                  TOTAL CURRENT ASSETS                                          5,393,324
                                                                            -------------

PROPERTY AND EQUIPMENT - NET                                                    1,645,279

OTHER ASSETS:
           Goodwill-net                                                         2,990,335
           Capitalized development costs-net                                    1,221,265
           Other assets                                                            84,584
                                                                            -------------
                  TOTAL OTHER ASSETS                                            4,296,184
                                                                            -------------
                                                                            $  11,334,787
                                                                            =============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
           Accounts Payable                                                 $   2,315,608
           Accrued Liabilities                                                  1,757,235
           Bank Note Payable                                                      970,000
           Current Portion Lease Payable                                           39,138
                                                                            -------------
                  TOTAL CURRENT LIABILITIES                                     5,081,981
                                                                            -------------

LONG-TERM LIABILITIES:
           Lease Payable-less current portion                                      91,592
           Convertible Debentures (less discount of $110,916)                     889,084
                                                                            -------------
                  TOTAL LONG-TERM LIABILITIES                                     980,676
                                                                            -------------

STOCKHOLDERS EQUITY:
           Common stock, par value $.015, authorized 50,000,000 shares;
                   issued and outstanding 10,927,229                              163,909
           Additional Paid in Capital                                          26,202,619
           Accumulated Deficit                                               (20,482,177)
           Less : Treasury Stock at Cost                                        (776,315)
           Cumulative Translation adjustment                                      164,094
                                                                            -------------
                           TOTAL STOCKHOLDERS EQUITY                            5,272,130
                                                                            -------------
                                                                            $  11,334,787
                                                                            =============
</TABLE>


                See notes to consolidated financial statements.

                                      F-2
<PAGE>

                             MUSE TECHNOLOGIES, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                                    Year Ended September 30,
                                                                 ------------------------------
                                                                       2000           1999
                                                                 -------------   -------------
<S>                                                              <C>             <C>
REVENUES                                                         $   6,069,592   $   1,723,267
                                                                 -------------   -------------

EXPENSES:
           Cost of revenues                                          3,396,238           -
           Selling, general and administrative expenses              7,712,411       4,180,717
           Research and development                                  2,992,721       2,302,885
           Officer severance costs                                     994,062           -
           Merger/acquisition costs                                    596,709           -
           Write-down of goodwill                                      637,159           -
           Amortization                                                706,400           -
           Depreciation                                                778,531         487,360
                                                                 -------------   -------------

TOTAL OPERATING EXPENSES                                            17,814,231       6,970,962
                                                                 -------------   -------------

NET OPERATING  LOSS                                               (11,744,639)     (5,247,695)
                                                                 -------------   -------------

OTHER INCOME (EXPENSE)
           Cost in excess of value of repurchased stock                  -           (563,636)
           Unrealized Loss on Investments                            (687,625)           -
           Interest Expense                                           (75,211)        (30,678)
           Interest Income                                             412,199         729,061
                                                                 -------------   -------------
TOTAL OTHER INCOME (EXPENSE)                                         (350,637)         134,747
                                                                 -------------   -------------

NET LOSS                                                         $(12,095,276)   $ (5,112,948)
                                                                 ============    ============

NET LOSS PER COMMON SHARE - BASIC                                $      (1.12)   $      (0.51)
                                                                 ============    ============

WEIGHTED AVERAGE NUMBER OF
           COMMON SHARES OUTSTANDING:                               10,823,329      10,123,942
                                                                 ============    ============
</TABLE>



                 See notes to consolidated financial statements.

                                       F-3

<PAGE>

                             MUSE TECHNOLOGIES, INC.

                        STATEMENT OF STOCKHOLDERS EQUITY

<TABLE>
<CAPTION>

                                                        Common Stock                  Additional      Stock
                                                    ------------------   Treasury       Paid-In    Subscription  Accumulated
                                                    Shares      Amount     Stock         Capital     Receivable      Deficit
                                                  ----------   --------   --------     -----------  ------------ -------------
<S>                                                <C>         <C>        <C>          <C>           <C>         <C>
Balance September 30, 1998                         8,838,893   $132,583   $    -       $14,442,966   $(87,500)   $ (3,273,953)

         Sale of common stock pursuant to
                 Initial Public Offering           1,380,000     20,700                  9,083,393
         Purchase of common shares for                                     (776,315)
                 the Treasury
         Issuance of common stock per
                 exercise of cashless option         155,265      2,329                    (2,329)
         Exercise of stock options                    33,990        510                     84,465
         Net Income                                                                                                (5,112,948)
                                                  ----------    -------    --------     ----------    -------      ----------
Balance September 30, 1999                        10,408,148    156,122    (776,315)    23,608,495    (87,500)     (8,386,901)

         Issuance of common stock per
                 exercise of cashless option          43,347        650                      (650)
         Issuance of common stock for
                 repayment of debt                    84,184      1,263                    261,812
         Issuance of common stock for
                 acquisitions of subsidiaries        391,550      5,874                  1,752,962
         Repayment of stock subscription
                 payable                                                                                87,500
         Warrants issued for services
                 and financing                                                             580,000
         Foreign Currency Translation
                 adjustment
         Net Loss                                                                                                 (12,095,276)
                                                  ----------    -------    --------     ----------    -------      ----------
Balance September 30, 2000                        10,927,229   $163,909   $(776,315)   $26,202,619   $       -   $(20,482,177)
                                                  ==========   ========   =========    ===========   ========    ============
</TABLE>


<TABLE>
<CAPTION>
                                                 Accumulated
                                                    Other            Total          Total
                                                 Comprehensive    Stockholders  Comprehensive
                                                     Loss           Equity           Loss
                                                  ------------ -------------   ---------------
<S>                                                 <C>        <C>             <C>
Balance September 30, 1998                          $  -       $  11,214,096   $       -

         Sale of common stock pursuant to
                 Initial Public Offering                           9,104,093
         Purchase of common shares for                             (776,315)
                 the Treasury
         Issuance of common stock per
                 exercise of cashless option                           -
         Exercise of stock options                                    84,975
         Net Income                                              (5,112,948)
                                                    --------   -------------   ------------

Balance September 30, 1999                             -          14,513,901           -

         Issuance of common stock per
                 exercise of cashless option                           -
         Issuance of common stock for
                 repayment of debt                                   263,075
         Issuance of common stock for
                 acquisitions of subsidiaries                      1,758,836
         Repayment of stock subscription
                 payable                                              87,500
         Warrants issued for services
                 and financing                                       580,000
         Foreign Currency Translation
                 adjustment                          164,094         164,094         164,094
         Net Loss                                               (12,095,276)    (12,095,276)
                                                    --------   -------------   ------------
Balance September 30, 2000                          $164,094   $   5,272,130   $(11,931,182)
                                                    ========   =============   ============
</TABLE>

                 See notes to consolidated financial statements.


                                       F-4

<PAGE>

                             MUSE TECHNOLOGIES, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                              Years Ended September 30,
                                                                           ------------------------------
                                                                                2000             1999
                                                                           -------------    -------------
<S>                                                                        <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
         Net loss                                                          $(12,095,276)    $ (5,112,948)
         Adjustments to reconcile net loss to net cash
               used in operating activities:
                      Depreciation                                               778,531         487,360
                      Amortization                                               706,400          25,521
                      Write-down of goodwill                                     637,159               -
                      Warrants issued for services                               459,000               -
                      Forgiveness of note receivable                             150,000               -
                      Write-off of note receivable                               250,000               -
                      Amortization of debt discount                               10,084               -
                      Unrealized loss on investments                             687,625
                      Repurchase of common shares for treasury                         -       (776,315)
         Changes in assets and liabilities:
               Accounts receivable                                             (329,451)       3,696,407
               Inventory                                                        (68,171)               -
               Other current assets                                                6,720       (195,870)
               Other assets                                                      (3,010)        (52,332)
               Accounts payable                                                1,335,856       (111,934)
               Accrued liabilities                                             (230,541)          71,093
                                                                          --------------   -------------
         NET CASH USED IN OPERATING ACTIVITIES                               (7,705,074)     (1,969,018)
                                                                          --------------   -------------

CASH FLOWS FROM INVESTING ACTIVITIES:
               Investment in marketable securities                           (1,950,228)
               Purchase of property and equipment                              (515,232)     (1,143,672)
               Capitalization of development costs                           (1,628,353)
               Acquisition of subsidiaries, net of cash acquired             (1,068,005)
                                                                          --------------   -------------
         CASH USED IN INVESTING ACTIVITIES                                   (5,161,818)     (1,143,672)
                                                                          --------------   -------------

CASH FLOWS FROM FINANCING ACTIVITIES :
               Net proceeds from sale of stock                                         -       9,104,093
               Receipt of stock subscription receivable                           87,500       4,000,000
               Net proceeds from exercise of stock options                             -          84,975
               Deferred offering costs                                                 -         363,860
               Issuance of notes receivable                                  (1,000,000)     (1,275,000)
               Payment of notes receivable                                        55,000               -
               Principal payments on capital leases                             (50,259)        (14,907)
               Repayments of notes payable-others                                      -       (625,000)
               Borrowings-convertible debentures                               1,000,000               -
               Borrowings-line of credit                                         970,000               -
                                                                          --------------   -------------
         NET CASH PROVIDED BY FINANCING ACTIVITIES                             1,062,241      11,638,021
                                                                          --------------   -------------

EFFECT OF EXCHANGE ON CASH                                                       181,721               -
                                                                          --------------   -------------

NET (DECREASE) INCREASE IN CASH                                             (11,622,930)       8,525,331

CASH - BEGINNING OF YEAR                                                      12,064,734       3,539,403

                                                                          --------------   -------------
CASH - END OF YEAR                                                        $      441,804   $  12,064,734
                                                                          ==============   =============

SUPPLEMENTAL DISCLOSURES OF
         CASH FLOW INFORMATION:

         Cash paid during the year for interest                           $       50,743   $      30,678
                                                                          ==============   =============
         Non-cash financing and investing activities:

                (1)   Issuance of common shares for
                      acquisition of business                                  2,021,910               -
                (2)   Issuance of notes payable for
                      acquisition of business                                    150,000               -
                (3)   Issuance of warrants for financing                         121,000               -
                (4)   Issuance of common shares pursuant
                      to exercise of cash-less options                               650           2,329
                (5)   Purchase of equipment through
                      capital leases payable                                           -          68,321
</TABLE>

                       See notes to financial statements.

                                       F-5




<PAGE>


                             MUSE TECHNOLOGIES, INC.

                          NOTES TO FINANCIAL STATEMENTS

              YEARS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 30, 1999

1.       THE COMPANY

         MUSE Technologies, Inc. (the "Company") was incorporated in Delaware on
         October 24, 1995 to develop and market software products, designed to
         enhance the user's ability to understand and analyze data and
         information and to provide solutions to complex data integration and
         data management problems. The multisensory capabilities of the software
         ("MuSE"), enables the user to present information in real time using
         visual, auditory, tactical and other analytical tools. The Company has
         also developed a proprietary software product, "Continuum", designed
         for multiuser, real-time collaboration within the MuSE environment.

         The Company commenced operations in December 1995. Prior to entering
         into an exclusive marketing agreement in July 1998 (see note 12), the
         majority of the Company's revenue had been generated from products
         utilizing the MuSE technology and applied research and development
         services for customers in the Federal, corporate and nonprofit markets
         of the United States.

         In November 1998, the Company completed an initial public offering of
         its securities.

         In July 1999 the Company created a wholly owned subsidiary, MUSE
         Federal Systems Group, Inc. (the "Subsidiary") to market the Company's
         software to various agencies of the federal government.

         On November 16, 1999, the Company purchased all of the outstanding
         stock of Virtual Presence, Ltd., and its subsidiaries ("VPL"), a U.K.
         company that creates 3D graphics solutions using proprietary and third
         party software and hardware. VPL (also known as MUSE Virtual Presence)
         operates out of offices in London and Manchester, U.K., and is the
         majority shareholder of Sim Team SARL, a French company that provides
         products and services similar to that of VPL, in France.

         On March 17, 2000, the Company through its VPL subsidiary purchased all
         of the outstanding stock of Simulation Solutions, Ltd., ("SimSol") a
         U.K. company that specializes in developing and implementing advanced
         software and consulting services, for use by manufacturer of industrial
         plant and equipment. SimSol (also known as MUSE Simulation Solution)
         operates out Manchester, U.K., in the offices of VPL.

         On March 28, 2000, the Company through its VPL subsidiary completed an
         asset purchase of the VRsource.com, ("VRsource") from The VR Source,
         Inc., a Colorado corporation. VRsource (also known as MUSE VRsource),
         is an e-commerce Web site that


                                      F-6
<PAGE>

         is a reseller of the Company's hardware and software products, along
         with outside vendors' hardware and software products, that are used in
         advanced computer graphics, virtual reality and data visualization.

         On November 9, 2000 the Company completed a business combination with
         Advanced Visual Systems Inc. ("AVS"), an international data
         visualization company. AVS, based out of Waltham, Massachusetts, sells
         software products and services through a direct sales force in North
         America and Europe and through such indirect channels as distributor
         networks and software vendors. The acquisition was completed under the
         Agreement and Plan of Merger (the "Merger Agreement"), dated as of July
         18, 2000, between the Company, MUSE Merger Sub, Inc., a wholly-owned
         subsidiary of the Company ("Merger Sub"), and AVS. Pursuant to the
         Merger Agreement, AVS which was merged with and into Merger Sub, became
         a wholly-owned subsidiary of the Company (the "Merger").The Merger will
         be accounted for as a pooling of interests.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         a.       Basis of Presentation - The accompanying consolidated
                  financial statements have been prepared assuming that the
                  Company will continue as a going concern. The Company has
                  incurred net losses of approximately $12,095,000 and
                  $5,113,000 for the years ended September 30, 2000 and 1999,
                  respectively. Additionally, the Company had an accumulated
                  deficit of $20,482,177 at September 30, 2000 and negative cash
                  flow from operations for the years ended September 30, 2000
                  and 1999, of approximately $7,705,000 and $1,969,000,
                  respectively. These conditions raise substantial doubt about
                  the Company's ability to continue as a going concern.

                  Management's plans with respect to the above include seeking
                  to raise additional capital through the private placement of
                  securities and/or entering into new loan and credit
                  facilities. The recovery of assets and continuation of future
                  operations are dependent upon the Company's ability to obtain
                  additional debt or equity financing and its ability to
                  generate revenues sufficient to continue pursuing its business
                  purposes. The accompanying consolidated financial statements
                  do not include any adjustments that might be necessary should
                  the Company be unable to continue as a going concern.

         b.       Principles of Consolidation - The accompanying consolidated
                  financial statements include the accounts of the Company and
                  all of its wholly owned and majority-owned subsidiaries. All
                  significant intercompany transactions and balances have been
                  eliminated in consolidation.

                                      F-7
<PAGE>

         c.       Minority Interest - Minority interest represents the minority
                  shareholders' proportionate share of the equity of the
                  Company's subsidiary, Sim Team SARL, which was acquired on
                  November 16, 1999. The minority shareholders' ownership is
                  approximately 7% at September 30, 2000. Total loss for the
                  minority interest in the year ended September 30, 2000 was
                  approximately $3,500.

         d.       Use of Estimates - The preparation of financial statements in
                  conformity with generally accepted accounting principles
                  requires management to make estimates and assumptions that
                  affect the reported amount of assets and liabilities, and
                  disclosure of contingent assets and liabilities at the date of
                  the financial statements and the reported amounts of revenues
                  and expenses during the reporting period. Actual results could
                  differ from those estimates.

         e.       Marketable Securities - The Company's securities investments
                  that are bought and held principally for the purpose of
                  selling them in the near term are classified as trading
                  securities. Trading securities are recorded at fair value on
                  the balance sheet in current assets, with the change in fair
                  value during the period included in income (loss).

         f.       Inventory - Inventories are stated at the lower of cost
                  (first-in, first-out method) or market.

         g.       Property and Equipment - Property and equipment are stated at
                  cost. Depreciation is calculated on the straight-line method
                  over three years, which is the estimated useful life of the
                  assets.

         h.       Goodwill - Goodwill represents the aggregate excess of the
                  cost of companies acquired over the fair value of their net
                  assets at dates of acquisition and is being amortized on the
                  straight line method over 5 to 15 years. Accumulated
                  amortization amounted to $293,881 at September 30, 2000.
                  Amortization expense charged to operations for 2000 was
                  $299,312. The Company also recorded a reduction in the
                  valuation of goodwill during the year ended September 30, 2000
                  of $637,159.

         i.       Capitalized Software Development Costs - The Company has
                  adopted Statement of Financial Accounting Standards No. 86,
                  ("FASB 86") "Accounting for the Costs of Computer Software to
                  Be Sold, Leased or Otherwise Marketed," which requires
                  capitalization of certain software development costs
                  subsequent to the establishment of technological feasibility.
                  Based on the Company's product development process,
                  technological feasibility is established upon completion of a
                  working model. When the software is fully documented and
                  available for unrestricted sale or license, capitalization of
                  development costs ceases, and amortization commences and is
                  computed on a product-by-product basis, based on either a
                  straight-line basis over the economic life of the product or
                  the ratio of current gross revenues to the total current and
                  anticipated future gross revenues, whichever is greater. The
                  establishment of technological feasibility and the ongoing

                                      F-8
<PAGE>

                  assessment of recoverability of capitalized software
                  development costs require considerable judgment by management
                  with respect to certain external factors, including, but not
                  limited to, technological feasibility, anticipated future
                  gross revenues, estimated economic life and changes in
                  software and hardware technologies.

                  Realization of capitalized software development costs is
                  subject to the Company's ability to market its software
                  product in the future and generate cash flows sufficient to
                  support future operations. Capitalized software development
                  costs totaled $1,628,353 as of September 30, 2000.
                  Amortization of capitalized software development costs was
                  $407,088 for the year ended September 30, 2000, and is
                  included as operating expenses in the accompanying statements
                  of operations. There was no capitalized software development
                  costs or related amortization as at and for the year ended
                  September 30, 1999.

         j.       Research and Development - Research and development
                  expenditures are charged to operations as incurred.

         k.       Revenue Recognition - The Company licenses software to end
                  users under license agreements. The Company recognizes
                  revenues in accordance with Statement of Position 97-2 ("SOP
                  97-2") as amended by Statement of Position 98-9 ("SOP 98-9"),
                  issued by the American Institute of Certified Accountants.
                  Under SOP 97-2, revenue from software licensing is recognized
                  upon shipment of the software provided that the fee is fixed
                  or determinable and that collectability of the revenue is
                  probable. If an acceptance period is required, revenues are
                  recognized upon the earlier of customer acceptance or the
                  expiration of the acceptance period, unless some additional
                  performance target is mandated, in which case revenue is
                  recognized upon satisfaction of that target, as defined in the
                  applicable software license agreement. SOP 98-9 amends certain
                  aspects of 97-2 to require recognition of revenue using the
                  "residual method" under certain circumstances.

                  The Company also offers support contracts and consulting and
                  training services. Support revenues are recognized ratably
                  over the term of the related contracts. Consulting and
                  training revenues are recognized in the period the services
                  are performed. If the Company estimates a loss relating to a
                  contract or project, the loss is recorded immediately. Amounts
                  received in advance for support contracts are recorded as
                  deferred revenues.

         l.       Foreign Currency Translation - Assets and liabilities of
                  subsidiaries operating in foreign countries are translated
                  into U.S. dollars using both the exchange rate in effect at
                  the balance sheet date or historical rate, as applicable.
                  Results of operations are translated using the average
                  exchange rates prevailing throughout the year. The effects of
                  exchange rate fluctuations on translating foreign currency
                  assets and liabilities into U.S. dollars are included in
                  stockholders equity (accumulated other comprehensive loss),
                  while gains and losses resulting from foreign currency
                  transactions are included in operations.

                                      F-9
<PAGE>

         m.       Net Loss Per Share - Basic loss per share is computed using
                  the weighted average number of shares of outstanding common
                  stock. Diluted per share amounts also include the effect of
                  dilutive common stock equivalents from the assumed exercise of
                  stock options.

         n.       Income Taxes - Income taxes are accounted for under Statement
                  of Financial Accounting Standards No. 109, "Accounting for
                  Income Taxes," which is an asset and liability approach that
                  requires the recognition of deferred tax assets and
                  liabilities for the expected future tax consequences of events
                  that have been recognized in the Company's financial
                  statements or tax returns.

         o.       Stock Based Compensation - The Company accounts for all
                  transactions under which employees, officers and directors
                  receive shares of stock or options in the Company in
                  accordance with the provisions of Accounting Principles Board
                  Opinion No. 25., "Accounting for Stock Issued to Employees,"
                  ("APB 25"), under which no compensation cost is recognized.
                  The Company adopted Statements of Financial Accounting
                  Standards No. 123 ("SFAS No. 123"), "Accounting for
                  Stock-Based Compensation," for disclosure purposes, and has
                  adopted the proforma disclosure requirements of SFAS 123.
                  Accordingly, no compensation has been recognized in the
                  results of operations for the employee, officers and directors
                  stock plan other than for options issued to non-employees for
                  consulting services or to debt providers that had stock or
                  options attached.

         p.       Fair Value of Financial Instruments - The Company's financial
                  instruments under Statement of Financial Accounting Standards
                  No. 107 ("SFAS 107") "Disclosures About Fair Value of
                  Financial Instruments," includes cash, accounts receivable,
                  notes receivable, and accounts payable. The Company believes
                  that the carrying amounts of these accounts are a reasonable
                  estimate of their fair value because of the short-term nature
                  of such instruments.

         q.       Impairment of Long-Lived Assets - The Company reviews
                  long-lived assets and certain identifiable assets on a
                  quarterly basis for impairment whenever circumstances and
                  situations change such that there is an indication that the
                  carrying amounts may not be recovered. At September 30, 2000,
                  the Company does not believe that any impairment has occurred.

         r.       Comprehensive Income - The Company has adopted Statement of
                  Financial Accounting Standards No. 130 ("SFAS 130), "Reporting
                  Comprehensive Income", which establishes standards for
                  reporting and display of comprehensive income, its components
                  and accumulated balances. Comprehensive income is defined to
                  include all changes in equity except those resulting from
                  investments by shareholders and distributions to shareholders.
                  The Company's comprehensive income for the years ended
                  September 30, 2000, was $164,094. The difference between net
                  income and comprehensive income is the Company's cumulative
                  translation adjustment.

                                      F-10
<PAGE>

         s.       New Accounting Standards

                  (i)      Segment Information - The Company has adopted SFAS
                           No. 131, Disclosures about Segments of an Enterprise
                           and Related Information. SFAS No. 131 establishes
                           standards for reporting information regarding
                           operating segments in annual financial statements and
                           requires selected information for those segments to
                           be presented in interim financial reports issued to
                           stockholders. SFAS No. 131 also establishes standards
                           for related disclosures about products and services
                           and geographic areas. Operating segments are
                           identified as components of an enterprise about which
                           separate, discrete financial information is available
                           for evaluation by the chief operating decision maker,
                           or decision-making group, in making decisions how to
                           allocate resources and assess performance. The
                           Company's chief decision maker, as defined under SFAS
                           No. 131, is the chief executive officer.

                           For the year ended September 30, 2000 the Company
                           measures operating results as a single reportable
                           segment, which provides data visualization solutions
                           to enable companies to transform massive quantities
                           of data into visual representations. The Company's
                           approach is based on the way that management
                           organizes the business within the Company for making
                           operating decisions and assessing performance.

                  (ii)     In June 1999, the Financial Accounting Standards
                           Board (FASB) issued Statement of Financial Accounting
                           Standard No. 137 ("SFAS No. 137"), "Accounting for
                           Derivative Instruments and Hedging Activities -
                           Deferral of the Effective Date of FASB Statement No.
                           133". SFAS No. 137 amends SFAS no. 133, "Accounting
                           for Derivative Instruments and Hedging Activities",
                           which was issued in June 1998. SFAS 137 defers the
                           effective date of SFAS No. 133 to all fiscal years
                           beginning after June 15, 2000. Accordingly, the
                           Company will adopt the provisions of SFAS No. 133 for
                           the fiscal year 2001 which commences on October 1,
                           2000. The application of the new pronouncement should
                           not have a material impact on the Company's financial
                           statements.

                  (iii)    In December 1999, the United States Securities and
                           Exchange Commission released Staff Accounting
                           Bulletin No. 101 ("SAB No. 101"), "Revenue
                           Recognition in Financial Statements". (The
                           implementation date of SAB 101, was subsequently
                           amended by SAB 101A and SAB 101B. ) Under SAB 101
                           additional guidance on revenue recognition criteria
                           and related disclosure requirements are required.
                           Implementation of SAB No. 101 is required no later
                           than the fourth fiscal quarter of fiscal years
                           beginning after December 15, 1999, but is effective
                           retroactively to the beginning of that fiscal period
                           (per SAB 101B). Company management has evaluated the
                           standard and the reporting implications thereof, and
                           has determined that there will not be a significant
                           impact on the Company's operating results.

                                      F-11
<PAGE>

3.       ACQUISITIONS

         a.       On November 16, 1999, the Company purchased all of the
                  outstanding equity of VPL. The following transactions
                  constitute the purchase price of VPL:

                  (i)      The Company acquired the former managing directors'
                           equity position for 225,317 shares of the Company's
                           common stock valued at $993,648, or $4.41 per share,
                           and $24,750 in cash, payable nine months subsequent
                           to the closing of the Purchase, or August 16, 2000.
                           As of January 26, 2001 the cash portion of the
                           Purchase agreement has not been paid.

                  (ii)     The Company acquired the remaining equity of the VPL,
                           not owned by the former managing director, from a
                           United Kingdom based company, for 121,338 shares of
                           the Company's common stock valued at $535,100, or
                           $4.41 per share, and 327,750 in cash. Of the cash
                           portion, $135,000 was payable upon closing, $108,750
                           was payable on May 15, 2000, and $84,000 payable on
                           August 15, 2000. As of January 26, 2001 the cash
                           portion due on August 15, 2000, for $84,000, has not
                           been paid.

                           As part of the purchase agreement, as it relates to
                           the stock issued to the United Kingdom based company,
                           in the event that the weighted average of the trading
                           price of shares of the common stock of the Company
                           for the previous 20 trading days up to and including
                           November 15, 2000 is less than $4.41 per share, the
                           Company was required to issue additional shares which
                           aggregated 172,834 based upon an agreed formula.
                           These additional shares have not yet been issued.

                  (iii)    In addition to the above equity purchases, the
                           Company assumed a note from a VPL vendor that was
                           repaid with the issuance of common stock and cash. On
                           the purchase date of November 16, 1999, the Company
                           issued 84,184 shares to the note holder valued at
                           $263,075 or $4.41 per share. Of the cash portion,
                           $165,000 was payable upon closing, $41,250 was
                           payable on May 15, 2000, and $41,250 payable on
                           August 15, 2000. As of January 26 2001 the cash
                           portion due on August 15, 2000, for $41,250, has not
                           been paid.

                           As part of the purchase agreement, as it relates to
                           the stock issued to the note holder, in the event
                           that the weighted average of the trading price of
                           shares of the common stock of the Company for the
                           previous 20 trading days up to and including November
                           15, 2000 is less than $4.41 per share, the Company
                           was required to issue additional shares which
                           aggregated 74,072 based upon an agreed formula. These
                           additional shares have not yet been issued.

                                      F-12
<PAGE>

         b.       On March 17, 2000, the Company through its VPL subsidiary
                  purchased all of the outstanding stock of SimSol. The purchase
                  price for SimSol was $117,333 in cash and 44,895 shares of the
                  Company's common stock, valued at $230,087 or $5.13 per share.
                  SimSol will be incorporated into the Company's existing
                  European operations.

         c.       On March 28, 2000, the Company through its VPL subsidiary
                  completed an asset purchase of the VRsource.com. The purchase
                  price for VRsource was $400,000 in cash.

         The following table gives an aggregate summary of the acquisitions of
         VPL, SimSol and VRsource:


            Purchase Price (including value of stock)           $   3,139,244
            Acquisition Costs                                         100,672
            Fair Value of Assets Acquired                         (1,185,725)
            Fair Value of Liabilities Assumed                       1,907,154
                                                                -------------
            Goodwill                                            $   3,961,345
                                                                =============

         The detailed components consist of the following:

            Purchase Price
                       Cash                                     $     967,333
                       Notes                                          150,000
                       Common Stock (677,745 shares)                2,021,911
                                                                -------------
                                                                $   3,139,244
                                                                =============

            Fair Value of Assets Acquired
                       Accounts Receivable                      $     377,069
                       Inventory                                       41,106
                       Property, Plant and Equipment                  753,733
                                                                -------------
                                                                $   1,185,725
                                                                =============

            Fair Value of Liabilities Assumed
                       Accounts Payable                         $     949,944
                       Accrued Liabilities                            375,636
                       Assumed Notes                                  581,574
                                                                -------------
                                                                $   1,907,154
                                                                =============


                                      F-13
<PAGE>


                  The following table summarizes pro forma consolidated results
                  of operations (unaudited) of the Company and the acquisitions
                  that occurred in the year ended September 30, 2000, as though
                  the acquisitions had been consummated at October 1, 1998. The
                  pro forma amounts give effect to the appropriate adjustments
                  for the fair value of assets acquired and amortization of
                  goodwill, depreciation and the debt incurred and resulting
                  interest expense.

                                                 Years Ended September 30,
                                                ---------------------------
                                                    2000           1999
                                                ---------------------------
                                                         (unaudited)
                                                ---------------------------
                  Revenue                       $  6,385,791   $ 5,491,241
                  Operating expenses              18,732,420    11,975,997
                                                ------------   -----------
                  Net operating loss             (12,346,629)   (6,484,756)
                  Net other expenses                (284,204)      (22,230)
                                                ------------   -----------
                  Net loss                      $(12,630,833)  $(6,506,986)
                                                ------------   -----------
                  Net loss per share            $      (1.16)  $     (0.61)
                                                ------------   -----------
                  Shares used in calculation      10,898,331    10,599,677
                                                ------------   -----------

         d.       On November 9, 2000 the Company completed a business
                  combination with AVS. At the effective time of the Merger, the
                  Company issued 1,929,579 shares of its common stock
                  (approximately 18% of outstanding common stock prior to the
                  Merger) in exchange for all of the outstanding common and
                  preferred shares of AVS and assumed all of the outstanding
                  stock options of AVS (approximately 1,445,196 million shares
                  upon exercise). In addition, $2,000,000 of AVS debt, which was
                  convertible into shares of AVS stock became convertible into
                  an aggregate of 202,839 shares of the Company's common stock.
                  The Merger will be accounted for as a pooling of interests.

                  The number of shares of the Company's common stock issued in
                  connection with the Merger was determined based on an exchange
                  rate of 3.286 shares of AVS capital stock for each share of
                  the Company's common stock (except AVS Series A Preferred
                  Stock which had an exchange rate of .0649646 shares for each
                  share of the Company's common stock). The number of shares of
                  common stock subject to stock options of the Company to be
                  issued to the holders of AVS stock options was determined
                  based on the same exchange rate of 3.286 shares of AVS common
                  stock for one share of the Company's common stock.

                  On May 12, 2000, the Company issued a demand note to AVS, in
                  the principal amount of $1,000,000, due one year from the date
                  of issue on May 12, 2001. The note bears interest at 10% per
                  year, with interest payments payable monthly in advance on the
                  first of each month. As of September 30, 2000, two months of
                  interest were outstanding, which was subsequently paid along
                  with $25,000 of principal. Repayment on the remaining
                  principal balance of $975,000 is scheduled to be repaid over
                  the remaining months to maturity.


                                      F-14
<PAGE>

                  The following table summarizes pro forma consolidated results
                  of operations (unaudited) of the Company and the acquisitions
                  of VPL, SimSol, and VRsource that occurred in the year ended
                  September 30, 2000, together with the acquisition of AVS in
                  November 2000, as though all such acquisitions had been
                  consummated at October 1, 1998. The pro forma amounts give
                  effect to the appropriate adjustments for the business
                  combination. The proforma also gives effect to the
                  acquisitions of VPL, SimSol and VRsource with their
                  appropriate adjustments for the fair value of assets acquired
                  and amortization of goodwill, depreciation and the debt
                  incurred and resulting interest expense.

                                                 Years Ended September 30,
                                                ---------------------------
                                                    2000           1999
                                                ---------------------------
                                                         (unaudited)
                                                ---------------------------
                  Revenue                       $ 19,372,069  $ 18,787,153
                  Operating expenses              31,558,960    26,460,410
                                                ------------  ------------
                  Net operating loss             (12,186,891)   (7,673,257)
                  Net other expenses              (1,045,823)     (637,714)
                                                ------------  ------------
                  Net loss                      $(13,232,714) $ (8,310,971)
                                                ------------  ------------
                  Net loss per share            $      (1.03) $      (0.66)
                                                ------------  ------------
                  Shares used in calculation      12,827,910    12,529,256
                                                ------------  ------------

                  The following table summarizes the pro forma unaudited
                  consolidated balance sheet of the Company, together with the
                  acquisition of AVS in November 2000, as though the acquisition
                  had been consummated at September 30, 2000.

                                            ASSETS

                  Current assets                             $  9,943,197
                  Property and equipment, net                   1,968,715
                  Other assets                                  4,403,593
                                                             ------------
                                                             $ 16,315,505
                                                             ------------

                              LIABILITIES AND STOCKHOLDERS' EQUITY

                  Current liabilities                        $ 12,042,656
                  Long-Term liabilities                         3,005,881
                  Stockholders' equity                          1,266,968
                                                             ------------
                                                             $ 16,315,505
                                                             ------------

                                      F-15
<PAGE>


4.       MARKETABLE SECURITIES

         At September 30, 2000, investments in marketable securities consists of
         equity securities with a fair value of $1,262,603.

         Since September 30, 2000, the Company's discovered additional
         significant losses in their marketable securities account. Management
         believes that such losses may be attributable to circumstances other
         than normal market fluctuations. As of December 31, 2000 the account
         had a market value of $286,207. The Company has engaged the services of
         legal counsel and other professionals to assist in analyzing the prior
         activity in the account and to recommend appropriate action based on
         their findings.

5.       CONCENTRATION OF CREDIT RISK

         a.       During the years ended September 30, 2000 and 1999, sales to
                  the United States government generated approximately $727,000
                  or 12%, and $830,000 or 48%, of revenue in 2000 and 1999,
                  respectively. In addition, in the year ended September 30,
                  2000, a client of one of the Company's UK subsidiary's
                  generated revenue of approximately $1,016,000 or 17% of
                  revenues. Accounts receivable from the above aggregated
                  approximately $724,000 at September 30, 2000. The Company does
                  not require collateral on its accounts receivable.

         b.       Cash and cash equivalents includes deposits which exceed the
                  maximum insured by the Federal Depository Insurance Corp.
                  (FDIC) by approximately $228,000 at September 30, 2000. The
                  foreign subsidiaries of the Company maintain cash and cash
                  equivalents in financial institutions in their respective
                  countries, which are insured under the respective banking laws
                  in the countries in which they are located. During the year
                  ended September 30, 2000, the foreign subsidiaries have at
                  times exceeded the maximum insured, under the respective
                  banking laws in the countries in which they are located.

                                      F-16
<PAGE>

6.       NOTES RECEIVABLE - RELATED PARTIES

         Notes receivable consists of the following as of September 30, 2000:

         a.     Employee Shareholders - Two notes each for $25,000
                bearing interest at 5% per annum, with principal and
                interest due upon maturity at December 2, 2001. The
                notes are each secured by 10,000 shares of the
                Company's common stock.                               $   50,000

         b.     Shareholder: - In October 1998 and November 1998,
                respectively, the Company issued two demand
                promissory notes in the principal amounts of $250,000
                and a $750,000. The maker of the note is an entity
                that purchased 1,000,000 shares of the Company's
                common stock in July 1998. The notes are payable upon
                demand and bear interest at 12% per annum. As of
                September 30, 2000, the Company has not made demand
                for payment, but is negotiating payment terms with
                the shareholder.

                The Company has reserved $250,000, with regard to
                collection of these notes.                               750,000

         c.     Officers: - In conjunction with an employment
                agreement, the Company's current President and Chief
                Financial Officer was issued a note in the principal
                amounts of $75,000, bearing interest at 5% per year.
                The note principal and accrued interest are due upon
                maturity on December 2, 2003. The note is secured by
                options to acquire 10,715 shares of the Company's
                common stock.                                             75,000

         d.     AVS: - In May 2000, the Company issued a demand note
                bearing interest at 10% per year to AVS, the entity
                that the Company acquired on November 9, 2000.
                Interest is payable monthly, in advance, on the first
                of each month. As of September 30, 2000, demand for
                payment of principal has not been made by the
                Company. This note is due one year from the date of
                issue in May 2001.                                   $ 1,000,000
                                                                     -----------
                                                                     $ 1,875,000
                                                                     ===========

                                      F-17

<PAGE>

7.       PROPERTY AND EQUIPMENT

         Property and equipment at September 30, 2000 is as follows:

                 Computer equipment                   $3,004,819
                 Furniture and fixtures                1,125,061
                 Vehicles                                120,937
                 Leasehold Improvements                   57,322
                                                      ----------
                                                       4,308,139
                 Less: accumulated depreciation        2,662,860
                                                      ----------
                                                      $1,645,279
                                                      ==========


8.       LINE OF CREDIT

         On June 16, 2000, the Company secured a $1,000,000 line of credit with
         a commercial bank based in Albuquerque to provide interim working
         capital. The agreement is for a one year period and expires on June 16,
         2001. Interest on the line is calculated at is 0.5% above the Chase
         Manhattan Bank prime rate, payable monthly in arrears. The initial rate
         was 10% per annum and as of September 30, 2000 such rate is also 10%.
         The balance owed as of September 30, 2000 is $970,000, with accrued
         interest of $4,006.

         The line is collateralized by the Company's marketable securities. As
         part of the agreement with the bank, the marketable securities were to
         have at all times a market value greater than or equal to $2,000,000.
         The value of such securities has dropped below the required level.
         Currently, the Company is in technical default of this agreement.
         However, no demand for payment has been made. The Company is in the
         process of reviewing this matter with the respective parties (see Note
         4).

9.       CONVETIBLE NOTE

         On August 7, 2000, the Company entered into a Purchase Agreement (the
         "Purchase Agreement"), by and between the Company and an investment
         company based out of the British Virgin Islands. ("Investment
         Company"). Pursuant to the Purchase Agreement, the Company sold to the
         Investment Company, a convertible note (the "Note") in the principal
         amount of $1,000,000. Interest on the Note accrues at the rate of 10%
         per annum. The Note is convertible, commencing on August 7, 2001, into
         shares of common stock of the Company at the lower of $2.375 per share
         and 88% of the five-day trading average prior to the date of
         conversion. The Note has a maturity date of August 6, 2002.

         The Company also issued to the Investment Company a warrant ("Warrant")
         to purchase 75,000 shares of common stock at an exercise price of
         $2.6125 per share in connection with the Purchase Agreement. The
         Warrant is not exercisable until August 7, 2001 and will expire on
         August 6, 2005. The Company recorded a discount on debt of $121,000

                                      F-18
<PAGE>

         related to the warrant portion of the debt, a total of $10,084 of the
         discount was amortized during the year ended September 30, 2000, with
         the remaining portion to be amortized over the life of the Note.

10.      ISSUANCES OF STOCK

         a.       In September 1997, the Company sold to an officer 11,513
                  shares of common stock at a purchase price of $7.60 per share
                  for an aggregate of $87,500. Payment of the purchase price was
                  made by issuance of a non-recourse promissory note secured by
                  a pledge of the shares purchased. On December 31, 1999 the
                  promissory note was paid in full.

         b.       In November 1998, the Company completed an initial public
                  offering of its securities. A total of 1,200,000 units were
                  sold for $8.00 per unit for a total of $9,600,000. In
                  addition, warrants to purchase 600,000 shares of common stock
                  were included in such units. The warrants are exercisable
                  until November 13, 2003 at $9.60 per share of common stock.
                  Net proceeds after underwriting commissions and other related
                  fees was approximately $8,360,000.

                  In December 1998, an additional 180,000 shares were
                  subsequently issued pursuant to the underwriter's over
                  allotment option. Net proceeds after underwriting commissions
                  and other related fees were approximately $1,253,000.

         c.       In March 1999, the Company's Chief Technical Officer resigned
                  as an employee of the Company and entered into a consulting
                  arrangement with the Company. Pursuant to the terms of an a
                  Employment Termination Agreement, the Company paid this
                  officer an aggregate of approximately $1,340,000 in exchange
                  for, among other things: a non-compete agreement, repurchase
                  of 155,263 shares of common stock, and the right of first
                  refusal on future sales of common stock. The Company charged
                  $563,636 of the consideration paid as costs in excess of the
                  value of repurchased stock on the Statements of Operations.
                  The balance of the payment is accounted for as the repurchase
                  of treasury stock for $776,315, representing a market value of
                  $5.00 per share. In addition, this officer exercised on a
                  cashless basis 310,526 options with an exercise price of
                  $2.50, to purchase an aggregate of 155,263 shares of common
                  stock.

         d.       In the year ended September 30, 1999 the Company issued 33,990
                  shares of common stock, pursuant to the exercise of stock
                  options at an exercise price of $2.50 per share.

         e.       In the year ended September 30, 2000 the Company issued 43,347
                  shares of common stock upon the exercise of 190,160 options at
                  $2.50 per share. This exercise is being accounted for as a
                  cashless exercise.

                                      F-19
<PAGE>

11.      EQUITY LINE AGREEMENT

         On June 1, 2000, the Company entered into a Private Equity Line
         Agreement (the "Equity Line Agreement"), with an Investment Company
         ("Investment Company") based out of the British Virgin Islands, with
         which the Company subsequently entered into a convertible note payable
         on August 7, 2000. Pursuant to this Equity Line Agreement, the Company
         has the ability to sell to the Investment Company, and subject to
         certain limitations based on market price and trading volume of the
         Company's common stock, the Investment Company is obligated to
         purchase, up to $18,000,000 of the Company's common stock. The price
         per share will be determined by applying a 10-12% discount to the
         average of the lowest intra-day trading prices of the Company's common
         stock for the five trading day period commencing two trading days
         prior, and ending two trading days after, a put notice is given to the
         Investment Company. The lowest intraday trading prices do not include
         trades below 1,000 shares. The applicable discount will be 10% if the
         market price (as determined in the Equity Line Agreement) of the
         Company's common stock is $8.00 or above or 12% if below $8.00. The
         term of the Equity Line Agreement is two years from November 14, 2000,
         the effective date of a registration statement covering resales of
         securities purchased by the Investment Company.

         The Company is obligated to sell to the Investment Company at least
         $7,500,000 of its common stock during the term of the Equity Line
         Agreement; provided, however, that such obligation will not be
         applicable in the event any issuance to the Investment Company would
         result in it obtaining in excess of 9.9% of the Company's common stock.

         The Company also issued to the Investment Company a warrant ("Warrant")
         to purchase 200,000 shares of common stock at an exercise price of
         $3.76 per share in connection with the Equity Line Agreement. The
         Warrant is exercisable commencing November 28, 2000 and will expire on
         November 27, 2004. The Warrant also contains certain anti-dilution
         protections. The Company recorded a valuation of $360,000 related to
         the warrant portion of the Equity Line Agreement, and is reflected in
         other expenses in the Statement of Operations for the year ended
         September 30, 2000.

         Additionally, if the effectiveness of the registration statement is
         suspended or revoked or if the Company does not sell at least
         $7,500,000 of its common stock to the Investment Company during the
         term of the Equity Line Agreement, then the Company will be subject to
         certain liquidated damages as set forth in the Equity Line Agreement.

         In connection with the Equity Line Agreement, the Company agreed to pay
         certain fees of the Investment Company's counsel up to $32,500 and will
         be obligated to pay an underwriter a finders fee of 4% of the proceeds
         received upon the sale of common stock to the Investment Company.

         No shares have been purchased by the Investment Company under the
         Equity Line Agreement.

                                      F-20
<PAGE>

12.      STOCK OPTIONS AND WARRANTS

         The Company currently has two stock option plans with essentially
         identical terms and conditions. Under the 1995 Stock Option Plan, the
         Company may grant non-qualified stock options to purchase up to
         3,586,513 shares of common stock. Under the 1996 Stock Option Plan, the
         Company may grant non-qualified or incentive stock options to purchase
         up to 1,644,737 shares of common stock. Options may be granted to
         employees, officers, directors, consultants and independent
         contractors. Under the Plans, options may be issued for periods up to
         ten years and become exercisable in varying amounts based on a vesting
         schedule. Generally, options are granted at prices equal to market
         value on the date of the grant with lives of ten years.

         For disclosure purposes the fair value of each stock option grant is
         estimated on the date of grant using the Black-Scholes option-pricing
         model with the following weighted average assumptions used for stock
         options granted during the years ended September 30, 2000 and 1999: (i)
         annual dividends of $0.00, (ii) expected volatility of 136.84% and
         68.14% for the years ended September 30, 2000 and 1999, respectively,
         (iii) risk-free interest rate of 5.7%, and (iv) expected option lives
         of five years for the years ended September 30, 2000 and 1999. The
         weighted average fair value of the stock options granted for the years
         ended September 30, 2000 and 1999 was $2.55 and $5.61, respectively.

         The following table illustrates the Company's stock option and warrant
         issuances and balances outstanding during the years ended September 30,
         1999 and 2000. The Company generally issues warrants to purchase shares
         of common stock in connection with debt and equity financing and to
         non-employee consultants.

                                      F-21
<PAGE>
<TABLE>
<CAPTION>
                                                       OPTIONS                           WARRANTS
                                                --------------------------       --------------------------
                                                                  Weighted                         Weighted
                                                  Shares          Average          Shares          Average
                                                Underlying        Exercise       Underlying       Exercise
                                                 Options            Price         Warrants          Price
                                                ----------        --------       ----------       ---------
<S>                                              <C>               <C>            <C>             <C>
         Outstanding at October 1, 1998          2,458,750         $  3.90        1,747,533       $ 7.99
                  Granted                          545,850            5.72          780,000         9.60
                  Canceled                        (171,711)           2.50        (279,079)         7.81
                  Canceled                        (102,000)           7.50
                  Exercised                       (189,253)           2.50                             -
                                               -----------         -------        ---------       ------
         Outstanding at September 30, 1999       2,541,636         $  4.35        2,248,454       $ 8.57
                  Granted                        1,521,350            2.95          357,500         3.55
                  Canceled                      (1,243,050)           4.35                -            -
                  Exercised                       (190,160)           2.50                -            -
                                                 ---------         -------        ---------       ------
         Outstanding at September 30, 2000       2,629,776         $  3.67        2,323,388       $ 7.88
                                                 ---------         -------        ---------       ------
</TABLE>


         The following is additional information with respect to the Company's
         options and warrants as of September 30, 2000

                               OPTIONS OUTSTANDING
--------------------------------------------------------------------------------
   Range of          Number           Weighted Average        Weighted Average
Exercise Price    Outstanding   Remaining Contractual Life     Exercise Price
--------------    -----------   --------------------------    ----------------
  $2.01-$2.50      9,201,169           7.81 years                  $2.33
  $2.72-$3.50        645,050           9.48 years                  $2.77
  $3.56-$5.77        318,150           8.55 years                  $5.23
  $6.19-$9.89        182,000           7.84 years                  $7.34
                   ---------
                   2,065,369
                   ---------



<TABLE>
<CAPTION>
                           WARRANTS OUTSTANDING                                             WARRANTS EXERCISABLE
--------------------------------------------------------------------------------     ---------------------------------
   Range of          Number           Weighted Average        Weighted Average           Number      Weighted Average
Exercise Price    Outstanding   Remaining Contractual Life     Exercise Price         Exercisable     Exercise Price
--------------    -----------   --------------------------    ----------------       -------------   -----------------
<S>                 <C>               <C>                         <C>                  <C>                <C>
  $2.61-$4.50        781,381           2.38 years                  $4.07                506,381            4.40
  $7.60-$9.60      1,817,000           2.80 years                  $9.56              1,817,007            9.56
                   ---------                                                          ---------
                   2,598,388                                                          2,323,388
                   ---------                                                          ---------
</TABLE>

         Had compensation cost for the Company's two option plans been
         determined in accordance with SFAS 123, the Company's net loss and loss
         per share would have been increased to the pro forma amounts indicated
         below:

                                      F-22
<PAGE>
                                                     Year Ended September 30,
                                                   ----------------------------
                                                        2000           1999
                                                   -------------   ------------
       Net loss:                      As reported  $(12,095,276)   $(5,112,948)
                                      Pro forma    $(15,046,410)   $(7,047,379)
       Net loss per share:

                  Basic and diluted   As reported  $      (1.12)  $      (0.51)
                  Basic and diluted   Pro forma    $      (1.40)  $      (0.70)


13.      FINANCIAL ADVISORY AGREEMENT

         In December 1999, the Company entered into an agreement with an entity
         for financial advisory services. The Company paid $75,000 and granted
         three year warrants to purchase 82,500 shares of common stock at an
         exercise price of $3.90 per share. The Company recorded a charge to
         operations of $113,000 in connection with the granting of such
         warrants.

14.      EMPLOYMENT AGREEMENTS

         The Company has entered into the following employment agreements:

         a.       The President and Chief Financial Officer receives an annual
                  base salary of $175,000 and a bonus of up to $65,000 upon the
                  Company achieving certain performance objectives. Upon
                  entering the employment agreement, this officer's received
                  options to purchase 117,500 shares of common stock at 7.50 per
                  share, which vests follows: 30,000 shares on June 1, 1999,
                  37,500 shares on June 1, 2000 and 50,000 shares on June 1,
                  2001. Such officer, as part of the agreement, received on
                  January 20, 1999 a five year loan in the amount of $75,000
                  bearing interest at 5% per year, in connection with his
                  relocation to New Mexico. The note is secured by options to
                  acquire 10,715 shares of common stock. The agreement which was
                  effective June 1, 1998 expires in June 2001. On January 27,
                  2000 the Company granted this officer options to purchase
                  another 117,500 shares of common stock at $2.72 per share,
                  with 50% of the options vesting upon issuance, and the balance
                  vesting over the remaining life of the employment contract.

b.                In the year ended September 30, 1999 the Company entered into
                  an employment agreement with the Vice President of
                  Communications. The term of the agreement is from July 12,
                  1999 through July 12, 2001with an annual base salary of
                  $120,000 and a bonus of up to 32.5% of the base upon the
                  Company achieving certain performance objectives. In the year
                  ended September 30, 2000, this officer became the Company's
                  Senior Vice President, with an amended annual base salary of
                  $180,000, effective over the remaining course of the
                  employment agreement.

                                      F-23
<PAGE>

                  This officer also received options to purchase 97,500 shares
                  of common stock at $2.72 per share, with 48,750 vesting upon
                  issuance, and the balance vesting over the remaining life of
                  the employment contract.

         Under the above agreements, if such officer is terminated by the
         Company other than for cause (as defined in each employment agreement),
         or if the officer dies or becomes permanently disabled, all stock
         options held by such officer shall immediately vest upon such
         termination and such officer shall receive severance payments in an
         amount equal to one year's base salary. Each of the employment
         agreements also contain provisions relating to severance payments equal
         to the salary and bonus for the remainder of the employment term plus
         an additional one year's base salary in the event of a change in
         control (as defined in the employment agreement).

         In addition to the above agreements, effective August 1, 1998 the
         Company entered into a three year employment agreement with an employee
         to serve as the Company's Director of Product Development at an annual
         salary of $90,000. During the year ended September 30, 2000, the
         employee became the Company's Vice President of Technology, with an
         amended annual salary of $117,000.

         The employment agreement with the Chief Technical Officer of the
         Company was terminated in March 1999 . As of the date of the
         Termination Agreement, the officer entered into a consulting agreement
         with the Company until December 31, 1999 for: (i) $3,000 per month from
         the date of the termination agreement until June 30, 1999 and (ii) from
         July 1, 1999 until December 31, 1999 at an annualized rate of $175,000,
         based upon days actually employed.

         On May 4, 2000, the Company's CEO and Chairman, resigned from both
         positions. As a result of certain severance arrangements and repurchase
         of stock options to purchase 750,000 shares of the Company's common
         stock in connection with his resignation, the Company incurred a charge
         to earnings of $994,000. As part of the resignation arrangement, the
         Company will make certain of these payments in varying amounts over a
         two-year period.

         Upon the acquisition of VPL, the Company's VPL unit hired its former
         Managing Director and principal shareholder to the same position he had
         prior to the acquisition. The term of the agreement is from November
         15, 1999 through November 15, 2002 with an annual base salary of
         $150,000 and a bonus of up to 30% of the base upon VPL achieving
         certain performance objectives. Upon commencement of this agreement the
         Managing Director received a one time signing bonus of $50,000. This
         officer also received options to purchase 90,000 shares of the
         Company's common stock, at an exercise price of $2.88 per share. On
         January 27, 2000, the Company issued the Managing Director an
         additional option to purchase 90,000 shares of the Company's common
         stock, at an exercise price of $2.72.

                                      F-24
<PAGE>

         On November 3, 2000, the Company's Managing Director's employment was
         terminated. On November 25, 2000, a "Notice of Originating Application
         with the Employment Tribunals" was filed in the UK, alleging unfair
         dismissal of his positions with VPL. Through its attorneys, VPL
         responded to the Managing Director's allegations on December 21, 2000.
         A hearing is scheduled for April 2001. The Company believes that the
         claims are without merit and intends to vigorously defend itself in
         this proceeding. Management believes that the ultimate outcome of this
         proceeding will not have a material adverse affect on our results of
         operations or financial condition.

15.      RETIREMENT PLAN

         In October 1996, the Company established a defined contribution plan
         (SARSEP plan) covering substantially all employees. Under the terms of
         the plan, eligible employees may contribute up to fifteen percent of
         their compensation, subject to statutory limitations. The Company
         charged to operations $47,995, for their contribution to the plan for
         the year ended September 30, 1999. This plan was dissolved in September
         1999.

         In October 1999, the Company established a 401(k) plan covering all
         United States-based employees. Under the terms of the plan, eligible
         employees may contribute up to fifteen percent of their compensation,
         up to the statutory limit. The Company is obligated to contribute a
         match of the employees' contribution of fifty percent of the first six
         percent of the employees' contribution. The Company charged to
         operations $56,432, for their contribution to the plan for the year
         ended September 30, 2000.

16.      LICENSE AGREEMENT

         The Company's license agreement, for the "MuSE" technology grants the
         Company exclusive rights to develop and commercialize MuSE until
         October 2005 and thereafter provides a non-exclusive right through
         2015. At the end of such ten year period of exclusivity, the Company
         may request the licensor to extend exclusivity through 2015,which
         determination shall be made in the licensor's sole discretion. The
         licensor has the right to terminate the license or make the license
         non-exclusive in the event the Company fails to pay the required
         royalties under the license agreement, with an annual minimum royalty
         of $20,000 through the year ended December 31, 2006. The Company was
         obligated to pay an annual license fee of $10,000 through the year
         ending December 31, 1999 and a one-time payment of $20,000 prior to
         July 1999.

17.      INCOME TAXES

         As of September 30, 2000 and 1999, the Company has net operating loss
         carry forwards of approximately $16,600,000 for federal tax purposes,
         expiring between 2012 through 2018. The resulting tax deferred tax
         asset of approximately $5,700,000, as of September 30, 2000 has been
         offset by a corresponding valuation allowance.


                                      F-25
<PAGE>

         A reconciliation between the federal statutory tax rate and the
         effective income tax rate for the years ended September 30, 2000 and
         1999 are as follows:

                                                     2000        1999
                                                     ----        ----
         Statutory Federal income tax rate           (34%)       (34%)
         Benefit of operating loss carry forwards      -           -
         Losses for which no benefit is provided      34%         34%
                                                     ----        ----
         Effective income tax rate                     0%          0%
                                                     ====        ====

         The Companies foreign subsidiaries are taxed at the statutory rates in
         the respective countries in which they conduct their business
         activities. As of September 30, 2000, the subsidiaries have net
         operating loss carryforwards of approximately $2,000,000. The resulting
         tax deferred asset of approximately $600,000, as of September 30, 2000
         has been offset by a corresponding valuation allowance.

18.      COMMITMENTS AND CONTINGENCIES

         a.       The Company leases its laboratory and office facilities under
                  non-cancelable lease arrangements. Rent expense for 2000 and
                  1999 was $567,061 and $114,579 respectively.

                  Future minimum lease payments under noncancellable operating
                  leases include:

                            2001                  $    365,711
                            2002                       247,432
                            2003                       111,620
                            2004                        90,000
                            2005                        90,000
                            Thereafter               1,620,000
                                                  ------------
                                                  $  2,524,763
                                                  ============

         b.       On December 12, 2000 the Company appointed an investment
                  banking entity, as their financial and investment banking
                  advisors. Under the term of a non-exclusive agreement, this
                  entity is to be paid a one-time retainer of $50,000 in
                  addition to monthly fees, plus a commission at the closing of
                  the sale of securities, if any, to certain institutional,
                  accredited individual or strategic investors.

         c.       On December 26, 2000 the Company entered into an agreement
                  with a company to assist the Company in identifying between
                  $3,500,000 and $10,000,000 in loan or credit facilities. Under
                  the terms of this agreement, this company was paid a retainer
                  fee of $25,000 and will receive a 6% placement fee on any
                  funds raised.

                                      F-26
<PAGE>

         d.       On January 2, 2001, the Company entered into an agreement with
                  a company for financial relations advisor services. This
                  agreement has a one year term, under which this company will
                  receive $7,000 per month in consulting fees. In addition to
                  the fees, the Company issued a warrant to purchase 100,000
                  shares of common stock at $0.52 per share, with shares vesting
                  on a pro rata monthly basis over the year of the agreement, or
                  8,333 shares per month. The agreement can be cancelled by
                  either party upon 90 days written notice, at which time this
                  company will refund a prorated portion of the warrant.

19.      GOVERNMENT CONTRACTS

         The Company derives a portion of its revenue from contracts with the
         Federal government. Recognition of revenue is generally conditioned
         upon compliance with terms and conditions of the contracts and
         applicable Federal regulations. Substantially all contracts are subject
         to audit by agencies of the Federal government or their designees.
         Disallowances by Federal officials as a result of these audits may
         become liabilities of the Company. The Company has not recorded any
         liability for disallowances which may be determined in the future.

20.      MARKETING AGREEMENTS

         In June 1998, the Company entered into an agreement with an entity
         which grants them the rights to market, sell and distribute the
         Company's products. This entity is the same that purchased 1,000,000
         shares of the Company's common stock in July 1998. Under the terms of
         the agreement, the Company received a $5,000,000 non-refundable fee
         granting the entity exclusive worldwide selling rights of the Company's
         products in the oil and gas industry for three years.

         The agreement was for an initial term of three years with a provision
         for three successive three year renewal periods. The agreement provided
         for the Company to receive a minimum of $12,000,000 from the entity for
         the sale of MuSE software over the initial term of the agreement. In
         June 2000, the Company renegotiated the terms of the agreement to
         commence on October 1, 2000 and end on September 30, 2003. Minimum
         sales to be generated for the first year are $250,000. The minimum
         sales for the subsequent two years have not been agreed to.

21.      PRODUCT SALE AGREEMENT

         On January 1, 2001 the VPL subsidiary transferred a contract, and
         marketing rights with respect to their medical product line, which
         primarily consists of two VPL products (MIST and VIST) to a Swedish
         company. Under the terms of the sales agreement with the Swedish
         company, VPL is entitled to purchase shares representing 5% of a
         company that develops and markets the VIST products. VPL is also be
         entitled to a 20% royalty in


                                      F-27
<PAGE>

         2001 and a 10% royalty in 2002 of the profits derived from the MIST
         product; a 5% royalty in 2001 and 2002 of all profits derived from the
         VIST product.

22.      SEGMENT AND GEOGRAPHIC INFORMATION

          Revenues, operating income loss and identifiable assets for the
          Company's domestic and foreign operations for the years ended
          September 30, 2000 and 1999 are summarized as follows:
<TABLE>
<CAPTION>
                                                                      Foreign
                                                  United States      Operations       Eliminations       Consolidated
                                                  -------------      ----------       ------------       ------------
<S>                                                <C>             <C>              <C>                   <C>
Year ended September 30, 2000
     Revenues to unaffiliated customers            $  1,181,749    $  4,887,843     $     -               $  6,069,592
     Loss from operations                            (9,958,150)     (1,786,489)          -                (11,744,639)
     Interest Expense                                   (50,743)        (24,468)          -                    (75,211)
     Interest Income                                     389,802          22,397          -                     412,199
     Identifiable assets                              11,898,959       2,465,033       (3,029,205)           11,334,787
</TABLE>

         There were no revenues, expenses and identifiable assets attributable
         to foreign operations for the year ended September 30, 1999.


                                      F-28