<PAGE>

                       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: December 31, 2000

                           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 December 31, 2000 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 2,598,388 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 December 31, 2000               3

         Consolidated statements of operations for the three months
             ended December 31, 2000 and 1999                             4

         Consolidated statements of cash flows for the three months
             ended December 31, 2000 and 1999                             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                                              15

INDEX TO EXHIBITS                                                        15

SIGNATURES                                                               16

                                        2

<PAGE>

                             MUSE TECHNOLOGIES, INC.
                           CONSOLIDATED BALANCE SHEET
                                DECEMBER 31, 2000
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                     ASSETS
<S>                                                                      <C>
CURRENT ASSETS:
         Cash and cash equivalents                                       $    893,640
         Marketable securities                                                286,206
         Accounts receivable                                                3,365,728
         Notes receivable-related parties (net of reserve of $250,000)        873,882
         Inventory                                                            219,842
         Other current assets                                                 359,413
                                                                         ------------
                  TOTAL CURRENT ASSETS                                      5,998,711
                                                                         ------------

PROPERTY AND EQUIPMENT - NET                                                1,732,730

OTHER ASSETS
         Goodwill-net                                                       2,838,586
         Capitalized development costs-net                                  1,017,721
         Other assets                                                         743,272
                                                                         ------------
                  TOTAL OTHER ASSETS                                        4,537,382
                                                                         ------------
TOTAL ASSETS                                                             $ 12,331,019
                                                                         ============

                      LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
         Accounts payable                                                $  3,832,595
         Accrued liabilities                                                5,989,298
         Bank note payable                                                  1,000,000
         Current portion lease payable                                        123,209
                                                                         ------------
                  TOTAL CURRENT LIABILITIES                                10,945,102

LONG TERM LIABILITIES
         Lease payable-less current portion                                    30,774
         Convertible debentures (less discount of $110,916)                 3,004,210
                                                                         ------------
                  TOTAL LONG-TERM LIABILITIES                               3,034,984
                                                                         ------------
STOCKHOLDERS' EQUITY:
         Common stock, par value $.015, authorized 50,000,000 shares;
             issued and outstanding 13,103,714 shares                         196,556
         Additional paid in capital                                        30,756,855
         Accumulated deficit                                              (31,944,891)
         Less: treasury stock at cost                                        (776,315)
         Cumulative translation adjustment                                    118,728
                                                                         ------------
             TOTAL STOCKHOLDERS' DEFICIENCY                                (1,649,067)
                                                                         ------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY                           $ 12,331,019
                                                                         ============
</TABLE>

                 SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

                                        3

<PAGE>

                             MUSE TECHNOLOGIES, INC.
                    CONSOLIDATED STATEMENTS OF OPERATIONS (1)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                         Three Months Ended
                                                            December 31,
                                                     2000                  1999
                                                     ----                  ----
<S>                                               <C>                   <C>
REVENUE                                           $3,870,944            $5,595,697

EXPENSES:
    Cost of products sold                          1,051,475               924,511
    Selling, general and administrative
    expenses                                       3,677,599             2,780,251
    Research and development                       1,131,949             1,084,737
    Merger/Acquisition costs                         314,000                    --
    Amortization                                     236,649                71,331
    Depreciation                                     267,462               273,169
                                                 -----------            ----------
TOTAL OPERATING EXPENSES                           6,599,865             5,133,999
                                                 -----------            ----------
NET OPERATING  INCOME (LOSS)                     $(2,808,190)           $  461,698
                                                 -----------            ----------
OTHER INCOME (EXPENSE)
    Restructuring expense                                 --               (70,000)
    Unrealized loss on investment                   (593,190)                   --
    Gain/(Loss) on foreign currency
    transactions                                     116,391               (39,312)
    Interest expense                                (104,761)              (67,464)
    Interest income                                   41,803               256,493
    Taxes                                                 --               (43,968)
                                                 -----------            ----------
TOTAL OTHER INCOME (EXPENSE)                        (539,757)               35,749
                                                 -----------            ----------
NET INCOME (LOSS)                                ($3,347,947)             $497,447
                                                 ===========            ==========
NET INCOME (LOSS) PER SHARE
Basic and assuming dilution                           ($0.26)                $0.04
                                                 ===========            ==========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING:                        12,980,261            12,480,514
                                                 ===========            ==========
NET LOSS                                         ($3,347,947)             $497,447
OTHER COMPREHENSIVE LOSS
     Change in cumulative translation
     adjustment                                       67,942                    --
                                                 -----------            ----------
COMPREHENSIVE INCOME (LOSS)                      ($3,280,005)             $497,447
                                                 ===========            ==========
</TABLE>

(1) See note page 5

                                        4
<PAGE>

                             MUSE TECHNOLOGIES, INC.
                    CONSOLIDATED STATEMENTS OF CASH FLOWS (1)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                 Three Months Ended
                                                                          December 31,
                                                                  ----------------------------
                                                                      2000           1999 (1)
                                                                  ------------    ------------
<S>                                                               <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES
    Net income (loss)                                             $ (3,347,947)   $    497,447
    Adjustment to reconcile net income (loss) to net cash
    (used in) operating activities:
         Depreciation                                                  267,462         273,169
         Amortization                                                  236,649          71,331
         Amortization of debt discount                                  15,126            --
         Realized and unrealized loss on investment                    593,190            --
Changes in assets and liabilities:
    (Increase)/decrease in accounts receivable                       1,356,584      (2,398,493)
    (Increase)/decrease in inventory                                  (102,461)         12,750
    (Increase in prepaid assets                                         42,308         (67,439)
    Increase in other assets                                          (177,180)       (921,302)
    Increase/(decrease) in accounts payable                            811,131        (351,766)
    Increase/(decrease) in accrued liabilities                         (28,428)       (226,839)
                                                                  ------------    ------------
         NET CASH USED IN OPERATING ACTIVITIES                        (333,566)     (3,111,143)
                                                                  ------------    ------------

CASH FLOWS FROM INVESTING ACTIVITIES
         Purchase of property and equipment                            (31,478)       (103,839)
         Acquisition of subsidiary-net of cash                            --          (300,000)
         Sale of marketable securities                                 540,000            --
                                                                  ------------    ------------
         NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES           508,522        (403,839)
                                                                  ------------    ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Collectionvof notes receivable                                        1,118          11,781
   Collection of stock subscription receivable                            --            87,500
   Principal payments on capital leases                                (25,024)        (11,605)
   Repayments of notes payable-affiliates                                 --            (5,257)
   Repayments of notes payable-other                                      --          (271,063)
   Borrowings-convertible debentures                                   100,000            --
   Borrowings-line of credit                                            30,000            --
   Repayments-line of crdit                                         (1,019,538)           --
                                                                  ------------    ------------
   NET CASH USED IN FINANCING ACTIVITIES                              (913,444)       (188,644)
                                                                  ------------    ------------

   EFFECT OF EXCHANGE ON CASH                                           67,942          (3,258)
                                                                  ------------    ------------

NET DECREASE IN CASH                                                  (670,546)     (3,706,884)
CASH - BEGINNING OF PERIOD                                           1,564,186      13,265,310
                                                                  ------------    ------------
CASH - END OF PERIOD                                              $    893,640    $  9,558,426
                                                                  ============    ============
</TABLE>

(1)   The consolidated statement 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 and
information. The Company also provides its customers with comprehensive software
solutions, systems integration, and training and support services 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.

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 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.   BUSINESS COMBINATION

     On November 9, the Company completed the merger with Advanced Visual
Systems Incorporated (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 December 31, 2000
and December 31, 1999 were $2.6 million and $3.8 million, respectively. Included
in restated net income for the three month periods ended December 31, 2000 and
December 31, 1999 were a net loss of $.8 million and a net income of $.3
million, respectively. Restated diluted net income per share for the three
months ended December 31, 2000 and December 31, 1999 included income of $.14 per
share and a net loss of $.42 per share respectively.

     In connection with the merger with AVS, the Company recorded approximately
$.3 million in charges in the three month period ended December 31, 2000 for
direct and other merger-related costs including fees of attorneys, accountants
and other direct and incremental charges.

4.   FINANCIAL ADVISORY AGREEMENTS

                                        6

<PAGE>

     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.

5.   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.

     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 is for a
one year period and expires 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 line of credit balance at December 31, 2000 was
$1,000,000 and interest expense of $4,167 was accrued at December 31, 2000. On
February 5, 2001, as a result of the diminution in value of the Company's
investment account which collateralized this line of credit, the Bank of
Albuquerque accelerated and demanded payment of amounts outstanding. The Company
negotiated a arrangement with the Bank and the demand for payment was withdrawn.
The arrangement, which is subject to execution of definitive documentation,
requires the Company to make payments of $100,000 on each of February 16, 2001,
March 1, 2001 and April 1, 2001, with the balance payable on May 1, 2001.

7.   SUBSEQUENT EVENTS

     On January 22, 2001, the Company 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 filed by January 29, 2001.
Although we have complied with this request, the Nasdaq Stock Market has

                                        7

<PAGE>

decided to review our ability to continue to comply with all listing maintenance
criteria, including the requirement to maintain net tangible assets of
$2,000,000. The Company has requested a hearing which is scheduled for March 16,
2001. The Company was not in compliance with the net worth requirement as of
December 31, 2000. There can be no assurance that the Company will be able to
convince the hearing panel that it will be able to maintain compliance with such
maintenance criteria in the future. There can also be no assurance that the
hearing panel will render a favorable decision or that such decision will not be
subject to conditions or other restrictions which the Company may not be able to
comply with or which may make it more difficult to trade in the Company's
securities. An unfavorable decision will result in the immediate delisting of
the Company's common stock and warrants from the Nasdaq Stock Market
irrespective of the Company's ability to appeal such decision. Any such
delisting will have an adverse impact on the liquidity of the Company's
securities, which may then trade on the OTC Bulletin Board or the
over-the-counter market, which may make it more difficult to trade in the
Company's securities or liquidate an investor's holdings. Also, such delisting
may make it more difficult for the Company to raise additional capital.

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

                                        8

<PAGE>

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.

     From the beginning of fiscal 1999 until the second quarter of fiscal 2000,
the primary sales strategy for the Company 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 Strategic Reselling
Partner (SRP) program, has produced lower than expected results to date, and
while several SRP distributors continue to promote and offer some of our
products and services, management believes that establishing a direct sales
relationship with potential customers will shorten the sales cycle, optimize
profitability, and ensure that the Company's software is effectively introduced
into its targeted markets.

     The Company's current strategy is to expand its sales force and convert all
operating units to a primarily direct sales model where a combination of
products and services are offered to its customers. For one operating unit, this
represents a material departure from the 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 the Company; however, as a means of creating a larger installed
base of users, the Company believes that the current sales strategy of all units
should be focused on direct contact with customers that have complex data
integration and data analysis challenges and large populations of users. The
Company believes that select target markets can benefit from an integrated
deployment of the Company's software and professional services, and that a
direct sales effort will produce 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, 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 expected in subsequent quarters. Currently, the
SRP program has been requiring a greater than anticipated sales cycle and,
therefore, sales attributable to resellers for the period ended June 30, 2000
were not significant.

                                        9

<PAGE>

     Although existing reseller agreements provide for minimum annual sales
commitments, failure to satisfy those commitments merely permit the Company 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.

     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.

     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 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
other srategic reselling partners are not affected by this agreement. The
agreement was terminated by Goodyear as of December 31, 2000 citing internal
budgeting constraints.

     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 U.K.. 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, the Company formed MUSE Federal Systems Group, Inc., a wholly
owned subsidiary that provides software and consulting services exclusively to
federal agencies and government contractors. Through direct sales efforts and
resellers, MUSE Federal Systems Group plans to broaden its customer base and
develop special capabilities and services that are designed to meet the unique
requirements of governmental agencies.

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

                                       10

<PAGE>

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.

     On March 17, 2000, the Company acquired Simulation Solutions, Ltd., a U.K.
company that provides advanced software and consulting services in the field of
plant and equipment manufacturing simulation. The Company acquired Simulation
Solutions for a total of $117,333 in cash and 44,895 shares of the Company's
common stock. Simulation Solutions has been incorporated into the Company's
existing European operation.

     On March 28, 2000, the Company purchased theVRsource.com, a prominent
e-commerce site for advanced visualization and virtual reality hardware, from
The VRSource, Inc., a Colorado corporation, for $400,000 in cash.
TheVRsource.com website offers high performance peripheral devices from leading
hardware manufacturers including Polhemus, Ascension, FakeSpace, Virtual
Technologies, Sony and Virtual Research Corporation.

     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 will make certain of these payments over a
two-year period.

     On May 4, 2000, the Company entered into a letter of intent to acquire
Advanced Visual Systems Inc. through a stock-for-stock exchange. Definitive
merger documents were executed on July 18, 2000. The Company believes that the
acquisition creates one of the software industry's leading companies dedicated
to developing and integrating software and solutions using 3D graphics
technology. On November 9, 2000, the Company issued 1,929,579 shares of common
stock in exchange for all of the common and preferred shares of AVS. The merger
was accounted for as a pooling-of-interests.

     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, has assumed CEO responsibilities.

                                       11

<PAGE>

RESULTS OF OPERATIONS

   Revenues for the three month period ended December 31, 2000 was $3,870,944 as
compared to revenues of $5,595,697 for the three month period ended December 31,
1999. The decrease of $1,724,753 or 31% for the three month period is primarily
attributable to a reduction in software, hardware and professional services
sales in the United States and Europe.

     Total operating expenses for the three month period ended December 31, 2000
were $6,679,134 as compared to total operating expenses of $5,133,999 for the
three month period ended December 31, 1999. The increase of $1,545,135 or 30%
for the three month period is primarily attributable to one-time legal and other
professional fees and expenses in connection with the merger with Advanced
Visual Systems. In addition, the three-month period ended December 31, 2000
included a full three months of expenses for the other acquisitions made during
the year ended September 30, 2000 of Virtual Presence LTD, Simulationl
Solutions, LTD and the VR Source.com which were only partially included in the
three month period ending December 31, 1999.

     Total other income/(expense) for the three month period ended December 31,
2000 was $539,757 of expense as compared to $35,749 of other income for the
three month period ended December 31, 1999. The expense for the three month
period ended December 31, 2000 is mainly attributable to a losses on marketable
securities of $593,190, an increase in interest expense of $37,297 as well as
decrease in interest income of $214,690 compared to 1999 because of reduced cash
balances.

     Accordingly, the net loss for the three-month period ended December 31,
2000 of $3,347,947 as compared to the net income of $497,447 for the three month
period ended December 31, 1999, reflected the significant decrease in revenues
in the European and US markets, additional costs associated with the AVS,
Virtual Presence and Simulation Solutions acquisitions, as well as an losses on
marketable securities and reduced interest income.

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
have also funded portions of the Company 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. The loan remains outstanding as of the date hereof. The
Company is currently in discussions with Continuum Resources to formalize a
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 the Company cannot reach agreement on payment terms or such
payment is not made upon demand, the Company will be entitled to terminate the
reseller agreement and Continuum Resources' exclusive distribution rights

                                       12

<PAGE>

for MuSE software in the oil and gas industry. The Company has been informed
that Continuum Resources is currently in the process of raising additional
capital through a private offering and other financing activities; however, the
Company cannot provide assurance that they will be successful in those efforts
or that the loan will be repaid in the near future. Accordingly, although
repayment of the loan is not contingent on such capital raising efforts, the
Company may be obligated to partially or fully write down the value of the loan
as circumstances warrant. The Company has taken a $250,000 reserve against the
repayment of the notes.

     On November 19, 1998, the Company 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 the Company's
initial public offering exercised its over-allotment option in full and the
Company received gross proceeds of $1,440,000. Total net proceeds to the Company
from the initial public offering were approximately $9,200,000.

     On November 16, 1999, the Company 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 the Company's common
stock, subject to certain restrictions. Of such shares, 205,522 shares are
subject to adjustment in the event that the average price of the Company's
common stock over the twenty day period prior to November 15, 2000 is less than
$4.41 per share. The Company is in the process of issuing 363,969 additional
shares in satisfaction of this agreement.

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

     The Company's primary sales strategy is to build a direct sales force that
can identify revenue opportunities outside of the customer bases served by the
SRP program. As a result of the significant lead time necessary to create an
effective direct sales force and consummate additional distribution and reseller
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.

     On March 17, 2000, the Company acquired Simulation Solutions for $117,333
in cash and 44,895 shares of common stock. On March 28, 2000, the Company
acquired the VRsource.com for $400,000 in cash.

     On May 4, 2000, the Company entered into a letter of intent to acquire AVS
through a stock-for-stock exchange. The acquisition created one of the software
industry's leading companies dedicated to developing and integrating software
and solutions using 3D graphics technology. On November 9, 2000, the Company
issued 1,929,579 shares of common stock in exchange for all of the common and
preferred shares of AVS.

                                       13

<PAGE>

     On June 1, 2000, the Company entered into an equity line agreement with
Kingsbridge Capital Limited. The equity line agreement entitles the Company to
sell and obligates Kingsbridge to purchase, from time to time, up to $18,000,000
of the Company's common stock. The Company's ability to require Kingsbridge to
purchase the Company's common stock is subject to certain limitations based on
the market price and trading volume of the Company's common stock. Additionally,
on August 7, 2000, the Company 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 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. 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 June 16, 2000, the Company secured a $1,000,000 line of credit with the
Bank of Albuquerque (the "Bank") to provide interim working capital. The
agreement is for a one-year period and expires 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 line of credit balance at
December 31, 2000 was $1,000,000 and interest expense of $3,958 was accrued at
December 31, 2000. On February 5, 2001, as a result of the diminution in the
value of the Company's investment account which collateralized this line of
credit, the Bank accelerated and demanded payment of the outstanding loan. The
Company has agreed to a satisfactory arrangement with the Bank and the demand
for payment was withdrawn. The arrangement, which is subject to execution of
definitive documentation, requires the Company to make payments of $100,000 on
each of February 16, 2001, March 1, 2001 and April 1, 2001, with the balance
payable on May 1, 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, if converted.

     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

                                       14
<PAGE>

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.

     In October 1999, we deposited $2,000,000 in an investment account with a
premier investment banking organization. As of December 31, 2000, the value of
such account was approximately $300,000. The Bank is currently in control of
such funds in connection with the line of credit discussed above. We believe
that such losses may be attributable to circumstances other than normal market
fluctuations. 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
extent that our claims are adverse to the investment banking organization
charged with supervisory oversight of such account, such claims will be subject
to an arbitration proceeding.

     For the three months ended December 31, 2000, there was a net decrease in
cash of $670,546 as compared to a net decrease in cash of $3,706,884 for the
three-month period ended December 31, 1999. The decrease in cash is primarily
attributable to the net loss of $3,347,947 and payments on notes payable of
$1,019,538 offset by decreases in accounts receivable of $1,356,584 and an
increase in accounts payable of $811,131. As of December 31, 2000 the Company
has 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 the private placement of securities and/or entering
into new loan and credit facilities. The recovery of assets and continuation of
future operations are dependant upon our ability to obtain additional debt or
equity financing and our ability to generate revenues sufficient to continue
pursuing our business plan.

     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 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 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, 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 our
substantially weakened cash position subsequent to our fiscal year end, it is
anticipated that the Company will 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

                                       15

<PAGE>

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
plans 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.

     On January 22, 2001, the Company 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 filed by January 29, 2001.
Although we have complied with this request, the Nasdaq Stock Market has decided
to review our ability to continue to comply with all listing maintenance
criteria, including the requirement to maintain net tangible assets of
$2,000,000. The Company has requested a hearing which is scheduled for March 16,
2001. The Company was not in compliance with the net worth requirement as of
December 31, 2000. There can be no assurance that the Company will be able to
convince the hearing panel that it will be able to maintain compliance with such
maintenance criteria in the future. There can also be no assurance that the
hearing panel will render a favorable decision or that such decision will not be
subject to conditions or other restrictions which the Company may not be able to
comply with or which may make it more difficult to trade in the Company's
securities. An unfavorable decision will result in the immediate delisting of
the Company's common stock and warrants from the Nasdaq Stock Market
irrespective of the Company's ability to appeal such decision. Any such
delisting will have an adverse impact on the liquidity of the Company's
securities, which may then trade on the OTC Bulletin Board or the
over-the-counter market, which may make it more difficult to trade in the
Company's securities or liquidate an investor's holdings. Also, such delisting
may make it more difficult for the Company to raise additional capital.

     The Company continually explores strategic, joint venture and acquisition
opportunities both in the United States and abroad. From time to time, the
Company 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. The Company will keep
investors informed as such negotiations mature.

                                       16

<PAGE>

                           PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

     The Company is not a party to any legal proceedings.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

     Not applicable.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

     Not applicable.

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

     Not applicable.

ITEM 5.  OTHER INFORMATION

     Not applicable.

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:

          (i)  Current Report on Form 8-K filed on November 1, 2000 reporting
               expected management changes in connection with the acquisition of
               AVS and anticipated fourth quarter results.

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

                                       17

<PAGE>

                                   SIGNATURES

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

Dated: February 20, 2001

                                            MUSE TECHNOLOGIES, INC.

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