SECURITIES AND EXCHANGE COMMISSION

                              Washington, DC 20549

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                                   FORM 10-QSB

                Quarterly report Under Section 13 or 15(d) of the
                         Securities Exchange Act of 1934

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                        For Quarter Ended: June 30, 2001

                           Commission File No. 1-14559

                             MUSE TECHNOLOGIES, INC.
        (Exact name of small business issuer as specified in its charter)

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              DELAWARE                             85-0437001
      (State of Incorporation)          (IRS Employer Identification No.)

                                300 FIFTH AVENUE
                             WALTHAM, MA 02451-4518
                     (Address of principal executive office)
                                   (Zip code)

                                 (781) 890-4300
                 Issuer's telephone number, including area code

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     Indicate by check mark whether the issuer (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
issuer was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                                 Yes [X] No [ ]

     As of June 30, 2001 there were issued and outstanding 13,103,714 shares of
Common Stock, $.015 par value per share, and Class A Redeemable Common Stock
Purchase Warrants to purchase 2,798,388 shares of Common Stock.

Transitional Small Business Disclosure Format

                                 Yes [ ] No [X]






<PAGE>



                             MUSE TECHNOLOGIES, INC.

                                      INDEX

                                                                     PAGE NUMBER
                                                                     -----------

PART I.  FINANCIAL INFORMATION

Item 1.  Condensed consolidated financial statements
             (unaudited)

         Consolidated balance sheet as of June 30, 2001                  3

         Consolidated statements of operations for the three and six
             Months ended June 30, 2001 and 2000                         4

         Consolidated statements of cash flows for the six Months
             ended June 30, 2001 and 2000                                5

         Notes to financial statements                                   6

Item 2.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations                             9

PART II.  OTHER INFORMATION                                              17

INDEX TO EXHIBITS                                                        17

SIGNATURES                                                               18






<PAGE>

                             MUSE TECHNOLOGIES, INC.

                           CONSOLIDATED BALANCE SHEET
                                   (UNAUDITED)

                                 June 30, 2001

                                     ASSETS
<TABLE>
<CAPTION>

CURRENT ASSETS:
<S>                                                                               <C>
Cash and cash equivalents                                                         $   292,373
Marketable securities                                                                  36,373
Accounts receivable (net of reserve of $156,000)                                    2,414,375
Notes receivable-related parties ( net of reserve of $750,000)                        433,189
Other current assets                                                                  185,190
                                                                              ----------------
TOTAL CURRENT ASSETS                                                                3,361,500
                                                                              ----------------

PROPERTY AND EQUIPMENT - NET                                                          509,181

OTHER ASSETS:
Capitalized development costs-net                                                     499,421
Other assets                                                                          315,428
                                                                              ----------------
TOTAL OTHER ASSETS                                                                    814,849
                                                                              ----------------

TOTAL ASSETS                                                                      $ 4,685,530
                                                                              ================

                    LIABILITIES AND STOCKHOLDERS' DEFICIENCY

CURRENT LIABILITIES:
Accounts Payable                                                                  $ 1,919,283
Accrued Liabilities                                                                 3,347,085
Deferred Maintenance Revenue                                                          960,501
Notes Payable                                                                         913,537
Bank Note Payable                                                                   1,000,000
Current Portion Lease Payable                                                          75,132
                                                                              ----------------
TOTAL CURRENT LIABILITIES                                                           8,215,538
                                                                              ----------------

LONG-TERM LIABILITIES:
Lease Payable-less current portion                                                     30,774
Convertible Debentures (less discount of $80,664)                                   3,131,969
                                                                              ----------------
TOTAL LONG-TERM LIABILITIES                                                         3,162,743
                                                                              ----------------
STOCKHOLDERS DEFICIENCY:
Common stock, par value $.015, authorized 50,000,000 shares;
 issued and outstanding 13,103,714                                                    196,556
Additional Paid in Capital                                                         30,756,855
Accumulated Deficit                                                               (36,700,679)
Less : Treasury Stock at Cost                                                        (776,315)
           Receivabletfor TreasurylStock                                              (69,300)
Cumulative Translation adjustment                                                     (99,867)
                                                                              ----------------
TOTAL STOCKHOLDERS DEFICIENCY                                                      (6,692,750)
                                                                              ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY                                    $ 4,685,530
                                                                              ================
</TABLE>


                 See notes to consolidated financial statements.

                                       3
<PAGE>
                             MUSE TECHNOLOGIES, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)
<TABLE>
<CAPTION>

                                                   Three Months Ended June 30,    Six Months Ended June 30,
                                                 -----------------------------  -------------------------------

                                                     2001          2000 (1)         2001           2000 (1)

<S>                                               <C>             <C>             <C>              <C>
REVENUES                                          $ 2,422,383     $ 2,677,399     $ 5,761,940      $ 7,080,424

EXPENSES:
Cost of revenues                                      380,409         623,783         850,634        1,385,438
Selling, general and administrative expenses        1,404,538       2,809,314       3,479,611        5,939,370
Research and development                            1,216,164       1,907,675       1,611,833        2,675,268
Officer Severance Costs                                     -         994,062               -          994,062
Bad Debt Expense                                            -               -         500,000                -
Amortization                                          227,326         144,701         496,125          234,315
Depreciation                                          220,892         238,236         439,562          380,822
                                                 -------------   -------------  --------------   --------------

TOTAL OPERATING EXPENSES                            3,449,329       6,717,771       7,377,765       11,609,275
                                                 -------------   -------------  --------------   --------------
NET OPERATING  LOSS                                (1,026,946)     (4,040,372)     (1,615,825)      (4,528,851)
                                                 -------------   -------------  --------------   --------------
OTHER INCOME (EXPENSE)
Other Expense                                         (13,577)       (178,582)         16,582         (179,338)
Unrealized Gain (Loss) on Investments                 (51,874)          3,136        (249,833)          58,506
Gain/(Loss) on Foreign Currency Transactions          (68,745)        (55,156)         44,534           25,916
Interest Expense                                      (63,028)        (54,010)       (174,448)        (110,004)
Interest Income                                             -          42,668               -          393,110
Loss on Asset Disposal                                 (6,176)              -               -                -
Merger/acquisition costs                                    -        (403,677)              -         (520,718)
Taxes                                                  (7,890)        (15,929)         (7,890)         (26,376)
                                                 -------------   -------------  --------------   --------------
TOTAL OTHER EXPENSE                                  (211,290)       (661,550)       (371,055)        (358,904)
                                                 -------------   -------------  --------------   --------------

NET LOSS FROM CONTINUING OPERATIONS                (1,238,236)     (4,701,922)     (1,986,880)      (4,887,755)
                                                 -------------   -------------  --------------   --------------

INCOME/(LOSS) FROM DISCONTINUED OPERATIONS           (424,978)         64,444      (1,596,386)        (162,345)

NET LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS      (958,085)              -        (958,085)               -
                                                 -------------   -------------  --------------   --------------
NET LOSS FROM DISCONTINUED OPERATIONS              (1,383,063)         64,444      (2,554,471)        (162,345)
                                                 -------------   -------------  --------------   --------------


                                                 -------------   -------------  --------------   --------------
NET LOSS                                         $ (2,621,299)   $ (4,637,478)   $ (4,541,351)    $ (5,050,100)
                                                 =============   =============  ==============   ==============


Net loss per common share -- Continuing Operations    $ (0.09)        $ (0.37)        $ (0.15)         $ (0.38)

Net income/(loss) per common share --
    Discontinued Operations                           $ (0.03)        $  0.01         $ (0.12)         $ (0.01)
                                                 -------------   -------------  --------------   --------------
Net loss per share -- Basic and Diluted               $ (0.13)        $ (0.36)        $ (0.27)         $ (0.40)
                                                 =============   =============  ==============   ==============
Weighted average number of common shares
    outstanding                                    13,103,714      12,738,461      13,103,714       12,738,461
                                                 =============   =============  ==============   ==============
NET LOSS                                           (2,621,299)     (4,637,478)     (4,541,351)      (5,050,100)
OTHER COMPREHENSIVE LOSS
    Change in cummulative translation adjustment       11,167         -               (99,867)         -
                                                 -------------   -------------  --------------   --------------
COMPREHENSIVE LOSS                               $ (2,610,132)   $ (4,637,478)   $ (4,641,218)    $ (5,050,100)
                                                 =============   =============  ==============   ==============
</TABLE>

     (1) The  consolidated  statement of  operations  have been restated to give
retroactive  effect to the  November  9,  2000  merger  accounted  for using the
pooling of interest method


                See notes to consolidated financial statements.

                                        4

<PAGE>
                             MUSE TECHNOLOGIES, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (UNAUDITED)
<TABLE>
<CAPTION>

                                                            Six months ended June 30
                                                      -------------------------------------
                                                            2001              2000 (1)
                                                      -----------------    ----------------

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                       <C>                 <C>
Net loss from continuing operations                       $ (1,986,880)       $ (4,887,755)
Adjustments to reconcile net loss from continuing
   operations to net cash provided  by (used in)
   operating activities of continuing operations:
Depreciation                                                   380,822             380,822
Amortization                                                   234,315             234,315
Write-off of note receivable                                   500,000                   0
Unrealized (gain)loss on investments                           249,833             (58,506)
Changes in assets and liabilities:
Accounts receivable                                            469,241           1,103,496
Inventory                                                                          (81,730)
Other current assets                                            (1,946)            105,162
Other assets                                                   572,045             138,162
Accounts payable                                               (68,134)           (201,088)
Accrued liabilities                                           (351,650)            263,265
Deferred Maintenace Revenue                                   (692,193)           (372,737)
                                                      -----------------    ----------------
NET CASH USED IN CONTINUING OPERATIONS                        (694,547)         (3,376,594)
                                                      -----------------    ----------------
NET CASH  USED IN
DISCONTINUED OPERATIONS                                       (707,761)         (2,549,564)

                                                      -----------------    ----------------
NET CASH USED FOR OPERATING ACTIVITIES                      (1,402,308)         (5,926,158)
                                                      -----------------    ----------------

CASH FLOWS FROM INVESTING ACTIVITIES
Sale/(purchase) of property and equipment                      235,213            (171,685)
Acquisition of subsidiaries, net of cash acquired                                 (397,949)
                                                      -----------------    ----------------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES                235,213            (569,634)
                                                      -----------------    ----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of marketable securirtes                                               (2,000,000)
Principal payments on capital leases                           (48,077)            (31,305)
Issuance of notes payable-others                               913,537                                     -
Borrowings-convertible debentures                              127,759             272,100
                                                      -----------------    ----------------
NET CASH PROVIDED FOR (USED IN) FINANCING ACTIVITIES           993,219          (1,759,205)
                                                      -----------------    ----------------

EFFECT OF EXCHANGE RATE ON CASH                               (143,844)            (38,216)
                                                      -----------------    ----------------
NET DECREASE IN CASH                                          (317,720)         (8,293,213)

CASH - BEGINNING OF PERIOD                                     610,093           9,703,916
                                                      -----------------    ----------------
CASH - END OF PERIOD                                         $ 292,373         $ 1,410,703
                                                      =================    ================

</TABLE>
     (1) The consolidate statements of cash flows have been restated to give
retroactive effect to the November 9, 2000 merger accounted for using the
pooling of interest method.

                 See notes to consolidated financial statements.

                                        5
<PAGE>





                          NOTES TO FINANCIAL STATEMENTS


1.   THE COMPANY

     MUSE  Technologies,  Inc. (the  "Company") was  incorporated in Delaware on
October 24, 1995,  and,  together  with its  subsidiaries,  develops and markets
software  products  designed to enhance a computer  user's ability to integrate,
present, analyze and better understand many different types of data. The Company
also provides its customers with professional services, systems integration, and
training  and  support  relating  to data  visualization  and other  methods  of
advanced  computer  graphics.  The  Company,  as of January  1,  2001,  conducts
business under the name Advanced  Visual  Systems (AVS).  As of January 1, 2001,
the Company  changed its financial  reporting year to end on December 31 instead
of a fiscal year end of September  30.



2.   BASIS OF PRESENTATION

     The  accompanying  unaudited  consolidated  financial  statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and the instructions to Form 10-QSB. Accordingly,  they do
not include all of the information and footnotes  required by generally accepted
accounting  principles  for  complete  financial  statements.  In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation  have been included. The results of operations
for the three and six month  periods  ended June 30, 2001,  are not  necessarily
indicative  of the results to be expected  for the full year ended  December 31,
2001. The unaudited  consolidated  financial  statements have been retroactively
restated  to give  effect to  Advanced  Visual  Systems  merger  consummated  on
November 9, 2000.  This merger was accounted for using the  pooling-of-interests
method. For further information, refer to the financial statements and footnotes
thereto  included  in the  Company's  Annual  Report on Form 10-KSB for the year
ended September 30, 2000.

3.        RECENT ACCOUNTING PRONOUNCEMENTS

     In July 2001, the Financial  Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 141 "Business Combinations" and SFAS
No. 142 "Goodwill and Intangible  Assets ("SFAS No. 142"). SFAS No. 141 requires
that all business  combinations  initiated  after June 30, 2001 be accounted for
using  the  purchase   method  of  accounting  and  prohibits  the  use  of  the
pooling-of-interests  method for such transactions.  SFAS No. 142 applies to all
goodwill and intangible assets acquired in a business combination. Under the new
standard,  all goodwill,  including goodwill acquired before initial application
of the standard,  should not be amortized but should be tested for impairment at
least annually at the reporting  level,  as defined in the standard.  Intangible
assets  other than  goodwill  should be  amortized  over their  useful lives and
reviewed for  impairment  in  accordance  with SFAS no. 121. The new standard is
effective for fiscal years  beginning  after December 15, 2001. The Company must
adopt this standard on January 1, 2002. As of June 30, 2001,  the Company had no
unamortized goodwill.

4.  GOING CONCERN

     The accompanying  financial statements have been prepared assuming that the
Company will  continue as a going  concern.  The Company  incurred a net loss of
approximately $4,541,00 for the six months ended June 30,2001. Additionally, the
Company had working capital and total capital deficiencies of approximately $4.9
million and $6.7 million at June 30, 2001, respectively.  These conditions raise
substantial  doubt about the Company's  ability to continue as a going  concern.
Management's  plans with respect to these  matters  include the  possibility  of
restructuring its existing debt, and raising  additional  capital through future
issuances of stock and or debentures.  The accompanying  financial statements do
not include any adjustments that might be necessary should the Company be unable
to continue as a going concern.

                                       6
<PAGE>

5.   BUSINESS COMBINATION

     On November 9, 2000,  we completed a merger with  Advanced  Visual  Systems
(AVS) and issued an aggregate of 1,929,579 shares of common stock of the Company
in exchange for all of the capital stock of AVS. The merger was accounted for as
a pooling  of  interests.  Accordingly,  the  Company's  consolidated  financial
statements  have been restated to include the pooled  operations of AVS as if it
had combined with the Company since AVS' inception. Included in net revenues for
the three-month periods ending June 30, 2001 and June 30, 2000 were $2.4 million
and  $2.5  million,  respectively.  Included  in  restated  net  income  for the
three-month  periods  ended June 30, 2001 and June 30, 2000 were a net income of
$260,000  and a net loss of $1.0  million,  respectively.  Restated  diluted net
income  per share for the three  months  ended June 30,  2001 and June 30,  2000
included income of $.02 per share and a net loss of $.08 per share respectively.
Included in net revenues for the six-month periods ending June 30, 2001 and June
30, 2000 were $5.6 million and $5.8 million, respectively.  Included in restated
net income for the  six-month  periods ended June 30, 2001 and June 30, 2000 was
net  income  of $1.4  million  and net  income  of $1.0  million,  respectively.
Restated  diluted net income per share for  the six-months  ended  June 30, 2001
and  June  30,  2000  included  income  of $.11 per  share  and  $.08 per  share
respectively.


6.       DISCONTINUED OPERATIONS


     On July 27, 2001,  we entered  into a definitive  agreement to sell Virtual
Presence,  Ltd. to Optionmaster Ltd., a U.K. company.  The transaction  involves
MUSE selling all of its interest in Virtual Presence Ltd.(including $1.9 million
in assets and $2.6  million in debt) to  Optionmaster  Ltd.  for  retirement  of
approximately  165,000  shares  of MUSE  common  stock  held by  John  Hough,  a
principal of Optionmaster Ltd. and former executive and director of the Company,
forgiveness   of  judgments  and   settlements   of  other  claims,   and  other
considerations. Under the terms of the transaction,  Optionmaster Ltd. will also
acquire Virtual Presence Ltd.  subsidiaries  SimTeam SARL,  Simulation Solutions
Ltd. and Virtual  Presence,  Inc. The  divestiture  will result in MUSE taking a
one-time  charge of $1.3  million  for the  quarter  ending  June 30,  2001 in a
write-down  of  goodwill  related  to its  acquisition  of Virtual  Presence  in
November 1999.

     All assets and liabilities of Virtual Presence and its'  subsidiaries  have
been written down to the net realizable value as of June 30, 2001. Net operating
results  for  Virtual  Presence  and its'  subsidiaries  has been  shown as "Net
Income/(Loss) from discontinued operations" for all reporting periods.


7.   NOTES PAYABLE

     In December  1997,  the Company,  through AVS,  entered into a  convertible
subordinated promissory note agreement with Kubota Corporation.  In exchange for
a $2,000,000 payment, Kubota received a convertible subordinated promissory note
due December 2001. The note,  which is subordinated to all the Company's  senior
indebtedness,  bears  interest at the rate of 5% per year  payable  quarterly in
arrears.  Kubota has the right to convert the Note into fully paid shares of the
Company's  common  stock at $9.86 per share.  Interest  expense  of $25,000  was
accrued  at June 30,  2001.  As of July 31,  2001,  we were in  arrears  for two
quarterly interest payments.

     On June 16, 2000, the Company  secured a $1,000,000 line of credit with the
Bank of Albuquerque to provide interim working capital.  The agreement was for a
one-year  period and expired on June 16, 2001.  The interest  rate is 0.5% above
the Chase  Manhattan  Bank prime rate.  The  initial  rate was 10% per annum and
interest  is payable  monthly.  The  Company  currently  is in arrears  for four
monthly  interest  payments as of August 20, 2001. The line of credit balance at
June 30, 2001 was $1,000,000 and interest  expense of $4,167 was accrued at June
30, 2001.  On February 5, 2001,  as a result of the  diminution  in value of our
investment account with a leading national investment firm (which collateralized
this line of credit),  the Bank of Albuquerque  accelerated and demanded payment
of amounts outstanding. The Company was unable meet this due date and management
is in discussions with the Bank of Albuquerque on various repayment plans.

                                       7
<PAGE>

     On June 1, 2000,  the  Company  entered  into an  $18,000,000  equity  line
agreement with Kingsbridge  Capital Limited subject to certain limitations based
on the market price and trading volume of the Company's  common stock. On August
7, 2000, the Company sold to Kingsbridge Capital, LTD, 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 the  Company's  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. If Kingsbridge does not elect to convert the note after the first
anniversary of its issuance,  the note is due and payable on August 7, 2002. The
Company also issued to  Kingsbridge  warrants to purchase  200,000 shares of the
Company's 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 the Company's  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 April 16, 2001 the  Company  received
notice from  Kingsbridge  Capital LTD  terminating its equity line agreement and
demanding  $900,000,  an amount equal to the unused  minimum  commitment  of the
equity line agreement  ($7,500,00)  multiplied by the applicable discount (12%).
The  Company  never  received  any funds nor issued any common  stock  under the
equity line agreement. Kingsbridge has never exercised any warrants.

     In June 2001,  the  Company  received  a total of  $350,000  in  short-term
financing from an individual, and in July 2001, the Company received $300,000 in
short-term  financing from Third  Millennium  Technologies.  Both notes carry an
annual interest rate of 9% and are due and payable 90 days from inception.  Both
notes are secured by the Company's Accounts Receivables.  As of August 19, 2001,
there was an  outstanding  balance of  $260,000  to such individual and $300,000
to Third Millennium.

8. Capitalized Development Costs

     The Company  accounts for  software  development  costs under  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 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 $570,767 as of June 30, 2001. Amortization of capitalized software
development  costs was $71,346 as of June 30, 2001 of which  $71,346 is included
as operating  expenses in the  accompanying  statements  of  operations  for the
tree-month  period ended June 30, 2001. For the six-month  period ended June 30,
2001, a total of $290,016 of amortization of capitalized  development costs were
included in operating  expenses.  Management has determined that due to the lack
of current product revenue for its' MuSE software  product,  that a writedown to
zero of the capitalized  software development costs associated with that product
was appropriate. A charge to income of $610,633 was reflected in the three-month
period ended June 30, 2001.

9.       LEGAL MATTERS

     During the  quarter  ended March  31,2001 it was  reported  that  Continuum
Resources had obtained a temporary restraining order ex parte  citation on April



                                       8
<PAGE>

11, 2001 in the District Court of Harris County, Texas, 129th Judicial District,
against  MUSE and AVS to refrain  from  destroying  the MuSE  source code and to
place a copy of the source code on CD-ROM and all related documentation with the
registry  of the Court  through  the Clerk of the  Harris  County  courts.  At a
subsequent  hearing  on  June  8,  2001,  the  Harris  County  Court  awarded  a
restraining order to Continuum Resources,  and the Company has complied with all
obligations  of the order and  provided  the  subject  source  code  directly to
Continuum  Resources.  On July 10 2001,  the Company and two of its officers and
directors were served with an amended petition by Continuum  Resources  claiming
breach of contract and other charges related to the Company's sale of securities
and certain  technologies  and related  distribution  rights to  Continuum.  The
amended  petition seeks adequate damages and includes the officers and directors
as  respondents.  The  Company's  lawyers have  entered a general  denial to the
amended  petition and are presently  evaluating  the complaint and the filing of
counterclaims.


     On June 13, 200l, a class action  complaint  was filed  against the Company
and one  former and one  current  officer  and  director  in the  United  States
District  Court for the  District of  Massachusetts  alleging  violations  under
Sections  10(b)  and 20(a) of the  Securities  Exchange  Act of 1934,  and other
provisions of the United States  Securities  laws during the period  January 24,
2000 through February 21, 2001. The Company is in the process of evaluating such
claims.


     On July 30, 2001,  the Company and two of its officers and  directors  were
served a summons in a civil case in the United States District  Court,  District
of Massachusetts,  by a former Company officer and director claiming the Company
failed to make all payments agreed to under an employment  resignation and stock
option repurchase agreement.  The Company's lawyers are presently evaluating the
complaint.

     On August 15,  2001,  the Company was served a notice of motion for summary
judgment in lieu of complaint in the Supreme  Court of the State of New York, by
Proskauer  Rose LLP, the  Company's  former  securities  counsel.  The notice of
motion  seeks  payment  from the Company of $563,536  for unpaid  legal bills as
agreed under the terms of a promissory note entered into by the Company on March
9, 2001, plus interest thereon at the rate of 10% per annum, compounded monthly,
from March 9, 2001, plus reasonable attorneys' fees and expenses. The promissory
note is payable  in full on August 30,  2001,  but has been  accelerated  due to
default by the failure to make required interim payments.


10.   OTHER MATTERS


     On April 16, 2001 the  Company's  common stock and warrants  were  delisted
from the Nasdaq  Small Cap  market for  failing  to meet  Nasdaq's  minimum  net
tangible asset  requirements  and other factors.  Commencing April 16, 2001, our
common stock and warrants are quoted on the OTC Bulletin Board.

     On July 18, 2001,  the Boston Stock  Exchange  notified the Company that it
was delisted  from that  exchange  for failure to meet its minimum  shareholders
equity requirement of $500,000.

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

     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.  Readers  are  encouraged  to  review  the  section
entitled  "Management's  Discussion  and  Analysis of  Financial  Condition  and
Results of  Operations--Factors  Affecting Operating Results and Market Price of
Stock"  commencing on page 24 of the Company's  Annual Report on Form 10-KSB for


                                       9
<PAGE>

the fiscal year ended  September  30, 2000 for a  discussion  of these risks and
uncertainties.

OPERATIONAL OVERVIEW

     The Company  receives  revenue from the sale and  licensing of its software
products,  the sale of third-party  manufactured  hardware and software,  and by
providing consulting,  training, support and maintenance services.  Revenues are
generated by two operating components (three prior to the disposition of Virtual
Presence subsidiaries on July 15, 2001), whose performance is outlined below:

1.   The MUSE  component of our business is related  exclusively  to the sale of
     our MuSE  (Multi-dimensional  user-oriented Synthetic Environment) software
     product and related  services.  From the beginning of fiscal 1999 until the
     second  quarter  of  fiscal  2000,  the  primary  sales  strategy  for  our
     MuSE-related  business was to distribute its software products and services
     through  a  network  of  resellers  that  had  extensive   vertical  market
     expertise.   That  distribution  strategy,  known  as  the  MUSE  Strategic
     Reselling  Partner (SRP) program,  has produced lower than expected results
     to date and is not expected to produce  significant  revenue in the future.
     Although  existing  reseller  agreements  provide for minimum  annual sales
     commitments,  failure of a SRP to satisfy those commitments  merely permits
     the Company,  under certain  circumstances,  to terminate  that  agreement.
     Accordingly,  the  Company  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.  From the second quarter of fiscal 2000
     through the first quarter of calendar 2001,  the Company  attempted to sell
     the MuSE software  product through a direct sales effort that produced only
     minimal results.

     In June 1998,  the  Company  entered  into a  strategic  reselling  partner
     agreement with Continuum Resources International, ASA, a Norwegian company,
     with respect to distribution of the Company's  products and services in the
     oil and gas  industry  worldwide.  In exchange for such  exclusive  rights,
     Continuum  Resources  paid the  Company  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 the  Company's  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.  Continuum  Resources has not met  renegotiated  minimum
     revenues  and has  brought  legal  action  against  the Company for matters
     related to the modified  agreement.  The Company has complied  with a court
     order and turned over the Muse source code to Continuum for its  restricted
     use.  Unless  and  until  required  by  court  order,  management  does not
     anticipate  any  compliance  from  Continuum  with its  obligations  to the
     Company under the various agreements. See Legal Proceedings.

     In April  1999,  the  Company  entered  into a  three-year  agreement  with
     Goodyear Tire & Rubber Company to develop  applications using the Company's
     advanced visualization and network collaboration  software. The Company has
     provided  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  other  strategic  reselling  partners  are not
     affected by this agreement.  The agreement was terminated by Goodyear as of
     December 31, 2000 citing internal budgeting constraints and is not expected
     to be reinstated.

     In 1999, the Company formed MUSE Federal Systems Group,  Inc.  ("MFSG"),  a
     wholly owned subsidiary that provides MuSE software  technology and related
     consulting   services   exclusively  to  federal  agencies  and  government
     contractors.  Through direct sales efforts and  resellers,  MFSG planned to
     broaden its customer  base and develop  special  capabilities  and services


                                       10
<PAGE>

     that  were  designed  to  meet  the  unique  requirements  of  governmental
     agencies. This effort has failed to meet management's  expectations and has
     produced insignificant revenue over the past several quarters.

     As a result of significantly  less than expected  economic results from the
     MUSE SRP  program,  the MuSE  software  product  and MFSG,  the Company has
     significantly  reduced  the  personnel  and  operations  related  to  these
     activities.  The MUSE  workforce in  Albuquerque,  NM has been reduced to a
     small team of  employees  and the Company  vacated its  Albuquerque  leased
     facilities in June 2000 to relocate  into  significantly  smaller  offices.
     MFSG  operations have been  functionally  terminated and it has vacated its
     Arlington,  VA  offices.   Included  in  these  workforce  and  operational
     reductions were the elimination of three Vice President  positions  related
     to technology  development,  business development and sales. Management has
     no  plans to  reactivate  MFSG in the near  term and has  relinquished  its
     facility security clearance.

     With  the  exception  of  insignificant  revenues  related  to the  ongoing
     licensing  of MuSE  software by a small  number of  customers,  no material
     future revenue is currently  expected from the MuSE product,  however,  the
     Company may elect to market the technology in the future.

2.   The AVS  component  of our  business  sells  a line  of data  visualization
     software products and related professional services through Advanced Visual
     Systems,  Inc.  (AVS),  a  wholly  owned  subsidiary  of the  Company,  and
     continues  to  be  the  primary  focus  of  management's  current  business
     strategy.

     AVS and its  subsidiaries  have  historically  sold AVS  software  products
     through  a direct  sales  force,  without  any  significant  dependence  on
     resellers or third party representatives. Through AVS, we have entered into
     several   Independent   Software  Vendor  (ISV)   relationships   in  which
     third-party  companies embed AVS technology  within their software products
     through a licensing and business  model that is different  than that of the
     MUSE SRP program.

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

     In September 2000, AVS entered into a software  licensing  agreement with a
     leading  software  manufacturer.  Under the terms of a perpetual  licensing
     agreement,  the  Company  received  a $1.5  million  one-time  payment  for
     software and professional  services.  In subsequent years, the customer can
     receive new releases of the Company's  OpenViz  technology  and support for
     $300,000 per year.

3.   On July 27, 2001 the Company  entered  into a defintive  agreement  to sell
     Virtual  Presence  Ltd. and its  subsidiaries  (see footnote 4 above to the
     financial   statements),   which   provide   highly   customized   advanced
     visualization  solutions;  systems  integration,  training  and  consulting
     services; and computer hardware and accessories to a predominately European
     customer base. The Company acquired Virtual Presence,  Ltd. on November 16,
     1999 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 the Company's common
     stock,  subject to  certain  restrictions.  Of those  shares,  205,522  are
     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.  The Company is in the process of issuing  363,969  shares to settle
     this agreement.

     In March,  2000,  through Virtual  Presence Ltd., the Company  acquired two
     additional  companies  (that were included in the sale of Virtual  Presence
     Ltd.):  Simulation  Solutions,  Ltd., a U.K. company that provides advanced
     software  and  consulting  services  in the  field of plant  and  equipment
     manufacturing simulation, and VRsource.com, a Colorado corporation, that is


                                       11
<PAGE>

     a prominent e-commerce site for advanced  visualization and virtual reality
     hardware.

     In April 2000, MUSE Virtual  Presence was awarded a major contract , valued
     at  $1,000,000,   with  the  Manchester  Visualization  Centre  to  provide
     hardware, software and services.

     Since the first quarter of fiscal 2001, the operations of Virtual  Presence
     had been reduced  through the transfer of certain  technologies  to another
     company and through employee attrition.

GENERAL

     On May 4, 2000,  the  Company's CEO and Chairman  resigned.  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  agreed to make certain  payments  over a
two-year  period.  The Company ceased  payments in December 2000, and the former
officer has brought legal action against the Company. See Legal Proceedings.


     On February 6, 2001, Russell G. Barbour, the Company's CEO since its merger
with  AVS,  resigned  to assume  the title of  President  of the  Company's  AVS
subsidiary.  Steve  Sukman,  Senior Vice  President and a member of the Board of
Directors,  immediately assumed CEO  responsibilities and was formally appointed
CEO on March 14, 2001, at which time Mr. Barbour ceased employment with AVS.

     As a result of the  elimination  of several  positions  within our US-based
marketing and  communications  departments in April 2001,  activities related to
strategic media relations, trade show attendance, direct marketing and promotion
have been significantly curtailed. Accordingly, it is possible that sales of our
software and services may decline in the future due to a  significant  reduction
in marketing activity.

     As a result of significant lead time necessary to market and consummate the
Company's  direct sales and ISV  activities,  quarterly  results are expected to
fluctuate  significantly  depending on the timing and  successful  completion of
such  arrangements  and any up  front  fees  and  sales  commitments  associated
therewith. Accordingly, results in any one quarter are not indicative of results
to be expected in subsequent quarters.  At the present time,  management efforts
are primarily  focused on seeking  additional  funding,  addressing  defaults on
Company  obligations and various legal matters to enable the Company to continue
as a going concern.


RESULTS OF OPERATIONS

     Revenues for the  three-month  period ended June 30, 2001 was $2,422,383 as
compared to revenues of  $2,677,399  for the  three-month  period ended June 30,
2000. The decrease of $255,016,  or 9%, for the three-month  period is primarily
attributable  to a reduction in MuSE  licensing  maintenance  and support  fees.
Revenues for the six-month period ended June 30, 2001 was $5,761,940 as compared
to revenues of  $7,080,424  for the  six-month  period ended June 30, 2000.  The
decrease of  $1,318,484,  or 19%, for the six-month  period was again  primarily
attributable to a reduction in MuSE licensing maintenance and support fees.


     Total  operating  expenses for the  three-month  period ended June 30, 2001
were  $3,449,329 as compared to total  operating  expenses of $6,717,771 for the
three-month period ended June 30, 2000. The decrease of $3,268,442,  or 49%, for
the  three-month  period is primarily  attributable to reduced cost of revenues,
significant  cutbacks  in staff,  decreased  legal  expenses  and  reduction  or
elimination  of certain  office  operations.  In addition,  there was a one-time
charge in the period  ending  June 30,  2000 for  $994,062  in  connection  with
resignation  of the  Company's  former CEO.  Total  operating  expenses  for the
six-month  period  ended June 30,  2001 were  $7,377,765  as  compared  to total
operating  expenses of $11,609,275 for the six-month period ended June 30, 2000.
The  decrease  of  $4,231,510  or  369%,  for  the  six-month  period  was  also


                                       12
<PAGE>

attributable  to  reduced  cost of  revenues,  significant  cutbacks  in  staff,
decreased  legal  expenses  and  reduction  or  elimination  of  certain  office
operations.  In addition,  there was a one-time charge in the period ending June
30, 2000 for $994,062 in connection  with  resignation  of the Company's  former
CEO.


     Total other  income/(expenses)  for the  three-month  period ended June 30,
2001 was  $211,290 of  expenses  as  compared  to  $661,550 of expenses  for the
three-month  period  ended June 30,  2000.  The  reduction of expenses is mainly
attributable  to an expense  for  merger and  acquisition  of  $403,677  in 2000
associated  with  the  acquisition  of  Advanced  Visual  Systems.  Total  other
income/(expenses) for the six-months ended June 30, 2001 and compared to the six
month ended June 30, 2000 were relatively constant.

     The loss from  discontinued  operations  of  $424,978  for the  three-month
period  ended June 30, 2001 versus an income of $64,444,  is a result of reduced
revenues  offset  by  reduced  operating  expenses.  The  loss  on  disposal  of
discontinued  operations  of $958,085 is the cost  associated  with the disposal
along with the write-off of the goodwill from the original acquisition. The loss
from  discontinued  operations for the six-month  period ended June 30, 2001 was
$1,596,386 and $958,085 loss on the disposal.

     Accordingly, the net loss for the three-month period ended June 30, 2001 of
$2,621,299 as compared to the net loss of $4,637,478  for the three month period
ended June 30, 2000, reflected a significant reduction in operating expenses due
to cost saving measures  enacted by the Company,  offset by a slight decrease in
revenues and a one-time charge for the disposition of Virtual Presence.  The net
loss for the  six-month  period ended June 30, 2001 of $4,541,351 as compared to
the net loss of  $5,050,100  for the six  month  period  ended  June  30,  2000,
reflected a  significant  reduction  in  operating  expenses  due to cost saving
measures  enacted by the Company,  offset by a slight decrease in revenues and a
one-time charge for the disposition of Virtual Presence.


     The  Company's  primary  revenue  strategy is to build a direct sales force
that can  identify  international  revenue  opportunities  for the AVS  software
products.  As a result  of the  significant  lead  time  necessary  to create an
effective direct sales force and consummate  additional  customer,  distribution
and ISV relationships, the Company's 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 any one quarter are not indicative of results to be experienced in subsequent
quarters.

     As of January 1, 2001,  we changed our financial  reporting  year to end on
December 31 instead of a fiscal year end of September 30.


LIQUIDITY AND CAPITAL RESOURCES

     Historically, the Company's capital requirements have been funded through a
series of debt and equity  financings  and  revenues  received  through  the SRP
program.  During fiscal 2000,  revenues  generated from direct sales  activities
also funded portions of the Company's capital needs.

     In July  1998,  the  Company  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, the Company 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.  In April 2001 the Company sent  Continuum a letter  demanding
payment of principal and accrued  interest.  The loan remains  outstanding as of
the date  hereof and our demand for  payment has  resulted  in  litigation  from
Continuum  Resources  for  claims  that  the  Company  failed  to  meet  certain
expectations of a June 2000 modified  agreement between our companies.  Pursuant
to the  June  2000  agreement,  Continuum  Resources  acknowledged  its  payment
obligations  on the loan and that the Company will be entitled to terminate  the
reseller agreement and Continuum  Resources'  exclusive  distribution rights for
MuSE  software  in the oil and gas  industry  if the  loan is  unpaid;  however,
management  cannot  provide  assurance  that that the loan will be repaid in the


                                       13
<PAGE>

near future. Accordingly, the Company wrote off $250,000 of the $1,000,000 loans
in the fiscal year ended  September  30, 2000 and has written off an  additional
$500,000 in the second quarter of 2001.


     As part of the acquisition of AVS through a merger,  the Company  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, if converted.

     On December 12, 2000, the Company  appointed  Bluestone  Capital  Partners,
L.P. as our  financial and  investment  banking  advisors.  Under the terms of a
non-exclusive agreement, Bluestone was to be paid a one-time retainer of $50,000
in addition to an advisory fee of $10,000 per month,  plus a  commission  at the
closing of the sale of securities, if any, to certain institutional,  accredited
individual or strategic  investors.  As of March 2001 the Company terminated its
monthly fee arrangement with Bluestone. No relevant sales were ever consummated.

     On December 26, 2000,  the Company  entered into an agreement  with Prevail
With Vision,  Inc. (PWV) 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,
PVW was paid a retainer fee of $30,000 and will  receive a 6%  placement  fee on
any funds raised by PVW. No funding activities have been consummated by PWV. The
agreement with PWV terminated on May 26, 2001.

     On January 2, 2001,  the Company  retained The Wall Street  Group,  Inc. as
financial relations advisors.  Under the terms of an agreement,  The Wall Street
Group  was to  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
number of shares of common stock  underlying the warrants  doubled to 200,000 in
April 2001 as a result of our non-payment of monthly fees. The agreement was for
a term of one year subject to cancellation by either party upon 90 days' written
notice,  at which time The Wall  Street  Group is  required to refund a prorated
portion of the warrants. Notice of termination was given in March 2001.

     In March 2001 the Company retained, on an hourly consulting basis, Geoffrey
D. Lurie & Associates LLC to assist its senior  management team in an evaluation
of our  operations  and to refine  our  short-  and  long-term  strategies.  The
agreement with Geoffrey D. Lurie & Associates was terminated in June, 2001.

     In October 1999, the Company deposited  $2,000,000 in an investment account
with a leading national  investment banking  organization.  The current value of
the account as of July 30, 2001 is less than  $20,000.  The Bank of  Albuquerque
has a  security  interest  in such funds in  connection  with the line of credit
discussed  above.  The  Company  believes  that  approximately  $900,000 of $1.4
million in losses may be attributable to circumstances  other than normal market
fluctuations.  The  Company  has  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.  Management believes that
improprieties  may have been  committed,  and to the extent that the Company may
have  valid  legal  claims  relating  to these  losses,  management  intends  to
prosecute those responsible. To the extent that the Company's claims are adverse
to the investment  banking  organization  charged with supervisory  oversight of
such account,  such claims will be subject to an arbitration  proceeding  unless
the Bank of Albuquerque  initiates a complaint in another forum. On May 8, 2001,
the Company  entered into  mediation with the  investment  banking  organization
resulting in an unaccepted settlement offer that is less than the full amount of
the Company's losses and is subject to additional negotiation and evaluation.

     On April 16, 2001 the  Company's  common stock and warrants  were  delisted
from the Nasdaq  Small Cap  market for  failing  to meet  Nasdaq's  minimum  net
tangible asset  requirements  and other factors.  Commencing April 16, 2001, our
common stock and warrants are quoted on the OTC Bulletin  Board.  As a result of
our Nasdaq  delisting  and current  trading on the OTC Bulletin  Board,  it will
likely become more difficult for the Company to raise capital and its stock will
likely be traded with  significantly  lower daily volume,  possibly resulting in
less liquidity for investors.

                                       14
<PAGE>

     On July 19, 2001 the  Company's  common stock and warrants that were traded
on the Boston Stock Exchange were removed from listing and  registration  on the
Boston Stock  Exchange due to the  Company's  inability to rectify a shareholder
equity deficit.

     During June and July,  2001,  the Company  received short term financing in
exchange for three 90-day loans in the aggregate amount of $650,000 ($100,000 on
June 14,  $250,000 on June 26, and $300,000 on July 9)that bear  interest at the
rate of 9% per annum and are secured by certain of the Company's  identified and
general accounts receivable.


     For the six months ended June 30, 2001, there was a net decrease in cash of
$317,720 as compared to a net decrease in cash of  $8,293,213  for the six-month
period ended June 30, 2000.  The decrease in net use of funds for  operations of
$1,279,464  was offset by borrowings on notes payable and sales of fixed assets.
As  of  June  30,  2001,  the  Company  had  a  working  capital  deficiency  of
approximately  $4.9 million.  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 new
loan and credit facilities, as the likelihood of equity-based funding sufficient
for working capital seems unlikely.  The recovery of assets and  continuation of
future  operations is dependant upon  management's  ability to obtain additional
financing and management's  ability to generate revenues  sufficient to continue
pursuing our current business plan.

     In the absence of substantial  outside financing,  of which there can be no
assurance,  the  Company  will be  required  to operate  only to the extent that
future sales and related collections permit.

     The Company's capital  requirements  depend on numerous factors,  including
the progress of product  development  programs,  ability to enter into strategic
arrangements   or   other   marketing   arrangements   which   result   in   the
commercialization  and  distribution  of the  Company's  products,  the  need to
purchase  or  lease  additional  capital  equipment  and  the  cost  of  filing,
prosecuting,  defending  and  enforcing  claims  by  and  against  the  Company,
including  any patent claims and other  intellectual  property  rights,  and the
combination  of the  Company's  operations  with  those of AVS.  Based  upon the
Company's current plans, management believes that current cash resources as well
as anticipated  funds to be generated from  operations,  will be insufficient to
satisfy the Company's  needs for the next 12 months.  The equity line  agreement
has been  terminated  and the  Company  has no current  sources of  equity-based
funding.  Accordingly,  the Company  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.

     Further,  as a result of the merger  with AVS on  November  9, 2000 and the
Company's  substantially  weakened cash  position  subsequent to our fiscal year
end, the Company continues to require  significant  additional funds in order to
complete  the  effective  combination  of the  Company's  operations  (including
international  operations)  and to  continue  to  fund  certain  projects  under
development.  The  Company  cannot  provide  assurance  that such  funds will be
available or that the Company can effectively  combine its operations with those
of AVS as anticipated.  The dollar amount  required to  successfully  market the
combined  product and service  offerings of the Company and AVS has not yet been
determined; however, management believes that it will be significant and may not
produce immediate results. The Company has significantly  reduced the dimensions
of its marketing  activities and may be unable to create a planned 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  the Company has engaged the  services of  investment  banking and
financial  services  firms  to  assist  management  in  identifying  sources  of
financing,  management  can provide no assurance that the amount or structure of
any such financings will be acceptable. As a result, the Company has been forced
to curtail  its  planned  marketing  and growth  strategies  and  certain of its


                                       15
<PAGE>

operations.  In this regard,  management  has cut costs where  feasible and have
significantly  reduced  personnel and operating  costs in the US offices and has
moved the Company's  principal offices and operations to Waltham,  Massachusetts
to take advantage of the synergies available as a result of the merger with AVS.

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

     The Company's  primary sales strategy is to build a direct sales force that
can identify  international revenue opportunities for the AVS software products.
As a result of the significant lead time necessary to create an effective direct
sales  force  and  consummate   additional   customer,   distribution   and  ISV
relationships,  the  Company's  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 any one quarter are not indicative of results to be experienced in subsequent
quarters.


PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

     In the FORM 10-QSB for the period  ended March  31,2001  filed on behalf of
the Company,  it was reported that Continuum  Resources had obtained a temporary
restraining  order ex parte  citation on April 11, 2001 in the District Court of
Harris County,  Texas, 129th Judicial District,  against MUSE and AVS to refrain
from  destroying  the MuSE source code and to place a copy of the source code on
CD-ROM and all related  documentation with the registry of the Court through the
Clerk of the Harris County courts. At a subsequent  hearing on June 8, 2001, the
Harris County Court awarded a restraining order to Continuum Resources,  and the
Company has complied with all  obligations of the order and provided the subject
source code directly to Continuum  Resources.  On July 10 2001,  the Company and
two of its  officers  and  directors  were  served  with an amended  petition by
Continuum Resources claiming breach of contract and other charges related to the
Company's sale of securities and certain  technologies and related  distribution
rights to  Continuum.  The  amended  petition  seeks  damages and  includes  the
officers and  directors as  respondents.  The  Company's  lawyers have entered a
general  denial  to the  amended  petition  and  are  presently  evaluating  the
complaint and the filing of counterclaims.


     On June 13, 200l, a class action  complaint  was filed  against the Company
and one  former and one  current  officer  and  director  in the  United  States
District  Court for the  District of  Massachusetts  alleging  violations  under
Sections  10(b)  and 20(a) of the  Securities  Exchange  Act of 1934,  and other
provisions of the United States  Securities  laws during the period  January 24,
2000 through February 21, 2001. The Company is in the process of evaluating such
claims.


     On July 30, 2001,  the Company and two of its officers and  directors  were
served a summons in a civil case in the United States District  Court,  District
of Massachusetts,  by a former Company officer and director claiming the Company
failed to make all payments agreed to under an employment  resignation and stock
option repurchase agreement.  The Company's lawyers are presently evaluating the
complaint.

     On August 15,  2001,  the Company was served a notice of motion for summary
judgment in lieu of complaint in the Supreme  Court of the State of New York, by
Proskauer  Rose LLP, the  Company's  former  securities  counsel.  The notice of
motion  seeks  payment  from the Company of $563,536  for unpaid  legal bills as
agreed under the terms of a promissory note entered into by the Company on March
9, 2001, plus interest thereon at the rate of 10% per annum, compounded monthly,
from March 9, 2001, plus reasonable attorneys' fees and expenses. The promissory
note is payable  in full on August 30,  2001,  but has been  accelerated  due to
default by the failure to make required interim payments.


                                       16
<PAGE>


ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

     On June 21, 2001,  the Board of Directors  granted  options to employees of
the Company and its  subsidiaries  pursuant to the  Company's  1996 Stock Option
Plan to purchase  5,605,000  shares of the Company's common stock at fair market
value, of which options to purchase  2,900,000 were granted to the directors and
executive  officers of the Company.  Fair market  value is $0.10 per share,  the
closing  price  on the  date of the  grant.  The  options  vest  in  four  equal
allotments  beginning on September  30, 2001,  and every six months  thereafter,
subject to  continuing  employment.  The options may be exercised on a "cashless
basis" so that sufficient  shares are considered to be exercised and immediately
sold to cover the excise  price of the options  exercised.  The shares for which
options were granted exceed the shares  currently  available  under the terms of
the plan as previously  approved by the  shareholders of the Company and to that
extent were granted subject to approval or  ratification of the  shareholders of
the Company.

     As of August 20, 2001,  the Company has  outstanding a total of $560,000 in
short-term notes payable which are secured by the Company's accounts receivable.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

     Defaults in the payment of interest and  principal in  indebtedness  of the
Company  not  cured  within  30 days are  discussed  above  (1) in note 7 to the
financial   statements  with  respect  to  Kubota   Corporation,   the  Bank  of
Albuquerque, and Kingsbridge Capital Limited, (2) under the "General" heading of
Part I, Item 2, Management's  Discussion and Analysis,  with respect to payments
due a former CEO and Chairman, and (3) under Part II, Item 1, Legal Proceedings,
with  respect  to  Proskauer  Rose LLP.  The  amounts of the  default  and total
arrearages  as of  August  20,  the date of the  filing  of this  report  are as
follows:


-------------------------------------- -------------- --------------
                                       Default        Total
                                       Amount         Arrearages
-------------------------------------- -------------- --------------
Kubota Corporation                     $2,000,000     $50,000

-------------------------------------- -------------- --------------
Bank of Albuquerque                    $1,000,000     $40,750

-------------------------------------- -------------- --------------
Kingsbridge Capital Limited            $1,000,000     $50,000

-------------------------------------- -------------- --------------
Former CEO & Chairman                  $429,101       $346,350

-------------------------------------- -------------- --------------
Prsokauer Rose LLP                     $563,537       563,537

-------------------------------------- -------------- --------------


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

     Not applicable.

ITEM 5.  OTHER INFORMATION

     As of January 1, 2001, the Company changed its financial report year to end
on December 31 instead of a fiscal year end of September 30.

     Effective  June 8, June 12 and June 13,  2001,  respectively,  each of Jack
Berenzwig,  Ed Masi and John Hough tendered their respective  resignations  from
the Company's  Board of Directors.  The Company's  Board of Directors  currently
consists  of Steve  Sukman and Brian R. Clark,  the  Company's  Chief  Executive
Officer, and President and Chief Financial Officer, respectively.


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

     (a)  Exhibit Index:

     (b)  The following Current Reports on Form 8-K have been filed during the
          period:

                                       17
<PAGE>

     1.  April 20,  2001:  On April 13,  2001,  MUSE  Technologies,  Inc.  d/b/a
Advanced Visual Systems (the "Company")  received  notification  from the Nasdaq
Stock Market  ("Nasdaq")  that Nasdaq's  hearing panel  determined to delist the
Company's securities,  effective April 16, 2001. The Nasdaq hearing with respect
to the Company's eligibility to maintain the listing of its securities on Nasdaq
was held on March 16, 2001. The Company's  Common Stock and Warrants have traded
on the Nasdaq Small Cap since  November 1998.  Following  delisting from Nasdaq,
the Company's  securities  began trading on the OTC Bulletin Board. On April 12,
2001, the Company received  notification from the Boston Stock Exchange advising
that the Company failed to meet the its minimum shareholder's equity maintenance
requirement.  The Company is in the process of submitting a response.  There can
be no assurance that  notwithstanding  such response,  the Boston Stock Exchange
will determine to maintain the listing of the Company's securities.


     2. June 28, 2001: On June 14, 2001, MUSE Technologies,  Inc. d/b/a Advanced
Visual Systems (the "Company")  received short term financing in the amount of a
90-day $100,000 loan ("Loan").  The Loan, which bears interest at the rate of 9%
per  annum,  is  secured  by  certain  of  the  Company's   identified  accounts
receivable.  While  the  Loan  addresses  certain  of  the  Company's  immediate
short-term cash flow needs, the Company's  accounts  receivable  collections are
less than forecasted  resulting in continued limited cash flow and a shortage of
working capital.  The Company continues to seek required long-term financing and
to explore  all other  alternatives,  including  the  possibility  of filing for
protection  under Title 11 of the United  States Code. On June 13, 200l, a class
action  complaint  was filed  against  the Company and certain of its former and
current  officers and  directors  in the United  States  District  Court for the
District of Massachusetts  alleging violations under Sections 10(b) and 20(a) of
the Securities  Exchange Act of 1934, and other  provisions of the United States
Securities  laws during the period  January 24, 2000 through  February 21, 2001.
The Company is in the process of evaluating such claims.  Effective June 8, June
12 and June 13, 2001,  respectively,  each of Jack  Berenzwig,  Ed Masi and John
Hough  tendered  their  respective  resignations  from  the  Company's  Board of
Directors.  The Company's Board of Directors  currently consists of Steve Sukman
and Brian R. Clark,  the Company's  Chief Executive  Officer,  and President and
Chief Financial Officer, respectively.


                                   SIGNATURES

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

Dated: August 20, 2001

                                            MUSE TECHNOLOGIES, INC.

                                            By: /s/ Brian R. Clark
                                                --------------------
                                                Brian R. Clark, President and
                                                Chief Financial Officer
                                               (Principal Financial and
                                                Accounting Officer)


                                            By: /s/ Steve Sukman
                                                --------------------
                                                Steve Sukman,
                                                Chief Executive Officer




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