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                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                  FORM 10-KSB

  [X]Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange
     Act of 1934

                    For fiscal year ended December 31, 2000

  [_]Transition Report Pursuant to Section 13 or 15(d) of the Securities
     Exchange Act of 1934

                       Commission file number 001-15819

                            ACTIVEWORLDS.COM, INC.
                (Name of Small Business Issuer In Its Charter)

              Delaware                                 13-3883101
   (State or Other Jurisdiction of          (IRS Employer Identification No.)
   Incorporation or Organization)

   95 Parker Street, Newburyport,                         01950
            Massachusetts                              (Zip Code)
   (Address of Principal Executive
              Offices)

                                 978-499-0222
               (Issuer's Telephone Number, Including Area Code)

Securities registered under Section 12(b) of the Exchange Act:

Title of Each Class                    Name of Each Exchange on Which Registered
-------------------                    -----------------------------------------
Common stock, $.001 par value per      Boston Stock Exchange
share.                                 Nasdaq SmallCap Market


Unit, each consisting of one share     Boston Stock Exchange
of common stock and one series B       Nasdaq SmallCap Market
redeemable common stock purchase
warrant, exercisable for one share
of common stock


Series B redeemable common stock       Boston Stock Exchange
purchase warrant, exercisable for      Nasdaq SmallCap Market
one share of common stock.




Securities registered under Section 12(g) of the Exchange Act:

  None.

  Check whether the issuer: (1) filed all reports required to be filed by
  Section 13 or 15(d) of the Exchange Act during the past 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 past 90 days.

    Yes [X]    No [_]

  Check if there is no disclosure of delinquent filers in response to Item
  405 of Regulation S-B contained in this form, and no disclosure will be
  contained, to the best of registrant's knowledge, in definitive proxy or
  information statements incorporated by reference in Part III of this Form
  10-KSB or any amendment to this Form 10-KSB [_]

  The issuer's revenues for the fiscal year ended December 31, 2000 were
  $1,615,882.

  As of March 1, 2001, the aggregate market value of the voting stock held by
  non-affiliates of the issuer based upon the average of the closing bid and
  asked prices of such stock as reported on the Nasdaq SmallCap Market was
  $1,652,353.

  As of March 1, 2001, the issuer had 8,515,235 shares of common stock, $.001
  par value, issued and outstanding.

  Documents incorporated by reference

    None.

  Transitional Small Business Disclosure Format (check one): Yes [_]  No [X]

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                            ACTIVEWORLDS.COM, INC.
                             INDEX TO FORM 10-KSB

<TABLE>
<CAPTION>
 Securities and Exchange Commission                                    Page No.
 Item Number and Description                                           --------
 ----------------------------------

                                    PART I

 <C>      <S>                                                          <C>
 Item 1.  Description of Business...................................       2
 Item 2.  Description of Property...................................      11
 Item 3.  Legal Proceedings.........................................      11
 Item 4.  Submission of Matters to a Vote of Security Holders.......      11

                                    PART II

 Item 5.  Market for Common Equity and Related Stockholder Matters..      11
 Item 6.  Management's Discussion and Analysis of Financial
          Condition and
          Results of Operations.....................................      13
 Item 7.  Financial Statements......................................      20
 Item 8.  Changes in and Disagreements With Accountants on
          Accounting and
          Financial Disclosure......................................      20

                                   PART III

 Item 9.  Directors, Executive Officers, Promoters and Control
          Persons; Compliance With Section 16(a) of the Exchange
          Act.......................................................      20
 Item 10. Executive Compensation....................................      22
 Item 11. Security Ownership of Certain Beneficial Owners and
          Management................................................      23
 Item 12. Certain Relationships and Related Transactions............      24
 Item 13. Exhibits, List and Reports on Form 8-K....................      25
</TABLE>

Inasmuch as the calculation of shares of the registrant's voting stock held by
non-affiliates requires a calculation of the number of shares held by
affiliates, such figure as shown on the cover page hereof, represents the
registrant's best good faith estimate for purposes of this Annual Report on
Form 10-KSB, and the registrant disclaims that such figure is binding for any
other purpose. The aggregate market value of the registrant's common stock
indicated is based upon the average of the closing bid and asked prices of
such stock as reported on the Nasdaq SmallCap Market. All outstanding shares
beneficially owned by executive officers and directors of the registrant or by
any shareholder beneficially owning more than 10% of registrant's common
stock, as disclosed herein, were considered for purposes of this disclosure to
be held by affiliates.

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                          FORWARD-LOOKING STATEMENTS

Some of the statements in this Form 10-KSB are "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934 and
Section 27A of the Securities Act of 1933 that address, among other things,
our expectations with respect to the development of our business and the
market for three-dimensional technology for the Internet. Words such as
"seek," "anticipate," "believe," "plan," "estimate," "expect," or "intend"
indicate forward-looking statements. We have made these statements based on
currently available operating, financial and competitive information. However,
actual results and future events may differ significantly from the results
contemplated in the forward-looking statements because of a number of factors,
including product and technology development, customer and market acceptance
of our product, demand for our product, the impact of competitive products and
pricing and other risks detailed in this Form 10-KSB and in our other
Securities and Exchange Commission filings.

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                                    PART I

Item 1. Description of Business

  About Activeworlds.com

  Activeworlds.com, Inc. ("Activeworlds" or the "Company" or "we") is a
  Delaware corporation which was incorporated on September 5, 1995 under the
  name Vanguard Enterprises, Inc. In January 1999, we acquired all of the
  issued and outstanding stock of Circle of Fire Studios, Inc., a Nevada
  corporation, in exchange for 5,433,211 shares of our common stock. We also
  effected a one-for-two reverse split of our common stock and sold 1,333,333
  shares of our common stock in an offering pursuant to a private placement.
  Concurrently with these transactions, we changed our corporate name to
  Activeworlds.com, Inc. and we changed the name of our subsidiary from
  Circle of Fire Studios, Inc. to Activeworlds, Inc. Our sole business became
  the business of Circle of Fire Studios, which is described in this annual
  report on Form 10-KSB. The former business of Vanguard Enterprises, which
  was the marketing of hair care products on cable television, was
  discontinued in 1996.

  Our address is 95 Parker Street, Newburyport, Massachusetts 01950. Our
  telephone number is (978) 499-0222. Our Web site address is
  www.activeworlds.com. Information contained on our Web site is not a part
  of this annual report.

  Our Business

  Activeworlds.com, Inc. is a provider of Internet software products and
  services that enable the efficient development and delivery of three-
  dimensional content over the Internet and intranets. Our comprehensive
  software platform is comprised of three principal components: our
  proprietary three-dimensional world server software which we license under
  the names uniserver for larger applications and galaxerver for smaller
  applications, a three-dimensional browser and development authoring tools.
  Our Active Worlds technology allows us and other users to create objects
  and structures in three-dimensional virtual environments, which we call
  worlds.

  We host numerous worlds on our own uniserver which visitors to our Web site
  can access and explore in real time. Visitors to our Web site can enter and
  move about in our worlds and interact with others either for free as
  tourists or, upon payment of an annual membership fee, as members, which we
  call citizens. We also license our server software to permit licensees to
  create their own worlds within which they can control the content and
  access, either on our uniserver or on their own uniserver or galaxerver.
  For example, a university licensee could restrict access to its world to
  its students. We also create content for worlds based on customer
  specifications. In addition, we act as an application service provider and
  permit users to license our technology for integration into their web
  applications, which may be hosted on our server. We also offer licensees of
  our world server technical services to assist them in the development of
  their worlds or to develop their worlds for them.

  We currently derive our revenue primarily from three sources:

    .  Licenses for our world server software, which include the right to
       use our technology either on our server or on a separate server
       which is licensed to the client for use at its facilities

    .  Membership fees, which are paid by users who become citizens

    .  Three dimensional content production for our licensees

  We generally grant our world server licensees a non-exclusive right to use
  our uniserver software (which can support a large number of worlds) or our
  galaxerver software (which supports only one world). One-time uniserver and
  galaxerver software license fees range from $1,995 to $150,000 depending on
  the size of the server and include the right to receive any upgrades for a
  one-year period. We generally have no obligation to maintain support for
  the software under the licensing agreement. The fee to purchase a world

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  on our uniserver ranges between $92 and $519 with a majority of world sales
  being between $92-$119. The fee allows the user access to and an exclusive
  right to create permanent objects or structures within the world for one
  year. The fee is significantly reduced for annual renewals of worlds. We do
  not constantly monitor the content of worlds created by our licensees, but
  we do have access to all worlds which reside on our uniserver and monitor
  the worlds from time to time. As of December 31, 2000, there were
  approximately 1,000 worlds supported by our uniserver, of which 10 worlds
  are our worlds and the remaining worlds were created by our users or
  licensees. Approximately 750 of these worlds are running at any one time.

  Users who want to become citizens of our Active Worlds worlds through our
  Web site pay an annual membership fee of $19.95. Membership fees
  represented approximately 11.9% of revenues in 2000.

  Development fees are negotiated individually with each licensee who
  contracts with us for custom content development and production.

  The Market for Three-Dimensional Technology

  We believe the three-dimensional multi-user Internet market is a growing
  market which is a natural evolution of the development of Internet
  communities as well as distance learning and collaboration environments. We
  believe that the next stages of Internet development will expand the
  Internet beyond the typical two-dimensional environment in which users can
  move only along horizontal and vertical axes (up, down, left and right)
  into a three-dimensional environment in which users can move forward and
  backward and interact with other users in an on-line virtual environment.

  We believe that three-dimensional technology has a wide variety of
  applications, including the following:

    .  The entertainment industry, which can use three-dimensional
       technology to offer virtual settings that allow the user to interact
       with both the environment and other visitors. We have created
       virtual worlds for the feature films Godzilla and The 13th Floor.
       For The 13th Floor, we created a virtual world that was used to
       launch a virtual premiere of the movie which was attended by the
       virtual renditions of stars of the movie and other well-known
       actors.

    .  The education industry, which can use three-dimensional technology
       as part of course material. Cornell University uses our technology
       for the development of a virtual science center. We are dedicating a
       uniserver to worlds which are to be developed for schools and
       universities.

    .  Distance learning, which can use our technology for training
       purposes. We are creating for Siemens Electromedical Systems Group a
       world to provide on-line training for medical personnel.

    .  E-commerce, where our technology can be used to develop and
       implement an electronic storefront in which visitors can interact
       and move about in a manner similar to a retail store.

    .  Three-dimensional communities, such as our AlphaWorld, the most
       popular world served by our uniserver. We have developed these
       communities, in which citizens and tourists can build structures,
       move about and communicate with each other. The presence of any
       visitor is shown by his or her physical representation known as an
       avatar.

    .  Chat rooms, such as the chat room we developed for Juno Online
       Services Inc., in which thousands of users can interact and chat
       with each in the same shared virtual space. The chat rooms can be
       part of a three-dimensional community or can be in separate worlds
       dedicated solely to chat. In addition to the text messages common to
       two-dimensional chat room, the three-dimensional capability permits
       visitors to see, move around, and interact with another visitor
       through their avatars. The three-dimensional capabilities include
       the ability of a citizen to develop an avatar with his or her
       picture.

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  The Active Worlds Worlds

  A world is a defined segment of our virtual environment. On our uniserver,
  we maintain our own worlds as well as worlds that are developed by our
  licensees or by us pursuant to agreements with our licensees. The licensee
  may restrict access to its world. Visitors can obtain access to our worlds
  by visiting our Web site, www.activeworlds.com, downloading our browser at
  no charge, and using the browser to visit one or more worlds that are
  maintained on our uniserver and which are not owned by licensees which
  restrict access. Our licensees may develop their worlds which are
  independent of our uniserver.

  Once in one of our worlds, users can create virtual three-dimensional
  structures, such as buildings, using our library of more than 3,000
  computer objects and textures. The design and texture of each world
  reflects the theme of that world. The theme of a world is reflected in the
  particular type of building objects that visitors can use to create
  structures. Thus, for example, our Mars and Atlantis worlds have themes and
  building materials that are consistent with our vision of a world on Mars
  and an undersea world. Similarly, the user's avatar, which is the user's
  physical representation in the world, may vary from world to world.

  Any person who downloads our browser can visit our worlds and the worlds of
  those of our licensees that permit access. A visitor may be a citizen, who
  registers with us and pays an annual fee, which is presently $19.95, or a
  tourist, who does not make any payment. We currently have over 40,000
  citizens. Any user can create a three-dimensional structure in our worlds,
  however, the structures created by citizens are permanent while the
  structures created by tourists can be changed or replaced by other users.
  While we have the ability and right to take down a structure created by a
  citizen who lets his or her citizenship lapse, it has not been our practice
  to do so. If a tourist constructs a structure in one of our worlds, a
  citizen can claim the space on which the tourist's structure is situated
  and construct his or her own structures. Our uniserver identifies those
  structures that are constructed by citizens and those that are constructed
  by tourists. All users can add picture, sound, music and information to
  their virtual structures through direct links to anywhere on the Internet.

  We operate one uniserver, through which more than 1.5 million users have
  downloaded and successfully installed our browser and entered into our
  virtual worlds. This uniserver receives more than 1,000,000 hits per day,
  with each hit representing an incidence of access to one of our 10 company
  created worlds such as downloading of building objects. Our primary method
  of delivering our browser (version 2.2 and version 3.1) is through the
  Internet.

  When a user visits any of our worlds, his or her presence is immediately
  indicated by his or her avatar and the user is greeted by his or her screen
  name. Citizens can create avatars from a range of formats, while the avatar
  of a tourist is limited to two forms which identify the visitor as a
  tourist. The avatar's position is shown on the world which the user is
  visiting. Other users in the same section of the world can see and converse
  with any user who is in the area at the same time. At present,
  communication is made through text messages which appear on each visitor's
  screen. Our server identifies, by screen name, each person within the area
  of vision. The avatars can be viewed from different angles and positions,
  including a view from above or from the eyes of user's avatar.

  Our worlds are under constant development by both citizens and tourists. By
  creating an object on an empty piece of land, a visitor can stake a claim
  to cyberspace. Our library of thousands of building objects contains the
  necessary materials for constructing a home, store, convention center, car,
  maze or any other kind of building or structure. Citizens, but not
  tourists, can customize their buildings with signs of all shapes and sizes.
  As of December 31, 2000, visitors had placed more than 78 million virtual
  objects and structures in AlphaWorld, our most popular world, and they have
  created virtual towns and cities, complete with traffic signs, community
  artwork and parkland, in which visitors (through their avatars) can stroll,
  explore and interact with other users. In one of these structures, users
  have created a portrait gallery in which citizens have placed pictures of
  themselves and others.

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  Citizens also have the ability to construct a transport, which, when
  touched, moves a visitor to another destination in the same world, a
  different world or another location on the Internet. We call the ability to
  transport users in this manner teleporting.

  Our worlds can have a commercial or non-commercial theme and can be based
  on specific themes or commercial applications, which are selected either by
  us or by our licensees. In addition to AlphaWorld, these other worlds
  include:

    .  Theme worlds, with themes such as underwater themes or space themes,
       in which users can construct structures appropriate to those
       environments.

    .  @mart, which is a virtual shopping mall.

    .  Movie and entertainment worlds, such as The 13th Floor and Godzilla,
       which we created for Centropolis Studios, a division of Columbia
       pictures. These worlds reproduce selected aspects of the movies.

    .  Educational worlds, such as Cornell University's virtual science
       center.

    .  Business worlds, such as Siemens medical training world. We are
       creating this world for Siemens to provide interactive on-line
       training to medical personnel.

    .  Game worlds, such as awbingo, which we developed to use artificial
       intelligence capabilities for games such as bingo.

    .  Chat worlds, such as the three-dimensional chat world we developed
       for Juno Online Services Inc.

  Our Objective

  Our goals are to be the leader in three-dimensional Internet environments
  and interactive communication and to position our software platform as a
  standard for the delivery of three-dimensional content over the Internet.
  In furtherance of these goals, we have chosen to offer our three-
  dimensional browser to users free of charge to promote the use of our
  software platform. More than 1.5 million users have downloaded and
  installed our browser and used it to access the Active Worlds worlds.

  Our objective is to be the industry leader in three-dimensional Internet
  technology platforms by:

    .  Enhancing and further developing the Active Worlds software and
       technology.

    .  Providing services to three-dimensional Internet virtual
       environments.

    .  Licensing our technology to businesses who may want to develop one
       or more unique worlds as part of their e-commerce strategy, which
       may be used either for their internal use or for visits by the
       general public.

    . Affording advertisers the ability to offer three-dimensional Internet
      interactive advertising.

    . Developing three-dimensional e-commerce solutions for businesses
      seeking to sell goods and services throughout the Internet.

    . Offering users a community in which they can create virtual
      structures, move about and communicate with other users.

  Our Strategy

  We believe that by continually enhancing our technology, developing and
  promoting new applications for the three-dimensional Internet market and
  partnering with and developing content for high-traffic Web sites, we will
  be able to achieve our goals. We believe that three-dimensional Internet
  applications provide enhanced richness that will be of interest to users
  developing Internet-based distance learning, training, entertainment, e-
  commerce, leisure time and chat applications and other on-line activities.
  As three-dimensional Internet technology becomes more accepted, we believe
  that a market will develop for our technology in these areas.

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  We intend to seek to meet our objective by:

  Licensing our technology to businesses

  As three-dimensional Internet technology becomes more accepted, we intend
  to market licenses to our uniserver and galaxerver software and our
  technical services to businesses. In order to achieve this goal, we intend
  to expand substantially our marketing effort directed at these businesses.
  As part of this marketing effort, we will seek to develop strategic
  relationships with businesses to develop commercial applications aimed at
  specific market segments.

  These relationships could take a number of forms and may involve the grant
  of an exclusive or semi-exclusive license for a specific market or
  application. These relationships may also involve a revenue-sharing
  arrangement and may provide us with additional development revenue.

  As part of this strategy, we have expanded our educational programs to
  include a new uniserver dedicated to education. We are designing this
  universe, which we call Education Universe, to enable schools, universities
  and non-profit educational groups to explore the potential of learning
  through three-dimensional worlds based on our technology. We intend to
  expose potential business licensees and individuals who have an ability to
  promote the use of our technology, such as course instructors, in this
  manner.

  Expanding our user base

  We intend to expand our user base by creating awareness of the
  Activeworlds.com name and products by promoting our Web site and technology
  through strategic partnerships and other traditional public relations
  channels. As part of this effort, we intend to create additional worlds and
  provide more content on the Web site. We believe that in order to generate
  revenue from citizenships in our worlds and licensing of our technology, we
  must increase the number of users who visit our Web site and choose to
  become citizens or create worlds of their own. More than 1.5 million users
  have downloaded and used our browser to access our worlds. We do not
  believe that this number is sufficiently large to sustain our growth.
  Accordingly, we believe that increasing our user base is critical to our
  ability to generate revenue from citizenships in our worlds, licensing of
  our technology and developing content for others.

  Marketing our Technology for e-commerce and advertising

  We intend to make our worlds attractive locations for both advertising and
  e-commerce. We are developing a virtual mall for 3DGlobal where store
  owners can have their own virtual stores. We will receive 1% of gross sales
  generated from this virtual mall as payment for the administration and
  operation of the virtual mall on our servers. The mall will also contain
  space for companies to place paid advertisement.

  We believe that we can make our worlds more attractive for e-commerce and
  advertising applications by:

    . Increasing our user base to show sufficient interest in our worlds.

    . Demonstrating the benefits which three-dimensional technology can
      offer both advertisers and businesses, both in terms of visual
      effects and technological features.

    . Implementing an extensive public relations effort with various news
      agencies.

  Our Technology

  The key element to our three-dimensional environment is our proprietary
  uniserver software which stores subscriber information, permits world
  servers to operate and enables:

    . the creation of three-dimensional worlds;

    . the communication of physical characteristics of three-dimensional
      objects in each world, so that a visitor to any world served by the
      uniserver can see the structures in the world, move about in the
      world and create new structures;

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    . the ability to locate structures and other users throughout the
      world,

    . the transmission of messages among users to the world, and

    . the transfer of information and files between any place on the
      Internet and a specific location on a world.

  The uniserver can operate on Unix, Linux or Windows 95, 98, NT, 2000 and
  Millennium platforms. Our galaxerver is similar to the uniserver except
  that unlike the uniserver, which supports a large number of worlds, the
  galaxerver only supports one world.

  We developed our proprietary three-dimensional browser, Active Worlds
  Browser (version 2.2 and version 3.1), which can be downloaded without
  charge. Users cannot access our three-dimensional environment without the
  browser. The browser software is based on a Windows platform and allows
  users to:

    . experience shared multi-user, multimedia and three-dimensional
      environments in any of the worlds which are publicly accessible in
      our universe.

    . develop and build virtual structures in our worlds.

    . access and display picture, sound or music files from anywhere on the
      Internet.

    . converse with other users by text-based chat, which can be directed
      to everyone who is currently visiting the world or conducted through
      private conversations through messaging to a specific user.

    . interface and integrate with two-dimensional Internet browsers, by
      permitting the three-dimensional window for Active Worlds to run side
      by side with a two-dimensional web page, which enables users to use
      all Internet-based technologies, including ActiveX and Java.

    . move between worlds in our universe and Web sites outside our
      universe.

    . automatically update our software.

    . register for citizen status.

  Our platform offers true color graphics, with 16 million colors, frame
  rates which could be in the range of ten to thirty frames a second and 16
  bit sound which supports MP3, Wav and Midi files. Using the browser, a
  visitor can see and interact with other visitors and the virtual
  environment. Our platform can accommodate thousands of simultaneous users.

  Using our software, servers and authoring tools, users can communicate,
  play games, conduct business and otherwise interact "face-to-face" in our
  shared three-dimensional worlds on the Internet.

  Marketing and Sales

  Since Active Worlds is an Internet-based platform, the potential market for
  our products is global. Our present marketing efforts are directed at:

    . Businesses and educational institutions, to which we are seeking to
      license our technology and assist them to develop three-dimensional
      applications to meet their specific needs.

    . Users, who we are trying to attract to our Web site by providing
      interesting content and access to our technology.

    . Advertisers, to whom we are trying to demonstrate a user base which
      meets their demographic requirements.

    . Educational and non-profit institutions through our Education
      Universe.

  In seeking to address the needs of businesses and educational institutions,
  we license our uniserver and galaxerver technology to others to allow our
  licensees to establish their own three-dimensional universe, which can be
  either on our uniserver or independent of our uniserver.

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  We have licensed our software products to such well-known companies as
  Boeing, Centropolis Studios (a division of Columbia Pictures), Siemens
  Electromedical Group, Kodak, Philips Multimedia, United States Government
  agencies (including NASA) and the Canadian Ministry of Education.
  Additionally, Cornell University, The University of Santa Cruz, The
  University of London, and Nagoya University (Japan) are using our software.
  Our software has received reviews, awards and coverage from numerous
  sources, including Bloomberg TV, CNET, Der Spiegel magazine, Industry
  Standard magazine, Softseek, Tucows, Yahoo Internet Life magazine, ZDNet,
  PC Magazine, PC Games, Computer Graphics World and The New York Times.

  The Tech Museum in San Jose, California continues to maintain its Internet
  Cafe project (started in 1998) focusing on the Active Worlds platform. The
  museum dedicated a whole section comprised of twelve computers to showcase
  Active Worlds as a computer technology advance.

  In October 1999, we entered into an agreement with 3DGlobal (formerly
  Advanced Shopping Centre Management Pty. Limited), an Australian company,
  pursuant to which we agreed to develop for it a virtual mall prototype
  which is suitable for applications for property developers, managers of
  retail shopping malls and retail merchants. The agreement contemplates the
  development of enhancements to our present software products and the grant
  to 3DGlobal of a four-year exclusive license to these enhancements. For
  developing the enhancements we will receive fees of between $1.0 million
  and $1.5 million, payable in installments, based on a delivery schedule and
  acceptance testing. In 2000, we received $225,000 in payments under this
  agreement.

  We distribute a monthly newsletter, which we deliver by e-mail. This
  newsletter describes developments in our program.

  We presently rely on third party marketing and advertising agencies to
  market our Web site and our other services both domestically and
  internationally. We use third parties to market our software and related
  products in the United Kingdom, Scandinavia, Spain, Germany, France, Korea,
  Brazil, Taiwan, Russia and China. Our international distributors have
  developed foreign language versions of our browser and have performed
  limited marketing activities. Our revenue from software sold through these
  distributors has not been significant.

  We have a content development agreement with Juno Online Services Inc. for
  the creation of a three-dimensional chat room. We are also currently
  developing content for Siemens Electromedical Group for the training of
  medical personnel.

  Our universe of worlds also includes @mart, a virtual shopping mall. (@mart
  is not related to the virtual shopping mall that we are in the process of
  developing for 3DGlobal.) To date, @mart has not generated significant
  revenues or traffic.

  Competition

  All aspects of the Internet market are relatively new, continually evolving
  and intensely competitive, and we expect competition to intensify in the
  future. Barriers to entry are low, and current and new competitors can
  easily launch new Web sites at a relatively low cost using commercially-
  available software. Our present competitors include nationally-known
  companies that have expertise in computer and Internet technology, and a
  number of other small companies, including those that serve specialty
  markets. Other major companies have the financial and technical ability to
  compete aggressively in the market for three-dimensional software products
  on the Internet. Many, if not all, of these companies have longer operating
  histories, larger customer bases, greater brand recognition in other
  business and Internet markets and significantly greater financial,
  marketing, technical and other resources than we have. Competitive
  pressures created by any one of these companies, or by our competitors
  collectively, could have a material adverse effect on our business, results
  of operations and financial condition, and we can give no assurance that we
  will be able to compete successfully against current and future
  competitors.

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  In addition, other major software developers have the capability both to
  develop three-dimensional software products, to market their products
  through strong distribution channels and to package their software with
  other popular products. To the extent that a significant market develops
  for three-dimensional software, we anticipate that major software, computer
  and Internet companies will develop competitive products. All of these
  companies are better known than we are, and they have significantly greater
  resources. In addition, competitive products may be under development by
  major software, computer and Internet companies of which we are unaware.

  We believe that the market for three-dimensional interactive Internet
  technologies is growing due to an increasing demand for interpersonal
  interaction among Internet users, along with an exploding interest in
  Internet-based applications generally. We also believe that the three-
  dimensional aspects of our environment is a departure from most Internet
  applications, which are two-dimensional and is a more aesthetically
  pleasing manner of using the Internet. We believe that Active Worlds'
  robust architecture, ease of use, speed, reliability and scalability have
  attracted and will continue to attract users worldwide.

  Companies which are developing three-dimensional Internet technology
  include Microsoft, Blaxxun (formerly Black Sun Interactive), Macromedia,
  Inc., Worlds, Inc. and Adobe Systems Inc.

  Since the three-dimensional market is an emerging market, it is possible
  that business may standardize on a technology which is not compatible with
  our technology, and major software and hardware companies may have the
  market power to impose on the marketplace an incompatible technology, and
  we may not have access to that technology. If we cannot offer products that
  meet this standard, whether imposed by a government agency or resulting
  from commercial preferences, our business will suffer.

  We believe that, at present, we have a competitive advantage over our
  competition in four fundamental areas:

    . We use World Wide Web standards for the three-dimensional components
      that make up our technology, and our technology permits the
      integration of standard Internet protocols.

    . We believe that our browser has smarter architecture and a more
      robust engine than our competitors. The software is only a 1 megabyte
      download and upgrades itself automatically upon entrance into the
      environment, making the download and upgrade process efficient and
      easy.

    . Users can integrate a two-dimensional browser within our browser to
      provide a simultaneous two-dimensional and three-dimensional Internet
      experience.

    . Each environment is unique and multimedia enriched, offering the user
      an almost unlimited combination of audio, video and graphical content
      options.

  Significant Customers

  During each of 2000, 1999 and 1998, only one client accounted for 5% or
  more of our revenue. In 2000, revenue from 3DGlobal for virtual mall
  development amounted to $809,000 for the development and construction for
  them of a virtual shopping mall which amounted to approximately 50.0% of
  our revenue for that year. During 1999, our largest customer was Fandom,
  Inc.com, which contracted with us for the development and construction of
  several worlds for them which resulted in revenues of $60,000 or
  approximately 10% of our revenue for that year. During 1998, our largest
  customer was The Tech Museum in San Jose, which purchased a special browser
  for $48,000, or 8.3% of revenue.

  Intellectual Property

  All of our software was either developed by us or acquired from a third
  party. We do not have any patents on any of our software. We have obtained
  copyright registration for a version of our source code. We are developing
  and upgrading our software on an ongoing basis and we do not have
  registered copyrights for the most recent versions of our software. We rely
  upon confidentiality agreements signed by our employees.

                                       9
<PAGE>

  We have registered Active Worlds and our AW design as trademarks and
  service marks under applicable federal trademark law. We have also applied
  to the United States Patent and Trademark Office for registration as a
  trademark and service mark of Activeworlds. It is our policy to vigorously
  oppose any infringement of our marks. See "Legal Proceedings".

  Government Regulations

  We believe that no government approval is necessary for our principal
  products or services and that there are no government regulations which
  currently have a material effect on our operations. As Internet commerce
  evolves, we expect that federal and state agencies may adopt legislation
  and regulations covering issues such as user privacy, pricing, defamation,
  taxation, content and quality of products and services and courts may
  interpret existing laws and regulations in a manner which affects the
  Internet and e-commerce. Although many of these regulations may not apply
  to our business directly, we expect the future legislation and regulation
  could expose companies involved in e-commerce and the sale of advertising
  over the Internet to liability which could limit the growth of Internet
  commerce generally. We could face exposure to liability resulting from
  allegations of defamation, breach of privacy or inappropriate usage of e-
  mail by visitors to our Web site. In addition, regulations which increase
  the cost of Internet access may have an effect on the use of the Internet.

  Research and Development

  We spent approximately $354,000 on research and development in 2000, and
  approximately $381,000 and $190,000 in 1999 and 1998, respectively. The
  balance of our research and development expenditures has been used to
  develop and enhance our technology. All of our research and development has
  been sponsored and paid for by us and was expensed as incurred.

  Employees

  As of March 1, 2001, we had 15 full-time employees who were engaged as
  follows: 2 in management, 5 in programming and content development; 3 in
  sales and marketing; 1 in customer service; 2 in technical support; and 2
  in administration. In addition, we have engaged 3 full-time and 3 part-time
  independent contractors to assist us in programming and content
  development, customer service and sales and marketing.

  Future Acquisition Strategies

  We may acquire other companies either for cash, notes, equity or
  combination. In addition, we may enter into joint ventures or other
  relationships, including joint marketing agreements, which we believe would
  further our growth. Although we anticipate that any acquisitions will be
  related to three-dimensional Internet technology, we may acquire companies
  in unrelated businesses. We may not generate net income from any future
  acquisition or agreement. We have not identified any particular business
  that we may acquire in the future, and we may not be able to make any
  acquisitions.

  Prior Business of Vanguard Enterprises, Inc.

  We were incorporated and conducted our initial public offering under the
  name Vanguard Enterprises, Inc. Vanguard Enterprises was incorporated on
  September 5, 1995. Vanguard Enterprises was formed for the purpose of
  marketing a patented hair care product produced by a hair products company,
  21st Century Hair Design, Inc. Vanguard Enterprises entered into one
  contract with 21st Century Hair Design. Based upon this contract, Vanguard
  Enterprises raised capital and used the funds to purchase cable TV airtime
  to broadcast infomercials featuring the product. Vanguard discontinued all
  business activities in 1996. From that time until January 1999, Vanguard
  Enterprises was not engaged in any business activities and had no material
  assets.

                                      10
<PAGE>

Item 2. Description of Property

  We lease approximately 4,500 square feet of office space at 95 Parker
  Street, Newburyport, Massachusetts 01950, pursuant to a lease which expires
  on February 28, 2002. Our present monthly rent is $2,625, which is subject
  to standard escalation provisions. Our office facilities are adequate for
  our meet our current needs, and we believe that, if additional space is
  required, we will be able to obtain it on reasonable terms.

Item 3. Legal Proceedings

  World Intellectual Property Organization Filing. On February 15, 2001 we
  filed a Complaint with the World Intellectual Property Organization
  ("WIPO") regarding a domain name dispute with Carnatic Trade Links Pvt. Ltd
  (the "Respondent"). The dispute centers upon the domain name
  "activeworld.com," which the Respondent has registered. The basis for the
  Complaint is that the Respondent's domain name is identical or confusingly
  similar to our trademarks and service marks, that the Respondent has no
  rights or legitimate interest in the domain name, and the that domain name
  was registered and is being used in bad faith by the Respondent.

  Upon review, the WIPO may transfer the disputed domain name to us, order
  that the disputed domain name not be used by either party, or allow the
  Respondent to continue using the disputed domain name. If an unfavorable
  outcome is received by either party, an action in a court of competent
  jurisdiction can be commenced. We plan to vigorously challenge the use of
  the domain name "activeworld.com" by the Respondent.

Item 4. Submission of Matters to a Vote of Security Holders

  None.

                                    PART II

Item 5. Market for Common Equity and Related Stockholder Matters

  Common Stock

  Our common stock has been traded on the Nasdaq SmallCap Market ("Nasdaq")
  and on the Boston Stock Exchange since May 2, 2000 under the symbol "AWLD."
  From January 22, 1999 to May 1, 2000, our common stock was traded on the
  Over-the-Counter Bulletin Board ("OTCBB") under the symbol AWDDE. From
  January 13, 1996 until January 21, 1999, our common stock was included in
  the OTCBB under the symbol VANG. During that period, our business was the
  same as the business of Vanguard Enterprises. The National Quotation
  Bureau, Inc. advised us that there was no trading in the common stock
  during the period from January 1, 1997 until January 14, 1999. The
  following table sets forth the high and low closing prices on the Nasdaq
  SmallCap Market and the OTCBB, as applicable, for the periods indicated.

<TABLE>
<CAPTION>
                                                              Common Stock
                                                              ---------------
     Period                                                    High      Low
     ------                                                   ------    -----
     <S>                                                      <C>       <C>
     First Quarter (January 15-January 21)................... $ 6.00    $0.75
     First Quarter (from January 22)......................... $13.875   $6.00
     Second Quarter.......................................... $12.5625  $6.9375
     Third Quarter........................................... $ 8.71875 $4.6875
     Fourth Quarter.......................................... $ 6.375   $6.00
     First Quarter........................................... $ 6.375   $4.875
     Second Quarter.......................................... $ 4.50    $1.875
     Third Quarter........................................... $ 1.875   $1.125
     Fourth Quarter.......................................... $ 1.4375  $ .50
</TABLE>

                                      11
<PAGE>

  On March 1, 2001, the prices of the common stock as reported by the Pink
  Sheets were $.50 closing bid and $.6875 closing ask. On such date there
  were approximately 61 holders of record of our common stock. The number of
  stockholders of record does not take into account stockholders for whom
  shares are being held in the name of brokerage firms or clearing agencies.

  Dividends

  We are unlikely to pay dividends on our common stock in the foreseeable
  future. We have not paid any dividends on our common stock since our
  inception and we do not anticipate paying any dividends in the foreseeable
  future. We plan to retain earnings, if any, to finance the development and
  expansion of our business.

  Recent Sales of Unregistered Securities

  Set forth below in chronological order is information regarding shares of
  common stock issued and options and warrants and other convertible
  securities granted by the Company during the year ended December 31, 2000.
  Also included is the consideration, if any, received by the Company for
  such shares and options and information relating to the section of the
  Securities Act of 1933, or rule of the Securities and Exchange Commission
  under which exemption from registration was claimed.

  (1) From January, 2000 to December, 2000, the Company pursuant to its 1999
      Stock Incentive Plan, issued options to purchase 177,000 shares of
      common stock to its key employees, with exercise prices ranging from
      $1.1875 to $1.3125 per share. These issuances were made in reliance on
      Section 4(2) of the Securities Act of 1933 and/or Rule 701 promulgated
      under the Securities Act of 1933 and were made without general
      solicitation or advertising. The purchasers were sophisticated
      investors with access to all relevant information necessary to evaluate
      these investments, and who represented to the Company that the shares
      were being acquired for investment.

  (2) In December, 2000 the Company issued an option to purchase an aggregate
      of 120,000 shares of common stock to Alvin M. Silver, a director of the
      Company. The exercise price for the option is $1.00 per share. The
      issuance was made in reliance on Section 4(2) of the Securities Act of
      1933 and/or Regulation D promulgated under the Securities Act of 1933
      and was made without general solicitation or advertising. The purchaser
      was a sophisticated investor with access to all relevant information
      necessary to evaluate this investment, and who represented to the
      Company that the shares were being acquired for investment.

  (3) In May, 2000 the Company issued an option to purchase an aggregate of
      46,000 shares of common stock to Alexander M. Adelson, a director of
      the Company. The exercise price for the option is $3.125 per share. The
      issuance was made in reliance on Section 4(2) of the Securities Act of
      1933 and/or Regulation D promulgated under the Securities Act of 1933
      and was made without general solicitation or advertising. The purchaser
      was a sophisticated investor with access to all relevant information
      necessary to evaluate this investment, and who represented to the
      Company that the shares were being acquired for investment.

  (4) In August, 2000 the Company issued a warrant to purchase an aggregate
      of 300,000 shares of common stock to Baytree Capital Associates LLC, a
      consultant of the Company, for management consulting services. The
      exercise price for the warrant is $1.1875 per share. The issuance was
      made in reliance on Section 4(2) of the Securities Act of 1933 and/or
      Regulation D promulgated under the Securities Act of 1933 and was made
      without general solicitation or advertising. The purchaser was a
      sophisticated investor with access to all relevant information
      necessary to evaluate this investment, and who represented to the
      Company that the shares were being acquired for investment.

  (5) In September, 2000 the Company issued a warrant to purchase an
      aggregate of 25,000 shares of common stock to Rubinstein Investor
      Relations, Inc., a consultant of the Company, for public relations

                                      12
<PAGE>

     services. The exercise price for the warrant is $1.40 per share. The
     issuance was made in reliance on Section 4(2) of the Securities Act of
     1933 and/or Regulation D promulgated under the Securities Act of 1933
     and was made without general solicitation or advertising. The purchaser
     was a sophisticated investor with access to all relevant information
     necessary to evaluate this investment, and who represented to the
     Company that the shares were being acquired for investment.

Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations

  The Notes to the Financial Statements and "Management's Discussion and
  Analysis of Financial Condition and Results of Operations" set forth herein
  contain forward-looking statements with respect to us and our operations
  that are subject to certain risks and factors which could cause our future
  actual results of operations and future financial condition to differ
  materially from that described herein. The amount of revenue recognized
  during the periods discussed below is not necessarily indicative of
  revenues to be recognized in future periods. These risk factors include,
  but are not limited to, our potential inability to realize the business
  plan, the intensity of competition from other companies which focus on
  enabling innovations for the Internet and business-to-business e-commerce,
  the status of our liquidity in future fiscal periods, factors that affect
  the Internet technology and on-line commerce industries such as network
  performance, reliability, speed of access, ease of use and bandwidth
  availability, and factors that generally affect Internet commerce, such as
  economic, political, regulatory, technological, and public taste
  environments, as well as the factors discussed below in "Risk Factors that
  May Affect our Results of Operations and Financial Condition."

  You should read the following discussion of our operating results in
  conjunction with the audited financial statements and notes thereto
  appearing elsewhere in this Annual Report on Form 10-KSB.

  Results of Operations

  Fiscal Year 2000 Compared with Fiscal Year 1999

  Our principal source of revenue to date has been from the license of our
  uniservers and galaxervers and from the development of worlds for our
  customers. We also generate revenue from the annual $19.95 registration
  fee, which is paid by our users who become citizens, and from technical
  support services which we offer to our licensees. Revenue from advertising
  has been nominal. We recognize revenue from licenses at such time as when
  the license has been granted and we have performed all of our obligations
  under the license agreement. We recognize revenue from membership fees
  ratably over the periods in which the memberships are in effect.

  Revenue for the year ended December 31, 2000 increased approximately 170%,
  to $1,616,000 from $599,000 in the year ended December 31, 1999. This
  increase resulted from an increase in licensing of our uniservers and
  galaxervers and content development. Fees for content development included
  payments from 3DGlobal for development of its virtual shopping mall. We
  have not experienced a significant increase in user fees.

  Our selling, general and administrative expenses in the year ended December
  31, 2000 increased approximately 18% to $1,519,000 from $1,288,000 in 1999.
  This increase resulted principally from expenses resulting from our status
  as a public company and payroll expenses. Our selling, general and
  administrative expenses for 2000 also included approximately $19,750 from
  the issuance of options and warrants as compensation for services.

  Research and development expenses in the year ended December 31, 2000
  decreased 7% to $354,000 from $381,000 in 1999. This decrease reflected a
  nominal reduction in the level of research and development conducted during
  the fiscal year.

  Interest income of $153,000 in 2000 resulted from the investment of
  proceeds of our May 2000 public offering. These amounts are invested in
  money market funds. We have a net operating loss carry forward in

                                      13
<PAGE>

  the amount of $1,888,000 as of December 31, 2000, which may be used to
  reduce our income taxes in the future if we recognize a profit. We cannot
  assure you we will make a profit.

  As a result of the foregoing, we sustained a net loss of $105,000, or $.013
  per share (basic and diluted), for the year ended December 31, 2000, as
  compared with a net loss of $1,046,000, or $.145 per share (basic and
  diluted), for 1999.

  Fiscal Year 1999 Compared with Fiscal Year 1998

  Year ended December 31, 1999 and 1998

  Revenue for the year ended December 31, 1999 increased approximately 4%, to
  $599,000 from $576,000 in the year ended December 31, 1998. This increase
  resulted from an increase in licensing of our uniservers and galaxervers.

  Our selling, general and administrative expenses in the year ended December
  31, 1999 increased approximately 182% to $1,288,000 from $456,000 in 1998.
  This increase resulted principally from approximately $550,000 of
  professional fees, consisting primarily of investor and public relations
  expenses and legal and accounting expenses we incurred in connection with
  the Circle of Fire Acquisition, as well as additional expenses resulting
  from our status as a public company. Our selling, general and
  administrative expenses for 1999 also included approximately $202,000 from
  the issuance of options and warrants as compensation for services. The
  increase in selling, general and administrative expenses also reflected an
  increase in executive compensation and increased payroll expenses generally
  as we increased our staff. Prior to 1999, we did not pay any compensation
  to Mr. J.P. McCormick, our chairman and chief financial officer, or Mr.
  Richard F. Noll, our president and chief executive officer. However, we
  accrued compensation to each of them at the annual rate of $50,000 in 1998.
  Since we had no obligation to pay this compensation, the amount of the
  compensation is treated as an increase to additional paid-in capital. Since
  January 1, 1999, we paid each of Messrs. McCormick and Noll a salary at the
  annual rate of $140,000.

  Research and development expenses in the year ended December 31, 1999
  increased 101% to $381,000 from $190,000 in 1998. This increase reflected
  an expansion of our research and development activities to enhance our
  technology and the development effort relating to our new browser, which we
  introduced in the spring of 1999.

  Interest income of $24,000 in 1999 resulted from the investment of proceeds
  of our January 1999 private placement. We have a net operating loss carry
  forward in the amount of $1,071,000 as of December 31, 1999, which may be
  used to reduce our income taxes in the future if we recognize a profit. We
  cannot assure you we will make a profit.

  As a result of the foregoing, we sustained a net loss of $1,046,000, or
  $.145 per share (basic and diluted), for the year ended December 31, 1999,
  as compared with a net income of $40,000, or $.007 per share (basic and
  diluted), for 1998.

  During 1997, we entered into an agreement with two former employee-
  stockholders settling claims asserted by those individuals against us.
  Pursuant to the settlement agreement, we agreed to pay the claimants
  $500,000, of which $385,000 was outstanding at December 31, 1998. The
  $500,000 settlement was expensed in 1997. The settlement involved a
  repurchase of shares of the two employee-stockholders and our grant to them
  of a security interest in certain of our technology. In 1998, we brought an
  action in the United States District Court for the District of
  Massachusetts seeking a declaratory judgment concerning the scope of the
  security interest, and the two employee-stockholders filed counterclaims.
  In one of these counterclaims, they alleged that we had committed
  securities fraud due to our failure to disclose an existing security
  interest in the technology when we repurchased their shares as part of the
  1997 settlement. In settlement of the litigation, the two former employee-
  stockholders accepted a reduction in the amount due to them and all claims
  between the parties were dismissed with prejudice. The reduction in the
  payments

                                      14
<PAGE>

  due by us in 1998 is reflected as an extraordinary gain from the
  extinguishment of debt relating the prior litigation settlement.

  As a result of the $110,000 extraordinary gain resulting from the
  extinguishment of debt related to the 1998 litigation settlement, our net
  income for 1998 was $40,000, or $.007 per share (basic and diluted).

  Financial Condition

  At December 31, 2000, we had working capital of $3,991,000, which included
  cash of $3,492,000. The working capital reflected the remaining cash from
  the May 2000 public offering, from which we received aggregate net proceeds
  of approximately $4.8 million. We used the balance of the net proceeds from
  the public offering for marketing, research and development and working
  capital. We have no credit facilities, and our revenues and the public
  offering have been our source of funds for operations. During the year
  ended December 31, 2000, we used $954,000 for our operations. Our cash
  balances represent 82.0% of our current assets.

  Our principal cash requirements are for working capital, principally to
  develop and implement an expanded marketing plan, research and development
  and for our administrative infrastructure. We believe that our current cash
  will be sufficient to meet our anticipated cash requirements for our
  operations until June, 2002. However, to the extent that our marketing
  program is not successful and these expenses exceed our expectations and we
  are unable to continue to generate cash flow from our operations, we may
  require additional funding during the next eighteen months. We may not be
  able to obtain financing when we require it, and any financing may not be
  on terms which are acceptable to us and may result in substantial dilution
  to our stockholders. If we are unable to raise needed funds, we may have to
  reduce the scope of our marketing and development activities, which would
  have a material adverse effect upon our business and financial condition.

  We may also acquire other businesses, including other companies or software
  or technology that would help us expand our business in the area of the
  three-dimensional Internet environments. However, we may also acquire
  companies or businesses in other industries if we are unable to develop our
  present business. To the extent that we make any acquisition, we may
  require additional funds to be used for the purchase price in the
  acquisitions, to integrate the acquired business with our existing business
  and to fund the operations of the combined businesses. In addition, we may
  incur expenses in connection with our negotiating acquisitions which are
  not consummated.

  Recent Accounting Pronouncements

  In December 1999, the Securities and Exchange Commission staff released
  Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition," to
  provide guidance on the recognition, presentation, and disclosure of
  revenue in financial statements. Changes in accounting to apply the
  guidance in SAB No. 101 may be accounted for as a change in accounting
  principle effective January 1, 2000. The adoption of SAB No. 101 did not
  have a material effect on the Company's revenue recognition and results of
  operations.

  In March 2000, the Financial Accounting Standards Board ("FASB") issued
  FASB Interpretation No. 44, "Accounting for Certain Transactions Involving
  Stock Compensation," (an Interpretation of Accounting Principles Bulletin
  Opinion No. 25 ("APB 25")) ("FIN 44"). FIN 44 provides guidance on the
  application of APB 25, particularly as it relates to options. The effective
  date of FIN 44 is July 1, 2000. The adoption of FIN 44 did not have a
  material effect on the Company's financial position or results from
  operations.

  Factors That May Affect Future Results

  Risks Related to Our Business

  We Have Incurred Operating Losses Since Our Organization and We May
  Continue to Incur Losses. We may never generate revenues sufficient to
  allow us to operate profitably. For the year ended December 31,

                                      15
<PAGE>

  2000, we had a net loss of $105,000, or $.013 per share (basic) on revenue
  of $1,616,000. During 2000, one long-term contract with a single customer
  accounted for approximately 50.0% of our revenues. We may experience a
  significant decrease in revenues unless we enter into additional material
  contracts with other customers.

  We May Not Be Successful in Marketing Our Technology for E-Commerce
  Applications. To operate profitably we need to license our technology for
  use as an integral component in e-commerce solutions for business,
  educational, training, entertainment, leisure-time and other commercial
  applications. We intend to do so through using strategic partnering and
  traditional media to promote the use of our technology. If our marketing
  efforts are unsuccessful, we will face difficult and costly choices in
  deciding whether and how to redirect these efforts. If we are unable to
  develop a successful licensing program, our business will be materially and
  adversely affected. Much of our business strategy relies upon our ability
  to sell our uniservers and galaxervers. To the extent that we are
  unsuccessful in our efforts to increase awareness of our technology and
  increase sales, we may fail to increase and may even suffer a decrease in
  our revenues.

  Our Failure to Develop Strategic Relationships Could Inhibit Our Ability to
  Grow. We believe that, in order to market our technology, we need to enter
  into strategic relationships with other businesses to develop commercial
  applications of our technology directed at specific businesses. We do not
  presently have any agreements relating to strategic relationships, we may
  never enter into such agreements, and our failure to develop such
  relationships could impair our ability to grow.

  Because We Are Seeking to Expand Our Business and Have Limited Management
  Personnel, We May Have Difficulty in Managing Our Growth. Our expenses,
  particularly personnel expenses incurred in connection with hiring and
  training new employees, have increased substantially. We expect these
  expenses to continue to increase as we implement our marketing and research
  and development programs. As a result, since our senior management is
  comprised only of our chief executive and financial officers, our
  personnel, management systems and resources are being strained, with no
  assurance that the implementation of our programs will result in increased
  revenue. To manage our growth, we must implement operational and financial
  systems and controls and recruit, train and manage new employees, including
  executive, middle management and technical personnel. We cannot be certain
  that we will be able to integrate new executives and other employees into
  our organization effectively. If we do not manage our growth effectively,
  our business, results of operations and financial condition could be
  materially and adversely affected.

  We May Have Difficulty Hiring Qualified Employees with Technical or Sales
  Experience. There is significant competition for qualified employees in the
  computer programming and Internet industries, and in the area of sales and
  we have experienced, and we expect to continue to experience, difficulty in
  hiring and retaining highly skilled employees with appropriate
  qualifications. We cannot be certain that we will be able to recruit and
  retain employees to meet our technical staffing or sales needs.

  We Are Dependent Upon Our Key Personnel. We are dependent upon the services
  of J.P. McCormick, our chief financial officer, Richard F. Noll, our
  president and Roland Vilett, our lead programmer. The loss of any of these
  persons' services would have a material adverse effect on our business and
  future prospects. Although Mr. McCormick, Mr. Noll and Mr. Vilett have
  entered into employment agreements with us, the existence of employment
  agreements does not guarantee their continued employment with us.

  We May Be Unable to Respond to the Rapid Technological Change in Our
  Industry. The computer and Internet industries are characterized by rapidly
  changing technologies, frequent new product and service introductions and
  evolving industry standards. Our future success will depend on our ability
  to adapt to rapidly changing technologies by continually improving the
  performance, features and reliability of our services, particularly with
  respect to other companies in the virtual reality area. If three-
  dimensional Internet standards evolve in a manner which is incompatible
  with our technology, we may not be able to effectively market our
  technology. Other software and hardware companies may have the market power
  to impose on the marketplace an incompatible technology, and we may not
  have access to that technology. Our failure to

                                      16
<PAGE>

  offer the most current or widely accepted technologies could have a
  material adverse effect upon our business.

  We May Make Acquisitions Without Informing Stockholders or Seeking Their
  Approval. We may make acquisitions of other businesses. Although we
  anticipate that any business we acquire will be related directly or
  indirectly to our present business, it is possible that we may make
  acquisitions in one or more unrelated businesses. Any acquisition may be
  made using our cash or a combination of cash and securities. At present, we
  are not engaged in formal or informal discussions with respect to any
  acquisition. However, if we make an acquisition, we may not seek
  stockholder approval or provide stockholders with any information
  concerning the acquisition prior to the execution of an acquisition
  agreement. Furthermore, we cannot assure you that any acquisitions which we
  may make will be profitable. If we make acquisitions, we could have
  difficulty integrating the acquired company's personnel and operations with
  our own. Negotiations relating to acquisitions could disrupt our business,
  distract our management and employees, increase our expenses and otherwise
  impair our operations and financial condition.

  We May Be Unable to Increase the Number of Our Citizens. Our business plan
  relies to a significant extent upon fee revenue paid by our registered
  citizens. To the extent our number of citizens does not increase or our
  existing citizens fail to renew their citizenships, we may suffer a
  decrease in revenue.

  Future Acquisitions Involve Risks for Us. We intend to evaluate future
  acquisitions of complementary product lines and businesses as part of our
  business strategy. Any future acquisitions may result in potentially
  dilutive issuances of equity securities, the use of our cash resources, the
  incurrence of additional debt and increased goodwill, intangible assets and
  amortization expense, which could negatively impact our profitability. In
  addition, acquisitions involve numerous risks, including difficulties in
  the assimilation of the operations and products of the acquired companies,
  the diversion of management's attention from other business concerns, risks
  of entering markets in which we have no or limited direct prior experience,
  and the potential loss of key employees of the acquired company.

  We Do Not Have Any Patent Protection for Our Software, and We May Not Be
  Able to Protect Our Intellectual Property Rights. Although we have
  registered a version of our source code with the United States Copyright
  Office, we have no patents on our software products, and we rely primarily
  on our nondisclosure agreements with our employees and others to whom we
  have provided technical proprietary information for protection of our
  software code. We also rely on licensed software products in our
  operations. However, the steps we have taken may not protect our
  intellectual property rights, and it is possible that third parties may
  infringe upon our proprietary rights.

  Risks Related to the Internet

  If Businesses Do Not Accept Three-Dimensional Internet Web Sites as a
  Medium for Advertising and E-Commerce, Our Ability to Generate Revenue May
  Be Limited. If we cannot demonstrate to both advertisers and businesses
  that our three-dimensional technology is viable and desirable as a medium
  for transacting business, our ability to generate revenue from both
  advertising and licensing of our technology will be limited.

  Our Systems May Fail or Experience a Slow Down and Our Users Depend Upon
  Others for Access to Our Web Site. Substantially all of our communications
  hardware and some of our other computer hardware operations are located at
  our headquarters in Newburyport, Massachusetts. We do not have a back-up
  computer system. Fire, floods, earthquakes, power loss, telecommunications
  failures, break-ins and similar events could damage these systems. Any of
  these occurrences could adversely affect our business. Our insurance
  policies may not adequately compensate us for any losses that may occur due
  to any failures or interruptions in our systems. Furthermore, if the
  response time of our Web site is slow for some reason, users could abandon
  our Web site and cease in using our products and services.

  If We Are Unable to Assure E-Commerce Vendors and Users that We Can Provide
  Adequate Security, Our Web Site May Not Be Accepted. Our Web site is
  vulnerable to physical or electronic break-ins, viruses or

                                      17
<PAGE>

  other problems that affect Web sites and Internet communication and
  commerce generally. As e-commerce becomes more prevalent, our customers may
  become more concerned about security. The circumvention of our security
  measures may result in the misappropriation of proprietary information,
  such as credit card information, or interruptions of our operations. Any
  such security breaches could damage our reputation and expose us to a risk
  of loss or liability.

  Portal Liability. A portion of our business acts as an Internet portal. The
  law relating to the liability of providers of listings of products and
  services sold over the Internet for errors, defects or other performance
  problems with respect to those products and services is currently
  unsettled. We do not pre-screen the types of products and services that may
  be purchased through our Web site. Some of these products and services
  could contain performance or other problems. We may not successfully avoid
  civil or criminal liability for problems related to the products and
  services sold through our Web Site. Any claims or litigation could still
  require expenditures in terms of management time and other resources to
  defend ourselves. Liability of this sort could require us to implement
  measures to reduce our exposure to this liability, which may require us,
  among other things, to expend substantial resources or to discontinue
  certain product or service offerings or to take precautions to ensure that
  certain products and services are not available through our Web Site.

  Government Regulation and Legal Uncertainties Could Add Additional Costs to
  Doing Business on the Internet. There are currently few laws or regulations
  that specifically regulate communications or commerce on the Internet.
  However, in the future, laws and regulations may be adopted and existing
  laws and regulations may be interpreted in a manner that address issues
  such as user privacy, pricing, defamation, taxation and the characteristics
  and quality of products and services which may have an adverse effect on
  the number of users of our technology.

  Our Growth and Operating Results Will Be Impaired if the Internet and On-
  Line Commerce Industries Do Not Continue to Grow. Our growth and operating
  results depend in part on widespread acceptance and use of the Internet as
  a point of convergence in the telecommunications, entertainment and
  technology industries, as well as on continued consumer and corporate
  acceptance of the Internet as a communications medium and for other forms
  of communication. These practices are at an early stage of development, and
  demand and market acceptance are uncertain. The Internet may not become a
  viable medium for telecommunications, entertainment and technology
  convergence or a healthy commercial marketplace due to inadequate
  development of network infrastructure and enabling technologies that
  address the public's concerns about:

    . network performance;

    . reliability;

    . speed of access;

    . ease of use; and

    . bandwidth availability.

  In addition, the Internet's overall viability could be adversely affected
  by increased government regulation. Changes in or insufficient availability
  of telecommunications or other services to support the Internet could also
  result in slower response times and adversely affect general usage of the
  Internet. Also, negative publicity and consumer concern about the security
  of transactions conducted on the Internet and the privacy of users may also
  inhibit the growth of commerce on the Internet.

  Risks Related to the Stock Market

  Our Common Stock Price Has Been and Is Likely to Be Highly Volatile. The
  market price of our common stock and warrants has been, and is likely to
  continue to be, highly volatile as the stock market in general, and the
  market for Internet-related and technology companies in particular, has
  been highly volatile. You

                                      18
<PAGE>

  may not be able to sell your shares of our common stock or our warrants
  following periods of volatility because of the market's adverse reaction to
  the volatility. In the past, following periods of volatility in the market
  price of a company's securities, securities class action litigation has
  often been instituted. Litigation could result in substantial costs and a
  diversion of management's attention and resources. We cannot assure you
  that our stock will trade at the same levels as other Internet stocks or
  that Internet stocks in general will sustain their current market prices.
  Factors that could cause volatility may include actual or anticipated
  fluctuations in our quarterly operating results, announcements of
  technological innovations, changes in financial estimates by securities
  analysts, conditions or trends in the Internet industry and changes in the
  market valuations of other Internet companies.

  We Are Unlikely to Pay Dividends on Our Common Stock in the Foreseeable
  Future. We have not paid any dividends on our common stock since our
  inception and we do not anticipate paying any dividends in the foreseeable
  future. We plan to retain earnings, if any, to finance the development and
  expansion of our business.

  We May Be Delisted from the NASDAQ SmallCap Market if We do Not Meet the
  Continued Listing Requirements. If we do not meet the minimum bid price
  requirement for The Nasdaq SmallCap Market, we may be delisted from The
  Nasdaq/SmallCap Market, in which case we anticipate that we would apply for
  our common stock to trade on the Over-the-Counter Bulletin Board. The
  minimum bid price requirement is no longer met in the event the closing bid
  price of our common stock remains below $1.00 for thirty consecutive
  trading days. In addition, in order to continue to be listed on Nasdaq, we
  must meet the following requirements:

    . net tangible assets of at least $2,000,000, or a market
      capitalization of $35,000,000 or $500,000 in net income for two of
      the last three years;

    . at least 500,000 shares in the public float;

    . a minimum market value for the public float of $1,000,000;

    . a minimum bid price of $1.00 per share;

    . 300 round lot (holders of 100 shares or more) stockholders;

    . two market makers; and

    . compliance with certain corporate governance standards.

  If we are delisted from The Nasdaq Small Capital Market, it may be more
  difficult to raise additional debt or equity financing and an investor
  likely would find it more difficult to sell or obtain quotations as to the
  price of our common stock and/or redeemable warrants.

  We May Issue Preferred Stock Without Approval of Our Stockholders Which
  Could Make it More Difficult for a Third-Party to Acquire Us and Depress
  Our Stock Price. We have the authority to issue preferred stock without a
  vote of our stockholders. In the future, our board of directors may issue
  one or more series of preferred stock that has more than one vote per share
  or which give the holders other preferential rights which may dilute or
  impair the rights of the holders of common stock. This could permit our
  board of directors to issue such stock to investors who support our
  management and give effective control of our business to our management.
  Furthermore, under some circumstances issuing preferred stock may violate
  the rules of the Nasdaq SmallCap Market, which could result in our common
  stock being delisted from that market. The delisting of our common stock
  from the Nasdaq SmallCap Market could result in both a drop in the stock
  price and decline in interest in our stock which could make it more
  difficult for you to sell your shares.

  We Are Controlled by Our Management Which Means that Management Can Prevent
  a Third Party from Acquiring Us Even if an Acquisition is in the Best
  Interest of Our Stockholders. Mr. Richard F. Noll, our president and chief
  executive officer, and Mr. J.P. McCormick, our chairman of the board and
  chief financial officer, together own approximately 60% of our outstanding
  common stock. As a result, they may be able

                                      19
<PAGE>

  to exercise control over all matters requiring stockholder approval,
  including the election of directors and approval of significant corporate
  transactions. Their voting control could have the effect of delaying or
  preventing a change of control which might benefit our stockholders.

Item 7. Financial Statements

  The Report of Independent Certified Public Accountants, Consolidated
  Financial Statements and Notes to the Consolidated Financial Statements
  appear in a separate section of this Form 10-KSB following Part III. The
  Index to Consolidated Financial Statements appears on page F-1.

Item 8. Changes in and Disagreements with Accountants on Accounting and
       Financial Disclosure

  None.

                                   PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons;
       Compliance with Section 16(a) of the Exchange Act

  The directors and executive officers of our company and their ages as of
  March 1, 2001, are as follows:

<TABLE>
<CAPTION>
   Name                     Age                     Position
   ----                     ---                     --------
   <S>                      <C> <C>
   Richard F. Noll.........  35 Chief Executive Officer, President and Director
   J.P. McCormick..........  40 Chairman of the Board of Directors, Chief
                                 Financial Officer, Treasurer, Secretary and
                                 Director
   Alexander M.
    Adelson(1).............  66 Director
   Sean Deson(1)...........  37 Director
   Alvin M. Silver(1)......  69 Director
</TABLE>

  (1) Member of the Audit and Compensation Committees.

  Richard F. Noll, our founder, has been president, chief executive officer
  and a director of us and our predecessor, Circle of Fire Studios since its
  organization in January 1997. From August 1995 until December 1996, Mr.
  Noll operated the business of Circle of Fire Studios, Inc. as a sole
  proprietorship. For more than five years prior to August 1995 he was an
  independent artist and designer. Mr. Noll attended Massachusetts College of
  Art and majored in the Fine Arts.

  J.P. McCormick has been chairman of the board, chief financial officer and
  a director of us and Circle of Fire Studios, Inc. since May 1997. He has
  been our treasurer since May, 1997 and our secretary since July, 1997. From
  1987 until May 1997 he was the president of Associated Corporate Services
  Ltd., a company which owned and operated two staffing franchises for
  Norrell Corp. Mr. McCormick is a graduate of Kent State University, Ohio.

  Alexander M. Adelson has been a director since November 1999. He has 36
  years of experience as an applied physicist and businessman specializing in
  technical marketing matters. Mr. Adelson is president, chief executive
  officer and vice chair of Antaeus Research, LLC, an information technology
  company dedicated to supplying software to the supply chain and B2B market
  with a primary focus on proprietary thin client architecture and advanced
  business e-components. Since 1974, he has led the Technology Resource Group
  of RTS Research Lab, Inc. Through RTS he helped conceive and develop the
  first portable bar code scanner. He also acted as program manager for
  twelve years with Symbol Technologies, Inc. Mr. Adelson also serves on and
  is the vice chairman of the board of directors of Base Ten Systems, Inc., a
  software technology development company focused on manufacturing execution
  and clinical supply systems and services for the pharmaceutical, chemicals
  and medical products industries.

                                      20
<PAGE>

  Sean Deson has been a director since December 1999. Mr. Deson recently
  became the managing partner of Deson & Co., a strategy development and
  investment firm focused on technology companies. Prior to that, Mr. Deson
  was a senior vice president in investment banking at Donaldson, Lufkin &
  Jenrette where he was a senior banker in its Internet focus group. Mr.
  Deson is also a director of Technology Flavors and Fragrances, Inc., a
  company which creates and manufactures flavors and fragrances for consumer
  products. Mr. Deson received his B.S. in computers and M.B.A. in finance,
  both from the University of Michigan.

  Dr. Alvin M. Silver has been a director since December, 2000. Since 1977,
  Dr. Silver has been executive vice president of the Ademco Division of
  Pittway Corporation. Dr. Silver holds a bachelors degree in industrial
  engineering from Columbia University, a Masters degree in industrial
  engineering from Stevens Institute of Technology and a doctor of
  engineering science degree in industrial engineering/operations research
  from Columbia University. Dr. Silver is a Professor at the Frank G. Zarb
  School of Business of Hofstra University.

  Directors are elected for a period of one year and thereafter serve until
  the next annual meeting at which their successors are duly elected by the
  stockholders. Officers serve at the will of the Board of Directors. Except
  as noted herein, there are currently no arrangements or understandings
  regarding the length of time each director is to serve in such a capacity.
  There is no immediate family relationship between or among any of the
  Directors or executive officers.

  We have granted the representatives of the underwriters the right, during
  the five-year period following the date of this prospectus, to designate
  one member to our board of directors or an advisor to the board. Dr. Silver
  is currently serving as such designee.

  Compliance with Section 16(a) of the Exchange Act

  Section 16(a) of the Securities Exchange Act of 1934 requires our directors
  and executive officers and persons who own more than ten percent of a
  registered class of our equity securities, to file with the Securities and
  Exchange Commission initial reports of ownership and reports of changes in
  ownership of common stock and other equity securities of our Company.
  Officers, directors and greater than ten percent stockholders are required
  by SEC regulations to furnish us with copies of Section 16(a) forms they
  file.

  To our knowledge, based solely on review of the copies of such reports
  furnished to us, the Company believes that, during the year ended December
  31, 2000, all of the Company's executive officers, directors and greater-
  than-ten percent stockholders complied with all Section 16(a) filing
  requirements other than one late report on Form 3 filed by each of J.P.
  McCormick, Richard F. Noll, Alexander M. Adelson, Sean Deson and Alvin M.
  Silver with respect to their first required disclosure upon becoming
  subject to the requirements of Section 16(a), and one late Form 4 filed by
  Mr. Adelson with respect to a grant of options that occurred in fiscal
  2000.

                                      21
<PAGE>

Item 10. Executive Compensation

Summary Compensation Table

  The following table sets forth information regarding compensation earned by
  our president and chief executive officer, our chief financial officer, and
  our lead programmer, from the fiscal year ending December 31, 1998 to the
  end of our last fiscal year. Except as set forth below, in 2000, 1999, and
  1998 none of our officers or any other employee received compensation in
  excess of $100,000:

<TABLE>
<CAPTION>
                                              Annual Compensation
                             ---------------------------------------------------------
                                                             Long Term
                                                            Compensation
                                                             Number of
                             Fiscal Year                     Securities
                                Ended                        Underlying    All Other
                             December 31  Salary  Bonus       Options     Compensation
                             ----------- -------- ------    ------------  ------------
   <S>                       <C>         <C>      <C>       <C>           <C>
   Richard F. Noll.........     2000     $140,000  - 0 -(3)     - 0 -        - 0 -
    Chief Executive Officer     1999     $140,000  - 0 -        9,333(2)     - 0 -
    and  President              1998(1)  $      0  - 0 -        - 0 -        - 0 -

   J.P. McCormick..........     2000     $140,000  - 0 -(3)     - 0 -        - 0 -
    Chairman of the Board       1999     $140,000  - 0 -        9,333(2)     - 0 -
    of Directors,  Chief        1998(1)  $      0  - 0 -        - 0 -        - 0 -
    Financial Officer,
    Treasurer  and
    Secretary

   Roland Vilett ..........     2000     $108,178 $1,000      150,000(5)     - 0 -
    Lead Programmer (4)         1999     $ 99,000 $2,000      156,667(6)     - 0 -
                                1998     $ 78,302  - 0 -       76,830(7)     - 0 -
</TABLE>
  --------
  (1) During 1998, neither Mr. Noll nor Mr. McCormick received any
      compensation from the Company. However, for financial statement
      purposes, we accrued compensation at the rate of $50,000 for each of
      them in 1998. Since we have no obligation to pay them the amount
      accrued, the amount of the compensation was treated as additional paid-
      in capital. Messrs. Noll and McCormick have relinquished their rights
      to collect this compensation at a later date.
  (2) In January 1999, we entered into three-year employment agreements with
      Messrs. Noll and McCormick, pursuant to which they received an annual
      salary of $57,000. These agreements were amended and restated in June
      1999, at which time their annual salaries were increased to $140,000,
      retroactive to January 21, 1999. Pursuant to the agreements, in January
      1999, we granted each of them an incentive stock option to purchase
      9,333 shares of common stock at $.83 per share, which was 110% of the
      fair market value of the common stock on the date of grant. The fair
      market value was the price at which we sold common stock to non-
      affiliated parties in the January 1999 private placement.
  (3) The employment agreements also provide that Messrs. Noll and McCormick
      will be eligible to participate in a bonus pool of not more than 10% of
      our income before income taxes in excess of $750,000. The amount of the
      bonus pool and the allocation of the bonus pool among our senior
      executive officers will be determined by our compensation committee.
      The employment agreements also provide Messrs. Noll and McCormick with
      a $4,200 annual automobile allowance.
  (4) In February 1999, we entered into a five year employment agreement with
      our lead programmer, Mr. Vilett, pursuant to which he receives a base
      salary of $100,000 with an annual increase of 10% of his salary.
  (5) We granted Mr. Vilett options to purchase 150,000 shares of our common
      stock at an exercise price of $1.3125 per share. These options were
      granted as qualified options under our 1999 long-term incentive plan
      and have a duration of the length of the plan.
  (6) We granted Mr. Vilett options to purchase 40,000 and 116,667 shares of
      our common stock at exercise prices per share of $.75 and $9.1875,
      respectively. These options were granted as qualified options under our
      1999 long-term incentive plan and have a duration of the length of the
      plan.
  (7) Mr. Vilett's 76,830 options granted in 1998 were originally granted in
      our predecessor (and now subsidiary) company, Circle of Fire Studios,
      and were converted into options to purchase shares of our common stock
      as part of our reorganization in January, 1999. These options have an
      exercise price pf $.645 per share.

                                      22
<PAGE>

  Option Grants to Executive Officers in Fiscal 2000

  No stock options or other equity incentives were granted to either Richard
  Noll or J.P. McCormick in 2000.

  Compensation of Directors

  We pay an annual fee of $15,000 to Mr. Adelson, $15,000 to Dr. Silver and
  $24,000 to Mr. Deson for each year of service as a director. In addition,
  in 1999 we granted Mr. Adelson options to purchase 100,000 shares of our
  common stock at $6.09 per share, and Mr. Deson options to purchase 146,667
  shares of our common stock at $6.09 per share. Mr. Adelson's options vest
  annually in equal amounts over five years, beginning on the date he became
  a director, provided that he is a director on the vesting dates. Mr.
  Deson's options vest annually over five years in the amount of 66,667
  options at the end of his first year of service as a director, followed by
  20,000 options at the end of each of years two, three, four and five for so
  long as he is a director. Neither Mr. Adelson's 100,000 nor Mr. Deson's
  146,667 options were granted pursuant to our 1999 long-term incentive plan.
  In May, 2000, we granted Mr. Adelson additional options to purchase 46,000
  shares of our common stock at $3.125 per share. These options were granted
  under our 1999 long-term incentive plan and vest annually in equal amounts
  over five years, provided that he is a director on the vesting dates. We
  have also granted Dr. Silver options to purchase 120,000 shares of our
  common stock at $1.00 per share. Dr. Silver's options were granted under
  our 1999 long-term incentive plan and vest in six equal amounts over five
  years, beginning on the date he became a director, provided that he is a
  director on the vesting dates.

  Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
                                    Values

  The following table sets forth, for each of the named executive officers,
  certain information regarding the exercise of stock options during fiscal
  2000, the number of shares of common stock underlying stock options held at
  fiscal year-end and the value of options held at fiscal year-end based upon
  the closing sales price of the common stock on the Nasdaq SmallCap Market
  on December 31, 2000 ($.50 per share).

<TABLE>
<CAPTION>
                                                   Number of Securities
                                                        Underlying           Value of Unexercised
                                                    Unexercised Options      In-the-Money Options
                              Shares               at December 31, 2000      at December 31, 2000
                             Acquired    Value   ------------------------- -------------------------
   Name                     on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
   ----                     ----------- -------- ----------- ------------- ----------- -------------
   <S>                      <C>         <C>      <C>         <C>           <C>         <C>
   Richard F. Noll.........    - 0 -     $- 0 -     1,866         7,467        $ 0          $ 0
   J.P. McCormick..........    - 0 -     $- 0 -     1,866         7,467        $ 0          $ 0
   Roland Vilett...........    - 0 -     $- 0 -    36,667       270,000        $ 0          $ 0
</TABLE>

Item 11. Security Ownership of Certain Beneficial Owners and Management

  The following table sets forth information as of March 1, 2001, relating to
  the ownership of our common stock by (i) each person known by us to be the
  beneficial owner of more than five percent of the outstanding shares of our
  common stock , (ii) each of our directors, (iii) each of the Named
  Executive Officers, and (iv) all of our executive officers and directors as
  a group. Except as may be indicated in the footnotes to the table and
  subject to applicable community property laws, each such person has the
  sole voting and investment power with respect to the shares owned.

<TABLE>
<CAPTION>
                                               Amount and Nature of   Percent
   Name and Address of Beneficial Owner(1)    Beneficial Ownership(2) of Class
   ---------------------------------------    ----------------------- --------
   <S>                                        <C>                     <C>
   Richard F. Noll(3)........................        2,527,899          29.7%
   J.P. McCormick(4).........................        2,495,079          29.3%
   Alexander M. Adelson(5)...................           43,333             *
   Sean Deson(6).............................           66,667             *
   Alvin M. Silver(7)........................           30,500             *
   Michael Gardner...........................          690,361           8.1%
   Directors and Executive Officers as a
    Group....................................        5,163,478          60.6%
</TABLE>
  --------
   * Less than 1%.
  (1) The address of each person named is 95 Parker Street, Newburyport, MA
      01950, except for Mr. Gardner, whose address is c/o Baytree Capital
      Associates, LLC, 40 Wall Street, 58th Floor, New York, NY 10005.

                                      23
<PAGE>

  (2) Beneficial ownership is determined in accordance with the rules of the
      Securities and Exchange Commission. Shares of common stock subject to
      options or warrants are deemed to be currently exercisable if they are
      convertible or exercisable within 60 days of the date as to which
      information is provided. Except as indicated in the footnotes to this
      table, the persons named in the table have sole voting and investment
      power with respect to all shares of common stock beneficially owned.
  (3) Shares beneficially owned by Mr. Noll include (a) 16,351 shares of
      common stock owned by Mr. Noll's wife, as to which Mr. Noll disclaims
      beneficial interest, and (b) 5,600 shares of common stock issuable upon
      exercise of outstanding options held by Mr. Noll.
  (4) Shares beneficially owned by Mr. McCormick includes 5,600 shares of
      common stock issuable upon exercise of outstanding options held by Mr.
      McCormick.
  (5) The shares beneficially owned by Mr. Adelson represent shares of common
      stock issuable upon exercise of options held by him.
  (6) The shares beneficially owned by Mr. Deson represent shares of common
      stock issuable upon exercise of options held by him.
  (7) Shares beneficially owned by Dr. Silver includes 20,000 shares of
      common stock issuable upon exercise of outstanding options held by Dr.
      Silver.

Item 12. Certain Relationships and Related Transactions

  Mr. Noll received cash advances from us in 1998. As of December 31, 2000,
  $10,491 of these amounts were owed by Mr. Noll to us.

  We believe that the transactions described above between us and our
  officers, directors and principal stockholders were on terms at least as
  fair to us as had these transactions been concluded with unaffiliated
  parties. Since Mr. McCormick and Mr. Noll were our only directors until
  November 1999, none of the foregoing transactions were approved by any
  unaffiliated outside directors. We will not offer preferred stock to our
  officers, directors or principal stockholders except upon the same terms as
  it is offered to all other existing stockholders or to new stockholders,
  unless the issuance is approved by the audit committee, who will have
  access, at our expense, to independent legal counsel. All future related
  party transactions, including any loans or advances, will be for bona fide
  business purposes and approved by a majority of our board which will
  include unaffiliated directors or by our audit committee who do not have an
  interest in the transactions and who will have access, at our expense, to
  independent legal counsel.

                                      24
<PAGE>

Item 13. Exhibits, List and Reports on Form 8-K

  (a) The following documents are included as part of this report:

<TABLE>
     <C>         <S>
      1.         Financial Statements. The financial statements filed as part
                 of this report are listed in the "Index to Financial
                 Statements" on page F-1 hereof.

      2.         Exhibits required to be filed by Item 601 of Regulation S-B:

     Exhibit No.                     Description of Exhibits
     -----------                     -----------------------

      2.         Plan of Reorganization between Vanguard Enterprises, Inc. and
                 Circle of Fire Studios, Inc. dated January 13, 1999.(1)

      3.1        Certificate of Incorporation of the Issuer as filed with the
                 Delaware Secretary of State on September 5, 1995. (1)

      3.2        Certificate of Amendment to Certificate of Incorporation of
                 the Issuer as filed with the Delaware Secretary of State on
                 September 29, 1995. (1)

      3.3        Certificate of Amendment to Certificate of Incorporation of
                 the Issuer as filed with the Delaware Secretary of State on
                 October 12, 1995. (1)

      3.4        Certificate for Renewal and Revival of Certificate of
                 Incorporation of the Issuer as filed with the Delaware
                 Secretary of State on September 10, 1997. (1)

      3.5        Certificate of Amendment to Certificate of Incorporation of
                 the Issuer as filed with the Delaware Secretary of State on
                 January 21, 1999. (1)

      3.5.1      Certificate of Amendment to Certificate of Incorporation as
                 filed with the Delaware Secretary of State on April 7, 2000.
                 (2)

      3.6        Bylaws of the Issuer. (1)

      3.6.1      Restated Bylaws of Issuer. (3)

      4.1        Form of Common Stock Certificate. (1)

      4.2        Form of Warrant Agreement, including form of Series B
                 Redeemable Common Stock Purchase Warrant. (4)

      4.3        Form of Series A Redeemable Common Stock Purchase Warrant. (1)

     10.1        Activeworlds.com, Inc. 1999 Long-term incentive plan. (1)*

     10.1.1      Activeworlds.com, Inc. Restated 1999 Long-term incentive plan.
                 (3)*

     10.1.2      Activeworlds.com, Inc. Restated 1999 Long-term incentive plan.
                 (5)*

     10.2        Lease Agreement dated February 27, 1999 between the Issuer and
                 Robert L. Wood. (1)

     10.3        Amended and Restated Employment Agreement, dated as of January
                 21, 1999, between the Issuer and Richard F. Noll. (1)*

     10.4        Amended and Restated Employment Agreement dated as of January
                 21, 1999, between the Issuer and J.P. McCormick (1)*

     10.5        Stock Option Agreement between the Issuer and Richard F. Noll.
                 (4)*

     10.6        Stock Option Agreement between the Issuer and J.P. McCormick.
                 (4)*

     10.7        Agreement dated October 1999, between the Issuer and 3DGlobal
                 (f/k/a Advanced Shopping Centre Management Pty. Limited). (4)

     10.8        Employment Agreement, dated February 12, 1999, between the
                 Issuer and Roland Vilett. (6)*

     21.         Subsidiaries of the Issuer. (6)

     23.         Consent of Pannell Kerr Forster PC. (6)

     24.         Power of Attorney (included on the Signature Page). (6)
</TABLE>

                                       25
<PAGE>

  --------
  (1) Incorporated by reference to similarly numbered exhibits in Issuer's
      registration statement on Form SB-2 filed with the Securities and
      Exchange Commission on August 13, 1999 under the Securities Act of
      1933, as amended (File No. 333-85095).
  (2) Incorporated by reference to similarly numbered exhibits in Issuer's
      Amendment No. 4 to Form SB-2 filed with the Securities and Exchange
      Commission on April 11, 2000 under the Securities Act of 1933, as
      amended (File No. 333-85095).
  (3) Incorporated by reference to similarly numbered exhibits in Issuer's
      Amendment No. 2 to Form SB-2 filed with the Securities and Exchange
      Commission on March 16, 2000 under the Securities Act of 1933, as
      amended (File No. 333-85095).
  (4) Incorporated by reference to similarly numbered exhibits in Issuer's
      Amendment No. 1 to Form SB-2 filed with the Securities and Exchange
      Commission on November 5, 1999 under the Securities Act of 1933, as
      amended (File No. 333-85095).
  (5) Incorporated by reference to Issuer's quarterly report on Form 10-QSB
      filed with the Securities and Exchange Commission on November 14, 2000
      under the Securities Act of 1934, as amended.
  (6) Included herewith.

  * Management contract or compensatory plan or arrangement.

  (b)  Reports on Form 8-K. No Current Reports on Form 8-K were filed by the
       Company during the quarter ended December 31, 2000.

                                      26
<PAGE>

                                   SIGNATURES

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

                                          Activeworlds.com, Inc.
                                          Dated: March 30, 2001

                                                  /s/ Richard F. Noll
                                          By: _________________________________
                                                      Richard F. Noll
                                               President and Chief Executive
                                                          Officer
<PAGE>

                               POWER OF ATTORNEY

  KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Richard F. Noll his attorneys-in-fact, each
with the power of substitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments to this Annual Report
on Form 10-KSB, and to file the same, with all exhibits thereto and all
documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that such attorneys-in-fact and agents or any of them, or his
or their substitute or substitutes, may lawfully do or cause to be done by
virtue hereof.

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

<TABLE>
<CAPTION>
                 Name                                Position                      Date
                 ----                                --------                      ----

<S>                                    <C>                                  <C>
       /s/ Richard F. Noll             President, Chief Executive             March 30, 2001
______________________________________  Officer, and Director
           Richard F. Noll

       /s/ J. P. McCormick             Chairman of the Board of Directors,    March 30, 2001
______________________________________  Chief Financial Officer, Treasurer,
           J. P. McCormick              Secretary and Director

     /s/ Alexander M. Adelson          Director                               March 30, 2001
______________________________________
         Alexander M. Adelson

          /s/ Sean Deson               Director                               March 30, 2001
______________________________________
              Sean Deson

         /s/ Alvin M. Silver           Director                               March 30, 2001
______________________________________
             Alvin M. Silver
</TABLE>
<PAGE>



                   Supplemental Information to be Furnished
              with Reports Filed Pursuant to Section 15(d) of the
                     Exchange Act by Non-Reporting Issuers

As of the date of filing of this Annual Report on Form 10-KSB, no annual
report or proxy material has been sent to security holders of the Company.
Proxy material is to be furnished to the Company's security holders subsequent
to the filing of this Annual Report on Form 10-KSB in connection with the
Company's annual meeting of stockholders.
<PAGE>


                             ACTIVEWORLDS.COM, INC.

                       Consolidated Financial Statements
      at December 31, 2000 and for years ended December 31, 2000 and 1999
<PAGE>

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                       Page
                                                                    -----------

<S>                                                                 <C>
Independent Auditors' Report.......................................     F-2

Consolidated Financial Statements

 Consolidated Balance Sheet--December 31, 2000.....................     F-3

 Consolidated Statement of Operations for Years Ended December 31,
  2000 and 1999....................................................     F-4

 Consolidated Statement of Changes in Stockholders' Equity
  (Deficiency) for Years Ended December 31, 2000 and 1999..........     F-5

 Consolidated Statement of Cash Flows for Years Ended December 31,
  2000 and 1999....................................................     F-6

 Notes to Consolidated Financial Statements........................ F-7 to F-17
</TABLE>

                                      F-1
<PAGE>

                         INDEPENDENT AUDITORS' REPORT

To the Stockholders
Activeworlds.com, Inc.

We have audited the accompanying consolidated balance sheet of
Activeworlds.com, Inc., as of December 31, 2000, and the related consolidated
statements of operations, changes in stockholders' equity (deficiency) and
cash flows for each of the two years in the period then ended. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Activeworlds.com, Inc. at December 31, 2000, and the consolidated results
of their operations and their consolidated cash flows for each of the two
years in the period then ended in conformity with accounting principles
generally accepted in the United States of America.

                        /s/ Pannell Kerr Forster, P.C.

Boston, MA
February 12, 2001

                                      F-2
<PAGE>

                             ACTIVEWORLDS.COM, INC.

                           Consolidated Balance Sheet
                               December 31, 2000

<TABLE>
<S>                                                                   <C>
Assets
Current assets
 Cash................................................................ $3,491,818
 Accounts receivable, trade--net of allowance for doubtful accounts
  of $5,000..........................................................    139,500
 Contracts in progress in excess of billings.........................    308,737
 Prepaid expenses....................................................     80,667
 Advances to officer/stockholder/employees...........................     11,551
 Prepaid marketing...................................................    223,450
                                                                      ----------
   Total current assets..............................................  4,255,723
                                                                      ----------
Property and equipment
 Leasehold improvements..............................................     27,334
 Equipment and fixtures..............................................    297,187
                                                                      ----------
                                                                         324,521
 Less: accumulated depreciation and amortization.....................     72,558
                                                                      ----------
   Property and equipment, net.......................................    251,963
                                                                      ----------
   Total assets...................................................... $4,507,686
                                                                      ----------
Liabilities and Stockholders' Equity
Current liabilities
 Current portion--capital lease...................................... $    9,900
 Accounts payable....................................................     52,382
 Accrued liabilities.................................................     66,705
 Deferred revenue....................................................    135,726
                                                                      ----------
   Total current liabilities.........................................    264,713
Capital lease, net of current portion................................      1,951
Commitments and contingencies........................................
                                                                      ----------
   Total liabilities.................................................    266,664
                                                                      ----------
Stockholders' equity
 Preferred stock, $.001 par value, 500,000 shares authorized, no
  shares issued or outstanding.......................................         --
 Common stock, $.001 par value, 50,000,000 shares authorized,
  8,515,235 shares issued and outstanding............................      8,515
 Additional paid-in capital..........................................  6,292,994
 Note receivable for shares issued...................................     (6,500)
 Treasury stock......................................................   (118,403)
 Accumulated deficit................................................. (1,935,584)
                                                                      ----------
   Total stockholders' equity........................................  4,241,022
                                                                      ----------
   Total liabilities and stockholders' equity........................ $4,507,686
                                                                      ==========
</TABLE>

                 See notes to consolidated financial statements

                                      F-3
<PAGE>

                             ACTIVEWORLDS.COM, INC.

                      Consolidated Statement of Operations

<TABLE>
<CAPTION>
                                                        Year Ended December 31
                                                        -----------------------
                                                           2000        1999
                                                        ----------  -----------
<S>                                                     <C>         <C>
Revenues..............................................  $1,615,882  $   598,993
                                                        ----------  -----------

Operating expenses
 Selling, general and administrative expenses.........   1,519,326    1,288,089
 Research and development expenses....................     354,499      381,193
                                                        ----------  -----------
 Total operating expenses.............................   1,873,825    1,669,282
                                                        ----------  -----------

 (Loss) from operations...............................    (257,943)  (1,070,289)
Interest income.......................................     152,847       24,470
                                                        ----------  -----------

 (Loss) before (provision for) benefit from income
  taxes...............................................    (105,096)  (1,045,819)
(Provision for) benefit from income taxes.............          --           --
                                                        ----------  -----------

 Net (loss)...........................................  $ (105,096) $(1,045,819)
                                                        ----------  -----------

Earnings (loss) per share of common stock
Basic.................................................  $    (.013) $     (.145)
                                                        ==========  ===========
</TABLE>



                 See notes to consolidated financial statements

                                      F-4
<PAGE>

                            ACTIVEWORLDS.COM, INC.

    Consolidated Statement of Changes in Stockholders' Equity (Deficiency)
                    Years Ended December 31, 2000 and 1999

<TABLE>
<CAPTION>
                            Preferred                                                 Note                   Total
                              Stock       Common Stock     Additional              Receivable            Stockholders'
                          ------------- -----------------   Paid-In   Accumulated  for Shares Treasury      Equity
                          Shares Amount  Shares    Amount   Capital     Deficit      Issued     Stock    (Deficiency)
                          ------ ------ ---------  ------  ---------- -----------  ---------- ---------  -------------
<S>                       <C>    <C>    <C>        <C>     <C>        <C>          <C>        <C>        <C>
Balances at January 1,
 1999...................    --    $     5,766,544  $5,766  $  391,457 $  (784,669)  $(6,500)  $     --    $ (393,946)
                          -----   ----  ---------  ------  ---------- -----------   -------   ---------   ----------
Private placements of
 common stock, net of
 issuance costs.........                1,438,933   1,439   1,511,538                                      1,512,977
Issuance of common stock
 for goods and
 services...............                  137,285     138     132,362                                        132,500
Issuance of stock
 options and warrants
 for services...........                                      202,062                                        202,062
Net (loss) for year.....                                               (1,045,819)                        (1,045,819)
                          -----   ----  ---------  ------  ---------- -----------   -------   ---------   ----------
Balances at December 31,
 1999...................    --          7,342,762   7,343   2,237,419  (1,830,488)   (6,500)        --       407,774
Issuance of common
 stock, net of issuance
 costs..................                1,260,000   1,260   4,035,825                                      4,037,085
Purchase of common
 stock..................                  (87,527)    (88)                                     (118,403)    (118,491)
Issuance of stock
 options and warrants
 for services...........                                       19,750                                         19,750
Net (loss) for year.....    --                                           (105,096)                          (105,096)
                          -----   ----  ---------  ------  ---------- -----------   -------   ---------   ----------
Balances at December 31,
 2000...................    --    $     8,515,235  $8,515  $6,292,994 $(1,935,584)  $(6,500)  $(118,403)  $4,241,022
                          =====   ====  =========  ======  ========== ===========   =======   =========   ==========
</TABLE>


                See notes to consolidated financial statements

                                      F-5
<PAGE>

                             ACTIVEWORLDS.COM, INC.

                      Consolidated Statement of Cash Flows

<TABLE>
<CAPTION>
                                                        Year Ended December 31
                                                        -----------------------
                                                           2000        1999
                                                        ----------  -----------
<S>                                                     <C>         <C>
Operating activities
 Net (loss)............................................ $ (105,096) $(1,045,819)
 Adjustment to reconcile net (loss) to net cash (used)
  by operating activities
  Depreciation and amortization........................     37,083       29,429
  Change in estimate of allowance for doubtful
   accounts............................................    (15,000)         --
  Common stock issued for goods and services...........        --       132,500
  Options issued for compensation and services.........     13,500      202,062
  Services provided in lieu of payment on an account
   receivable..........................................        --         8,000
  Contracts in progress in excess of billings..........   (308,737)         --
  Changes in operating assets and liabilities which
   provided (used) cash
   Accounts receivable.................................   (101,981)      21,317
   Prepaid expenses....................................   (259,285)     (44,832)
   Advances to officer/stockholder/employees...........        940       (2,000)
   Accounts payable....................................   (111,440)     103,621
   Accrued liabilities.................................     34,630     (263,413)
   Deferred revenue....................................   (138,169)     129,555
   Customer deposit....................................        --        (5,000)
                                                        ----------  -----------
    Net cash (used) by operating activities............   (953,555)    (734,580)
                                                        ----------  -----------
Investing activities
Purchases of equipment and leasehold improvements......   (189,903)     (82,496)
                                                        ----------  -----------
    Net cash (used) by investing activities............   (189,903)     (82,496)
                                                        ----------  -----------
Financing activities
 Purchase of Treasury stock............................   (118,491)         --
 Payments on capital lease obligation..................     (9,575)      (7,661)
 Net proceeds from sale of stock.......................  4,281,934    1,512,977
 Payments on 8% note payable to officer/stockholder....        --       (54,753)
 Deferred offering costs...............................        --      (238,599)
                                                        ----------  -----------
    Net cash provided by financing activities..........  4,153,868    1,211,964
                                                        ----------  -----------
Net increase in cash...................................  3,010,410      394,888
Cash at beginning of year..............................    481,408       86,520
                                                        ----------  -----------
    Cash at end of year................................ $3,491,818  $   481,408
                                                        ----------  -----------
Supplemental disclosure information
 Cash paid for interest during the year................ $    1,014  $     1,708
                                                        ----------  -----------
 Cash paid for income taxes during the year............ $      --   $       --
                                                        ----------  -----------
Supplemental schedule of noncash investing activities
 Equipment purchased under capital lease............... $      --   $    29,088
                                                        ----------  -----------
 Shares issued for note receivable..................... $      --   $     6,500
                                                        ----------  -----------
 Value of stock options issued for services relating to
  offering costs....................................... $    6,250  $       --
                                                        ----------  -----------
 Deferred offering costs charged against paid-in-
  capital.............................................. $  238,599  $       --
                                                        ==========  ===========
</TABLE>

                 See notes to consolidated financial statements

                                      F-6
<PAGE>

                            ACTIVEWORLDS.COM, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1--Organization and basis of presentation

  On January 22, 1999, Vanguard Enterprises, Inc., a publicly traded Delaware
  corporation, acquired all of the issued and outstanding common stock of
  Circle of Fire Studios, Inc., a Nevada corporation ("Circle of Fire"), in
  exchange for 5,433,211 shares of its common stock (the "1999 Acquisition")
  pursuant to an Agreement and Plan of Reorganization with Circle of Fire. As
  part of the 1999 Acquisition, outstanding options to acquire common stock
  of Circle of Fire were exchanged for options to purchase 322,682 shares of
  the Company's common stock. (See note 7.) At the time of the 1999
  Acquisition, Vanguard had no significant operations. Simultaneous with the
  1999 acquisition, Vanguard Enterprises, Inc. changed its name to
  Activeworlds.com, Inc. (the "Company") and changed the name of its
  subsidiary from Circle of Fire Studios, Inc. to Activeworlds, Inc. ("Inc."
  ).

  Inc. was accounted for as the acquiring party and the surviving accounting
  entity because the former stockholders of Inc. received approximately 94%
  of the voting rights in the combined corporation. The shares issued by the
  Company pursuant to the 1999 Acquisition have been accounted for as if
  those shares had been issued upon the organization of Inc. The outstanding
  capital stock of the Company immediately prior to the 1999 Acquisition has
  been accounted for as shares issued by Inc. to acquire the net assets of
  the Company as of December 31, 1998.

  The 1999 Acquisition is being accounted for as if it had taken place on
  December 31, 1998. All intercompany accounts and transactions have been
  eliminated in consolidation. The consolidated financial statements are
  presented as those of Activeworlds.com, Inc.

  Immediately prior to the 1999 Acquisition, the Company effected a one-for-
  two reverse split in its outstanding common stock, with no change in the
  par value per share. In connection with the 1999 Acquisition, the Company
  also issued 133,333 shares of common stock to a financial advisor and sold
  1,333,333 shares of common stock at $.75 per share in private placement.

  All share and per share information in the consolidated financial
  statements reflect (a) the consummation of the 1999 Acquisition whereby
  shares and options issued by Inc. were exchanged for shares of the
  Company's common stock and options to purchase shares of the Company's
  common stock, (b) the one-for-two reverse split, and (c) the two-for-three
  reverse stock split which became effective on April 10, 2000.

  The outstanding Inc. common stock at the time of the 1999 Acquisition was
  held principally by officers.

Note 2--Summary of significant accounting policies

  A. Nature of operations

  The Company provides computer software products and on-line services that
  permit users to enter, move about and interact with others in computer-
  generated, three-dimensional virtual environment using the Internet.

  B. Accounting estimates

  The preparation of financial statements in conformity with accounting
  principles generally accepted in the United States of America 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 the financial statements and the reported
  amounts of revenues and expenses during the reporting period. Actual
  results could differ from those estimates.


                                      F-7
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  C. Financial instruments

  The estimated fair value of the Company's financial instruments, which
  include cash, accounts receivable, accounts payable and a capital lease
  obligation, approximates carrying value.

  D. Depreciation and amortization

  Equipment and fixtures are depreciated using accelerated methods and
  estimated lives of five years. Leasehold improvements are amortized over
  six years, the period of the lease. Depreciation and amortization expense
  of property and equipment totaled $37,083 and $25,488 for 2000 and 1999,
  respectively.

  Organization costs were being amortized over five years on a straight-line
  basis. In accordance with American Institute of Certified Public
  Accountants Statement of Position 98-5, Reporting on the Costs of Start-Up
  Activities, $3,941, the remaining balance as of January 1, 1999, was
  expensed in 1999. Because of the immaterial amount, it was included in
  selling, general and administrative expenses rather than being reported as
  the cumulative effect of a change in accounting principle.

  E. Marketing and public relations costs

  Marketing and public relations costs are expensed as incurred if it was
  determined that the benefit was received during the year. Marketing and
  public relations costs paid for services providing a benefit in the future
  are recorded as assets and amortized over the period benefited usually
  based on contract requirements. Marketing and public relations costs
  expensed in 2000 and 1999 were $87,241 and $75,733, respectively.

  F. Research and development of software

  Research and development costs are expensed as incurred.

  G. Revenues

  Memberships, licensing and royalties

  Membership revenue and revenue from licensing the Company's worlds are
  recognized ratably over the periods the memberships are in effect and the
  licensing periods for the worlds. Advances on royalties from licensing
  agreements are recognized over the period the royalties are earned. Revenue
  from licensing the Company's uniservers and galaxservers is recognized when
  the license is granted and the Company has performed all of its obligations
  under the license agreement.

  Services

  Revenue from technical services is recognized when the services are
  performed.

  Long-term contracts

  In 1999, the Company entered into a significant long-term contract (note
  14). Revenue from the contract was recognized as the phases were accepted
  by the customer. At December 31, 1999, the Company had not completed a
  phase under the contract and contract payments received were recognized as
  deferred revenue. In 2000, as the contract developed and more reliable
  estimates were available, the percentage of completion

                                      F-8
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  method of accounting was determined to be the preferable method of
  accounting for long-term contracts. Under the percentage of completion
  method of accounting, costs and estimated gross margins are recorded as
  revenue as work is performed based on the percentage that incurred costs
  bear to estimated total costs utilizing the most recent estimates of costs.
  Billings on the contracts are recorded as advance billings on the contract
  until the contract is substantially completed. As of December 31, 2000,
  costs and estimated gross margin on the contract in excess of advanced
  billings was $308,737.

  Management believes that the new method more accurately reflects periodic
  results of operations. The effect of this change in accounting principle on
  the 1999 financial statements was immaterial as the contract work commenced
  in the latter part of 1999. Accordingly, an adjustment to those financial
  statements was not considered necessary.

  H. Significant customers

  During 2000 and 1999, revenue from one customer amounted to approximately
  50.0% and 10.0%, respectively. The customer was not the same in the two
  years.

  I. Earnings per share of common stock

  Earnings per share of common stock is computed by dividing net income
  (loss) by the weighted-average number of common shares outstanding for the
  year.

  J. Income taxes

  The Company reports income for tax purposes on the cash basis. Deferred
  taxes result from temporary differences and net operating loss
  carryforward. An allowance for the full amount of the gross deferred tax
  asset has been established due to the uncertainty of utilizing the deferred
  tax asset in the future.

Note 3--Cash

  Two checking accounts and one savings account are with the same bank; total
  balances at that bank as of December 31, 2000, exceeded the amount insured
  by the Federal Deposit Insurance Corporation by $395,317. Additionally, the
  Company has a money market account with a balance of $3,063,105 at December
  31, 2000. The Company has not experienced any losses on such balances.

Note 4--Deferred revenue

  Deferred revenue consists of the following at December 31, 2000:

<TABLE>
   <S>                                                                  <C>
   Deferred memberships................................................ $ 74,757
   Advances on royalties...............................................   25,227
   Deferred licenses...................................................   35,742
                                                                        --------
                                                                        $135,726
                                                                        ========
</TABLE>

                                      F-9
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 5--Capital lease

  The Company leases equipment under a capital lease which will expire in
  2002. Annual payments are applicable first to interest (at 6.3%) with the
  balance to principal.

  At December 31, 2000, future minimum payments are: 2001--$10,587; and 2002
  (final year)--$1,765. The amount representing interest was $501, and the
  present value of net minimum lease payments was $11,851.

  At December 31, 2000, the cost and accumulated depreciation of the leased
  equipment were $29,088 and $10,471, respectively.

Note 6--Issuance of common stock

  A. Private placement offerings

  In connection with the 1999 Acquisition, Vanguard sold 1,333,333 shares of
  common stock at $.75 per share in a private placement.

  In June 1999, the Company sold nine private placement units at $100,000 per
  unit. Each private placement unit consisted of 11,733 shares of common
  stock and a five-year warrant to purchase 13,333 shares of common stock at
  $8.55 per share. The price of the units reflects a price of $8.52 per
  share, with no value being allocated to the warrants. In connection with
  this private placement, the Company paid the placement agent $117,000. The
  Company also issued the placement agent a warrant to purchase one placement
  agent's unit for $90,000. A placement agent's unit consists of 10,560
  shares of common stock and a warrant to purchase 12,000 shares of common
  stock at $8.55 per share. The warrants were terminated on the date the
  Company's public offering was declared effective by the Securities and
  Exchange Commission.

  The net proceeds of these private placements, after deducting costs of
  $387,023, were $1,512,977.

  Reference is also made to notes 7 and 15.

  B. Issuance of common stock for goods and services

  In connection with the 1999 Acquisition, Vanguard issued 133,333 shares of
  common stock to an investment banker for services with a value of $100,000.

  In 1999, the Company also issued 1,253 shares of common stock for purchases
  of furniture with a value of $8,500 and 2,698 shares of common stock for
  investor relations services with a value of $24,000.

  C. Public offering

  In May 2000, the Company issued 1,260,000 shares of its common stock in a
  public offering and received $4,819,500 of proceeds after deducting
  underwriter's discount but before deducting offering related expenses. The
  offering was for 1,260,000 units. Each unit consisted of one share of
  common stock and a Series B redeemable common stock purchase warrant to
  purchase one share of common stock at $4.675 per share. In connection with
  this offering, the underwriters were granted a unit purchase option to
  purchase 126,000 units at $7.0125. Each unit consists of a share of common
  stock and a warrant to purchase a share of common stock at $4.675.

  Reference is also made to note 15.

                                     F-10
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 7--Stock options and warrants

  Stock options

  In 1999, the Company established a qualified Stock Incentive Plan for its
  employees. Additionally, it issued non qualified stock options to
  employees, independent contractors and others during both 2000 and 1999.

  Statement of Financial Accounting Standards No. 123 ("SFAS 123") allows the
  Company to account for stock-based compensation, including options, granted
  to employees under the provisions of Accounting Principles Board Opinion
  No. 25 ("APB 25") and disclose in a footnote the pro forma effect on net
  income (loss) if the fair value accounting method of SFAS 123 had been
  used.

  The methodology used in estimating the fair value of the stock options was
  the Minimum Value Method adjusted for the facts and circumstances of the
  stock option agreements. Significant assumptions included a risk free
  interest rate of 6% and an expected life of one year. The value of the
  options issued after January 22, 1999 is determined based on the fair value
  of the stock traded at the date granted.

  During 2000, four employees were granted a total of 177,000 stock options
  under the Company's Stock Incentive Plan. During 1999, the Company granted
  incentive stock options to purchase 259,667 shares to employees under the
  Stock Incentive Plan with an exercise price equal to the fair value of the
  publicly traded stock at the date the options were granted. Additionally,
  18,666 incentive stock options were granted to officers at 10% above fair
  value. The options expire either five or ten years from the grant date
  under the Plan.

  In 2000, the Company entered into an agreement with an individual to become
  a board member. The individual was granted 120,000 options to purchase
  stock at an exercise price of $1.00, fair value of the publicly traded
  stock at the date the option was granted.

  During November and December 1999, the Company entered into agreements with
  two individuals to become members of the Board of Directors. By agreeing to
  serve as a member of the Board of Directors, they were granted options to
  purchase 100,000 and 146,667 shares of the Company's common stock at an
  exercise price of approximately $6.09. The director who was granted 100,000
  shares in 1999 was granted an additional 46,000 options to purchase the
  Company's common stock at an exercise price of $3.125, in 2000.

  In 2000 and 1999, the Company also granted stock options to purchase a
  total of -0- shares and 31,890 shares, respectively, in accordance with the
  terms of various agreements with other contractors or others providing
  services. The options were granted at the fair value of the stock at the
  time the agreements were signed. The options expire ranging up to ten years
  from the date of grant.

  Under APB 25, no compensation was recognized in the consolidated financial
  statements for the value of the stock options issued to employees with an
  exercise price in excess of the estimated fair value of the Company stock
  at the time of grant. In situations where the fair value of the stock
  options was considered compensation, compensation expense was recorded and
  a corresponding amount recorded as additional paid in capital.

  The estimated value of stock options during 2000 and 1999 ranged between
  $.185 and $.76. The expense recognized for compensation and services for
  these stock options granted in 2000 and 1999 was $13,500 and $202,062,
  respectively. Additionally, the value of stock options issued for services
  relating to offering costs in 2000 was $6,250.

                                     F-11
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The table below sets forth information as to options granted in 2000 and
  1999:

<TABLE>
<CAPTION>
                                  Number   Weighted Number of Shares  Weighted
                                 of Shares Average  Under Option in   Average
                                   Under   Exercise  Excess or Less  Fair Value
                                  Option    Price   Than Fair Value    Price
                                 --------- -------- ---------------- ----------
   <S>                           <C>       <C>      <C>              <C>
   Outstanding at January 1,
    1999.......................    322,683  $.645           --          $--
   Granted during the year.....    556,890   6.19        45,890         3.35
   Exercised during the year...        --     --            --           --
   Expired during the year.....        --     --            --           --
                                 ---------               ------
    Outstanding at December 31,
     1999......................    879,573   4.15        45,890         3.35
   Granted during the year.....    469,000   4.34           --           --
   Exercised during the year...        --     --            --           --
   Expired during the year.....        --     --            --           --
                                 ---------               ------
    Outstanding at December 31,
     2000......................  1,348,573   3.26        45,890         2.00
                                 ---------               ------
   Exercisable at December 31,
    2000.......................    555,039   2.67        34,691         5.34
   Exercisable at December 31,
    1999.......................    369,908    .95        27,224         8.17
</TABLE>

  The shares under options at December 31, 2000 were in the following
  exercise price ranges:

<TABLE>
<CAPTION>
                                              December 31, 2000
                             ---------------------------------------------------
                                                              Options Currently
                                   Options Outstanding           Exercisable
                             ------------------------------- -------------------
                                        Weighted  Weighted              Weighted
                                        Average    Average              Average
                               Number   Exercise Contractual   Number   Exercise
   Exercise Range            of Options  Price      Life     of Options  Price
   --------------            ---------- -------- ----------- ---------- --------
                                                 (in years)
   <S>                       <C>        <C>      <C>         <C>        <C>
   $0.00-$6.75.............. 1,086,673   $3.06         8      512,473    $ 2.16
   $6.76-$13.12.............   261,900    8.46         5       42,566      9.69
                             ---------                        -------
                             1,348,573                        555,039
                             ---------                        -------
</TABLE>

  Reference is also made to note 15.

  Warrants

  In May 1999, the Company issued to an investor a warrant to purchase
  166,667 shares of common stock at $8.55 per share (see note 15). The
  warrant was issued in consideration of the waiver by the investor of
  registration and other rights the Company had granted in connection with
  its services relating to the 1999 Acquisition. On April 25, 2000 the
  investor transferred and gave back to the Company, without recourse, the
  warrant.

  In 1999, the Company cancelled a contract it had for a marketing firm to
  provide investor relations services with payments to be made in stock
  warrants. At the time of cancellation, 166,667 stock warrants had been
  granted at an exercise price of $5.70.

                                     F-12
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  In 2000, 325,000 warrants were granted in accordance with the terms of
  agreements for marketing and financial services. The warrants were granted
  at the fair value at the time the agreements were signed.

  Reference is also made to note 6A and 6C.

  Warrants outstanding as of December 31, 2000 are as follows:

<TABLE>
<CAPTION>
                                                                     Shares
                                          Date   Exercise  Exercise   under
   Description                           Granted   Price    Period   Warrant
   -----------                           ------- --------- -------- ---------
   <S>                                   <C>     <C>       <C>      <C>
   Marketing services...................  4/99   $    3.80   4/04     166,667
   Financial services...................  5/99        5.70   5/04   * 166,667
   Services in connection with private
    placement...........................  6/99        5.70   6/04     119,999
   Placement agent warrants.............  6/99   8.55-8.52   6/04   *  22,560
   Public offering......................  5/00       4.675   5/05   1,260,000
   Underwriter unit purchase warrants...  5/00       4.675   5/05     126,000
   Marketing and financial services.....  8/00       1.187   8/05     300,000
   Marketing services...................  9/00        1.40   9/05      25,000
                                                                    ---------
                                                                    2,186,893
   Cancellations........................                            *(189,227)
                                                                    ---------
    Outstanding at December 31, 2000....                            1,997,666
                                                                    ---------
</TABLE>

  * Warrants cancelled in connection with May 2000 public offering.

Note 8--Treasury stock

  In August, 2000 the Company announced a repurchase plan of up to 450,000
  shares of common stock. At December 31, 2000, treasury stock is shown at a
  cost of $118,403, which represents 87,527 shares of common stock purchased
  during August, September and October 2000.

Note 9--Operating leases

  Through March, 1999 the Company leased office facilities in Newburyport,
  Massachusetts under a tenant-at-will lease agreement requiring sixty days'
  advance notice of vacancy. In March, 1999 the Company entered into a lease
  for office space with a 3 year term and a 3 year renewal period. The annual
  minimum rental payments under the lease will be approximately $31,500.

  Additionally, the Company leased vehicles in 1999 on three year operating
  leases.

                                     F-13
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The future minimum rental payment under all operating leases are as follows
  (including the 3 year renewal period on the lease for office space):

<TABLE>
<CAPTION>
             Year Ending December 31               Amount
             -----------------------              --------
             <S>                                  <C>
             2001................................ $ 40,491
             2002................................   33,315
             2003................................   31,500
             2004................................   31,500
             2005 (final year)...................    5,250
                                                  --------
              Total.............................. $142,056
                                                  ========
</TABLE>

  Rent expense for 2000 and 1999 was $43,614 and $36,849, respectively.

Note 10--Income taxes

  At December 31, 2000, the Company has a net operating loss carryforward of
  approximately $1,888,000 that may be used to offset future taxable income.
  If not used, the carryforward will begin to expire with the year 2018. The
  temporary difference for income tax reporting on a cash basis results in
  additional losses of approximately $704,000.

  An allowance has been established for the full amount of the gross deferred
  tax asset due to the uncertainty of utilizing the deferred taxes in the
  future.

  The tax effect of each type of temporary difference and carryforward is
  reflected in the following table as of December 31, 2000:

<TABLE>
   <S>                                                                 <C>
   Net operating loss carryforward...................................  $408,900
   Accrual basis versus cash basis tax reporting.....................   342,900
                                                                       --------
   Deferred tax asset before valuation allowance.....................   751,800
   Valuation allowance...............................................   751,800
                                                                       --------
   Net deferred tax asset............................................  $     --
                                                                       ========
</TABLE>

  The effective combined Federal and State tax rate used in the calculation
  of the deferred tax asset was 40%.

  The operating loss carryforward is available to reduce Federal and State
  taxable income and income taxes, respectively, in future years, if any. The
  realizability of deferred taxes is not assured as it depends upon future
  taxable income. However, there can be no assurance that the Company will
  ever realize any future cash flows or benefits from these losses.

  Permanent book/tax differences result from the value of the services of two
  officers and an employee which was accrued for financial statement purposes
  but which is not deductible for income tax purposes. These permanent
  book/tax differences are not reflected in the net deferred tax asset.

                                     F-14
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 11--Earnings per share of common stock

  The number of shares on which the basic earnings per share of common stock
  has been calculated is as follows:

<TABLE>
<CAPTION>
                                                                      Weighted
                                                                       Average
                                                                      Number of
      Year Ended December 31,                                          Shares
      -----------------------                                         ---------
      <S>                                                             <C>
      1999........................................................... 7,207,145
      2000........................................................... 8,160,899
</TABLE>

  Diluted earnings per share of common stock has not been presented for 2000
  and 1999 since the effect of including the stock options and warrants
  outstanding during these years (note 7) would be antidilutive.

  Reference is also made to note 15.

Note 12--Related party transactions

  An officer/stockholder of the Company has received advances from the
  Company during 1998. Advances to the officer/stockholder outstanding at
  December 31, 2000 and 1999 totaled $10,491.

  In 2000, two members of the Board of Directors will receive annual
  compensation of $15,000 and $24,000, respectively. A third member was added
  to the Board of Directors in December of 2000. He will receive an annual
  compensation of $15,000.

  The wives of two officers/stockholders are employed by the Company.

  Reference is also made to notes 2E, 7 and 14.

Note 13--Pro forma information

  Pro Forma Compensation:

  The Company granted nonqualified options to purchase 76,830 shares of
  common stock to an employee. The fair value of these options has been
  estimated at $.19 per share. During the period from June 1, 1997 to May 31,
  1998, 38,415 of the options vested and the remaining 38,415 options vested
  during the period June 1, 1998 to May 31, 1999. Additionally, the Company
  granted 100,000 stock options to a member of the Board of Directors upon
  joining the Board (see note 7): 20,000 options vested immediately at the
  date of grant; the remaining 80,000 options vest at the rate of 20,000 on
  each of the four succeeding anniversary dates. The fair value of the vested
  options has been estimated at $.34 per share. (None of the 146,667 stock
  options granted to the other member of the Board vest until after services
  have been performed. No services were performed during 1999.)

                                     F-15
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  SFAS 123 allows the Company to account for stock-based compensation
  arrangements under the provisions of APB 25. Accordingly, the proforma
  compensation for the stock options is $-0- and $9,996 for 2000 and 1999,
  respectively.

<TABLE>
<CAPTION>
                                                         Year Ended December
                                                                 31,
                                                        ----------------------
                                                          2000        1999
                                                        ---------  -----------
   <S>                                                  <C>        <C>
   Proforma information
   Net (loss) before (provision for) benefit from
    income taxes, per consolidated statement of
    operations......................................... $(105,096) $(1,045,819)
   Proforma adjustment for fair value of stock
    options............................................        --       (9,996)
                                                        ---------  -----------
   Proforma (loss)..................................... $(105,096) $(1,055,815)
                                                        ---------  -----------
</TABLE>

  Reference is also made to note 15.

Note 14--Commitments

  A. Software development

  On October 9, 1999 the Company entered into an agreement with a customer to
  develop software for use in operating a virtual shopping mall. The term of
  the agreement is four years. The total amount of the contract is for no
  less than $1,000,000 but no more than $1,500,000. Additionally, the Company
  will receive a fee equal to 1% of the revenue collected by the customer for
  the virtual shopping mall once it is operational. In 2000 the Company
  recognized revenue of $376,662 on the contract.

  In January 2001 the Company entered into a contract with a customer to
  develop virtual reality environments for use by the customer. The amount of
  the contract is approximately $52,000. The contract will expire upon the
  completion of the development of the environments as specified in the
  contract.

  B. Employment contracts

  Effective January 21, 1999, the Company entered into three-year employment
  agreements with its president and chief financial officer. Under the
  agreements annual compensation for each is $140,000. Additionally, the
  president and chief financial officer each were granted options to purchase
  up to 9,333 shares of the Company's common stock at an exercise price of
  $.83 per share. The agreements also provide for the president and chief
  financial officer to be eligible to participate in a bonus pool of not more
  than 10% of income before taxes, in excess of $750,000. A compensation
  committee will have sole discretion as to the allocation of the bonus pool
  among the senior executives. The bonus is not cumulative during any fiscal
  year.

  Each agreement contains a provision whereby if the Company breaches the
  provisions of the agreement, if the employee terminates the agreement for
  "good reason" or if the Company terminates the employee other than for
  cause (as defined in the agreement), the employee shall be entitled to
  payment equal to the lesser of (a) one year's salary and bonus for the
  period of employment prior to calendar year in which termination occurred;
  or (b) the salary due for the balance of the term plus a pro rata portion
  of the bonus paid to the employee for the previous year.

  Each agreement contains a provision whereby if the Company breaches the
  provisions of the agreement, if the employee terminates the agreement for
  "good reason" or if the Company terminates the employee other

                                     F-16
<PAGE>

                            ACTIVEWORLDS.COM, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  than for cause (as defined in the agreement), the employee shall be
  entitled to payment equal to the lesser of (a) one year's salary and bonus
  for the period of employment prior to calendar year in which termination
  occurred; or (b) the salary due for the balance of the term plus a pro rata
  portion of the bonus paid to the employee for the previous year.

  Effective February 12, 1999, the Company entered into a five-year
  employment agreement with the Company's lead programmer. Under the
  agreement, annual compensation starts at $100,000, increased annually by
  10% of previous year's salary. Additionally, the employee was granted
  options to purchase up to 116,667 shares of the Company's common stock at
  an exercise price of $9.19 per share. (See note 7.)

  C. Revenue Sharing Agreement

  During 2000 the Company entered into an agreement with an internet on-line
  service provider to promote and market the Activeworlds.com services to the
  service provider's members. The term of the agreement is one year. Revenue
  from new members generated under the agreement is shared equally. The
  agreement requires Activeworlds.com to make four quarterly installments in
  the amount of $112,500 as a guarantee against future revenues earned from
  memberships derived from the on-line service provider. As of December 31,
  2000, the Company made two installments in the total amount of $225,000
  that was recorded as a prepayment on the contract. Approximately $3,100 was
  received from memberships under the contract as of December 31, 2000.
  Therefore $1,550 was recognized as an expense in 2000 leaving a prepaid
  balance as of December 31, 2000 of $223,450.

  D. Marketing services

  In 2000, the Company entered into a contract with two consultants to
  provide marketing services. Under the agreements, the consultants are to
  provide the Company with prospective customers to utilize the products and
  services of the Company. The consultants will receive a consulting fee
  and/or stock options in the event the prospective customers become
  customers. The contracts expire on or before December 31, 2001. As of
  December 31, 2000, the Company did not enter into an agreement with a
  prospective customer provided by the consultants.

Note 15--Reverse stock split

  On February 29, 2000, the Company approved a two-for-three reverse stock
  split of the Company's outstanding common stock, an action which also
  resulted in adjustments to the Company's outstanding stock options and
  warrants (which were also converted on a two-for-three basis) and the
  related exercise prices (which were increased accordingly by 50%). The
  reverse stock split became effective on April 10, 2000. The accompanying
  financial statements and footnotes have been restated to reflect this two-
  for-three reverse stock split.

                                     F-17