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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-KSB
                Annual Report Pursuant to Section 13 or 15(d) of
                       the Securities Exchange Act of 1934

      For the Fiscal Year Ended                   Commission File No. 1-14831
         December 31, 1999


                                Digital Lava Inc.
             (Exact name of registrant as specified in its charter)


             Delaware                                       95-4584080
 (State or other jurisdiction of                       (IRS Employer Id. No.)
   incorporation or organization)


                          13160 Mindanao Way Suite 350
                            Marina del Rey, CA 90292
               (Address of principal executive offices) (zip code)

       Registrant's telephone number, including area code: (310) 577-0200

           Securities registered pursuant to Section 12(b) of the Act:

                         Common Stock, $.0001 par value
                                (Title of Class)

Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. Yes [X]
No [_].

Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.
[X].

The registrant's revenues for the year ended December 31, 1999 were $1,488,045.

As of March 17, 2000, the Registrant had outstanding 4,671,962 of Common Stock.
The aggregate market value of the registrant's Common Stock on such date held by
those persons deemed to be non-affiliates was approximately $72,318,656.

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                                     PART I

ITEM 1.       BUSINESS

INTRODUCTION

   Digital Lava is a provider of rich mixed media software products and services
for use in corporate training, communications and sales and marketing
applications. Each of these markets represents multibillion expenditures each
year by Fortune 1000 companies. The company is positioned within the developing
streaming media industry.

   Rich media is defined as streaming video and streaming audio technology.
Streaming technology allows an Internet or intranet user to access information
in a file before the file is completely downloaded. As a result, large files
containing audio and video can be heard or seen almost immediately even with
slower connections. By combining streaming audio and video with traditional
media assets of slides, graphics, text animation and web links, Digital Lava has
created the next generation category of rich mixed media that can be delivered
via compact discs, the Internet or intranets.

   Digital Lava's current product line includes VideoVisorProfessional,
VideoVisorWeb and vPublisher. VideoVisorProfessional and VideoVisorWeb are
proprietary viewers that allow the user to access the content published in the
unique Digital Lava format. vPublisher is a proprietary authoring software tool
that allows the integration of text, data, voice, video and web links into an
interactive desktop application, known as a VideoCapsule. VideoCapsule files are
accessed by either the VideoVisorProfessional software viewer on compact discs
and corporate intranets or via the VideoVisorWeb software viewer on the
internet. VideoVisorProfessional and VideoVisorWeb allow the user to
individually manage, manipulate and navigate the VideoCapsule information. This
allows the user to experience full integration of, and interaction with,
differing media types on their computer screen both at home and in the office.

   We believe this new technology represents a significant new market
opportunity to shift activity and revenue from classic methods of communicating
product information, financial results, training content and general information
to a more interactive and effective software application. By utilizing the
development of streaming technology and the growth of the Internet, we believe
corporations across all business sectors will be able to increase the
effectiveness of their sales and marketing efforts, enhance corporate
communications and deliver effective financial reporting while eliminating the
high cost of travel and executive down time.

   Digital Lava generates revenues by providing publishing services and software
license sales of the VideoVisorProfessional viewer and the vPublisher publishing
tool. There is an associated revenue stream provided to Digital Lava by
reselling web hosting services.

   Digital Lava's customers include large corporations and business enterprises,
such as:

Lotus Development Corporation
Primedia
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Ardent Software, Inc.
Dell Computers
Cisco Systems
Zurich American Insurance
Shell Chemical
ASI Entertainment
Vantive Software

INDUSTRY BACKGROUND

     We believe the demand for our software applications in the corporate
training, communications and distance learning markets will be led by trends and
technologies that enable computer-based and Internet-based video training and
communications to be used increasingly as substitutes for videotapes,
instructor-led training, live meetings and other traditional forms of
communications and training. These trends and technologies include:

     - the growth of multimedia-capable computers and sophisticated computer
networks;
     - advances in personal computer processing power;
     - high speed communications capabilities;
     - the emergence of the Internet and corporate intranets for a wide variety
of business applications; and
     - the continued growth of streaming media applications.

     Streaming technology enables the transmission and playback of continuous
"streams" of multimedia content, such as audio and video, over a computer
network. The introduction of streaming media technology from companies such as
RealNetworks, Inc., Microsoft Corporation and Apple Computer, Inc. are now
providing software developers the opportunity to efficiently deliver significant
media content and applications over the Internet and corporate intranets. On the
Internet, many businesses and content providers now offer audio, video and other
multimedia information. RealNetworks broadcasts thousands of hours per week of
live audio and video content over the Internet using its streaming technology,
with a substantially greater amount of recorded media already stored and
available on the Internet.

     We believe that the use of streaming media by businesses and other users is
growing. Lotus Development Corporation, makers of Lotus Notes, a market leader
in collaborative software, announced in September, 1999, its plan to integrate
RealNetworks' RealPlayer with Lotus Notes client software, enabling Lotus Notes
users worldwide to view and hear streaming media content at their desktops.
Additionally, Netscape Communications Corporation announced in May, 1999, that
it plans to distribute RealNetworks' RealPlayer software as an integral part of
its Netscape Communicator browser software, providing Netscape users with access
to streaming media content without separately having to download the RealPlayer
software.

     According to a 1998 report from International Data Corporation, a leading
information technology consulting company, the overall market for business and
training software is expected to grow over the next several years. The worldwide
business software applications market is expected to double over the next five
years, with license revenues from business

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software applications growing from $50 billion in 1997 to over $100 billion in
2002. Digital Lava provides solutions which fit well into a smaller, but
growing, section of this space.

     In the United States, corporations are making substantial investments to
train their employees. Video, in the form of videotapes, is already widely used
within corporations to record and distribute training and communications
content. A 1997 U.S. corporate training study conducted by Training Magazine
found that 74 percent of the respondents were using videotapes for training. The
same survey also found that U.S. companies budgeted an estimated $58.6 billion
for employer-provided training in 1997. This growth in employer provided
training expenditures provides an increased market size for Digital Lava, as
training is a prime application for its desktop solutions. Digital Lava believes
that training on new information technologies within corporations is growing
rapidly worldwide. According to a study published by International Data
Corporation's Information Technologies, Training and Education Services research
program, the information technologies' training and education market is expected
to surpass $28.3 billion by 2002.

     Although there can be no assurance that the increased use of videotapes in
training will result in sales of our products, we believe that our technology
can take advantage of the growing demand for business, video training,
communications and distance learning applications. Digital Lava's software and
services provide a rapid, flexible, and low-cost alternative to videotapes,
instructor-led training, live meetings, and other traditional forms of
communications and training.

DIGITAL LAVA'S SOLUTION

     Today, most streaming video applications provide the user with a passive
experience, similar to watching videotape. The ability to search within the
video stream for the location of desired information is limited. The user may
have to make several attempts before the correct information is found. When
viewing a Digital Lava VideoCapsule, the user will see a video track, hear an
audio track, view supporting slides and other graphics all at the same time on
their computer screen. Additionally, the user can watch the video content in
either a linear format or individually choose sections of the presentation via a
table of contents or a search engine. This allows the user to have complete
control of the content, order and frequency of the presentation.

     By deploying the Digital Lava solution, users can instantly and seamlessly
navigate through the video, text and graphics to find and view the information
that will answer the question at hand. The time that was previously spent
searching is now applied to the learning process. Digital Lava believes this
personalized experience will increase the effectiveness of the end user to
understand and utilize the information that is presented.

     As the average employee struggles to maintain contact with their work
through e-mail, pagers, cellular systems and hand held devices, they are facing
ever increasing demands on their available time. Users of the Digital Lava
solution can access the information when they want it, how they want it and as
often as they want it. This can improve the ability for a company to get its
critical message across to their employee or customer.

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     Clients provide Digital Lava with all the content. Once the media assets
are in place, Digital Lava will publish the content using the vPublisher tool
into a VideoCapsule and then provide the customer the option to deploy either on
the Internet utilizing the VideoVisorWeb software or via compact discs with the
VideoVisorProfessional software.

     Digital Lava software products support the current streaming standards
provided by Microsoft Windows Media Technology and RealNetworks. The
implementation of a standards-based technology allows clients complete
flexibility in their choice of video hosting servers and architecture. Digital
Lava's solution maximizes a corporation's previous technological decisions
without an additional hardware investment.

     Digital Lava products have won multiple awards, including Desktop Video
Communications' "Best New Streaming Product" and "Networked Multimedia People's
Choice Award," the "NewMedia Invision 98 Award," and we are a four-time winner
of MultimediaCom's "Best Streaming Product Award."

GROWTH STRATEGY

     Our objective is to be the leading provider of interactive and on demand
streaming content through the Internet and corporate intranets. To achieve this
objective, our strategy includes the following key elements:

     Publishing Services Business Model. We provide all the publishing services
associated with the creation of interactive on demand content. By eliminating
the need for customers to purchase hardware and software as well as the
requirement of highly trained personnel, Digital Lava offers a one stop
publishing service to potential customers. This allows sales and marketing
efforts to focus on establishing the benefits to utilizing a streaming
technology solution. Digital Lava's publishing services helps control the
quality of the produced content to insure a repeatable customer experience. We
believe that as the market matures there may be a need to shift the business
model to a higher mix of software sales to publishing revenue.

     Vertical Market Focus. We believe the Digital Lava solution can be utilized
in virtually any corporate application across nearly all industry market
segments. This represents a long-term opportunity for the company to continue to
expand its customer base. In the near term, Digital Lava believes that the
vertical markets in the high technology, financial and healthcare industries
provide the most immediate revenue opportunities. Within these markets, Digital
Lava will focus on applications within the training, corporate communications
and sales and marketing departments.

     Build Sales and Marketing Efforts. Digital Lava intends to generate revenue
growth through the deployment of a direct sales force and selected resellers.
The direct sales force will be focused on geographic territories as well as
specific vertical markets. This will allow for the greatest sales coverage and
expansion capabilities. Strategic resellers will be contracted within specific
vertical markets in order to take advantage of previously established
relationships and contacts.

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     Strategic Partner Relationships. As advances in technology continue, it
will be important for Digital Lava to have strong relationships with various
companies throughout the technology chain. These strategic relationships will
provide Digital Lava with access to software and business development assets
outside of the company.

     Product Development. There will be a continued emphasis on the improvement
of current product offerings as well as the development of new and derivative
applications. Digital Lava believes it will need to provide solutions for both
the high end custom requirement as well as the low end desktop application.

     Business Development. Through partnerships and relationships, Digital Lava
will explore opportunities associated with, but not limited to, emerging market
opportunities in digital set-top boxes and broadband delivery systems.

PRODUCTS AND SERVICES

     Digital Lava's current product line includes VideoVisorProfessional,
VideoVisorWeb and vPublisher.

     vPublisher. The vPublisher software assists in compiling digital video and
other information from diverse sources, organizes its content, creates links to
other important data, and then rapidly publishes the information in a
VideoCapsule file. VideoCapsules may be distributed on compact discs and digital
video discs and streamed over intranets and the Internet using technology
provided by RealNetworks, Silicon Graphics, InfoValue computing, Starlight
Networks and Microsoft. Digital Lava does not currently make its proprietary
vPublisher available to the general marketplace.

     vPublisher provides Digital Lava with several key benefits. First, the
system simplifies the publishing process and does not require personnel to be
proficient in the use of programming, scripting or authoring language. Second,
vPublisher allows Digital Lava to rapidly create rich mixed media interactive
content. Depending on the complexity and length of the content, a VideoCapsule
can be completed in less than 24 hours providing a very quick turnaround time
for clients. Third, due to the proprietary software, Digital Lava's management
belives it is able to produce VideoCapsules at a very low cost relative to other
computer based editing tools.

     VideoVisorProfessional. VideoVisorProfessional is a software application
that allows access to VideoCapsule information on compact disc or through a
corporate intranet. With VideoVisorProfessional loaded on the desktop, the user
can individually manipulate and navigate through all the content with the click
of a mouse.

     The VideoVisorProfessional application provides the most robust experience
including full screen video, subtitles in multiple languages, the ability to
reorganize video content, software demonstrations, the ability to access notes,
and extensive search and bookmark capabilities. VideoVisorProfessional is
licensed either as a one time full desktop application or on a per compact disc
basis. The user needs to have the Windows Media Player or the Real Networks G2
player on the desktop in order to install the VideoVisorProfessional software.

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     In March 2000, Digital Lava released beta versions of HotFoot for
PowerPoint and HotFoot Host, new products which are designed to allow users to
create and host their own web-based presentations with streaming audio.

     VideoVisorWeb. VideoVisorWeb is an Internet application that allows access
to VideoCapsule information over the Internet. VideoVisorWeb content is hosted
on video server provided by either Microsoft or RealNetworks. VideoVisorWeb
utilizes web browsers from Microsoft or Netscape. The user experience is similar
to VideoVisorProfessional except for certain limitations on video screen size,
notes and subtitling as a result of bandwidth considerations of the Internet.
The video screen size is scaled larger when the client has higher bandwidth
access.

     Consulting and Custom Services. We provide a range of consulting and
programming services that principally relate to the creation and maintenance of
video content and applications based on Digital Lava's technology.

     Customer Service and Support. Digital Lava currently makes available
customer support through a technical hotline and defect correction to all
clients. Digital Lava uses customer feedback as a source of ideas for product
enhancement and development.

STRATEGIC RELATIONSHIPS

     Microsoft. Digital Lava is a NetShow independent software vendor. NetShow
is Microsoft's proprietary software to view streaming media over the Internet
and intranets. Digital Lava also licenses Microsoft's Internet Explorer
Administration Kit under a royalty free license and distribution agreement. This
agreement permits Digital Lava to customize Microsoft's Internet Explorer web
browser for integration into VideoVisorProfessional and VideoVisorWeb software.
The integrated products allow end-users to view streamed video content that is
linked with other Web browser content.

     RealNetworks. Digital Lava has entered into a consulting and development
agreement with RealNetworks, Inc. under which RealNetworks has developed custom
software to allow Digital Lava to integrate RealNetworks RealPlayer software
with VideoVisorProfessional and VideoVisorWeb.

     INTERVU. Digital Lava has entered into a co-marketing agreement to promote
and sell a fully integrated solution for VideoVisorWeb content hosted on the
INTERVU network. The LAVA Hosting Services provides for an end to end solution
that is marketed by both Digital Lava and INTERVU. Digital Lava is licensed to
resell INTERVU hosting services and content management services. INTERVU is
licensed to sell Digital Lava's VideoVisorWeb application and publishing
services.

COMPETITION

   The market for software and services for the Internet and intranets is
relatively new, constantly evolving and intensely competitive. Digital Lava
expects that competition will intensify in the future. Digital Lava's principal
competitors include:

     - Eloquent, Inc.;

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     - Veon, Inc.;
     - Vsoft, Inc.;
     - VStream, Inc.;
     - LiveNote, Inc.;
     - Adobe Systems, Inc.; and
     - Visionary Information Systems, Inc.

     Digital Lava also competes or may compete with computer-based training
software companies including Macromedia, Inc., Asymetrix Corporation, and Allen
Communications, Inc. Digital Lava also competes or may compete with more general
purpose audio and video streaming software companies including:

     - Microsoft;
     - RealNetworks;
     - VDOnet Corporation;
     - Xing Technology Corporation; o Cubic VideoComm, Inc.;
     - Motorola, Inc.;
     - Vosaic LLC; and
     - Oracle Corporation.

     Digital Lava's vPrism and VideoVisor software also competes indirectly with
delivery systems for multimedia content other than audio and video, such as
Flash by Macromedia and Enliven by Narrative Communications Corp. Many of
Digital Lava's competitors have longer operating histories, greater name
recognition and significantly greater financial, technical and marketing
resources than Digital Lava. As a result, these competitors may be able to
develop products comparable or superior to Digital Lava's or adapt more quickly
to new technologies or evolving customer requirements.

   Competitive factors in this market include:

     - the quality and reliability of software;
     - features for creating, editing and publishing video;
     - ease of use and interactive user features;
     - cost per user; and
     - compatibility with the user's existing network components and software
systems.

     To expand its user base and further enhance the user experience, Digital
Lava must continue to innovate and improve the performance of its software.
Digital Lava is committed to the continued market penetration of its brand,
products and services. Digital Lava may, as a strategic response to changes in
the competitive environment, implement pricing, licensing, service or marketing
changes designed to extend its current brand and technology franchise. For
example, Digital Lava may elect to reduce the price for select versions of its
software or even make select versions available for download free of charge.
Continued price concessions or the emergence of other pricing or distribution
strategies by competitors may reduce future revenues, earnings, cash flows and
the business may be harmed.

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INTELLECTUAL PROPERTY

     Our success depends in part on our ability to protect our proprietary
software and other intellectual property. To protect our proprietary rights, we
rely generally on patent, copyright, trademark and trade secret laws,
confidentiality agreements with employees and third parties, and license
agreements with consultants, vendors and customers. Despite these protections, a
third party could copy or otherwise obtain and use our products or technology,
or develop similar technology independently.

     Digital Lava currently has one patent pending in the U.S. relating to its
product architecture and technology. The pending patent application may not be
granted, or, if granted, may not provide any competitive advantage to Digital
Lava. Many of Digital Lava's current and potential competitors dedicate
substantially greater resources to protection and enforcement of intellectual
property rights, especially patents. If a patent has issued or issues in the
future which covers Digital Lava's products, Digital Lava would need to either
obtain a license or design around the patent. We may not be able to obtain a
license on acceptable terms, if at all, nor design around the patent.

     We attempt to avoid infringing known proprietary rights of third parties in
our product development efforts. However, we have not conducted and do not
conduct comprehensive patent or trademark searches to determine whether we
infringe patents or other proprietary rights held by third parties.

     If discovered that our products violated third-party proprietary rights,
there can be no assurance that we would be able to obtain licenses to continue
offering our products without substantial reengineering or that reengineering
would be successful, that a license would be available on commercially
reasonable terms, if at all, or that litigation could be avoided or settled
without substantial expense and damage awards. Any claims against Digital Lava
relating to the infringement of third-party proprietary rights, even if without
merit, could result in the expenditure of significant financial and managerial
resources and in injunctions preventing Digital Lava from distributing certain
products.

     To license many of its products, Digital Lava relies in part on
"shrinkwrap" and "clickwrap" licenses that are not signed by the end user and,
therefore, may be unenforceable under the laws of certain jurisdictions. As with
other software products, Digital Lava's products are susceptible to unauthorized
copying and uses that may go undetected, and policing unauthorized use is
difficult. In general, Digital Lava's efforts to protect its intellectual
property rights may not be effective to prevent misappropriation of its
technology, or to prevent the development and design by others of products or
technologies similar to or competitive with those developed by Digital Lava.
Digital Lava's failure or inability to protect its proprietary rights could
materially adversely affect Digital Lava's business, financial condition and
results of operations.

     Digital Lava also relies on certain technology that it licenses from third
parties, including software that is integrated with internally developed
software and used in Digital Lava's products, to perform key functions. In the
future, third-party technology licenses may not be

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available to Digital Lava on commercially reasonable terms. The loss of any of
these technologies could have a material adverse effect on Digital Lava's
business, financial condition and results of operations.

CORPORATE HISTORY

     Digital Lava Inc. originally operated as LAVA, L.L.C., a New Jersey limited
liability company that was formed in July 1995. In November 1996, LAVA, L.L.C.
merged into Digital Lava Inc., a Delaware corporation. As part of this
transaction, the ownership interests in LAVA, L.L.C. were exchanged for shares
of Series A, Series B, Series B-1 and Series C convertible preferred stock of
Digital Lava Inc. All of the Preferred Stock was converted into common stock in
connection with Digital Lava's initial public offering.

HUMAN RESOURCES

     Digital Lava currently has 79 full-time employees and two part time
employees, including sixteen in product development, thirty-five in customer
service, twenty-three in sales and marketing and seven in finance and
administration. Employees are based at varying locations nationwide while
Digital Lava's executive offices are in Marina del Rey, California.

     Digital Lava has entered into an employment agreement with Robert Greene,
our Chief Executive Officer, which expires in July of 2002, and Joshua Sharfman,
our President, which expires in December of 2001. Mr. Greene currently receives
an annual base salary of $300,000, and Mr. Sharfman currently receives an annual
base salary of $253,000. Digital Lava intends to hire additional employees in
product development, sales and marketing. None of Digital Lava's employees is
subject to a collective bargaining agreement, and Digital Lava believes that its
relations with its employees are good.

ITEM 2.       PROPERTIES

     Digital Lava's headquarters are located in Marina del Rey, California.
Digital Lava leases an aggregate of 24,698 square feet at a current monthly
lease rate of $42,943.89. The lease agreement for this location is
non-cancelable and terminates on August 30, 2005. Digital Lava currently has the
option to extend the lease agreement for an additional five-year period at the
then current market value.

ITEM 3.       LEGAL PROCEEDINGS

     None.


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

     During the fourth quarter of 1999, no matter was submitted to a vote of the
security holders of Digital Lava.

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                                     PART II

ITEM 5.       MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Digital Lava's Common Stock commenced trading on the American Stock
Exchange on February 17, 1999 under the symbol "DGV." The following table sets
forth, for the periods indicated, the high and low sales prices for the Common
Stock, as reported on the American Stock Exchange.

                                                         Price Range
2000                                              High                Low
First Quarter (through March 17)............... $17 1/4                $4 5/8


1999                                              High                Low
First Quarter.................................. $15 5/8                $5
Second Quarter................................. $13 5/16               $5 3/8
Third Quarter.................................. $ 6 3/4                $3 9/16
Fourth Quarter................................. $ 7                    $3


     As of March 23, 2000, there were approximately 98 holders of record of the
Common Stock. Digital Lava believes that the number of beneficial owners is
substantially greater than the number of record holders, because a large portion
of the Common Stock is held of record in broker "street names."

     Digital Lava has paid no dividends on its Common Stock and does not expect
to pay cash dividends in the foreseeable future. Digital Lava is not under any
contractual restrictions as to its present or future ability to pay dividends.
Digital Lava currently intends to retain any future earnings to finance the
growth and development of its business.

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

     The following discussion and analysis of the financial condition and
results of operations of Digital Lava should be read in conjunction with Digital
Lava's financial statements and the notes to the financial statements and the
other financial information included elsewhere in this report. In addition to
historical information, this Management's Discussion and Analysis of Financial
Condition and Results of Operations and other parts of this report contain
forward-looking information that involve risks and uncertainties. Digital Lava's
actual results could differ materially from those anticipated by forward-looking
information.

OVERVIEW

     Digital Lava invested significant resources in sales, marketing,
development, production and other operating activities during the year ended
December 31,1999. Digital Lava believes that its success depends largely on
building superior technology and quality into its products and services,
extending its technological lead on the competition and developing brand
recognition

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early in a product's life cycle. Accordingly, Digital Lava expects to continue
spending heavily on these activities in the near future. Despite these heavy
investments in marketing and product development, growth in revenues may not be
achieved in the future. In light of Digital Lava's limited operating history,
rapid improvements in technology, and improvements in Digital Lava's marketing
capabilities, Digital Lava believes that period-to-period comparisons of its
revenues and operating results, including its gross profit and operating
expenses as a percentage of total net revenues, are not necessarily meaningful
and should not be relied upon as indications of future performance.

     Digital Lava has incurred significant net losses and negative cash flows
from operations since inception, and as of December 31, 1999, had an accumulated
deficit of $20,904,991. Digital Lava intends to continue to invest heavily in
technology, development, sales and marketing and promotion. As a result, Digital
Lava believes that it will continue to incur operating losses and negative cash
flows from operations for the foreseeable future and that the rate at which
these losses will be incurred may increase from current levels. There can be no
assurance that Digital Lava will be able to achieve or sustain revenue growth,
profitability, or positive cash flow on either a quarterly or annual basis.

RESULTS OF OPERATIONS

     Comparison of Year Ended December 31, 1999 to Year Ended December 31, 1998

     REVENUES

     The Company generally recognizes revenue from licensing of the Company's
software products when all the following criteria are met: (1) persuasive
evidence of an arrangement exists, (2) delivery has occurred, (3) the Company's
fee is fixed or determinable, and (4) collectibility is probable. In addition,
for licensing contracts with multiple obligations (e.g. deliverable and
undeliverable products, services and maintenance), revenue is allocated to each
component of the contract based on evidence of fair value which is specific to
the Company. Revenues increased to $1,488,045 for the year ended December 31,
1999 from $1,463,618 for the year ended December 31, 1998. The increase of
$24,427 or 1.7% was primarily due to an increase in sales publishing services to
new customers. Software license revenues accounted for approximately 10.5% and
72.3% of revenues for the year's ended December 31, 1999 and 1998, respectively.
Services revenues accounted for approximately 89.5% and 27.7% of revenues for
the year's ended December 31, 1999 and 1998, respectively. Services accounted
for the majority of our revenue due to the Company's change to a services model
in mid 1999. This model serves the current market requirement for new
technologies to be delivered in an end to end solution model. One customer
accounted for approximately 55.0% of revenue in 1999 and 46.0% of revenue in
1998. With Digital Lava's marketing focus on building their services revenue
model, the Company anticipates that publishing services revenue will account for
a larger share of revenues for the foreseeable future.

     COST OF REVENUES

     Cost of revenues consist primarily of the cost of materials, freight and
applicable labor incurred for the delivery of the product or service. Costs of
revenues increased to $385,575, or

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25.9% of revenues, for year ended December 31, 1999 from $288,778, or 19.7% of
revenues, for the year ended December 31, 1998. This increase was primarily due
to the change in the mix of revenues from primarily software licenses to
primarily publishing services. Publishing services carry a higher cost of sale
due to the labor intensity associated with them. Digital Lava expects its cost
of revenue to continue to increase in dollar amount while declining as a
percentage of revenue as Digital Lava expands its customer base.

     OPERATING COSTS AND EXPENSES

     SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and
administrative expenses consist primarily of salaries, taxes and benefits and
related costs for general corporate functions, including executive management,
finance, accounting, facilities, legal, fees for professional services and
depreciation and amortization. Selling, general and administrative expenses
increased to $6,730,926, or 452.3% of revenues, for the year ended December 31,
1999, from $3,103,418, or 212.0% of revenues, for the year ended December 31,
1998. The increase was primarily due to increasing the size of the sales force,
trade show participation, additional personnel and professional fees required to
build an infrastructure to support Digital Lava's products and anticipated
growth. In addition, selling, general and administrative expenses for the year
ended December 31, 1999 and December 31, 1998 included non-cash compensation
expenses of $129,961 and $559,101, respectively, which represents the granting
of stock options and warrants to non-employees in exchange for services rendered
to Digital Lava. Digital Lava expects that selling, general and administrative
expenses will increase in absolute dollars as Digital Lava continues to hire
personnel and incurs expense related to the further growth of the business.

     RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist of expenditures related to technology and software development expenses.
Research and development expenses increased to $1,005,634, or 67.6% of revenues,
for the year ended December 31, 1999 from $442,718, or 30.3% of revenues, for
the year ended December 31, 1998. Research and development expenses increased in
both dollars and as a percentage of revenue because of the addition of
development personnel. Digital Lava believes that significant investments in
technology and content development are required to be a technological leader and
remain competitive and, therefore, expects that its research and development
expenses will continue to increase in absolute dollars for the foreseeable
future; however, research and development expenses are presently anticipated to
decline as a percentage of revenues.


     OTHER INCOME AND EXPENSE, NET. Other income and expense includes interest
expense related to Digital Lava's financing obligations, interest income from
its marketable securities and the recognized gain or loss on its marketable
securities. Other income of $100,593 for the year ended December 31, 1999 was
related to interest income from investments of the proceeds from the IPO in
February 1999. Other expense of $1,359,245 for the year ended December 31, 1998
was related to interest expense on debt which was repaid or converted at the
IPO. The change was primarily due to repayment and conversion of debt and the
investment in marketable securities. Other expense for the year ended December
31, 1998 included amortization of debt discount and issuance costs related to
warrants issued in connection with notes payable of $602,509.

                                       12

<PAGE>

     NET LOSS. For the year ended December 31, 1999, Digital Lava's net loss
totaled $10,206,153 as compared to $3,730,541 for the year ended December 31,
1998.

     NET OPERATING LOSS CARRYFORWARDS. At December 31, 1999, Digital Lava had
available net operating loss carryforwards for federal and state purposes of
approximately $15,222,000 and $11,981,000, respectively. The utilization of the
loss carryforwards to reduce future income taxes will depend upon Digital Lava's
ability to generate sufficient taxable income prior to the expiration of the net
operating loss carryforwards. The federal and state carryforwards expire
beginning in the years 2008 and 2000, respectively. The Internal Revenue Code of
1986 limits the maximum annual use of net operating loss and tax credit
carryforwards in certain situations where changes occur in the stock ownership
of a corporation. As a result of the IPO, a change in ownership occurred which
may substantially restrict Digital Lava's use of the net operating loss
carryforwards for federal and state income tax purposes.

LIQUIDITY AND CAPITAL RESOURCES

     On February 22, 1999, Digital Lava completed an initial public offering of
1,200,000 units, each unit consisting of two shares of common stock and one
redeemable warrant, and received aggregate proceeds of $18,120,000 and net
proceeds of $14,596,469. Digital Lava used approximately $4,489,000 of the
proceeds to repay bridge notes. On March 30, 1999, Digital Lava completed the
exercise by its underwriter of the over allotment option of 113,312 units and
received aggregate proceeds of $1,711,011 and net proceeds of $1,513,567. During
the period from completion of the Offering through December 31, 1999, Digital
Lava has used approximately $4,489,000 of the proceeds to repay bridge notes,
$1,005,000 for product development expenses, $2,333,000 for sales and marketing
expenses, $1,565,000 for facilities and other capital expenditures, and
$3,054,000 for working capital and general corporate purposes.

     As of December 31, 1999, cash increased to $708,031 from $30,893 at
December 31, 1998.

     Net cash used in operating activities increased to $7,899,570 for the year
ended December 31, 1999 from $849,884 for the year ended December 31, 1998. The
increase in use of cash from operations resulted primarily from increasing net
losses, increasing receivables and cash used to reduce accounts payable
partially offset by the non-cash extraordinary loss on extinguishment of debt.

     Cash flows used in investing activities increased to $4,477,564 for the
year ended December 31, 1999 from $912,485 for December 31, 1998 resulting
primarily from the purchase and of short-term securities, restriction of cash
related to the Company's new operating lease and the purchase of fixed assets.

     Net cash provided by financing activities increased to $13,054,272 for 1999
from $1,620,000 for 1998. The increase was due to net proceeds received due to
the completion of the Company's initial public offering and the underwriter's
exercise of their over-allotment option offset by the repayment of notes
payable.

                                       13
<PAGE>

     Digital Lava's capital requirements depend on numerous factors, including
market acceptance of Digital Lava's products and services, the amount of
resources Digital Lava devotes to investments in its products, the resources
Digital Lava devotes to marketing and selling its services and its brand
promotions and other factors. Digital Lava has experienced a substantial
increase in its capital expenditures since its inception consistent with the
growth in Digital Lava's operations and staffing, and anticipates that this will
continue for the foreseeable future. Additionally, Digital Lava will continue to
evaluate possible investments in businesses, products and technologies, and
plans to expand its sales and marketing programs and conduct more aggressive
brand promotions.

     The Company currently anticipates that current cash balances, short-term
investments and cash provided by operations will be sufficient to meet its
anticipated needs for working capital and capital expenditures for the next 6
months. Digital Lava anticipates it will seek additional funding either through
additional public or private sales of its securities. The Company is currently
taking action on such alternatives to raise capital in the next three to four
months, however the outcome of such efforts to raise working capital cannot be
assured.

YEAR 2000 RISK

     Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
distinguish whether "00" means 1900 or 2000. This may result in software
failures or the creation of erroneous results. We believe that our products and
internal systems are currently year 2000 compliant. We have confirmed our year
2000 compliance by obtaining representations by third party vendors of their
products' year 2000 compliance, as well as specific testing of our products. We
have not incurred significant costs to date complying with year 2000
requirements and we experienced no problems at January 1, 2000. However, there
can be no assurance we have discovered all problems or that we will not
experience problems in the future.

CAUTIONARY STATEMENT

     Certain written and oral statements made or incorporated by reference from
time to time by Digital Lava or its representatives in this Form 10-K, other
filings or reports with the Securities and Exchange Commission, press releases,
conferences, or otherwise, are "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995. Digital Lava is
including this Cautionary Statement to make applicable and take advantage of the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995
for any such forward-looking statements. Forward-looking statements include any
statement that may predict, forecast, indicate, or imply future results,
performance, or achievements, and forward-looking statements can be identified
by the use of terminology such as "believe," "anticipate," "expect," "estimate,"
"may," "will," "should," "project," "continue," "plans," "aims," "intends,"
"likely," or other words or phrases of similar terminology. Management cautions
you that forward-looking statements involve risks and uncertainties which may
cause actual results to differ materially from the forward-looking statements.

                                       14
<PAGE>

ITEM 7.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The information called for by this Item 8 is included following the "Index
to Financial Statements" contained in this Annual Report on Form 10-KSB.

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

     None

                                    PART III

ITEM 9.       DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Set forth below are the directors and officers of Digital Lava:

NAME                             Age      Position
----                             ----     --------
Robert Greene                     42      Chairman of the Board and Chief
                                          Executive Officer

Roger Berman                      45      Director

John Carrington                   56      Director

Dr. James W. Stigler              45      Director

Michael Wheeler                   49      Director

Joshua D.J. Sharfman              42      President and Chief Technology Officer

Danny Gampe                       45      Chief Financial Officer

Peter Webb                        46      Vice President, Sales

Ralph Boulware                    57      Vice President, Services

Kipley Bruketa                    39      Vice President , Marketing

James Hicks                       38      Vice President, Product Development

     There is hereby incorporated by reference the information appearing under
the captions "Board of Directors and Officers" and "Compliance with Section
16(a) of the Securities Exchange Act of 1934" in Digital Lava's definitive proxy
statement relating to its Annual Meeting of Stockholders to be held on June 1,
2000.

                                       15
<PAGE>


ITEM 10.      EXECUTIVE COMPENSATION SUMMARY COMPENSATION.

     There is hereby incorporated by reference the information under the caption
"Executive Compensation" in the Registrant's definitive proxy statement relating
to its Annual Meeting of Stockholders to be held on June 1, 2000.

ITEM 11.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     There is hereby incorporated by reference the information under the
captions "Principal Stockholders" and "Board of Directors and Officers" in
Digital Lava's definitive proxy statement relating to its Annual Meeting of
Stockholders to be held on June 1, 2000.

ITEM 12.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     There is hereby incorporated by reference the information under the caption
"Certain Transactions" in Digital Lava's definitive proxy statement relating to
its Annual Meeting of Stockholders to be held on June 1, 2000.

                                     PART IV

ITEM 13.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

     (a)                  FINANCIAL STATEMENTS AND EXHIBITS

               (1)        Financial Statements

                          Report of Independent Accountants

                          Balance Sheet at December 31, 1999

                          Statement of Operations for the years ended December
                          31, 1999 and 1998

                          Statement of Changes in Stockholders' Equity

                          (Deficit) for the period for the years ended

                          December 31, 1999 and 1998 Statement of Cash Flows
                          for the years ended December 31, 1999 and 1998

                          Notes to Consolidated Financial Statements

               (2)        FINANCIAL STATEMENT SCHEDULES

                          All financial statement schedules are omitted
                          because they are not applicable or the required
                          information is shown in the financial statements or
                          note thereto.

               (3)        EXHIBITS

     Exhibits

                                       16

<PAGE>

3(a)+       Second Amended and Restated Certificate of Incorporation

3(b)+       Bylaws of the Company, in effect as of the date hereof

4(a)*       Form of Common Stock Certificate

4(b)**      Form of Warrant Agreement

4(c)**      Form of Representative's Warrant Agreement

4(d)*       1996 Incentive and Non-Qualified Stock Option Plan

4(e)*       Warrant Agreement dated as of September 30, 1996 between the Company
            and Millennium Capital Management (1)
4(f)*       Warrant Agreement dated as of September 30, 1996 between the Company
            and Miracle Investments Co. (1)

4(g)*       Registration Rights Agreement between the Company, Miracle
            Investments Co. and Millennium Capital Management

4(h)*       Warrant Agreement dated November 1, 1996 between the Company and
            Eilenberg & Zivian (1)

4(i)*       Warrant Agreement dated January 27, 1997 between the Company and
            Eilenberg & Zivian (1)

4(j)*       Warrant Agreement dated May 30, 1997 between the Company and certain
            investors and finders (1)

4(k)*       Registration Rights Agreement dated May 30, 1997 between the Company
            and certain investors and finders

4(l)*       Letter Agreement dated October 6, 1998 between the Company and
            certain investors

4(m)*       Warrant Agreement dated July 11, 1997 between the Company and
            certain investors and finders (1)

                                       17
<PAGE>

4(n)*       Registration Rights Agreement dated July 11, 1997 between the
            Company and certain investors and finders

4(o)**      Warrant Agreement between the Company and Schwartz Communications

4(p)*       Warrant Agreement dated February 19, 1998 between the Company and
            certain investors and finders (1)

4(q)*       Registration Rights Agreement dated February 19, 1998 between the
            Company and certain investors and finders

4(r)*       Form of Promissory Note dated February 19, 1998 between the Company
            and certain investors

4(s)*       Warrant Agreement dated May 1, 1998 between the Company and The
            Whitestone Group (1)

4(t)*       Registration Rights Agreement dated May 1, 1998 between the Company
            and The Whitestone Group

4(u)*       Letter Agreement between the Company and certain investors and
            finders dated July 15, 1998

4(v)*       Letter Agreement between the Company and certain investors and
            finders dated July 16, 1998

4(w)*       Letter Agreement between the Company and certain investors and
            finders dated July 29, 1998

4(x)*       Warrant Agreement dated as of October 7, 1998 between the Company
            and certain consultants

4(y)*       Registration Rights Agreement dated as of October 7, 1998 between
            the Company and certain consultants

4(z)*       Letter Agreement as of October 7, 1998 between the Company and
            certain investors

4(aa)*      Amended and Restated Option Agreement dated as of May 1, 1998
            between the Company, Judson Cooper and certain founders of the
            Company (1)

4(ab)*      Amended and Restated Option Agreement dated as of May 1, 1998
            between the Company, E&Z Investments and certain founders of the
            Company (1)

4(ac)***    Warrant Agreement between the Company and United Resources Partners

                                       18

<PAGE>

4(ad)**     Warrant Agreement dated January 7, 1999 between the Company and
            certain investors

4(ae)**     Warrant Agreement between the Company and certain investors dated
            December 7, 1998

4(af)**     Registration Rights Agreement between the Company and certain
            investors dated December 7, 1998.

4(ag)***    Registration Rights Agreement between the Company and United
            Resources Partners dated September 18, 1998

10(a)*      Employment Agreement dated September 1, 1998 between the Company and
            Thomas Stigler

10(b)*      Employment Agreement dated September 1, 1998 between the Company and
            Joshua D.J. Sharfman

10(c)*      Consulting Agreement dated September 1, 1998 between the Company and
            Roger Berman

10(d)*      Consulting Agreement dated September 1, 1998 between the Company and
            Dr. James Stigler

10(e)*      Consulting Agreement dated September 1, 1998 between the Company and
            Prism Ventures L.L.C.

10(f)**     Consulting Agreement dated May 1, 1998 between the Company and the
            Whitestone Group

10(g)**     Consulting Agreement dated October 7, 1998 between the Company and
            Shahrokh "Shawn" Sedaghat

10(h)****   Agreement dated January 8, 1998 between the Company and
            RealNetworks, Inc. (2)

10(i)****   Agreement dated April 1, 1998 between the Company and RealNetworks,
            Inc. (2)

10(j)****   Software License Agreement dated March 31, 1997 between the Company
            and Cinax Designs, Inc. (2)

10(k)**     Agreement dated August 8, 1998 between the Company and Lesson Lab

10(l)+      Agreement dated August 13, 1999 between the Company and Cisco
            Systems, Inc.

                                       19
<PAGE>

10(m)+      Agreement dated October 26, 1999 between the Company and Cisco
            Systems, Inc.

23+         Consent of PricewaterhouseCoopers, LLP

27+         Financial Data Schedule
---------

*           Incorporated by reference to Form SB-2 Registration Statement of
            Digital Lava dated October 23, 1998 (No. 333-66099)

**          Incorporated by reference to Form SB-2/Amendment No. 1 Registration
            Statement of Digital Lava dated January 12, 1999 (No. 333-66099)

***         Incorporated by reference to Form SB-2/Amendment No. 2 Registration
            Statement of Digital Lava dated January 26, 1999 (No. 333-66099)

****        Incorporated by reference to Form SB-2/Amendment No. 6 Registration
            Statement of Digital Lava dated February 12, 1999 (No. 333-66099)

+           Filed herewith

(1)         These agreements were entered into prior to the reverse split of the
            Company's Common Stock and, therefore, do not reflect such reverse
            split.

(2)         Confidential information is omitted and identified by a * and filed
            separately with the SEC pursuant to a request for Confidential
            Treatment.

(b)         Reports on Form 8-K

     No reports on Form 8-K were filed by the registrant during the last quarter
of 1999.

                                    20
<PAGE>

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                                  DIGITAL LAVA INC.


                                            By: /s/ ROBERT GREENE
                                                --------------------------------
                                            Robert Greene, Chairman and Chief
                                            Executive Officer
                                            Date: March 30, 2000

     Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:

Signatures                  Title                                           Date
--------------------        -------------------------                      -----
/s/James Stigler            Director                              March 30, 2000
--------------------
James Stigler

/s/ Danny Gampe             Chief Financial Officer               March 30, 2000
--------------------        (Principal Financial
Danny Gampe                 and Accounting Officer)

/s/ Roger Berman            Director                              March 30, 2000
--------------------
Roger Berman

/s/ John Carrington         Director                              March 30, 2000
--------------------
John Carrington

/s/ Michael Wheeler         Director                              March 30, 2000
--------------------
Michael Wheeler

/s/ Robert Greene           Chairman and Chief Executive          March 30, 2000
--------------------        Officer (Principal Executive
Robert Greene               Officer)

<PAGE>

                                DIGITAL LAVA INC.

                          Index to Financial Statements

                                                                          Page
                                                                          ----
        Report of Independent Accountants                                 F-2
        Balance Sheet at December 31, 1999                                F-3
        Statement of Operations for the years ended
          December 31, 1999 and 1998                                      F-4
        Statement of Stockholders' Equity/(Deficit) for the
          years ended December 31, 1999 and 1998                          F-5
        Statement of Cash Flows for the years ended
          December 31, 1999 and 1998                                      F-6
        Notes to Financial Statements                                     F-7



<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and
Stockholders of Digital Lava Inc.

     In our opinion, the financial statements listed in the index appearing
under Item 13 (a) (1) on page 16 present fairly, in all material respects, the
financial position of Digital Lava Inc. at December 31, 1999, and the results of
its operations and its cash flows for each of the two years in the period ended
December 31, 1999 in conformity with accounting principles generally accepted in
the United States. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

     The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has suffered recurring losses, negative cash
flows from operations, has a significant accumulated deficit, and expects to
incur future losses. These factors raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 2. The accompanying financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.

PricewaterhouseCoopers LLP

Costa Mesa, California

February 1, 2000


                                      F-2
<PAGE>

                                DIGITAL LAVA INC.

                                  Balance Sheet

<TABLE>

                                                                              December 31,
                                                                                 1999

                                  Assets

<S>                                                                          <C>
Current Assets:
    Cash and cash equivalents.............................................   $  708,031
    Short term investments................................................    2,956,287
    Accounts receivable...................................................    1,174,689
    Other current assets..................................................      142,796
                                                                            ---------------

        Total current assets..............................................    4,981,803
    Fixed assets, net.....................................................    1,204,578
    Restricted cash.......................................................      486,455
    Other assets..........................................................      237,462
                                                                            ---------------

                                                                             $6,910,298

                                                                            ===============
                       Liabilities and Stockholders' Equity

Current liabilities:
    Accounts payable......................................................   $  186,362
    Current portion of capital lease......................................       75,869
    Accrued expenses and other current liabilities........................      609,026
    Deferred rent.........................................................      291,953
    Deferred revenue......................................................      279,184
                                                                            ---------------

Total current liabilities                                                     1,442,394

    Long term portion of capital lease obligations........................      166,382
                                                                            ---------------
                                                                              1,608,776

Commitments and contingencies (Note 10)

Stockholders' equity:
    Preferred stock, $.0001 par value; 5,000,000 shares authorized; none
        issued and outstanding............................................           --
    Common stock, $0.0001 par value; 35,000,000 shares authorized;
        4,636,887 shares issued and outstanding...........................          463
    Additional paid-in capital............................................   26,237,992
    Deferred compensation.................................................      (16,928)
    Accumulated deficit...................................................  (20,904,991)
    Accumulated other comprehensive loss..................................      (15,014)
                                                                            ---------------

        Total stockholders' equity........................................    5,301,522
                                                                            ---------------

                                                                             $6,910,298

                                                                            ===============
</TABLE>

The accompanying notes are an integral part of these financial statements.
---------------------------------------------------------------------------


                                      F-3
<PAGE>

                                DIGITAL LAVA INC.

                             Statement of Operations

<TABLE>

                                                                     Year Ended December 31,
                                                                     -----------------------
                                                                     1999             1998
                                                                     ----             ----
<S>                                                               <C>             <C>
Revenues:
    Software licenses....................................         $  155,693      $ 1,057,794
    Services.............................................          1,332,352          405,824
                                                                  ----------      -----------

       Total revenues....................................          1,488,045        1,463,618
                                                                  ----------      -----------

Cost of revenues:
    Cost of software licenses............................              5,349           13,168
    Cost of services.....................................            380,226          275,610
                                                                  ----------      -----------

       Total cost of revenues............................            385,575          288,778
                                                                  ----------      -----------

       Gross Profit......................................          1,102,470        1,174,840
                                                                  ----------      -----------

Operating costs and expenses:
    Selling, general and administrative..................          6,730,926        3,103,418
    Research and development.............................          1,005,634          442,718
                                                                  ----------      -----------

       Total operating costs and expenses................          7,736,560        3,546,136
                                                                  ----------      -----------

       Loss from operations..............................         (6,634,090)      (2,371,296)

    Other income and (expense), net......................            100,593       (1,359,245)
                                                                  ----------      -----------

       Loss before extraordinary item....................         (6,533,497)      (3,730,541)
    Extraordinary loss on extinguishment of debt.........         (3,672,656)             ---
                                                                  ----------      -----------

       Net loss..........................................        (10,206,153)      (3,730,541)
                                                                  ==========      ===========

Net loss available to common stockholders................       ($10,866,176)     ($3,730,541)
                                                                  ==========      ===========
Basic and diluted loss per share:

    Loss before extraordinary item.......................       $      (1.82)    $     (28.36)
    Extraordinary loss on extinguishment of debt.........               (.93)             ---
                                                                  ----------      -----------

Net loss.................................................       $      (2.75)    $     (28.36)
                                                                  ==========      ===========

Weighted average common shares used in basic and diluted
    loss per share (Note 2)..............................          3,950,935          131,524
                                                                  ==========      ===========
</TABLE>

The accompanying notes are an integral part of these financial statements.


                                       F-4
<PAGE>

                                DIGITAL LAVA INC.

                   Statement of Stockholders' Equity (Deficit)
<TABLE>

                                         Series A        Series B       Series B-1       Series C
                                       Convertible     Convertible     Convertible     Convertible
                                        Preferred       Preferred       Preferred       Preferred
                                          Stock           Stock           Stock           Stock
                                      --------------  --------------  --------------  --------------
                                      Shares  Amount  Shares  Amount  Shares  Amount  Shares  Amount
                                      ------  ------  ------  ------  ------  ------  ------  ------
<S>                                   <C>     <C>     <C>     <C>     <C>     <C>     <C>     <C>
Balance, December 31, 1997.........   88,584       9   5,552      --     930      --   3,283      --
  Modification of outstanding
    convertible preferred stock
    warrants.......................       --      --      --      --      --      --      --      --
  Modification of outstanding
    common stock warrants..........       --      --      --      --      --      --      --      --
  Issuance of common stock warrants
    for services...................       --      --      --      --      --      --      --      --
  Issuance of common stock warrants
    in conjunction with notes
    payable........................       --      --      --      --      --      --      --      --
  Modification of options issued by
    management and principal
    stockholders for services
    performed by consultants.......       --      --      --      --      --      --      --      --
  Net loss.........................       --      --      --      --      --      --      --      --
                                      ------  ------  ------  ------  ------  ------  ------  ------

Balance, December 31, 1998            88,584  $    9   5,552  $   --     930  $   --   3,283  $   --
                                      ======  ======  ======  ======  ======  ======  ======  ======

  Conversion of preferred stock to
    common stock...................  (79,760)    (8)  (5,552)     --    (930)     --  (3,283)     --
  Modification of series B and C
    convertible preferred stock
    conversion rates...............       --     --       --      --      --      --      --      --
  Dividend to series B and series C
    convertible preferred
    stockholders in connection with
    modification of conversion rates      --     --       --      --      --      --      --      --
  Series A convertible preferred
    stock contributed by founders..   (8,824)    (1)      --      --      --      --      --      --
  Common stock contributed by
    founders.......................       --     --       --      --      --      --      --      --
  Conversion of notes payable, plus
    accrued interest, to common
    stock..........................       --     --       --      --      --      --      --      --
  Issuance of common stock and
    warrants pursuant to public
    offering, net of expenses of
    $5,613,375.....................       --     --       --      --      --      --      --      --
  Issuance of common stock warrants
    for services...................       --      --      --      --      --      --      --      --
  Comprehensive loss:
     Unrealized loss on available
       for sale securities.........       --      --      --      --      --      --      --      --
       Net loss....................       --      --      --      --      --      --      --      --
  Total comprehensive loss                --      --      --      --      --      --      --      --
                                      ------  ------  ------  ------  ------  ------  ------  ------

  Balance, December 31, 1999              --    $ --      --    $ --      --    $ --      --    $ --
                                      ======  ======  ======  ======  ======  ======  ======  ======
</TABLE>


                                       F-5
<PAGE>

<TABLE>

                                                                                  Accumulated
                                                                                   Other
                                                          Additional              Compre-
                                                            Paid-In  Accumulated  -hensive    Deferred
                                        Common Stock        Capital    Deficit      Loss      Compensation    Total
                                      ------------------  ---------- ------------ ----------- ------------ ------------
                                       Shares    Amount

                                      --------  --------
<S>                                   <C>       <C>       <C>        <C>          <C>         <C>          <C>
Balance, December 31, 1997..........   131,524        13   3,351,030   (6,968,297)                           (3,617,245)
  Modification of outstanding
    convertible perferred stock
    warrants........................        --        --      30,978           --                                30,978
  Modification of outstanding
    common stock warrants...........        --        --      10,050           --                                10,050
  Issuance of common stock warrants
    for services....................        --        --      92,701           --                                92,701
  Issuance of common stock warrants
    in conjunction with notes
    payable.........................        --        --     787,137           --                               787,137
  Modification of options issued by
    management and principal
    stockholders for services
    performed by consultants........        --        --     346,400           --                               346,400
  Net loss..........................        --        --          --   (3,730,541)                           (3,730,541)
                                      --------  --------  ----------  ----------- ---------- -------------- -----------
Balance, December 31, 1998..........   131,524  $     13  $4,618,296 $(10,698,838)        --             -- $(6,080,520)
                                      ========  ========  ==========  =========== ========== ============== ===========

  Conversion of preferred stock to
    common stock....................   907,156        91         (83)          --         --             --          --
  Modification of series B and
    series C convertible preferred
    stock conversions rates.........    88,003         9     660,014           --         --             --     660,023
  Dividend to series B and series C
    convertible preferred
    stockholders in connection with
    modification of conversion rates        --        --    (660,023)          --         --             --    (660,023)
  Series A convertible preferred
    stock contributed by founders...        --        --           1           --         --             --          --
  Common stock contributed by
    founders........................   (11,028)       (1)          1           --         --             --          --
  Conversion of notes payable, plus
    accrued interest, to common
    stock...........................   894,608        89   5,363,123           --         --             --   5,363,212
  Issuance of common stock and
    warrants pursuant to publice
    offering, net of expenses of
    $5,613,375...................... 2,626,624       262  16,109,774           --         --             --  16,110,036
  Issuance of common stock warrants
    for services....................        --        --     146,889           --         --        (16,928)    129,961
  Comprehensive loss:
    Unrealized loss on available
      for sale securities...........        --        --          --           --    (15,014)            --     (15,014)
    Net loss........................        --        --          --  (10,206,153)        --             -- (10,206,153)
                                                                                                            -----------
  Total comprehensive loss                  --        --          --           --         --             -- (10,221,167)
                                      --------- -------- ----------- ------------ ---------- -------------- -----------

  Balance, December 31, 1999          4,636,887 $    463 $26,237,992 $(20,904,991)$  (15,014)$      (16,928)$ 5,301,522
                                      ========= ======== =========== ============ ========== ============== ===========

The accompanying notes are an integral part of these financial statements.

</TABLE>


                                       F-6
<PAGE>

                                DIGITAL LAVA INC.

                             Statement of Cash Flows

<TABLE>

                                                                Year Ended December 31,
                                                          -----------------------------------
                                                             1999                   1998
                                                          ----------------  -----------------
<S>                                                      <C>                     <C>
Cash flows from operating activities:
    Net loss...................................          $(10,206,153)           $(3,730,541)
    Adjustments to reconcile net loss to net
        cash to be used in operating
        activities:
        Extraordinary loss on extinguishment of
           debt................................             3,672,656                    ---
        Deferred revenues......................                92,275                186,909
        Depreciation and amortization..........               141,399                182,963
        Amortization of debt discount..........               130,758                602,509
        Compensation from grant of non-employee
           stock options and warrants..........               129,961                559,101
    Changes in assets and liabilities affecting
        operating cash flows:
        Accounts receivable....................              (970,493)               (37,084)
        Other assets...........................              (350,079)               (24,808)
        Accounts payable.......................              (512,384)               307,501
        Accrued interest.......................              (523,952)               759,180
        Accrued expenses and other current                    204,489                344,386
        Deferred rent..........................               291,953                    ---
                                                          ----------------  ----------------

Net cash used in operating activities..........            (7,899,570)              (849,884)
                                                          ----------------  ----------------

Cash flows used in investing activities:

Purchase of short term investments.............           (11,619,279)                   ---
Sale of short term investments.................             8,647,978                    ---
Restricted cash ...............................              (486,455)                   ---
Deferred offering costs .......................                   ---               (888,493)
Acquisition of fixed assets....................            (1,019,808)               (23,992)
                                                          ----------------  ----------------

Net cash used in investing activities..........            (4,477,564)              (912,485)
                                                          ----------------  ----------------

Cash flows from financing activities:

Payments on capital lease obligations .........               (20,757)                   ---
Proceeds from notes payable ...................                   ---              1,620,000
Repayment of notes payable ....................            (3,923,500)                   ---
Proceeds from issuance of common stock ........            19,831,011                    ---
Cost of common stock issuance .................            (2,832,482)                    --
                                                          ----------------  ----------------

Net cash provided by financing activities......            13,054,272              1,620,000
                                                          ----------------  ----------------

Net increase (decrease) in cash and cash
   equivalents.................................               677,138               (142,369)
Cash and cash equivalents at beginning of
   period......................................                30,893                173,262
                                                          ----------------  ----------------

Cash and cash equivalents at end of period                $   708,031          $      30,893
                                                          ================  ================
</TABLE>

The accompanying notes are an integral part of these financial statements.

                                      F-7

<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements

1.   Nature of Business

     Digital Lava Inc., a Delaware corporation (the "Company"), is a provider of
software products and services related to the use of rich mixed media for
corporate training, communications, research and other applications. Digital
Lava's product line includes VideoVisor Professional (vvPro),
VideoVisorWeb(vvWeb) and vPublisher. VideoVisorProfessional and VideoVisorWeb
are proprietary viewers that allow the user to access the content published in
the Digital Lava format. vPublisher is a proprietary authoring software tool
that allows the integration of text, data, voice, video and web links into an
interactive desktop application, known as a VideoCapsule. VideoCapsule files are
accessed by either the vvPro software viewer on compact discs and private
Intranets or via the vvWeb software viewer on the internet. vvPro and vvWeb
allow the user to individually manage, manipulate and navigate the VideoCapsule
information on their computer screen.

2.   Summary of Significant Accounting Policies Basis of presentation

     The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. Since inception, the Company has
suffered recurring losses and negative cash flows from operations, has a
significant accumulated deficit, and expects to incur future losses. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. The Company currently anticipates that current cash balances,
short-term invetments and cash provided by operations will be sufficient to meet
its anticipated needs for working capital and capital expenditures for the next
6 months. Digital Lava anticipates it will seek additional funding either
through additional public or private sales of its securities. The Company is
currently taking action on such alternatives to raise capital in the next three
to four months, however the outcome of such efforts to raise working capital
cannot be assured. The accompanying financial statements do not include any
adjustments relating to the recoverability of the carrying amount of recorded
assets or the amount of liabilities that might result from the outcome of these
uncertainties.

Reverse stock split

     In February 1999, the Company effected a 1 for 9.139 reverse stock split
applicable to all issued and outstanding shares of the Company's common and
preferred stock. All common and preferred shares, stock options, warrants and
related per share data reflected in the accompanying financial statements and
notes thereto have been adjusted to give retroactive effect to the stock split.

Use of estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of


                                      F-8
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

Cash and cash equivalents

     The Company considers all highly liquid investments purchased with an
initial maturity of 90 days or less to be cash equivalents and investments with
original maturities of greater than 90 days to be short-term investments.

Short Term Investments

     During 1999, the Company purchased short term investments comprised of Euro
Dollar bonds and medium and short term notes. The Company accounts for short
term investments in accordance with Statement of Financial Accounting Standards
No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity
Securities." This statement addresses the accounting and reporting for
investments in equity securities which have readily determinable fair values and
all investments in debt securities. The Company's short term investments are
classified as available-for-sale under SFAS 115 and are reported at fair value.
The net unrealized gains or losses on these investments are reported as a
separate component of stockholders' equity, net of tax, and represented an
unrealized loss on available-for-sale securities of $15,014 at December 31,
1999. At December 31, 1999, available-for-sale securities were comprised of Euro
Dollar bonds and medium and short term notes of $1,839,402 and $1,116,885,
respectively.

Fair value of financial instruments

     The carrying amounts of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable and accrued expenses
approximates fair value due to their short maturities. The fair values of the
Company's capital lease obligations, including current maturities, are estimated
using discounted cash flow analyses, based on the estimated current incremental
borrowing rates for similar types of capital leases. The carrying amount of the
Company's capital lease obligations at December 31, 1999 approximates fair
value.

Concentration of risk

     Financial instruments which potentially subject the Company to
concentration of credit risk consists primarily of cash, to the extent balances
exceed limits that are insured by the Federal Deposit Insurance Corporation,
short term investments and accounts receivable. The Company places its short
term investments in Euro Dollar Bonds and short term notes. The Company, by
policy, limits the amount of credit exposure through diversification and
investment in highly rated securities. The company maintains an allowance for
uncollectible accounts receivable based upon expected collectibility and
generally does not require collateral. For the year ended December 31, 1999, no
allowance for uncollectible accounts was deemed necessary by management.

                                      F-9
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


Property and Equipment

     Property and equipment are stated at cost. Depreciation is based on the
straight-line method over the estimated useful lives of the assets, which are
six years for furniture and fixtures and three years for equipment. Capital
leases and leasehold improvements are amortized over the term of the related
lease.

Revenue recognition

     In accordance with Statement of Position ("SOP") 97-2, "Software Revenue
Recognition," as amended by SOP 98-9, "Modification of SOP 97-2, Software
Revenue Recognition", the Company generally recognizes revenue from licensing of
the Company's software products when all the following criteria are met: (1)
persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the
Company's fee is fixed or determinable, and (4) collectibility is probable. In
addition, for licensing contracts with multiple obligations (e.g. deliverable
and undeliverable products, services and maintenance), revenue is allocated to
each component of the contract based on evidence of fair value which is specific
to the Company.

     Service revenues, which consist of short-term professional service
contracts, such as video encoding and capsule creation, are deferred until
significant contractual obligations have been fulfilled. Costs associated with
professional service contracts, such as salaries and materials, are deferred
until the related revenue is recognized.

Software development costs

     Development costs incurred in the research and development of new software
products and enhancements to existing software products are expensed as incurred
until technological feasibility has been established. After technological
feasibility is established, any additional costs would be capitalized. Through
December 31, 1999, software development has been substantially completed
concurrently with the establishment of technological feasibility and,
accordingly, no costs have been capitalized.

Income taxes

     Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences affecting the Company's tax liabilities are expected to be recovered
or settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. A
valuation allowance is provided if it is more likely than not that some or all
of resulting deferred tax assets will not be realized.

Stock based compensation

     As permitted by Statement of Financial Accounting Standards ("SFAS") No.
123, "Accounting for Stock-Based Compensation", the Company accounts for its
stock-based

                                      F-10
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


compensation arrangements pursuant to Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and complies
with the disclosure provisions of SFAS No. 123. Under APB No. 25, compensation
cost is recognized based on the difference, if any, on the date of grant between
the fair value of the Company's stock and the amount an employee must pay to
acquire the stock.

     The Company accounts for non-employee stock-based awards in which goods or
services are the consideration received for the equity instruments issued based
on the fair value of the award in accordance with the provisions of SFAS No. 123
and Emerging Issues Task Force No. 96-18, "Accounting for Equity Instruments
that are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services".

Segment reporting

     In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" which requires the Company to disclose
certain segment information used by management for making operating decisions
and assessing the performance of the Company. Management has determined that the
Company operated within one discrete reportable business segment for the years
ended December 31, 1999 and 1998. Sales to customers outside and inside the
United States for the years ended December 31, 1999 and 1998 were as follows:

<TABLE>
<CAPTION>

                                                         Twelve Months Ended December 31,
                                                       -------------------- -----------------
                                                              1999                1998
                                                       -------------------- -----------------
<S>                                                                 <C>               <C>
Sales made to customers outside the United States                   46,408            12,841
Sales made to customers inside the United States                 1,441,637         1,450,777
                                                       -------------------- -----------------
                        Total                                    1,488,045         1,463,618
                                                       ==================== =================
</TABLE>

     Sales by significant customers for the years ended December 31, 1999 and
1998 were as follows:

<TABLE>

<S>                                                                    <C>             <C>
Customer A                                                             55%                --
Customer B                                                              --               46%
Other customers                                                        45%               54%
                                                       -------------------- -----------------
                        Total                                         100%              100%
                                                       ==================== =================
</TABLE>

     At December 31, 1999, one customer accounted for $841,453, or 72%, of
accounts receivable.

Comprehensive loss

     In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
130, "Reporting Comprehensive Income". The statement established standards for
the reporting and display of comprehensive income and its components. The
disclosures required by SFAS 130 have been included in the statements of
stockholders' equity (deficit). The difference between net loss and
comprehensive loss for the year ended December 31, 1999 represented unrealized


                                      F-11
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


loss on available-for-sale securities. For the year ended December 31, 1998,
there was no difference between net loss and comprehensive loss.

Loss per share

     Basic loss per share is computed by dividing net loss available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted loss per share gives effect to all dilutive potential common
shares outstanding during a period. In computing diluted loss per share, the
treasury stock method is used in determining the number of shares assumed to be
purchased from the conversion of common stock equivalents.

     Because their effects are anti-dilutive, net loss per share for the periods
ended December 31, 1999 and 1998 do not include the effects of:

<TABLE>
<CAPTION>

                                                         Twelve Months Ended December 31,
                                                       --------------------------------------
                                                              1999                1998
                                                       -------------------- -----------------
<S>                                                              <C>                <C>
Convertible preferred stock on as if converted basis                   ---           983,490
Stock options outstanding                                          860,170            59,618
Warrants to purchase series A convertible
     preferred stock on as if converted basis                                        171,340
Warrants to purchase common stock                                2,272,575           608,109

                                                       -------------------- -----------------
                        Total                                    3,132,745         1,822,557
                                                       ==================== =================
</TABLE>

     Net loss available to common stockholders represents net loss for the year
ended December 31, 1999 and 1998 increased in 1999 by a dividend of $660,023
recorded in February 1999 to the then holders of Series B and C convertible
preferred stock in conjunction with the change in conversion rates of such
shares (Note 7).

Recent Accounting Pronouncements

     In December 1999, the Securities and Exchange Commmission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements. SAB No. 101 provides the SEC staff's views in applying generally
accepted accounting principles to selected revenue recognition issues. SAB No.
101, as amended, is required to be adopted by registrants no later than their
second fiscal quarter of the fiscal year beginning after December 15, 1999. The
Company is currently analyzing SAB No. 101, but believes that adoption of this
new accounting priniple will not have a material effect on the Company's
financial statements.

     Effective January 1, 1999, the Company adopted Statement of Position No.
98-5, "Reporting on the Costs of Start-Up Activities". SOP No. 98-5 requires
that all start up costs related to new operations must be expensed as incurred.
In addition, start up costs that were capitalized in the past must be written
off when SOP No. 98-5 is adopted. The implementation


                                      F-12
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


of SOP 98-5 did not have a material effect on the consolidated financial
statements, as the Company had not previously capitalized the costs of start-up
activities..

3.   Fixed Assets

     Fixed Assets comprised the following:

                                                               December 31,
                                                                   1999
                                                             ------------------
      Furniture and fixtures                                          $351,998
      Equipment                                                        868,969
      Leasehold improvements                                           246,980
                                                             ------------------
                                                                     1,467,947
      Less: Accumulated depreciation and amortization                 (263,369)
                                                             ------------------
                                                                     1,204,578
                                                             ==================

     Property and equipment includes assets acquired under capital leases,
comprising mainly furniture and fixtures of approximately $228,020 and
accumulated amortization of $12,668, and equipment of $34,988 and accumulated
amortization of $3,888 at December 31, 1999.

4.   Accrued Expenses

     Accrued expenses and other current liabilities comprised the following:

                                                                 December 31,
                                                                     1999
                                                               ---------------
                 Wages and benefits payable                          $ 215,853
                 Accrued taxes - other                                 150,000
                 Other accrued liabilities                             243,173
                                                             ------------------
                                                                      $609,026
                                                             ==================
5.   Related Party Transactions

     In January and December 1997, certain members of management and principal
stockholders of the Company granted a consultant options to acquire up to 15,600
of their shares of series A convertible preferred stock and 19,941 of their
shares of common stock in exchange for services provided to the Company. The
options had an exercise price of $45.70 per share of series A convertible
preferred stock and $4.57 per share of common stock. Effective May 1998, these
options were amended. Under the revised terms and in exchange for additional
consulting services provided to the Company, the strike prices of the options
were reduced to $9.14 per share of series A convertible preferred and $.91 per
share of common stock. The total incremental difference between the value of the
options before and after the modification of the option terms, as determined
using the Black-Scholes model, in the amount of $346,400, was


                                      F-13
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements

recorded as a contribution of capital by the stockholders and a charge to
general and administrative expense in 1998. The options are exercisable for a
period of ten years and none were exercised at December 31, 1999.

     Since inception, the Company has received ongoing consulting and legal
services from certain stockholders. Services rendered for years ended December
31, 1999 and 1998, amounted to $588,829 and $542,719, respectively, of which
$13,169 is included in accounts payable at December 31, 1999.

     At December 31, 1999 the Company had a $230,000 unsecured, non-interest
bearing note receivable from an officer included in other assets. The note is
due in full upon termination of employment if such termination occurs prior to
July 1, 2001. If termination of employment does not occur prior to July 1, 2001,
the note will be canceled. The note is being amortized to general and
administrative expense over the life of the note. Accumulated amortization at
December 31, 1999 was $17,692. Imputed interest as determined based on an
interest rate of 9% for the year ended December 31, 1999, is considered
immaterial.

6.   Extinguishment of Debt

     During the period from March 1996 through December 1998, the Company issued
an aggregate principal amount of $5,339,500 in promissory notes. In 1998, the
Company renegotiated an aggregate principal amount of $2,832,000 of such
promissory notes with certain holders whereby, effective upon consummation of
the Company's IPO (Note 7), and in exchange for extending the maturity date, the
Company repaid in cash one half of the face value of the promissory notes plus
any accrued fees. The remaining one half of the face value of the promissory
notes, accrued but unpaid interest and the related outstanding warrants issued
in connection with the issuance of promissory notes, as discussed in Note 7,
were converted into 849,600 shares of common stock equal to 225% of the original
principal amount of the promissory note at a per share amount of $7.50. The
company recorded an extraordinary loss of $3,672,656 on extinguishment of these
promissory notes based on the difference between (a) cash paid and the value of
stock issued offset by the value of related warrants reacquired and canceled,
and (b) the book value of debt and accrued interest. The Company repaid the
remaining principal amount of $2,507,500 in cash upon the consummation of the
Company's IPO (Note 7).

7.       Stockholders' Equity (Deficit)

Underwritten initial public offering

         On February 22, 1999, the Company completed an underwritten initial
public offering ("IPO") of 1,200,000 units at a price of $15.10 per unit. Each
unit consisted of two shares of common stock, at a price of $7.50 per share, and
a redeemable warrant, at a price of $0.10 per warrant, to purchase one share of
common stock. Proceeds, net of discounts and commissions of $1,514,832, and
offering expenses paid of $2,008,699, totaled $14,596,469. In addition, on March
30, 1999 the underwriter exercised its over-allotment option to purchase an
additional

                                      F-14
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements

113,312 units for total proceeds, net of discounts and commissions of
$143,136, and offering expenses paid of $54,308, of $1,513,567. The warrants are
exercisable commencing February 17, 2000 through February 2004 at an exercise
price of $9.00 per share of common stock, subject to adjustment for stock
dividends, stock splits, combinations or reclassifications of common stock. In
addition, commencing August 17, 2000 the warrants are redeemable by the Company,
in whole and not in part, at $0.10 per warrant. The warrants are redeemable only
if the average closing price of common stock equals or exceeds $19.95 for any 20
trading days within a period of 30 consecutive trading days ending on the fifth
trading day prior to the date of notice of redemption.

         Upon the closing of the IPO, the Company issued warrants to the
underwriter to purchase 240,000 shares of common stock at an exercise price of
$12.38 per share of common stock, subject to the same adjustments as discussed
above. In addition, the Company issued 120,000 redeemable common stock purchase
warrants at an exercise price of $0.17 per warrant of which warrant purchased is
exercisable at an exercise price of $9.00 per share of common stock. The
redeemable common stock purchase warrants are subject to the same terms of
redemption as discussed above for redeemable warrants issued in the IPO. The
warrants are exercisable for four years commencing February 22, 2001. The total
estimated value of the warrants granted to the underwriter of $1,892,400 was
reflected as non-cash offering expenses.

         In conjunction with the completion of the IPO, the Company cancelled
8,824 shares of series A convertible preferred stock (which converted to 88,222
shares of common stock) and 11,028 shares of common stock returned by certain
officers of the Company. This resulted in the cancellation of 99,250 shares of
common stock and was recorded as contributed capital.

Preferred stock

         Upon completion of the Company's IPO, all shares of the Company's
convertible preferred stock converted into common stock of the Company. This
transaction was reflected in 1999 as follows:

         Conversion of series A and B-1 convertible preferred stock

                  Each share of the Company's series A and B-1 convertible
         preferred stock outstanding converted into 797,600 and 20,411 shares of
         common stock, respectively.

         Conversion of series B and C convertible preferred stock

                  In conjunction with the completion of the IPO, the Company
         changed the conversion rate for series B and C convertible preferred
         stock from 10 to 1 to 20.3099 to 1 and 19.3702 to 1, respectively. As
         such, each share of the Company's series B and C convertible preferred
         stock outstanding converted into 112,763 and 63,586 shares of common
         stock, respectively. The value based on the IPO price of the 88,003
         incremental common shares issued to Series B and C preferred holders
         resulting from the change in conversion rates was recorded as a
         dividend to the preferred stockholders in the amount of $660,023.



                                      F-15
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements

Warrants issued with debt

         In conjunction with the issuance of promissory notes (Note 6), the
holders of promissory notes were granted warrants to purchase 15,601 and 728,287
shares of series A convertible preferred and common stock, respectively, at
initial exercise prices ranging from $68.54 to $182.78 and $6.85 to $11.42 per
share of series A convertible preferred and common stock, respectively. Certain
warrants granted have been adjusted due to 1) anti-dilution provisions resulting
from the issuance of securities at prices below previously issued warrants'
exercise prices and 2) the conversion of warrants to purchase series A
convertible preferred stock to warrants to purchase common stock due to the
conversion of convertible preferred stock to common stock upon the completion of
the Company's IPO, and now represent warrants to purchase a total of 939,334
shares of common stock at exercise prices ranging from $6.85 to $18.28 per
share. The warrants are exercisable at any time prior to dates ranging from
February 2003 to March 2007. The total value of the warrants at the time of
issuance, as determined using the Black-Scholes model, of $1,795,651 was treated
as debt discount and amortized to interest expense over the initial term of the
promissory notes of which $625,059 was recorded during the year ended December
31, 1998 for promissory notes issued in 1998. In exchange for either waiving the
acceleration of the maturity date of the promissory notes caused by the Company
raising additional financing in excess of a specified amount or extending the
maturity date, the exercise prices of the warrants were reduced to prices
ranging from $45.70 to $68.54 and $4.57 to $8.23 per share of series A
convertible preferred and common stock, respectively. The total incremental
difference between the value of the warrants before and after the modifications
of the terms, as determined using the Black-Scholes model, of $269,826, was
treated as additional debt discount and amortized to interest expense over the
remaining life of the debt of which $41,028 was recorded during the year ended
December 31, 1998 for debt modified in 1998. None of the warrants have been
exercised as of December 31, 1999.

         As discussed in Note 6, in conjunction with the issuance of common
stock in exchange for extinguishment of one half of the face value of promissory
notes issued in the aggregate principal amount of $1,416,000, the Company
reacquired and cancelled warrants previously issued to the note holders to
purchase 10,669 and 237,721 of series A convertible preferred and common stock,
respectively, at exercise prices ranging from $68.54 to $182.78 and $6.85 to
$11.42 per share, respectively. In addition, in exchange for issuance of 45,005
shares of common stock, the Company reacquired and cancelled warrants to
purchase 182,139 shares of common stock at an exercise price of $8.59 per share,
as adjusted for anti-dilution provisions resulting from the issuance of
securities at prices below previously issued warrants' exercise price, issued in
connection with promissory notes issued in the aggregate principal amount of
$1,350,000.

         Amortization of debt discount for the years ended December 31, 1999 and
1998 was $130,758 and $602,509, respectively.

Finder warrants

         In connection with the issuance of certain promissory (Note 6), the
Company issued warrants to purchase 438 and 108,237 of series A convertible
preferred stock and common stock, respectively, at exercise prices ranging from
$114.24 to $182.78 and $8.68 to $11.42 per share of series A preferred stock and
common stock, respectively, as a finders fee. Certain warrants granted have been
adjusted due to 1) anti-dilution provisions resulting from the issuance of
securities at prices below previously issued warrants' exercise prices and 2)
the conversion of warrants to purchase series A convertible preferred stock to
warrants to purchase common stock due to the conversion of convertible preferred
stock to common stock upon the completion of the Company's IPO, and now
represent warrants to purchase a total of 118,606 shares of common stock at
exercise prices ranging from $7.41 to $13.52 per share. The total value of the
warrants granted, as determined using the Black-Scholes model, of $306,757 was
treated as debt issue costs and amortized to interest expense over the initial
maturity date of the related notes of which $42,028 was recorded during the year
ended December 31, 1998 for warrants granted in 1998. The warrants are
exercisable at any time prior to dates ranging from February 2003 to July 2008.
None of the warrants have been exercised as of December 31, 1999. Amortization
of debt issue costs for the years ended December 31, 1999 and 1998 was $3,517
and $124,481, respectively.



                                      F-16
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements

         In 1998 the Company entered into agreements to settle outstanding
disputes regarding finders fees related to certain note issuances. Under the
terms of the agreements, the Company granted warrants to acquire 27,885 shares
of common stock at exercise prices ranging from $4.11 to $7.38 per share and
agreed to pay $62,500 in cash. The fair value of the warrants as determined
using the Black-Scholes model, in the amount of approximately $120,000 was
recorded as general and administrative expense for the year ended December 31,
1998. In February 1999, the Company and certain finders agreed to cancel 27,356
of these warrants. The cancellation of such warrants did not have an impact on
the results fro the years ended December 31, 1999 and 1998.

Consulting and services warrants

         In November 1996 and January 1997, in exchange for legal services
provided, the Company issued warrants to purchase 1,095 and 10,943,
respectively, of shares of series A convertible preferred stock and common stock
at exercise prices, as adjusted, of $68.54 and $6.85 per share of series A
preferred and common stock respectively. Certain warrants granted have been
adjusted due to 1) anti-dilution provisions resulting from the issuance of
securities at prices below previously issued warrants' exercise prices and 2)
the conversion of warrants to purchase series A convertible preferred stock to
warrants to purchase common stock due to the conversion of convertible preferred
stock to common stock upon the completion of the Company's IPO, and now
represent warrants to purchase a total of 23,212 shares of common stock at an
exercise price of $6.48 per share. The warrants are exercisable at any time
prior to dates ranging from June 2003 to November 2006. None of the warrants
have been exercised as of December 31, 1999.

         During the period from November 1996 through August 1999, the Company
has entered into various one year consulting agreements. In conjunction with
these agreements, the Company issued warrants to purchase 54,074 shares of
common stock at exercise prices ranging from $3.56 to $9.14 per share of common
stock. The warrants are exercisable at any time prior to dates ranging from
December 2003 to February 2005. The total value of the warrants at time of
issuance, as determined using the Black-Scholes model, of $239,596 was amortized
to general and administrative expense over the term of the consulting agreement
of which $129,967 and $92,701, respectively, was recorded for warrants granted
in 1999 and 1998 and $16,928 was included in deferred compensation at December
31, 1999. In February 1999, the Company and a consultant agreed to cancel
warrants to purchase 10,943 shares of common stock at an exercise price of $4.57
per share. None of the warrants have been exercised as of December 31, 1999.

         A number of the warrants granted to consultants and in connection with
promissory notes (Note 6) contain anti-dilution provisions requiring adjustment,
if at a later date, securities are issued at prices below the respective
warrants' exercise price. In conjunction with the completion of the Company's
IPO, certain of these warrants were cancelled.

         The following table is a summary of the shares issuable upon exercise
of warrants outstanding as of December 31, 1999, as adjusted for events which
have triggered anti-dilution provisions contained in the respective warrant
agreements:

                                      F-17
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


<TABLE>
<CAPTION>

                                                                  Common            Exercise
                                                                  Shares             Price
                                                                 Issuable             Per
                                        Expiration                 Upon              Common
Issuance Date                              Date                  Exercise            Share
-------------                   ---------------------         --------------    ------------------
<S>                             <C>                            <C>               <C>
September 1996                  September 2006                      2,858             9.6891
September 1996                  September 2006                     64,295             9.8054
September 1996                  September 2006                      3,112            13.5155
November 1996                   November 2006                      11,606             6.4783
January 1997                    January 2007                       11,606             6.4783
May 1997                        May 2005                           30,313             6.3980
May 1997                        May 2005                              630            11.4240
May 1997                        May 2003                           35,289            11.4240
June 1997                       June 2005                           1,329             7.3780
July 1997                       July 2005                          11,753             7.3780
July 1997                       July 2005                           2,875             7.4954
January 1998                    January 2003                       77,581             7.4118
January 1998                    December 2003                      13,131             9.1390
December 1998                   December 2008                      21,885             4.1130
December 1998                   December 2003                     275,000             9.7500
January 1999                    July 2003                           6,000             7.3780
February 1999                   February 2005                      20,000             6.7500
February 1999                   February 2004                   1,200,000             9.0000
February 1999                   February 2004                     240,000            12.3750
February 1999                   February 2004                     120,000             9.1650
March 1999                      March 2004                        113,312             9.0000
August 1999                     August 2004                        10,000             3.5625


                                                             ----------------   ------------------
Total shares and average
exercise price                                                  2,272,575           $ 9.3038
                                                             ================   ==================
</TABLE>


8.   Employee Benefits 1996 stock option plan

     The Company's 1996 Stock Option Plan (the "1996 Option Plan") permits the
grant of both "incentive stock options" designed to qualify under the Internal
Revenue Code Section 422 and non-qualified stock options. Incentive stock
options may only be granted to employees of the Company whereas non-qualified
stock options may be granted to non-employees, directors and consultants. A
total of 1,000,000 shares of Common Stock have been reserved for issuance under
the 1996 Option Plan. Each option, once vested, allows the optionee the right to
purchase one share of the Company's Common Stock. The Board of Directors
determines the exercise price of the options; options granted to date generally
vest 25% per year over four years and expire ten years from the date of grant.
Compensation expense equal to the difference between the assumed fair value of
the Company's Common Stock at the grant date and the exercise price of the
options, if any, is recognized ratably over the vesting period.

                                      F-18
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


     Stock option activity can be summarized as follows:

<TABLE>
<CAPTION>

                                                                    Options Outstanding
                                                                ----------------------------
                                                                                   Weighted
                                            Options                                Average
                                            Available            Shares         Exercise Price
                                        ---------------      -------------    ------------------
<S>                                     <C>                 <C>                  <C>
    Balance at December 31, 1997            121,895              42,237                 $9.14
        Additional authorization             85,868                  --                   --
        Granted                             (23,946)             23,946                  9.14
        Canceled                              6,565              (6,565)                 9.14
                                          -----------        -------------
    Balance at December 31, 1997            190,382              59,618                 $9.14
        Additional authorization            750,000                  --                    --
        Granted                            (827,448)            827,448                  5.50
        Canceled                             26,896             (26,896)                 6.08
                                          -----------        -------------      ---------------
Balance at December 31, 1999                139,830             860,170                 $5.73
                                          ===========        =============      ===============

</TABLE>

The following table summarizes information concerning currently outstanding and
exercisable stock options for the 1996 Stock Option Plans as of December 31,
1999

<TABLE>
<CAPTION>

                                                                          Options Exercisable at
                               Options Outstanding at December 31, 1999      December 31,1999
                               ----------------------------------------   -------------------------
                                                              Weighted                   Weighted
                                           Weighted Average   Average                    Average
                                Number         Remaining      Exercise      Number       Exercise
  Range of Exercise Prices    Outstanding  Contractual Life     Price     Exercisable      Price
  ------------------------    -----------  ----------------   ---------   -----------  -----------
<S>                           <C>          <C>                <C>            <C>        <C>
        $3.00 - $4.63             194,850         9.8              $3.59          ---        ---
        $5.00 - $6.13             533,621         9.5              $5.92       52,270      $5.43
        $7.50 - $9.14             131,699         8.5              $8.14      131,699      $8.14
                              ------------                                ------------
                                  860,170                                     183,969
                              ============                                ============
</TABLE>

     Pro forma information regarding net income or loss is required by SFAS No.
123. For purposes of pro forma disclosure, the estimated fair values of the
options are amortized to expense over the options' vesting period. Had
compensation cost for these options been determined pursuant to SFAS No. 123,
the difference between the Company's net loss as reported and as adjusted for
the compensation costs for the years ended December 31, 1999 and 1998 would be
as follows:

<TABLE>
<CAPTION>

                                                                         Year Ended
                                                                        December 31
                                                              -----------------------------------
                                                                  1999               1998
                                                              ----------------     ---------------
<S>                                                           <C>                 <C>
Net loss
      As reported                                              $ (10,206,153)       $(3,730,541)
      Pro Forma                                                  (10,573,725)        (3,730,541)
</TABLE>


                                      F-19
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


<TABLE>
<CAPTION>

<S>                                                           <C>                 <C>
Basis and diluted loss per share
      As reported                                                     $(2.75)           $(28.36)
      Pro Forma                                                        (2.84)            (28.36)
</TABLE>


          In accordance with the provisions of SFAS No. 123, prior to being a
     public company, the Company disclosed the pro forma effects of accounting
     for stock-based compensation using the minimum value method, which does not
     incorporate an assumption for volatility, and subsequent to becoming a
     public company uses the Black-Scholes model including a volatility
     assumption. The weighted average fair value of options granted for the
     years ended December 31, 1999 and 1998 were $4.10 and $0.00, respectively.
     Weighted average assumptions used for options granted during the years
     ended December 31, 1999 and 1998 were as follows:

                                            1999                 1998
                                         -----------           ----------
Risk free interest rate                     4.83%                5.124%
Volatility                                    95%                    0%
Expected lives (years)                         5                     5
Expected dividends                            --                    --

9.   Income Taxes

     No provision for income taxes was recorded for the years ended December 31,
1999 and 1998, as the Company incurred net losses during the period.

     The reported provision for income taxes differs from the amount computed by
applying the U.S. statutory federal income tax rate of 34 percent to loss before
extraordinary items and income taxes as follows:

<TABLE>
<CAPTION>

                                                                Year Ended December 31,
                                                        -----------------------------------------
                                                           1999        %        1998        %
                                                        -----------------------------------------
<S>                                                     <C>          <C>     <C>          <C>
Provision computed at statutory rate                   $(2,221,000)  (34.0) $(1,269,000)  (34.0)
Increase (decrease) resulting from:
     State tax, net of federal benefit                    (353,000)   (5.4)    (247,000)   (6.6)
     Tax credits                                           (65,000)   (1.0)     (42,000)   (1.1)
     Other                                                  83,000     1.3       17,000      .4
     Change in valuation allowance                       2,556,000    39.1    1,541,000    41.3
                                                       ------------   ------  -----------  ------
                                                       $         0       0%           0       0%
                                                       ============   ======  ===========  ======
</TABLE>




                                      F-20
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


     Deferred tax assets and liabilities at December 31, 1999 and 1998, are
comprised of the following (in thousands):

<TABLE>
<CAPTION>

                                                                  December 31,
                                                              ----------------------
                                                                 1999       1998
                                                              ----------------------
<S>                                                             <C>        <C>
      Deferred revenue                                        $      112   $    ---
      Net operating loss carryforwards                             5,894      3,225
      Non-employee warrants                                          589        578
      Research and Development costs capitalized for tax             448        144
      Research credit carryforwards                                  170         65
      Other                                                           22         33
                                                              ----------------------
      Gross deferred tax assets                               $    7,235   $  4,045
      Gross deferred tax liabilities                                 (31)       (87)
      Net deferred tax assets                                      7,204      3,958
      Less valuation allowance                                    (7,204)    (3,958)
                                                              ----------------------
      Deferred tax assets net of valuation allowance          $        0   $      0
                                                              ======================
</TABLE>
     The change in the valuation allowance for the years ended December 1999 and
1998 was $3,246,000 and $948,000, respectively.

     Because of the "change of ownership" provision of the Tax Reform Act of
1986, utilization of the Company's net operating loss and research credit
carryforwards are subject to an annual limitation against income in future
periods. As a result of the annual limitation, a portion of these carryforwards
may expire before ultimately becoming available to reduce future tax
liabilities.

     As of December 31, 1999, the company had net operating loss carryforwards
for federal and state purposes of $15,222,000 and $11,981,000, respectively.
Federal net operating loss carryforwards expire from 2008 through 2019 and state
net operating loss carryforwards expire from 2000 through 2004. Given the recent
history of operating losses, deferred tax assets require full valuation
allowance because management believes it is more likely than not that these
assets will not be realized. Accordingly, the accompanying statement of
operations includes no deferred benefit for income taxes.

10.  Commitments and Contingencies

Operating leases

     The Company entered into a non-cancelable operating lease for its facility
which expires in August 2005. Under the terms of the lease, the Company may
extend the term of the lease for an additional five-year period at the then
current fair market value. Under the terms of this agreement, the Company
entered into a letter of credit as collateral for the lease. Restricted cash of
$350,000 invested in a certificate of deposit at December 31, 1999
collateralized that letter of credit. As part of the facility transition, the
former operating lease was retired at a cost of $40,880 which was charged to
rent expense in 1999. Rent expense under operating leases was $229,804 and
$85,479 for the years ended December 31, 1999 and 1998, respectively.

     The Company entered into a non-cancelable capital lease for furniture and
equipment which expires in September 2002. Under the terms of this agreement, a
letter of credit was created as collateral for the lease. Restricted cash of
$136,455 invested in a certificate of deposit at December 31, 1999
collateralized that letter of credit.

     Future minimum lease payments under all non-cancelable operating and
capital leases, as of December 31, 1999 are as follows:


                                      F-21
<PAGE>

                                DIGITAL LAVA INC.

                          Notes to Financial Statements


<TABLE>
<CAPTION>

Fiscal Year ended December 31,                            Capital Leases      Operating Leases
                                                         ----------------  ---------------------
<S>                                                          <C>                  <C>
2000                                                         $104,197             $568,816
2001                                                          104,197              568,816
2002                                                          84,514               562,396
2003                                                            ---                549,556
2004                                                            ---                549,556
Thereafter                                                      ---                412,167
                                                        -------------------- --------------------
                                                              292,908            $3,211,307
                                                                             ====================
Less: Amount representing interest                            50,567
                                                        --------------------
                                                              242,251
Less: Current portion                                         75,869
                                                        --------------------
Long-term portion of capital lease obligations             $    166,382
                                                        ====================
</TABLE>


Employment Agreements

     In September 1998, the Company and two members of management entered into
two-year consulting agreements for financial, operational and strategic
development services, effective upon the closing of the IPO (Note 7). Under the
terms of the agreements, the Company paid bonuses totaling $100,000 upon the
closing of the IPO and is required to pay annual consulting fees totaling
$84,000.

11.  Non-Cash Supplemental Disclosure

     Non-cash items occurring in the years ended December 31, 1999 and 1998
included the following:

<TABLE>
<CAPTION>

                                                               1999                 1998
                                                            -----------         -----------
<S>                                                         <C>                 <C>
Modification of outstanding convertible preferred
    stock warrants                                              ---                $30,978
Modification of outstanding common stock warrants               ---                 10,050
Issuance of common stock warrants in conjunction with
    notes payable                                               ---                624,935
Conversion of notes payable, plus accrued interest,
    to common stock                                           1,690,556
Issuance of warrants to underwriter to purchase
    common stock and warrants to purchase redeemable
    common stock warrants                                     1,892,400
Dividend to series B and series C convertible
    preferred stockholders in connection with
    modification of conversion rates                            660,023               ---
Unrealized loss on available for sale securities                 15,014               ---
Purchase of equipment under capital lease                       263,008               ---
</TABLE>


                                      F-22