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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-QSB

[X]      Quarterly  Report Under Section 13 or 15(d) of the Securities  Exchange
         Act of 1934

                For the quarterly period ended September 30, 2004

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

  For the transition period from __________________ to ______________________.

                        Commission file number 001-14480

                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
        (Exact Name of Small Business Issuer as Specified in its Charter)

            DELAWARE                                        95-4592204
  (State or Other Jurisdiction of                        (I.R.S. Employer
  Incorporation or Organization)                        Identification No.)

          14011 VENTURA BLVD., SUITE 501 SHERMAN OAKS, CALIFORNIA 91423
                    (Address of Principal Executive Offices)

                                 (818) 615-1500
                (Issuer's Telephone Number, Including Area Code)

         Check whether the issuer (i) 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 the past 90 days.

                              Yes [X]      No [ ]

         State the number of shares  outstanding of each of the issuer's classes
of common equity,  as of the latest  practicable  date:  Common Stock, par value
$0.001, 42,857,153 shares issued and outstanding as of November 1, 2004.

         Transitional  Small Business  Disclosure Format (check one):

                              Yes [_]      No [X]

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<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.

                              INDEX TO FORM 10-QSB


PART I   FINANCIAL INFORMATION.................................................3

Item 1.  Financial Statements..................................................3

         Condensed Consolidated Balance Sheet as of September 30,
            2004 (unaudited)...................................................3

         Condensed Consolidated Statements of Operations for
            the three and nine months ended September 30, 2004
            and September 30, 2003 (unaudited).................................4

         Condensed Consolidated Statements of Cash Flows for
            the nine months ended September 30, 2004 and
            September 30, 2003 (unaudited).....................................5

         Notes to Consolidated Financial Statements (unaudited)................6

Item 2.  Management's Discussion and Analysis or Plan of Operation ...........16

Item 3.  Controls and Procedures..............................................32

PART II  OTHER INFORMATION....................................................34

Item 1.  Legal Proceedings....................................................34

Item 2.  Changes in Securities and Small Business
            Issuer Purchases of Equity Securities.............................34

Item 3.  Defaults Upon Senior Securities......................................34

Item 4.  Submission of Matters to a Vote of Security Holders..................34

Item 6.  Exhibits and Reports on Form 8-K.....................................35

         Signatures...........................................................36


                                       2
<PAGE>


                                     PART I
                              FINANCIAL INFORMATION

Item 1.  Financial Statements

                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEET
                                 (In thousands)
                                                                      SEPTEMBER
                                                                          30,
                                                                         2004
                                                                      ----------
ASSETS                                                               (unaudited)
Current assets:
    Cash and cash equivalents ......................................   $    697
    Restricted cash ................................................         75
    Accounts receivable, net .......................................      1,926
    Note receivable ................................................         54
    Other assets, net ..............................................        155
                                                                       --------
Total current assets ...............................................      2,907
Property, plant and equipment, net .................................        128
License Rights .....................................................      1,222
                                                                       --------
Total assets .......................................................   $  4,257
                                                                       ========

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
    Accounts payable ...............................................   $    756
    Accrued expenses, related parties ..............................      3,061
    Accrued expenses ...............................................        562
    Guaranteed minimum payments, related party .....................        360
    Deferred revenue ...............................................         89
    Secured convertible promissory notes, including accrued interest      4,209
                                                                       --------
Total current liabilities ..........................................      9,037
Other long term liabilities ........................................        142
Long-term Guaranteed Minimum Payments, related party ...............        300
                                                                       --------
Total liabilities ..................................................      9,479

Stockholders' deficit:
    Common stock ...................................................         47
    Additional paid-in capital .....................................     69,702
    Accumulated deficit ............................................    (75,094)
    Unrealized gain on marketable securities and
    foreign exchange transactions ..................................        123
                                                                       --------
Total stockholders' deficit ........................................     (5,222)
                                                                       --------
Total liabilities and stockholders' deficit ........................   $  4,257
                                                                       ========

                 See Notes to Consolidated Financial Statements.


                                       3
<PAGE>


<TABLE>
                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                      (In thousands, except per share data)

<CAPTION>
                                                     THREE MONTHS            NINE MONTHS
                                                  ENDED SEPTEMBER 30,     ENDED SEPTEMBER 30,
                                                 --------------------    --------------------
                                                   2003        2004        2003        2004
                                                 --------    --------    -------     --------
                                               (unaudited) (unaudited) (unaudited) (unaudited)
<S>                                              <C>         <C>         <C>         <C>
Revenues:
      Marketing services .....................   $    848    $  1,461    $  1,417    $  4,890
      Licensing and other services ...........        360         523       1,250       1,588
      Distribution and technology from related
       party .................................         28        --           486        --
      Digital content ........................        107         130         470         358
                                                 --------    --------    --------    --------
           Total revenues ....................      1,343       2,114       3,623       6,836

Costs and expenses:
     Costs of revenues .......................        160         247         449         945
     Sales and marketing .....................        390         282         788         946
     General and administrative ..............      2,079       1,513       4,264       4,734
     Research and development ................        115         122         421         356
     Depreciation and amortization ...........         91           6         144          28
                                                 --------    --------    --------    --------
                                                    2,835       2,170       6,066       7,009
                                                 --------    --------    --------    --------
Income (loss) from operations ................     (1,492)        (56)     (2,443)       (173)
Other income (expense):
     Other Income ............................       --             1       2,097           6
     Loss on write off of deferred fees ......       --          --          (206)       --
     Interest expense ........................       (824)     (2,004)     (1,820)     (4,445)
                                                 --------    --------    --------    --------
     Total other income (expense) ............       (824)     (2,003)         71      (4,439)
                                                 --------    --------    --------    --------
Net income (loss) ............................     (2,316)     (2,059)     (2,372)     (4,612)
Unrealized Gain Marketable Securities ........       --          --          --          --
Foreign currency translation adjustment
   (net of tax effects) ......................       --            41          33         123
                                                 --------    --------    --------    --------
Comprehensive income (loss) ..................   $ (2,316)   $ (2,018)   $ (2,339)   $ (4,489)
                                                 ========    ========    ========    ========

Basic and fully-diluted net income (loss)
   per share .................................   $  (0.06)   $  (0.05)   $  (0.06)   $  (0.11)
                                                 ========    ========    ========    ========
Weighted average number of shares used
   in computing basic and fully-diluted
   net income (loss) per share ...............     40,316      42,857      35,836      42,686
                                                 ========    ========    ========    ========
</TABLE>

                 See Notes to Consolidated Financial Statements.


                                       4
<PAGE>


                     BRILLIANT DIGITAL ENTERTAINMENT, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

                                                                 NINE MONTHS
                                                             ENDED SEPTEMBER 30,
                                                             ------------------
                                                               2003       2004
                                                             -------    -------
                                                                 (unaudited)

OPERATING ACTIVITIES
Net loss ..................................................  $(2,372)   $(4,612)
Adjustments to reconcile net loss to the net cash
   provided by (used in) operating activities:
      Depreciation and amortization .......................      144         27
      Effect of accrued interest expense on convertible
         debt & capital funding ...........................    1,820        226
      Effect of amortization of debt issuance costs .......     --        3,869
      Effect of warrant amortization related to promissory
         notes ............................................      317       --
      Effect of warrant amortization related to agreements       514       --
      Effect of warrant amortization related to purchase
         of license rights ................................      522        524
      Changes in operating assets and liabilities:
         Accounts receivable ..............................   (1,877)       196
         Other assets .....................................      140        214
         Accounts payable and accruals ....................    3,011       (440)
         Deferred revenue .................................   (2,182)       (54)
         Notes receivable .................................     (197)        71
         Guaranteed minimum payments due to related parties     --         (240)
         Other long-term liabilities ......................       35       --
                                                             -------    -------
Net cash (used in) provided by operating activities .......     (125)      (219)

INVESTING ACTIVITIES
Purchase of equipment .....................................      (70)       (49)
                                                             -------    -------
Net cash used in investing activities .....................      (70)       (49)

FINANCING ACTIVITIES
Proceeds from issuance of shares, net of costs ............       37       --
Proceeds from issuance of promissory notes net of discount       200       --
Repayments of notes payable ...............................     --          (50)
Restricted cash ...........................................     (222)      --
                                                             -------    -------
Net cash used in financing activities .....................       15        (50)
                                                             -------    -------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ......     (180)      (318)

Effect of exchange rate changes on cash ...................        8        135
Cash and cash equivalents at beginning of period ..........      236        880
                                                             -------    -------
Cash and cash equivalents at end of period ................  $    64    $   697
                                                             =======    =======

Supplemental  disclosure of cash flow  information:
Cash paid during the period for:
   Interest ...............................................  $  --      $  --
                                                             =======    =======


                 See Notes to Consolidated Financial Statements.


                                       5
<PAGE>


                                                          6
                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                               SEPTEMBER 30, 2004

1.       BASIS OF PRESENTATION, RISKS AND GOING CONCERN UNCERTAINTY

         The accompanying  unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted  accounting  principles
in the United States for interim financial information and with the instructions
to Form 10-QSB and Item 310 of Regulation S-B. Accordingly,  they do not include
all of the information and footnotes required by generally  accepted  accounting
principles  in  the  United  States  for  complete  financial  statements.   The
accompanying  unaudited condensed  consolidated financial statements reflect all
adjustments that, in the opinion of management,  are considered  necessary for a
fair  presentation of the financial  position,  results of operations,  and cash
flows for the periods presented.  The results of operations for such periods are
not necessarily  indicative of the results  expected for the full fiscal year or
for any future period. The accompanying  financial  statements should be read in
conjunction  with the audited  consolidated  financial  statements  of Brilliant
Digital  Entertainment,  Inc.  and  consolidated  subsidiaries  (the  "Company")
included in the  Company's  Form 10-KSB for the fiscal year ended  December  31,
2003.

         The  discussion and analysis of the Company's  financial  condition and
results of operations are based upon their  consolidated  financial  statements,
which have been  prepared in accordance  with  accounting  principles  generally
accepted in the United States.  The  preparation of these  financial  statements
requires the Company to make  estimates and  judgments  that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent  assets and liabilities.  On an on-going basis, the Company evaluates
its  estimates,  including  those  related to  reserves  for bad debts and those
related to the possible  impairment of long-lived  assets. The Company bases its
estimates on historical  experience  and on various other  assumptions  that are
believed to be reasonable under the circumstances, the results of which form the
basis for making  judgments  about the carrying value of assets and  liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.  The Company's use of
estimates,  however, is quite limited, as they have adequate time to process and
record actual results from operations.

         The  Company is subject to a number of risks  similar to those of other
companies  in a  comparable  stage  of  development  including  reliance  on key
personnel,   successful  marketing  of  its  services  in  an  emerging  market,
competition from other companies with greater technical,  financial,  management
and marketing  resources,  successful  development  of new services,  successful
integration of acquired  businesses and technology,  the enhancement of existing
services,  and the  ability  to secure  adequate  financing  to  support  future
operations.

         The accompanying  consolidated  financial statements have been prepared
assuming that the Company will continue as a going concern,  which  contemplates
the  realization  of assets and the  satisfaction  of  liabilities in the normal
course of business.  The carrying amounts of assets and liabilities presented in
the financial  statements  do not purport to represent  realizable or settlement
values.  However,  the Company has suffered  recurring  operating  losses and at


                                       6
<PAGE>


September 30, 2004, had negative working capital of approximately $6,130,000 and
a  stockholders'  deficit  of  approximately  $5,222,000.  These  factors  raise
substantial doubt about the Company's ability to continue as a going concern. In
their report on the Company's  financial  statements for the year ended December
31, 2003, the Company's  independent  certified public  accountants  included an
explanatory  paragraph expressing  substantial doubt about the Company's ability
to continue as a going concern.

         The Company is seeking additional  funding.  There can be no assurance,
however,  that the Company will be able to secure additional  funding or that if
such funding is available,  whether the terms or conditions  would be acceptable
to the Company.

2.       SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

         The  consolidated  financial  statements  include  the  accounts of the
Company and majority  owned and  controlled  domestic and foreign  subsidiaries.
Intercompany transactions have been eliminated.

RESTRICTED CASH

         At September  30, 2004,  $75,000 of cash was pledged as  collateral  on
outstanding  secured   convertible   promissory  notes  and  was  classified  as
restricted cash on the balance sheet.

REVENUE RECOGNITION

         Under SEC Staff  Accounting  Bulletin  No. 104,  generally  the Company
recognizes  revenue when all of the following  criteria are met: (1)  persuasive
evidence of an  arrangement  exists,  (2) delivery has occurred or services have
been rendered, (3) the seller's price to the buyer is fixed or determinable, and
(4) collectibility is reasonably  assured.  In the case of each of the Company's
products  and service  lines,  the Company  establishes  a contract or insertion
order  with its  customers  with  specific  requirements  for a fixed  price,  a
delivery schedule, and terms for payment. The Company also recognizes revenue in
accordance  with  the  following  with  respect  to the  specific  products  and
services.  The Company regularly evaluates the collectibility of its receivables
based on a combination of factors.  When a customer's  account becomes past due,
it initiates  dialogue with the customer to determine the cause.  If the Company
determines  that the customer will be unable to meet its financial  obligations,
due to a bankruptcy filing, deterioration in the customer's operating results or
financial position or other material events impacting its business,  the Company
records a specific reserve for bad debt to reduce the related  receivable to the
amount it expects to  recover  given all  information  presently  available.  If
circumstances  related to specific  customers change,  the Company's estimate of
the  recoverability  of receivables  could materially  change.  At September 30,
2004, the Company had a reserve of $129,000 to cover several customers from whom
collectibility is uncertain.

         The Company's revenues are derived principally from marketing services,
licensing and other services, and digital content revenue.


                                       7
<PAGE>


         Marketing   services   revenues   are  derived  from  paid  search  and
advertising services. Under the terms of the Company's agreement with The Excite
Network,  Inc., the Company is paid a non-refundable bounty for the installation
of each Excite My Search  toolbar  bundled for  distribution  with the Company's
Altnet Loyalty Points Manager on an English  speaking user's  computer,  and the
Company is paid a percentage of the gross profit earned as a result of clicks on
paid search  results by any end users of these  toolbars.  The  Company  derives
advertising  revenue  by  selling  advertising  inventory  on behalf of  Sharman
Networks  Limited  ("Sharman")  in exchange for a percentage of revenue  Sharman
receives from its advertising  clients.  Sharman's  clients pay a fee based on a
cost per thousand impressions (CPM) or specified conversions delivered (CPA).

         Licensing  and other  services  revenues are derived from the Company's
sublicense  of rights to the  TruNames  patent (see  License  Rights),  business
development  services,  and payment processing services.  Under the terms of the
Company's  patent  sublicense  agreement  with Sharman,  the Company  recognizes
sublicense  payments  as  revenue  on a monthly  basis as  earned.  The  Company
generates fee income for performing business development services for Sharman in
accordance  with an agreement.  The Company  negotiates  with third parties that
desire to enter into a business  transaction  with Sharman relating to the Kazaa
Media Desktop (or KMD) software  application.  The Company receives a percentage
of the gross revenue received by Sharman for each transaction entered into based
on the  Company's  efforts.  The Company  also  generates  fees from  processing
payments for the purchase of digital content using the Altnet payment processing
gateway

         Digital  content  revenues are derived from  processing  digital  media
content (music,  PC games,  software,  movies) for placement on the peer-to-peer
network operated by the Company's  subsidiary,  Altnet,  Inc., and by promoting,
distributing,  and selling the content to end users of the network.  The Company
charges  clients a processing  fee to prepare  content for  distribution  on the
network. The amount of this fee varies based on the number of files, the size of
the files,  digital encoding costs, and the preparation of collateral  marketing
materials,  such as artwork.  The Company charges clients for content promotions
on a cost per  specified  number  of  downloaded  files.  A  customer  typically
pre-purchases  an agreed upon number of downloaded  files.  The amounts  charged
vary based on volume and the  complexity  of the campaign.  The Company  charges
clients for content sales based on a revenue sharing basis where they receive an
agreed  upon  percentage  of  the  sales  price  for  each  transaction,  and  a
combination  of  revenue  share and a cost per  specified  number of  downloaded
files.

LICENSE RIGHTS

         In October 2002, the Company  entered into a patent  license  agreement
with  Kinetech,  Inc.,  pursuant to which the Company  acquired a license to the
TruNames patent,  and in consideration  for such license,  the Company issued to
Kinetech a warrant to  purchase  up to  5,000,000  shares of common  stock at an
exercise price of $0.001 per share. In July 2003, the Company modified the terms
of the  warrants  with  Kinetech,  to  accelerate  vesting.  As a result  of the
accelerated  vesting and the fact that the Company now  recognizes  revenue on a
monthly basis from  sub-licensing  the TruNames patent,  the Company  determined
that the warrants granted to Kinetech as consideration for the patent rights had
a determinable value. The fair value of the warrants was re-examined at the date
of  modification  and was  based on a  Black-Scholes  model  with the  following
weighted average  assumptions for 2003: interest rates of 4.5%;


                                       8
<PAGE>


dividend yield rates of 0;  volatility  factors of expected  market price of the
Company's  common  stock of 50%;  and the expected  life of the  warrants,  or 6
years.  The value of these  warrants was determined to be $2,096,000 and will be
amortized over the remaining useful life of the patent license  agreement,  or 3
years.  During the first nine months of 2004, the Company has recorded  $524,000
of amortization expense related to the patent, leaving an unamortized balance of
$1,222,000  at September  30, 2004,  which is reflected on the balance  sheet as
License Rights.

         The Company assesses the  recoverability  of long-lived assets whenever
events or changes in business  circumstances indicate that the carrying value of
an asset may not be recoverable.  Annual estimated  amortization expense for the
remaining long-lived asset for each of the five succeeding years is as follows:

                                        Amortization
                          Year            Expense
                          ----          ----------

                          2004          $  174,000
                          2005             698,000
                          2006             350,000
                                        ----------
                         Total          $1,222,000
                                        ==========

CONCENTRATION OF REVENUE RISK

         For the nine months ended  September  30, 2004,  the Company  generated
100% of its total  revenue  either  directly  from Sharman or from other parties
based on activities  dependent upon the  availability of the Kazaa Media Desktop
to computer users.

         For the nine months ended September 30, 2004,  Sharman  contributed 30%
of the Company's revenue, from content sales, patent licensing,  advertising and
payment  processing.  The Excite Network (TEN)  contributed 70% of the Company's
revenue,  from the  amortization  of a  non-recoupable  signing bonus,  bounties
earned on activated installations of the TEN toolbar, and profit sharing on paid
searches via the TEN toolbar.

         Financial   instruments  which  potentially   subject  the  Company  to
concentrations  of credit risk  consist  primarily of accounts  receivable.  The
Company  had  $2,013,000  of  accounts   receivable  from  The  Excite  Network,
representing 98% of the Company's  accounts  receivable balance at September 30,
2004. The Company  performs  credit  evaluations  and generally does not require
collateral.

         The Company  maintains the majority of its cash and cash equivalents in
one bank and with one brokerage  house in the United States and with one bank in
Australia. The bank account maintained in the United States is guaranteed by the
Federal  Deposit  Insurance  Corporation  ("FDIC") up to  $100,000.  The banking
system in Australia does not provide the same guarantees. At September 30, 2004,
the Company had  approximately  $533,000 at the United States bank, which was in
excess of the FDIC insurance limit and approximately  $164,000 in the Australian
bank, which was not guaranteed.


                                       9
<PAGE>


3.       RELATED PARTY TRANSACTIONS

         In May 2003,  Altnet  entered  into a license  to use  rights to Joltid
Ltd.'s Content Distribution Environment peer-to-peer computer program,  commonly
referred to as  PeerEnabler.  In exchange for the license,  Altnet agreed to pay
Joltid a guaranteed  monthly fee of $30,000  based on a  percentage  of revenues
earned  from the  exploitation  of the  licensed  rights,  subject  to a maximum
aggregate  amount.  The  Company  has  reflected  the  current  portion  of  the
guaranteed  payment of $360,000 as a current  liability,  and the balance of the
commitment  of $300,000  as a long-term  liability.  The  company  assesses  the
recoverability  of  long-lived  assets  whenever  events or changes in  business
circumstances  indicate  that  the  carrying  value  of  an  asset  may  not  be
recoverable.  During the fourth quarter of 2003, in connection with this review,
the Company  obtained an independent  valuation to assist them in evaluating the
Company's  intangible  assets for  impairment  in  accordance  with FAS 144.  An
impairment loss is recognized when the sum of the expected  undiscounted  future
net cash flows over the remaining  useful life, is less than the carrying amount
of the asset.  Prior to the impairment  evaluation the Company  capitalized  and
reflected on its balance sheet an asset;  Purchased  Technology  associated with
our purchase of additional  shares of our Altnet  subsidiary  from Joltid.  As a
result of the independent  evaluation of these assets,  the Company  recorded an
impairment  charge of $1,484,000  during the fourth quarter of 2003. The Company
paid  Joltid  $240,000  for  services  provided  during  the nine  months  ended
September 30, 2004, and had an outstanding trade payable to them of $19,176.

         The Company  entered into a Patent  Sublicense  Agreement with Sharman,
the distributor of the Kazaa Media Desktop file sharing software application (or
KMD). Pursuant to the Patent Sublicense Agreement, the Company granted Sharman a
limited,  non-exclusive  sublicense  to the  Company's  rights  to the  TruNames
patent,  which the Company  licenses from  Kinetech  Inc. The  TrueNames  patent
covers a method of  identifying  digital files based on the actual data contents
of the  file,  rather  than by its name,  origin,  location,  address,  or other
information that can easily be changed. As consideration for the sublicense, the
Company will receive from Sharman a monthly license fee.  Additionally,  in June
2003,  the Company and Altnet  entered into a Joint  Enterprise  Agreement  with
Sharman,  to act as their exclusive  representative for the sale, license and/or
other commercial  exploitation of index search results displayed on or otherwise
accessed  using the KMD in response to end user search  requests.  The agreement
also granted the Company a  non-exclusive  right to enter into  agreements  with
third parties to provide for the  establishment  of one or more browse  channels
within the KMD that enable  users to find and  download  rights-managed  content
from the relevant  browse channel in a single click process,  and to provide for
all the terms and conditions governing the management,  maintenance,  operation,
and other elements of each browse  channel.  The Company shall share in revenues
derived from the browse  channels.  As of September 30, 2004, the Company has an
outstanding  accounts  payable  balance  to  Sharman  of  $2,187,000,  which  is
classified on the balance sheet as Accrued Expenses Related Parties.

         The Company paid Europlay Capital Advisors,  LLC, a company  controlled
by Mark Dyne, a significant  stockholder of the Company and its former Chairman,
$638,000 in  commissions  to secure new  business,  during the nine months ended
September  30, 2004. As of September  30, 2004,  the Company has an  outstanding
balance to Europlay Capital  Advisors,  LLC of $874,000,  which is classified on
the balance sheet as Accrued Expenses Related Parties.


                                       10
<PAGE>


         The Company leases its U.S. offices,  under operating lease agreements,
from Topanga  Victory  Partners,  LP, an entity owned by Harris Toibb, a secured
debt holder and the largest shareholder in the Company. The Company paid rent to
Toibb of $101,000 and $60,000  during the nine months ended  September  30, 2004
and 2003, respectively.

         The Company has paid $30,950,  as reimbursement  for bandwidth and data
hosting  services  associated with content placed on our Altnet  network,  to an
entity owned by a member of our Board of Directors, during the first nine months
of 2004.

4.       SIGNIFICANT AGREEMENTS

SECURED CONVERTIBLE PROMISSORY NOTES

         At  September  30,  2004,  the Company was indebted to its secured debt
holders in the amount of $4,209,000,  which  indebtedness was due and payable on
September 26, 2004.  The principal and accrued  interest is  convertible  by the
holders into the Company's  common stock at price $0.1203 per share, for a total
of 33,270,801  shares of common stock at September 30, 2004. In connection  with
this financing,  and in consideration of several extensions of the maturity date
of the  indebtedness,  the note holders  received  warrants to purchase up to an
aggregate of 73,787,613  shares of common stock at exercise  prices ranging from
$0.1353 per share to $0.2091 per share.  In November  2004,  the Company and the
secured debt holders extended the maturity date of the indebtedness to September
26, 2005. See Note 9 for supplemental disclosure.

5.       STOCKHOLDERS' DEFICIT

         Options and  warrants  representing  common  shares of  92,144,631  and
144,943,790  were  excluded  from  the  average  number  of  common  and  common
equivalent shares outstanding in the diluted EPS calculation for the nine months
ended   September   30,  2003  and  2004,   respectively,   because   they  were
anti-dilutive.

         On March 30, 2004,  in  consideration  for the  agreement to extend the
maturity date of the Company's secured  convertible  promissory notes from March
1, 2004 to September 26, 2004, the Company  agreed to amend the expiration  date
of previously issued warrants to purchase 44,542,718 shares of common stock held
by the note  holders  from May 23,  2004 to October 4, 2005.  In  addition,  the
Company  issued  the note  holders  additional  warrants  to  purchase  up to an
aggregate of 4,018,867 shares of the Company's common stock at an exercise price
of $0.15 per share. The fair value of the previously issued 44,542,718  warrants
and the  4,018,867  new warrants  were  examined at the date of grant based on a
Black-Scholes pricing model with the following inputs for 2004: interest rate of
1.9%;  dividend yield of 0;  volatility  factors of the expected market price of
the Company's common stock of 135%; and the expected life of the warrants of 1.3
and 1.5 years  respectively.  The  Company  amortized  the total  value of these
warrants  in the amount of  $1,913,000  during  the second and third  quarter of
2004.


                                       11
<PAGE>


6.       COMMITMENTS AND CONTINGENCIES

         The Company  continues its obligation under two facility leases.  As of
September 30, 2004, the commitments under these leases were as follows:

                                   UNITED
                     YEAR          STATES       AUSTRALIA
                  ----------      --------      --------
                        2004      $ 24,000      $ 12,000
                        2005        92,000         4,000
                        2006        92,000          --
                        2007        92,000          --
                  Thereafter        77,000          --
                                  --------      --------
                                  $377,000      $ 16,000
                                  ========      ========

         Rent  expense  was  $60,000  and  $101,000  for the nine  months  ended
September 30, 2003 and 2004, respectively.

         In March  2004,  in the  Federal  Court of  Australia,  New South Wales
District  Registry,  Brilliant  Digital  Entertainment,  Inc., its  subsidiaries
Altnet  Inc.  and  Brilliant  Digital  Entertainment  Pty.  Limited,  and  Kevin
Bermeister and Anthony Rose, the Chief  Executive  Officer and Chief  Technology
Officer, respectively,  were joined as defendants in the suit by Universal Music
Australia  Pty.  Ltd.  and  other  record  labels  against   Sharman  and  other
defendants,   alleging   infringement  of  the  copyright  in  sound  recordings
controlled by the  plaintiffs.  The plaintiffs  allege that due to the Company's
business  dealings  with  Sharman,  the  Company is  integrally  involved in the
operation  of the Kazaa  Media  Desktop  and  therefore  liable for the  alleged
copyright  infringement  occasioned by its  development  and  distribution.  The
plaintiffs  are seeking  damages  under the  Australian  Copyright  Act of 1968,
recovery of costs and  interest,  and a  permanent  injunction  restraining  the
Company from making copies of,  communicating to the public, or distributing the
Plaintiff's  sound  recordings  without a license.  The Company  believes  these
allegations  are without merit,  and intends to vigorously  defend against these
claims The lawsuit is scheduled for trial in December 2004.

7.       STOCK BASED COMPENSATION

1996 STOCK OPTION PLAN

         The Company adopted a Stock Option Plan (the "1996 Plan"), which became
effective on September 13, 1996. Each director,  officer, employee or consultant
of the Company or any of its  subsidiaries  is eligible to be considered for the
grant of awards  under the 1996  Plan.  The  maximum  number of shares of Common
Stock  that may be  issued  pursuant  to awards  granted  under the 1996 Plan is
35,000,000,  subject to certain  adjustments to prevent dilution.  Any shares of
Common Stock  subject to an award,  which for any reason  expires or  terminates
unexercised  are again  available for issuance  under the 1996 Plan. The maximum
number of shares of Common Stock with respect to which  options or rights may be
granted under the 1996 Plan to any executive or other employee during any fiscal
year is one-half of the number of shares reserved for issuance under the amended
1996 Plan  Although any award that was duly granted may  thereafter be exercised
or settled in accordance with its terms, no shares of Common Stock may be issued


                                       12
<PAGE>


pursuant to any award made after September 13, 2006.  Options granted  generally
have a term of 10 years  and  usually  vest  over 4 years at the rate of 25% per
year beginning on the first day in the year subsequent to the year of the grant.

         The Company  accounts  for  employee  stock  options or similar  equity
instruments  in  accordance  with  Statement of Financial  Accounting  Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). SFAS
No. 123 defines a  fair-value-based  method of  accounting  for  employee  stock
options or similar equity instruments. This statement gives entities a choice to
recognize related  compensation  expense by adopting the fair-value method or to
measure   compensation   using  the  intrinsic  value  method  under  Accounting
Principles  Board  (APB)  Opinion  No. 25, the  former  standard.  If the former
standard  for  measurement  is  elected,  SFAS  No.  123  requires  supplemental
disclosure to show the effect of using the new measurement criteria. The Company
uses the intrinsic value method prescribed by APB Opinion No. 25. See Note 6 for
supplemental disclosure.

         These pro forma amounts may not be representative of future disclosures
since the  estimated  fair value of the options is amortized to expense over the
options' vesting  periods.  The pro forma effect on net loss for the nine months
ended September 30, 2004 and 2003 is not  representative of the pro forma effect
on net loss in future periods because it reflects expense for only three-months'
vesting.   Pro  forma   information  in  future  years  will  also  reflect  the
amortization of any stock options granted in succeeding years. The Company's pro
forma information is as follows:

                                                    NINE MONTHS     NINE MONTHS
                                                       ENDED           ENDED
                                                   SEPTEMBER 30,   SEPTEMBER 30,
                                                       2003             2004
                                                   -------------   -------------
Net loss, as reported ..........................   $(2,339 ,000)   $(4,489,000)
Employee compensation expense ..................   $   (118,000)   $  (124,000)
Net loss, pro forma ............................   $ (2,457,000)   $(4,613,000)
Basic and diluted loss per share, as reported ..   $      (0.06)   $     (0.11)
Basic and diluted loss per share, pro forma ....   $      (0.06)   $     (0.11)

         The fair value of the options as examined at the date of grant is based
on a  Black-Scholes  model with the following  weighted-average  assumptions for
2004 and 2003, respectively: interest rates of 4.5% and 5.5%; dividend yields of
0% for both  years;  volatility  factors  of the  expected  market  price of the
Company's common stock of 50.0% and 50.0%; and expected life of the options of 3
years for both years.  These  assumptions  resulted in a weighted  average  fair
value of $0.06 and $1.66 per share for stock  options  granted in 2004 and 2003,
respectively.

         The  Black-Scholes  model was developed for use in estimating  the fair
value of traded  options.  The  Company's  employee  stock options have not been
traded. In addition,  the assumptions used in option valuation models are highly
subjective,  particularly  the expected stock price volatility of the underlying
stock.  Because  changes in these  subjective  input  assumptions can materially
affect the fair value estimate,  in management's opinion, the existing models do
not provide a reliable  single  measure of the fair value of its employee  stock
options.


                                       13
<PAGE>


8.       GUARANTEES

         In November  2002, the FASB issued FIN No. 45  "Guarantor's  Accounting
and Disclosure  Requirements for Guarantees,  including  Indirect  Guarantees of
Indebtedness of Others - an  interpretation of FASB Statements No. 5, 57 and 107
and  rescission of FIN 34." The  following are a summary of agreements  that the
Company has determined are within the scope of FIN 45.

         Under its bylaws,  the Company has agreed to  indemnify  its  officers,
directors and employees for certain events or occurrences arising as a result of
the  officer,  director,  or  employee  serving in such  capacity.  The  maximum
potential  amount of future payments the Company could be required to make under
these  indemnification  agreements  is  unlimited.  However,  the  Company has a
directors and officer liability insurance policy that mitigates its exposure and
enables  it to  recover a portion of any  future  amounts  paid,  subject to the
applicable  terms of the policy.  As a result of its insurance  policy coverage,
the  Company  believes  the  estimated  fair  value  of  these   indemnification
agreements is minimal and has no liabilities recorded for these agreements as of
September 30, 2004. If legal expenses and other costs of defense are not covered
by  our  insurance   policies  or  reimbursed  by  third  parties   pursuant  to
indemnification  agreements,  the  cash  required  to pay for  these  costs  and
expenses would not be available for other purposes and the Company's  results of
operations and financial condition would be materially  adversely affected.  The
Company  occasionally  enters  into  indemnification  provisions  under  (i) its
agreements with other  companies in its ordinary  course of business,  typically
with business  partners,  contractors,  customers,  and landlords,  and (ii) its
agreements  with  investors.   Under  these  provisions  the  Company  generally
indemnifies  and holds  harmless the  indemnified  party for losses  suffered or
incurred by the indemnified party as a result of the Company's activities or, in
some  cases,  as a  result  of the  indemnified  party's  activities  under  the
agreement.  These  indemnification  provisions  often  include  indemnifications
relating  to  representations  made by the Company  with regard to  intellectual
property rights. These indemnification  provisions generally survive termination
of the underlying agreement.  In addition, in some cases, the Company has agreed
to reimburse  employees for certain expenses and to provide salary  continuation
during  short-term  disability.  The maximum potential amount of future payments
the Company could be required to make under these indemnification  provisions is
unlimited.  The Company has not incurred  material  costs to defend  lawsuits or
settle claims  related to these  indemnification  agreements.  As a result,  the
Company  believes  the  estimated  fair value of these  agreements  is  minimal.
Accordingly,  the Company has no liabilities recorded for these agreements as of
September 30, 2004.

9.       SUBSEQUENT EVENTS

         In November 2004, the Company and its secured debt holders extended the
maturity date of the Company's  senior secured  indebtedness  from September 26,
2004 to September  26, 2005.  In  consideration  of the  extension,  the Company
agreed to the following material terms:

         o        To extend the  expiration  date of  warrants  to  purchase  an
                  aggregate  of  73,787,613  shares of common  stock held by the
                  note holders to October 4, 2008;

         o        To reduce the conversion  price of the  convertible  notes and
                  the exercise price of the warrants to $0.07 per share; and


                                       14
<PAGE>


         o        To  make  the  following  payments  to  the  note  holders  in
                  repayment  of the  indebtedness:  (i) $50,000 per month,  plus
                  (ii) 50% of any quarterly  EBITDA in excess of $600,000,  plus
                  (iii) 50% of any  increased  revenue  received  from  existing
                  sources of revenue or from new sources of revenue.


                                       15
<PAGE>


ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

         The information contained in this Form 10-QSB is intended to update the
information  contained  in our Annual  Report on Form  10-KSB for the year ended
December 31, 2003 and presumes  that readers have access to, and will have read,
the "Management's  Discussion and Analysis of Financial Condition and Results of
Operations" and other information  contained in such Form 10-KSB.  The following
discussion  and  analysis  also should be read  together  with our  consolidated
financial  statements  and the notes to the  consolidated  financial  statements
included elsewhere in this Form 10-QSB.

         THIS  DISCUSSION  SUMMARIZES  THE  SIGNIFICANT  FACTORS  AFFECTING  THE
CONSOLIDATED OPERATING RESULTS, FINANCIAL CONDITION AND LIQUIDITY AND CASH FLOWS
OF BRILLIANT DIGITAL  ENTERTAINMENT FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
AND SEPTEMBER 30, 2003. EXCEPT FOR HISTORICAL INFORMATION, THE MATTERS DISCUSSED
IN THIS  MANAGEMENT'S  DISCUSSION  AND ANALYSIS OR PLAN OF OPERATION ARE FORWARD
LOOKING  STATEMENTS  THAT  INVOLVE  RISKS AND  UNCERTAINTIES  AND ARE BASED UPON
JUDGMENTS CONCERNING VARIOUS FACTORS THAT ARE BEYOND OUR CONTROL. ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE  FORWARD-LOOKING  STATEMENTS
AS A RESULT OF,  AMONG  OTHER  THINGS;  THE  FACTORS  DESCRIBED  BELOW UNDER THE
CAPTION "CAUTIONARY STATEMENTS AND RISK FACTORS."

OVERVIEW

         Brilliant Digital  Entertainment,  Inc. is a company which, through our
Altnet, Inc.  subsidiary,  operates a  peer-to-peer-based  content  distribution
network  and  payment  gateway  that  allows  us  to  securely  and  efficiently
distribute a content owner's music,  video,  software and other digital files to
computer  users  via the  Internet.  Using  internally  developed  and  licensed
technology,  we have  created  technologies  including  a private,  or  "closed"
peer-to-peer  network,  which  allows  us to  distribute  a digital  file,  with
authorization  from the copyright owner,  directly from one computer user (peer)
to another  (peer).  Our ability to manage  files  distributed  over our private
network,  as well as our use of widely available  digital rights  management (or
DRM) technologies from Microsoft Corporation, TryMedia Systems, Softwrap Limited
and others, prevent the unauthorized use of a digital file once it resides on an
end user's  computer.  We  commercialize  Altnet by partnering  with third party
operators of web sites and other Internet  applications to enable users of those
web sites and  applications  to search for and download  digital  files over the
Altnet  network.  We also operate a payment  processing  "gateway"  that enables
computer users to purchase content distributed by Altnet.

         We own 75.5% of the outstanding  capital stock of Altnet and manage all
of its day-to-day operations,  and the remaining 24.5% is owned by Joltid, Ltd.,
the company from whom we license a substantial portion of Altnet's  peer-to-peer
technology.  We have an option,  which expires in May 2005, to purchase Joltid's
remaining  1,102,500  shares of Altnet  common stock in exchange  for  7,000,000
shares of Brilliant's common stock.

         Our revenues are derived principally from marketing services, licensing
and  other  services,  and the  processing,  distribution  and  sale of  digital
content.


                                       16
<PAGE>


         Marketing   services   revenues   are  derived  from  paid  search  and
advertising services.  Under the terms of our agreement with The Excite Network,
Inc., we are paid a non-refundable bounty for the installation of each Excite My
Search toolbar bundled for  distribution  with our Altnet Loyalty Points Manager
on an English  speaking  user's  computer,  and we are paid a percentage  of the
gross  profit  earned as a result of clicks on paid  search  results  by any end
users of these toolbars.  We derive advertising  revenue by selling  advertising
inventory on behalf of Sharman in exchange for a percentage  of revenue  Sharman
receives from its advertising  clients.  Sharman's  clients pay a fee based on a
cost per thousand impressions (CPM) or specified conversions delivered (CPA).

         Licensing and other  services  revenues are derived from our sublicense
of rights to the TruNames patent,  business  development  services,  and payment
processing  services.  Under the terms of our patent  sublicense  agreement with
Sharman,  we  recognize  sublicense  payments  as revenue on a monthly  basis as
earned. We generate fee income for performing business  development services for
Sharman in accordance  with an agreement.  We negotiate  with third parties that
desire to enter into a business  transaction  with Sharman relating to the Kazaa
Media  Desktop (or KMD)  software  application.  We receive a percentage  of the
gross revenue received by Sharman for each transaction entered into based on our
efforts.  We also  generate  fees from  processing  payments for the purchase of
digital content using the Altnet payment processing gateway.

         Digital  content  revenues are derived from  processing  digital  media
content  (music,  PC  games,  software,  movies)  for  placement  on our  Altnet
peer-to-peer network, and by promoting, distributing, and selling the content to
end users of the network.  We charge clients a processing fee to prepare content
for  distribution  on the  network.  The amount of this fee varies  based on the
number  of  files,  the  size of the  files,  digital  encoding  costs,  and the
preparation  of  collateral  marketing  materials,  such as  artwork.  We charge
clients for content  promotions  on a cost per  specified  number of  downloaded
files. A customer typically  pre-purchases an agreed number of downloaded files.
The amounts charged vary based on volume and the complexity of the campaign.  We
charge  clients for  content  sales  based on a revenue  sharing  basis where we
receive an agreed upon percentage of the sales price for each transaction, and a
combination  of  revenue  share and a cost per  specified  number of  downloaded
files.

SIGNIFICANT CHALLENGES AND RISKS

         Altnet is a new business that we are pursuing  based upon our perceived
market opportunity;  yet its business model is unproven. There are no guarantees
that the model will be successful,  however,  we have made significant  progress
towards our goal of proving the  viability  of the  business  model.  Our future
success  will  depend on our  ability  to  overcome  the  following  operational
challenges:

         o        Our ability to acquire  in-demand content from independent and
                  major musical recording and filmed entertainment  companies as
                  well as video game and software application publishers;

         o        Our  ability  to  diversify   our  reliance   upon  one  large
                  distribution partner, Sharman;


                                       17
<PAGE>


         o        Our ability to increase  revenue from our core  business - the
                  distribution and sale of content over the Altnet network;

         o        Our  ability to raise the  funding  necessary  to support  the
                  sales,  marketing,  and research and development  necessary to
                  grow the Altnet business;

         o        Our ability to license our technologies and patents to various
                  parties;

         o        Our  ability  to  either  pay  or   restructure   our  secured
                  convertible promissory notes and unsecured trade payables; and

         o        Our successful  defense  against claims brought against us and
                  our  executive  officers in the pending legal  proceedings  in
                  Australia.

         We intend to continue to aggressively  pursue content  acquisition with
both  the  major  and  smaller   independent   musical   recording   and  filmed
entertainment  companies  in order to address our content  needs and to increase
revenue from the  distribution  of content.  To date, our efforts in this regard
have been  hampered  by the  litigation  surrounding  our  largest  distribution
partner,  Sharman,  over the legality of the KMD.  Despite our efforts,  we have
been unable to obtain  download  licenses for music files from the major musical
recording  companies,  even though these companies have granted  licenses to our
competitors.  Several of these  musical  recording  companies  have sued us, our
subsidiaries Altnet, Inc. and Brilliant Digital  Entertainment Pty. Limited, and
Kevin  Bermeister  and  Anthony  Rose,  our Chief  Executive  Officer  and Chief
Technology Officer, in the Federal Court of Australia for activities relating to
our business  dealings with Sharman.  There can be no assurance  that we will be
granted such  licenses at any time in the future.  The lawsuit is scheduled  for
trial in December 2004.

         In order to reduce our reliance on a single large distribution partner,
we will continue to pursue other distribution outlets for our products including
peer-to-peer  application providers seeking to commercialize their applications,
web  sites  with  traffic  seeking  an easy way to manage  content  provisioning
solutions,  content  oriented web sites with  targeted  traffic  seeking to sell
content,  and mobile and wireless  companies  seeking to provide  customers with
content via wireless devices.

         We intend to  continue  our pursuit of  additional  capital to fund our
expansion  efforts and to pay both our secured debt holders and unsecured  trade
creditors.  At September  30, 2004, we were indebted to our secured note holders
in the amount of $4,209,000, and our trade payables,  including related parties,
were  $4,379,000.  We are also  working  with both our secured  debt holders and
certain of our unsecured trade  creditors to restructure  amounts owed them into
long-term arrangements.  There can be no assurance that we will be successful in
raising additional capital to pay these obligations,  or in restructuring  these
obligations to avoid a payment default.

         The accompanying  financial statements have been prepared assuming that
we will continue as a going  concern,  which  contemplates  the  realization  of
assets and the satisfaction of liabilities in the normal course of business. The
carrying amount of assets and liabilities  presented in the financial statements
do not purport to represent  realizable or settlement  values.  We have suffered
recurring  operating  losses and at  September  30, 2004,  had negative  working
capital of approximately $6,130,000 and a stockholder's deficit of approximately
of  $5,222,000.


                                       18
<PAGE>


These factors raise  substantial  doubt about our ability to continue as a going
concern.  We  anticipate  that our  current  cash  reserves,  plus our  expected
generation  of cash from existing  operations in 2004,  may not be sufficient to
fund our  anticipated  expenditures.  Consequently,  we may  require  additional
equity or debt financing during 2005, the amount and timing of which will depend
in large part on our spending program.  The report of our Independent  Certified
Public  Accountants for the December 31, 2003 financial  statements  included an
explanatory paragraph expressing substantial doubt about our ability to continue
as a going concern.

SETTLEMENT AGREEMENT AND MUTUAL RELEASE

         In June 2004, we entered into a Settlement Agreement and Mutual Release
with Big Seven  Entertainment,  LLC, a distributor  of digital  content over the
Altnet network, and Detershan Pty. Ltd. Big Seven is owned by Michael Toibb, the
son of Harris Toibb,  our largest secured  creditor and  stockholder.  Under the
terms of the agreement,  we agreed to acquire from Michael  Toibb,  on or before
the first  anniversary  of the agreement,  all of his ownership  interest in Big
Seven in  exchange  for the  issuance to him of  6,666,667  shares of our common
stock or, in lieu of such issuance, the payment to him of $0.15 in cash for each
such share (for aggregate  proceeds of $1,000,000).  Prior to our acquisition of
Mr. Toibb's  ownership  interest in Big Seven,  we agreed to operate Big Seven's
business and are responsible for all of Big Seven's liabilities and are entitled
to retain  all of its  revenues.  We also  agreed  to  reimburse  Michael  Toibb
$150,000 in legal and professional  fees and pay him a management fee of $15,000
per month until we consummate our  acquisition  of Big Seven.  We also agreed to
indemnify Mr. Toibb for all losses, damages and expenses that may arise from our
operation of Big Seven.

         If we sell Big Seven or any of its assets at any time after the date of
the settlement  agreement and prior to the first  anniversary of consummation of
our  acquisition  of Big Seven,  the proceeds of the sale would be allocated and
paid as follows:  (i) the first  $1,000,000 of such proceeds  would be allocated
and paid to us; (ii) the next $180,000 of such  proceeds  would be allocated and
paid to Michael Toibb;  and (iii) all remaining  proceeds would be allocated and
paid to us.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

         Our discussion  and analysis of our financial  condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance  with  accounting  principles  generally  accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues  and  expenses,   and  related  disclosure  of  contingent  assets  and
liabilities.  On an on-going basis,  we evaluate our estimates,  including those
related  to  reserves  for  bad  debts.  We base  our  estimates  on  historical
experience and on various other  assumptions  that are believed to be reasonable
under  the  circumstances,  the  results  of which  form the  basis  for  making
judgments  about the  carrying  values of assets  and  liabilities  that are not
readily  apparent  from other  sources.  Actual  results  may differ  from these
estimates  under  different  assumptions  or  conditions.  Our use of estimates,
however, is quite limited, as we have adequate time to process and record actual
results from operations.


                                       19
<PAGE>


         Our  critical  accounting  policies  are  described  in  Note  2 to the
consolidated  financial  statements  included in Item 2 of this Form 10-QSB.  We
believe our most critical accounting policies include revenue  recognition,  the
corresponding  accounts  receivable and long-lived asset impairment.  We believe
the following critical accounting policies affect our more significant judgments
and estimates used in preparation of our consolidated financial statements.

         Under  SEC  Staff  Accounting  Bulletin  No.  104 (SAB  104) and  AICPA
Statement  of Position  97-2 (SOP 97-2),  we  recognize  revenue when all of the
following  criteria are met: (1) persuasive  evidence of an arrangement  exists,
(2) delivery has occurred or services have been rendered, (3) the seller's price
to the buyer is fixed or  determinable,  and (4)  collectibility  is  reasonably
assured.  In the case of each of our product and  service  lines we  establish a
contract or insertion order with our customers with specifics for  requirements,
a fixed price, a delivery schedule,  and terms for payment.  Unless cash is paid
in advance,  our  receivables  are  recorded as revenue is earned.  We regularly
evaluate  the  collectibility  of our  receivables  based  on a  combination  of
factors.  When a customer's  account becomes past due, we initiate dialogue with
the customer to determine the cause.  If we determine  that the customer will be
unable to meet its  financial  obligations  to us, due to a  bankruptcy  filing,
deterioration in the customer's operating results or financial position or other
material events  impacting their business,  we record a specific reserve for bad
debt to reduce the related  receivable  to the amount we expect to recover given
all  information  presently  available.  If  circumstances  related to  specific
customers  change,  our estimates of the  recoverability  of  receivables  could
materially change.

         Long-lived  assets and intangible  assets with  determinable  lives are
reviewed for impairment  quarterly or whenever events or circumstances  indicate
that the carrying  amounts of assets may not be recoverable  in accordance  with
SFAS No. 144,  "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG LIVED ASSETS".
We  evaluate  recoverability  of  assets  to be held and used by  comparing  the
carrying  amount  of an  asset  to  future  net  undiscounted  cash  flows to be
generated  by the asset.  If such  assets are  considered  to be  impaired,  the
impairment  to be  recognized  is measured  as the amount by which the  carrying
amount of the assets  exceeds the fair value of the assets.  Such reviews assess
the fair value of the assets  based upon our  estimates of the future cash flows
we expected  the assets to  generate.  In  response  to changes in industry  and
market conditions,  we may be required to strategically realign our resources in
the future, which could result in an impairment of long lived assets.


                                       20
<PAGE>


RESULTS OF OPERATIONS

         REVENUES.  Revenues  increased 87% from  $3,623,000 for the nine months
ended  September 30, 2003 to $6,836,000 for the nine months ended  September 30,
2004. Revenues by groups of similar service were as follows:

                REVENUES                   2003          2004        NET CHANGE
------------------------------------    ----------    ----------     ----------
Marketing services .................    $1,417,000    $4,890,000           245%
Licensing and other services .......     1,250,000     1,588,000            27%
Distribution and technology
    revenue from related party .....       486,000          --            (100%)
Digital content ....................       470,000       358,000           (24%)
                                        ----------    ----------     ----------
Total Revenue ......................    $3,623,000    $6,836,000            87%
                                        ==========    ==========     ==========

         Marketing  services revenue increased to $4,890,000 for the nine months
ended  September  30,  2004,  primarily  as a result of revenue  earned from our
agreement  with The Excite  Network,  Inc. which was entered into in April 2003.
Licensing  and other  services  revenues  increased to  $1,588,000  for the nine
months  ended  September  30, 2004 from  $1,250,000  for the nine  months  ended
September 30, 2003, due to a $490,000  increase in payment  processing  revenues
recognized  during  2004,  offset by a $170,000  decrease  in patent  sublicense
revenue, relating to a payment received at the signing of the agreement in 2003.
Digital  content  revenue  decreased  from  $470,000  for the nine months  ended
September  30,  2003,  to $358,000 for the nine months ended 2004 as a result of
the decrease in the sale of digital content,  primarily PC games,  over Altnet's
peer-to-peer  network.  Distribution and technology revenue from a related party
was $458,000  during the nine months ended  September 30, 2003,  relating to our
contract with e-New Media Company.  We recognized  none of these revenues during
the nine months ended September 30, 2004, as we fulfilled all of our obligations
under our contract with e-New Media Company during 2003.

         COST OF REVENUES. Cost of revenues increased from $449,000 for the nine
months  ended  September  30,  2003  to  $945,000  for  the  nine  months  ended
September30,  2004.  This net  increase of $496,000  is  primarily  related to a
$556,000  increase in the costs  associated  with the  operation  of our payment
gateway  services,  an  increase  of  $115,000  in  costs  associated  with  the
preparation of digital  content placed on the Altnet  network,  in addition to a
$31,000 increase related to the services support  agreement with Joltid,  signed
in June 2003.  These were offset by a $77,000  decrease in bandwidth costs, as a
result of the consolidation of and improved pricing from bandwidth providers. In
addition,  there was a  $132,000  decrease  in  royalty  payments  for  licensed
technology during 2004.

         SALES AND MARKETING. Sales and marketing expenses increased by 20% from
$788,000 for the nine months ended  September  30, 2003 to $946,000 for the nine
months  ended  September  30,  2004.  The net  increase  of $158,000 in 2004 was
primarily  attributable  to the  increase of $270,000  in  commissions  paid for
securing  new  business  offset by a  $110,000  decrease  in the  marketing  and
promotional costs spent to support our marketing efforts for the Altnet network.


                                       21
<PAGE>


         GENERAL  AND  ADMINISTRATIVE.   General  and  administrative   expenses
primarily  include  salaries  and  benefits  of  management  and  administrative
personnel,  rent,  insurance  costs,  professional  fees  and  non-cash  warrant
expense.  General and administrative  expenses increased $470,000,  or 10%, from
$4,264,000  for the nine months ended  September 30, 2003 to $4,734,000  for the
nine months  ended  September  30,  2004.  This  increase is  attributable  to a
$955,000  increase in legal costs  associated  with defending  lawsuits  brought
against the company and two of its executives,  a $383,000  increase in salaries
and benefits, related to personnel additions in mid 2003, and a $77,000 increase
in travel and other operating expenses. These were offset by a $830,000 decrease
in non-cash  warrant expense during the nine months ended September 30, 2004, as
well as a $110,000 reduction in corporate franchise tax filing fees.

         RESEARCH AND  DEVELOPMENT.  Research and development  expenses  include
salaries and benefits of personnel  conducting research and development relating
to our Internet web site, payment gateway and related information database,  and
the development of the Altnet Peer Points Manager  software  application.  These
costs  decreased  from $421,000 for the nine months ended  September 30, 2003 to
$356,000  for  the  nine  months  ended  September  30,  2004,  as  most  of the
development  costs  incurred for the  development of our Peer Points program and
our payment gateway, were incurred in 2003.

         DEPRECIATION.  Depreciation  expense  relates to  depreciation of fixed
assets such as computer  equipment  and  cabling,  furniture  and  fixtures  and
leasehold improvements.  These fixed assets are depreciated over their estimated
useful lives (up to five years)  using the  straight-line  method.  Depreciation
expense was $144,000 for the nine months ended September 30, 2003 as compared to
$28,000 for the nine months ended September 30, 2004, as many of the depreciable
assets have been fully depreciated.

         OTHER INCOME AND EXPENSE.  Other income and expense primarily  includes
interest  expense and, in 2003,  deferred  revenue related to our agreement with
E-New Media.  Other income and expense  decreased from net income of $71,000 for
the nine months ended  September 30, 2003 to a net expense of $4,439,000 for the
nine months  ended  September  30,  2004.  During the nine months ended June 30,
2003, we recognized  deferred  revenue of $2,097,000  related to the E-New Media
agreement,  and a loss of $206,000 on the write-off of deferred fees  associated
with  terminated  contracts.  During the nine months ended  September  30, 2004,
interest expense included interest accrued on outstanding convertible promissory
notes, $350,000 of fees paid to the convertible note holders in conjunction with
their  agreement to extend the maturity date of the  indebtedness  from December
31,  2003 to March 1, 2004,  and an  additional  $2,800,000  of  amortized  debt
issuance costs associated with the agreement to further extend the maturity date
of the indebtedness  from March 1, 2004 to September 26, 2004. These were offset
by a $174,000 reduction in interest expense on convertible notes which were paid
off in 2003.

LIQUIDITY AND CAPITAL RESOURCES

         As of  September  30,  2004,  our  cash and  cash  equivalents  totaled
approximately  $697,000.  This is a decrease of $318,000 as compared to December
31,  2003.  As of  September  30,  2004,  we had a working  capital  deficit  of
$6,130,000.  Included in this  working  capital  deficit are  accounts  payable,
accrued expenses and accrued expenses to related parties of $2,987,000 which are
over 90 days past due, and $4,209,000 of secured indebtedness.


                                       22
<PAGE>


         We currently satisfy our working capital requirements primarily through
cash flows  generated  from  operations and sales of equity  securities.  We are
seeking additional  funding.  There can be no assurance that with any additional
financing, higher cash flows will be generated by operations.

CASH FLOWS

         Cash flows from operating,  financing and investing  activities for the
nine months ended  September  30, 2004 and 2003 are  summarized in the following
table:

Activity:                                            2003                2004
----------------------------------------          ----------          ----------
Continuing Operations ..................          $(125,000)          $(219,000)
Investing ..............................            (70,000)            (49,000)
Financing ..............................             15,000             (50,000)

         During the nine months ended  September 30, 2004, we had a net decrease
in cash of  $318,000.  The net cash used in  operating  activities  of  $219,000
during the nine months ended  September 30, 2004 was primarily the result of the
net loss of $4,612,000,  a decrease of $440,000 in accounts  payable and accrued
expenses,  a $240,000  decrease in  guaranteed  minimum  payments  and a $54,000
decrease in deferred  revenues.  These  amounts  were  offset  primarily  by the
amortization of $3,869,000 in debt issuance costs,  $226,000 in accrued interest
on capital financing,  $524,000 in amortization of license rights, a decrease in
accounts receivable of $196,000,  a decrease in other assets of $214,000,  and a
decrease in notes receivable of $71,000.

         During the nine months ended  September  30,  2004,  we used $49,000 of
cash in investing activities, for purchases of equipment, and $50,000 of cash in
financing activities, for repayments of notes payable.

         At September 30, 2004, 91% of the accounts  receivable was  outstanding
from a single customer. Cash necessary to fund operations and for other purposes
is heavily  dependent on the receipts from this customer.  If this customer were
unable to honor its accounts  receivable,  the cash required to fund  operations
and for other purposes would not be available and our financial  condition would
be materially adversely affected.

         We expect a  significant  use of cash  during  2004  fiscal  year as we
continue to develop the business  opportunity for Altnet,  Inc. We are currently
generating  sufficient  cash  flow  on a  monthly  basis  to  meet  our  monthly
obligations;  however,  we are not  generating  sufficient  cash flow to pay our
existing current  liabilities and secured debt. While we have been successful in
working with our secured debt holders to achieve short term extensions,  we will
continue  working  with our secured  debt  holders and  unsecured  creditors  to
restructure our  obligations,  however there can be no guarantee that we will be
successful in our efforts.  Consequently,  we may require  additional  equity or
debt financing  during 2005, the amount and timing of which will depend in large
part on our spending program and our success in  restructuring  our secured debt
and  current  liabilities.  Our  previous  financings  have  been  significantly
dilutive to our  stockholders  and if  additional  funds are raised  through the
issuance of equity  securities,  our  stockholders  may  experience  significant
additional  dilution.  Furthermore,  there can be no


                                       23
<PAGE>


assurance  that  additional  financing  will be available when needed or that if
available,  such financing will include terms  favorable to our  stockholders or
us. If such  financing is not  available  when  required or is not  available on
acceptable terms, we may be unable to pay our secured debt holders as their debt
matures or trade  creditors under our  contractual  terms with them,  develop or
enhance our products and services,  take advantage of business  opportunities or
respond to  competitive  pressures,  any of which could have a material  adverse
effect on our business, financial condition and results of operations, and would
most likely  result in our having to file for  bankruptcy  protection  under the
Bankruptcy Code.

         In March  2004,  in the  Federal  Court of  Australia,  New South Wales
District  Registry,  Brilliant  Digital  Entertainment,  Inc., our  subsidiaries
Altnet,  Inc.  and  Brilliant  Digital  Entertainment  Pty.  Limited,  and Kevin
Bermeister and Anthony Rose, our Chief  Executive  Officer and Chief  Technology
Officer, respectively,  were joined as defendants in the suit by Universal Music
Australia  Pty.  Ltd.  and  other  record  labels  against   Sharman  and  other
defendants,   alleging   infringement  of  the  copyright  in  sound  recordings
controlled by the  plaintiffs.  The  plaintiffs  allege that due to our business
dealings with Sharman,  we are integrally involved in the operation of the Kazaa
Media  Desktop  and  therefore  liable for the  alleged  copyright  infringement
occasioned by its  development and  distribution.  While we believe these claims
are without merit, if we are unable to have these charges  dismissed,  defending
against these claims,  and defending  against any other actions brought by these
or  similarly  situated  plaintiffs  in  Australia,  the United  States or other
jurisdictions,  could require a significant  use of cash during 2004 and beyond.
If the legal  expenses  and other  costs of defense  are not  covered for by our
insurance  policies or reimbursed by third parties  pursuant to  indemnification
agreements,  the cash required to pay for these costs and expenses  would not be
available  for other  purposes  and our  results  of  operations  and  financial
condition would be materially  adversely affected.  The lawsuit is scheduled for
trial in December 2004.

CONTRACTUAL OBLIGATIONS

         The following  summarizes our contractual  obligations at September 30,
2004 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:

<TABLE>
<CAPTION>
                                          Payments Due by Period
                         --------------------------------------------------------------
                                      Less than       1-3          4-5        After 5
Contractual Obligations     Total       1 Year       Years        Years        Years
                         ----------   ----------   ----------   ----------   ----------
<S>                      <C>          <C>          <C>          <C>          <C>
Secured convertible
   promissory notes ..   $4,209,000   $4,209,000   $     --     $     --     $     --
Minimum royalty
   payments ..........   $  660,000   $  360,000   $  300,000   $     --     $     --
Operating lease
   commitments .......   $  393,000   $   36,000   $  188,000   $  169,000   $     --
                         ----------   ----------   ----------   ----------   ----------
   Total .............   $5,262,000   $4,605,000   $  488,000   $  169,000   $     --
                         ==========   ==========   ==========   ==========   ==========
</TABLE>

         At September  30, 2004, we were indebted to our secured debt holders in
the amount of $4,209,000,  which  indebtedness  was due and payable on September
26, 2004. This indebtedness was convertible by the holders into our common stock
at price $0.1203 per share, for a total of 33,270,801  shares of common stock at
September 30, 2004. In connection with this financing,  and in  consideration of
several  extensions of the maturity date of the  indebtedness,  the note holders
received  warrants to purchase up to an aggregate of 73,787,613 shares of common


                                       24
<PAGE>


stock at exercise prices ranging from $0.1353 per share to $0.2091 per share. In
November 2004, the secured debt holders and us extended the maturity date of the
indebtedness  from September 26, 2004 to September 26, 2005. In consideration of
the extension, we agreed to the following material terms:

         o        To extend the  expiration  date of  warrants  to  purchase  an
                  aggregate  of  73,787,613  shares of common  stock held by the
                  note holders to October 4, 2008;

         o        To reduce the conversion  price of the  convertible  notes and
                  the exercise price of the warrants to $0.07 per share; and

         o        To  make  the  following  payments  to  the  note  holders  in
                  repayment  of the  indebtedness:  (i) $50,000 per month,  plus
                  (ii) 50% of any quarterly  EBITDA in excess of $600,000,  plus
                  (iii) 50% of any  increased  revenue  received  from  existing
                  sources of revenue or from new sources of revenue.

OFF-BALANCE SHEET ARRANGEMENTS

         At September 30, 2004 and 2003, we did not have any relationships  with
unconsolidated  entities  or  financial  partnerships,  such as  entities  often
referred to as structured finance or special purpose entities,  which would have
been established for the purpose of facilitating  off-balance sheet arrangements
or other contractually  narrow or limited purposes.  As such, we are not exposed
to any  financing,  liquidity,  market or credit risk that could arise if we had
engaged in such relationships.

CAUTIONARY STATEMENTS AND RISK FACTORS

         Several   of  the   matters   discussed   in  this   document   contain
forward-looking  statements  that  involve  risks  and  uncertainties.   Factors
associated with the  forward-looking  statements that could cause actual results
to differ  materially  from those  projected  or  forecast  are  included in the
statements  below.  In addition to other  information  contained in this report,
readers should carefully consider the following cautionary statements.

         RISKS RELATED TO AN INVESTMENT IN OUR COMMON STOCK

         THERE IS DOUBT ABOUT OUR ABILITY TO  CONTINUE  AS A GOING  CONCERN.  We
currently  have a number  of  obligations  that we are  unable  to meet  without
generating  additional  revenues  or raising  additional  capital.  If we cannot
generate  additional revenues or raise additional capital in the near future, we
may  become  insolvent.   As  of  September  30,  2004,  our  cash  balance  was
approximately  $697,000  and we had a working  capital  deficit  of  $6,130,000.
Historically,  we have  funded  our  capital  requirements  with debt and equity
financing.  Our ability to obtain additional equity or debt financing depends on
a  number  of  factors  including  our  financial  performance  and the  overall
conditions in our industry.  If we are not able to raise additional financing or
if such financing is not available on acceptable terms, we may liquidate assets,
seek or be  forced  into  bankruptcy,  and/or  continue  operations  but  suffer
material harm to our  operations and financial  condition.  These measures could
have a material adverse affect on our ability to continue as a going concern.


                                       25
<PAGE>


         WE HAVE A HISTORY OF LOSSES,  A NEGATIVE NET WORTH AND MAY NEVER ATTAIN
PROFITABILITY.  We  realized a  comprehensive  loss of  $4,489,000  for the nine
months ended September 30, 2004. Since inception,  we have incurred  significant
losses  and  negative  cash  flow,  and  as of  September  30,  2004  we  had an
accumulated  deficit of  approximately  $75 million.  We anticipate that we will
continue  to generate  operating  losses for the  foreseeable  future as we fund
operating and capital  expenditures in the areas of brand  promotion,  sales and
marketing, administration, and research and development, all principally related
to deployment of our Altnet peer-to-peer  network and operating  infrastructure.
Additionally,   as  of  the  date  of  this  report,  our  current   liabilities
significantly exceed our current assets.

         In fiscal 2002, we all but eliminated the  development and marketing of
our proprietary  software  authoring  tools,  and our services for serving "rich
media" Internet banner advertisements  (banner advertisements that use audio and
animation).   Additionally,   we  have  ceased  all   internal   production   of
three-dimensional  animated content.  Our business model assumes that our growth
and  substantially  all of our future  revenues  will be derived from our Altnet
peer-to-peer  business,  which only became  operational in the fourth quarter of
2002.  This business model is not yet proven and we cannot make  assurances that
we will ever achieve or sustain  profitability or that our operating losses will
not  increase  in the future or be  inconsistent  with the  expectations  of the
public market.  Primarily as a result of our continued  losses,  our independent
public  accountants  included an  explanatory  paragraph in their opinion on our
financial statements wherein they expressed  substantial doubt about our ability
to continue as a going concern.

         WE HAVE A  SUBSTANTIAL  NUMBER  OF  OUTSTANDING  DERIVATIVE  SECURITIES
WHICH,  IF EXERCISED OR CONVERTED INTO COMMON STOCK,  WILL RESULT IN SUBSTANTIAL
DILUTION TO OUR STOCKHOLDERS.  We have outstanding  $4,209,000 of senior secured
indebtedness  which is evidenced by convertible  promissory  notes due September
26, 2005,  which  indebtedness is convertible by the note holders into shares of
our common stock at a price of $0.07 per share. The conversion of the promissory
notes would increase the number of shares  outstanding and result in dilution to
our other stockholders.

         The  conversion  price of the  secured  promissory  notes is subject to
reduction if we issue additional securities at a price below the then applicable
conversion price, with exceptions for certain types of securities issuances.  If
we issue securities at a price below the conversion  price,  then the conversion
price  will be  adjusted  downward  to  equal  the  price  at  which we sold the
additional securities. As a consequence,  if we trigger the adjustment provision
for the secured  promissory  notes,  the holders of the  convertible  promissory
notes could  convert them at a lower price,  which would  increase the number of
shares of Common Stock they would receive.

         The table  below sets  forth the  number of shares of our common  stock
that could be acquired by the holders upon  conversion of the  principal  amount
and accrued interest of promissory notes, and the percentages of our outstanding
common stock that the shares issued upon conversion would represent. The amounts
assume  conversion on the maturity date of the promissory notes on September 26,
2005, and include all interest that would accrue on the entire  principal amount
of the promissory notes through such date. The share amounts and percentages are
based on our closing  share  price of $0.08 on November 1, 2004,  and on assumed
closing share prices of $0.06,  $0.04 and $0.02,  which prices  represent a 25%,
50% and 75% decline,


                                       26
<PAGE>


respectively,  in our November 1, 2004 closing  share price.  The table  assumes
that we would issue additional  securities at these prices, and thus trigger the
price  adjustment  provisions of the notes.  The  percentages  are also based on
42,857,153 shares of our common stock outstanding on November 15, 2004.

Percentage Decline in                                             Percentage of
  November 1, 2004       Assumed                                   Outstanding
    Closing Price     Closing Price   Shares of Common Stock      Common Stock
--------------------- -------------   ----------------------      -------------
        --               $0.08*             57,345,703                 57.2%
        25%              $0.06              66,903,320                 61.0%
        50%              $0.04             100,354,980                 70.1%
        75%              $0.02             200,709,960                 82.4%

* Based on the terms of the notes,  if we sold  securities at this share closing
price the conversion price of the notes would be $0.07 per share.


         Additionally,  we  anticipate  that during the remainder of 2004 and in
2005, we may need to raise  additional  capital,  as our current  operations are
only  generating a modest  positive cash flow. As such, any  additional  capital
raising efforts would cause further dilution to stockholders.  Additionally, any
further extensions of the maturity date of our convertible promissory notes will
likely  require us to issue a substantial  number of additional  warrants to the
note holders.

         The following table  illustrates as of November 15, 2004, the number of
shares  issued and  outstanding  as, as well as the number of shares that may be
issued  in  the  future  upon  conversion  of  outstanding  secured  convertible
promissory notes and exercise of outstanding options and warrants:

                                                                      PERCENTAGE
                                                                       OF FULLY
                                                      SHARES OF         DILUTED
SECURITY                                             COMMON STOCK       SHARES
-------------------------------------------------    ------------     ----------
Outstanding Common Stock ........................     42,857,153          23.9%
Secured Convertible Promissory Notes,
  with accrued interest .........................     57,345,703          32.0%
Outstanding Warrants(1) .........................     53,361,582          30.0%
Outstanding Options .............................     25,135,918          14.1%
                                                     -----------         ------
  Fully Diluted Shares of Common Stock(2) .......    178,700,356         100.0%

----------
(1)      For purposes of this table,  we have only  included  warrants  that are
         "in-the-money"  (the exercise  price of the warrants is below the price
         of our  common  stock),  and the  number  of  shares  of  common  stock
         underlying the outstanding warrants has been calculated on a "cashless"
         exercise  basis,  whereby  the  holder of each  warrant  receives  upon
         exercise a number of shares of common  stock with a value  equal to (i)
         the total value of the shares  underlying  the  warrants  LESS (ii) the
         aggregate  exercise price of the warrants,  and is calculated  based on
         the  closing  sales  price of our common  stock on the Over the Counter
         Bulletin  Board on  November  1, 2004,  which was $0.08.

(2)      This number  excludes (i) 9,618,457  shares that have been reserved for
         issuance  under our 1996 Stock Option Plan that were not the subject of
         an  outstanding  stock option or other award at November 15, 2004,  and
         (ii)59,598,849  shares  underlying  warrants that have exercise  prices
         ranging from $0.14 to $0.6096 per share, and thus not "in-the-money."


                                       27
<PAGE>


         The following table  illustrates as of November 15, 2004, the number of
shares  issued  and  outstanding,  as well as the  number of shares  that may be
issued in the future upon conversion of outstanding convertible promissory notes
and exercise of outstanding options and warrants. For the purposes of this table
we have included all warrants  whether they are  "in-the-money"  or not, and the
number of shares of common stock  underlying the  outstanding  warrants has been
calculated on a "paid-for"  exercise  basis,  whereby the holder of each warrant
receives upon exercise a number of shares of common stock equal to the number of
warrants held:

                                                                      PERCENTAGE
                                                                       OF FULLY
                                                      SHARES OF         DILUTED
SECURITY                                             COMMON STOCK       SHARES
-------------------------------------------------    ------------     ----------
Outstanding Common Stock ........................     42,857,153          18.0%
Secured Convertible Promissory Notes,
  with accrued interest .........................     57,345,703          24.1%
Outstanding Warrants. ...........................    112,960,431          47.4%
Outstanding Options .............................     25,135,918          10.5%
                                                     -----------         ------
  Fully Diluted Shares of Common Stock...........    238,299,205         100.0%

         IF WE  BECOME  INSOLVENT,  WE  WILL BE IN  DEFAULT  UNDER  OUR  SECURED
CONVERTIBLE  PROMISSORY  NOTES,  WHICH  COULD  RESULT IN OUR  OBLIGATION  TO PAY
IMMEDIATELY ALL AMOUNTS THEN OUTSTANDING UNDER THE NOTES. If we generally do not
pay,  or become  unable to pay,  our debts as such  debts  become  due,  we will
default  under  our  outstanding  Secured  Convertible  Promissory  Notes,  with
aggregate principal and accrued interest and fees of $4,209,000 at September 30,
2004.  If a default  occurs,  all amounts owed to the holders of the notes would
immediately become due and payable. If we are not able to repay the indebtedness
when due,  the holders of the notes will be  entitled  to exercise  all of their
rights and remedies, including foreclosure on all of our assets which we pledged
as collateral to secure repayment of the debt.

         OUR STOCK PRICE AND TRADING VOLUME FLUCTUATE WIDELY AND MAY CONTINUE TO
DO SO IN THE FUTURE. AS A RESULT, WE MAY EXPERIENCE  SIGNIFICANT DECLINES IN OUR
STOCK PRICE.  The market  price and trading  volume of our common  stock,  which
trades on the Over the  Counter  Bulletin  Board  (OTCBB),  has been  subject to
substantial volatility,  which is likely to continue. This volatility may result
in significant declines in the price of our common stock. Factors that may cause
these fluctuations include:

         o        variations in quarterly operating results;

         o        the gain or loss of significant contracts;

         o        changes in management;

         o        announcements of technological  innovations or new products by
                  us or our competitors;

         o        recommendations by securities industry analysts;

         o        dilution to existing stockholders  resulting from the issuance
                  of additional shares of common stock; and

         o        short sales and hedging of our common stock.


                                       28
<PAGE>


         Additionally,  the  stock  market  has  experienced  extreme  price and
trading volume fluctuations that have affected the market price of securities of
many technology companies.  These fluctuations have, at times, been unrelated to
the operating  performances  of the specific  companies whose stock is affected.
The  market  price and  trading  volume of our  stock  may be  subject  to these
fluctuations.

         IF  OUR  STOCK  DOES  NOT  SUSTAIN  A   SIGNIFICANT   TRADING   VOLUME,
STOCKHOLDERS  MAY BE UNABLE TO SELL LARGE  POSITIONS IN OUR COMMON STOCK. In the
past,  our common  stock has not  experienced  significant  trading  volume on a
consistent  basis and has not been actively  followed by stock market  analysts.
The average  trading  volume in our common stock may not increase or sustain its
current  levels.  As a result,  we cannot be certain  that an  adequate  trading
market will exist to permit  stockholders  to sell large positions in our common
stock.

         FLUCTUATIONS IN OPERATING  RESULTS MAY RESULT IN UNEXPECTED  REDUCTIONS
IN REVENUE AND STOCK PRICE VOLATILITY. We operate in an industry that is subject
to significant  fluctuations in operating results from quarter to quarter, which
may lead to  unexpected  reductions  in  revenues  and stock  price  volatility.
Factors that may influence our quarterly operating results include:

         o        the  introduction  or  enhancement  of software  products  and
                  technology by us and our competitors, and

         o        our  ability  to operate  and  expand our Altnet  peer-to-peer
                  business.

         Additionally,  a  majority  of the unit  sales for a product  typically
occurs in the  quarter in which the  product  is  introduced.  As a result,  our
revenues  may  increase  significantly  in a  quarter  in which a major  product
introduction occurs and may decline in following quarters.

         DECREASES IN THE PRICE OF OUR COMMON STOCK COULD  INCREASE  SHORT SALES
OF OUR COMMON STOCK BY THIRD PARTIES,  WHICH COULD RESULT IN FURTHER  REDUCTIONS
IN THE PRICE OF OUR COMMON STOCK. Our sales of common stock at a discount to the
market price of our common  stock,  which may be  necessary to raise  additional
capital to fund  operations,  could result in  reductions in the market price of
our common  stock.  Downward  pressure  on the price of our common  stock  could
encourage short sales of the stock by third parties.  Material  amounts of short
selling could place further downward  pressure on the market price of the common
stock.  A short  sale is a sale of stock  that is not owned by the  seller.  The
seller  borrows the stock for  delivery at the time of the short sale,  and buys
back the stock when it is necessary to return the borrowed shares.  If the price
of the common stock declines between the time the seller sells the stock and the
time the seller subsequently  repurchases the common stock, then the seller sold
the shares for a higher  price than he  purchased  the shares and may  realize a
profit.

         WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE  OF OUR  COMMON  STOCK.  Our  ability  to issue up to  700,000  shares  of
preferred  stock and some  provisions of our  certificate of  incorporation  and
bylaws and of  Delaware  law could make it more  difficult  for a third party to
make an unsolicited  takeover  attempt of us. These  anti-takeover  measures may
depress  the price of our  common  stock by making  third  parties  less able to
acquire  us by  offering  to  purchase  shares of our stock at a premium  to its
market price. Our Board of Directors can issue up to 700,000 shares of preferred
stock and determine the price, rights, preferences, privileges and restrictions,
including  voting rights,  of those shares without


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<PAGE>


any further vote or action by our  stockholders.  Our Board of  Directors  could
issue the preferred  stock with voting,  liquidation,  dividend and other rights
superior to the rights of our common stock.  The rights of holders of our common
stock  will be  subject  to,  and may be  adversely  affected  by, the rights of
holders  of the share  purchase  rights and of any  preferred  stock that may be
issued in the future. The issuance of preferred stock, while providing desirable
flexibility  in  connection  with  possible  acquisitions  and  other  corporate
purposes could make it more difficult for a third party to acquire a majority of
our outstanding voting stock.

         RISKS RELATED TO OUR BUSINESS

         ALTNET IS AN UNPROVEN  BUSINESS  VENTURE  AND MAY  REQUIRE  SIGNIFICANT
CAPITAL TO BE  SUCCESSFULLY  IMPLEMENTED.  Our Altnet  peer-to-peer  business is
unproven and we cannot  guaranty  that it will be  financially  successful.  The
success of the business  will depend,  in part, on our ability to enter into end
user agreements with a sufficient  number of qualified  personal computer owners
to  allow  the  network  to work  efficiently  and  effectively,  acceptance  by
corporate customers of our services, the technical viability of the commercially
available digital rights  management,  or DRM, software we employ to protect the
proprietary  content  that will pass  through  the Altnet  network and reside on
network  computers,  acceptance  of content  offered  through  TopSearch,  broad
acceptance and use of our micro-payment  processing  system,  and our underlying
peer-to-peer  technology.  Additionally,  we do not have  sufficient  capital to
internally fund Altnet's development and operations.  Consequently,  the capital
necessary  to fund  Altnet  and  expand  the  operations  will need to come from
outside  sources.  We cannot make  assurances  that  sufficient  capital will be
available at all or on terms  acceptable to us to fund Altnet's  development and
operations.

         ALTNET'S MICRO-PAYMENT PROCESSING SYSTEM IS RELIANT UPON THE TECHNOLOGY
AND SYSTEMS OF THIRD PARTY VENDORS THAT PROVIDE THEIR SERVICES TO ALTNET. We use
the  technology  and  services  of third  parties  to  process  payment  for the
individual  sale  of  digital  content  over  our  Altnet  peer-to-peer  system.
NewGenPay Inc. currently provides payment processing  technology and services to
us. The ability to process  payment for  individual  sales at price  points well
below  $1.00  (better  known as micro  payments)  is  integral to our ability to
commercialize  the secure  distribution  to and sale of our  customers'  digital
content to  millions  of users.  Our ability to  commercialize  Altnet  could be
materially  adversely  affected if we do not maintain our relationships with the
vendors that provide these services on our behalf. Additionally, a disruption in
these vendors'  services,  problems with their technology,  or any other matters
that interfere with their  provision of services to us could disrupt our ability
to collect  fees for the  digital  content  we  distribute,  which  would have a
materially  adverse  affect  on our  operations  and our  relationship  with our
customers.

         OUR FAILURE TO MAINTAIN A STRATEGIC  RELATIONSHIP  WITH  SHARMAN  COULD
ADVERSELY AFFECT  OPERATING  RESULTS.  We receive  compensation as the exclusive
representative  of  Sharman  for the  sale,  license,  and/or  other  commercial
exploitation  of index search results  displayed on or otherwise  accessed using
the KMD in  response  to end user  search  requests.  Additionally,  through our
business  development  arrangement with Sharman, we receive compensation for the
sale of advertising  campaigns and other revenue  received by Sharman,  which is
generated as a result of our efforts. We also receive a monthly license fee from
Sharman  in  connection  with its  license  from us of rights  to the  TrueNames
patent.  If we do not maintain our strategic  relationship


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<PAGE>


with Sharman,  these sources of revenue may be eliminated  which would adversely
affect our financial condition and results of operations.

         OUR  FAILURE TO  MAINTAIN  STRATEGIC  RELATIONSHIPS  WITH  DISTRIBUTION
PARTNERS COULD REDUCE THE NUMBER OF ALTNET PEER-TO-PEER APPLICATIONS WE ARE ABLE
TO  DISSEMINATE  TO  CONSUMERS,  WHICH WOULD  REDUCE THE NUMBER OF USERS FOR OUR
ALTNET PEER-TO-PEER BUSINESS. We distribute the software necessary to create and
run our Altnet  peer-to-peer  business  primarily by bundling it with  Sharman's
KMD. We rely on computer  users'  demand for the KMD to increase  the  installed
base of our Altnet software,  which is necessary to connect users to our private
peer-to-peer network.  Additionally,  through our agreement with Sharman, Altnet
distributes and sell digital files to users of the KMD. Our business, results of
operations and financial condition could be materially  adversely affected if we
do not maintain our distribution  relationship  with Sharman on acceptable terms
or if this  relationship  does not achieve  the  projected  distribution  of our
Altnet software or sales of authorized digital files.

         CURRENT LITIGATION AGAINST SHARMAN MAY PREVENT FURTHER  DISTRIBUTION OF
OUR ALTNET  PEER-TO-PEER  SOFTWARE,  AND  ADVERSELY  AFFECT OUR ABILITY TO SERVE
BRILLIANT  BANNERS ON, AND  DISTRIBUTE  AND SELL DIGITAL  FILES TO USERS OF, THE
KAZAA MEDIA DESKTOP.  A disruption in the  distribution of the KMD or its use by
consumers would necessarily  adversely impact (1) the future distribution of our
Altnet software,  (2) revenues we derive from serving  Brilliant  Banners on the
KMD, and (3) Altnet's sale of authorized  digital files to users of the KMD. For
the nine months ended September 30, 2004, we generated approximately 100% of our
total revenues from  activities  dependent upon the  availability  of the KMD to
computer users.  If there is a disruption in the  distribution of the KMD or its
use by  consumers,  we may not be able to replace  this source of revenue in the
short  term,  or at all.  Sharman,  the KMD,  and  other  peer-to-peer  software
products,   currently   are  the   subject  of  multiple   lawsuits,   including
METRO-GOLDWYN-MAYER STUDIOS, INC. ET. AL. V. GROKSTER LTD. ET. AL., filed in the
United States  District  Court for the Central  District of California  (Western
Division) by twenty-eight  entertainment  companies  claiming that,  among other
things,   the  KMD   facilitates,   contributes  to  and  encourages   copyright
infringement.  To the extent that Sharman is precluded from distributing the KMD
as a result of this  litigation,  our business and financial  condition could be
materially  and  adversely  affected.   While  we  understand  that  Sharman  is
vigorously defending against the claims raised in this litigation, we are unable
to determine at this time whether Sharman will prevail.

         WE HAVE  BEEN  SUED IN  AUSTRALIAN  FEDERAL  COURT AS A  RESULT  OF OUR
BUSINESS  DEALINGS  WITH  SHARMAN.  In  March  2004,  in the  Federal  Court  of
Australia,  New South Wales District Registry,  Brilliant Digital Entertainment,
Inc., our  subsidiaries  Altnet Inc. and Brilliant  Digital  Entertainment  Pty.
Limited,  and Kevin Bermeister and Anthony Rose, our Chief Executive Officer and
Chief Technology Officer, respectively, were joined as defendants in the suit by
Universal  Music Australia Pty. Ltd. and other record labels against Sharman and
other  defendants,  alleging  infringement of the copyright in sound  recordings
controlled by the  plaintiffs.  The  plaintiffs  allege that due to our business
dealings with Sharman,  we are  integrally  involved in the operation of the KMD
and therefore liable for the alleged  copyright  infringement  occasioned by its
development  and  distribution.  The  plaintiffs  are seeking  damages under the
Australian  Copyright  Act of  1968,  recovery  of  costs  and  interest,  and a
permanent injunction  restraining us from making copies of, communicating to the
public,  or  distributing  their sound  recordings  without a license.  While we
believe these claims are without  merit,  if we are unable to


                                       31
<PAGE>


have these charges  dismissed,  defending  against these claims would be costly,
and an adverse outcome may result in significant  monetary damages or injunctive
relief  against  us, all of which  would have a material  adverse  impact on our
financial position and results of operations. The lawsuit is scheduled for trial
in December 2004.

         IF OUR PRODUCTS  INFRINGE ANY PROPRIETARY  RIGHTS OF OTHERS,  A LAWSUIT
MAY BE BROUGHT  AGAINST US THAT COULD REQUIRE US TO PAY LARGE LEGAL EXPENSES AND
JUDGMENTS AND REDESIGN OR DISCONTINUE  SELLING OUR PRODUCT.  We believe that our
Altnet  software,  does not infringe any valid  existing  proprietary  rights of
third parties.  Any infringement  claims,  however,  whether or not meritorious,
could  result in costly  litigation  or  require  us to enter  into  royalty  or
licensing  agreements.  If we are found to have infringed the proprietary rights
of others,  we could be  required  to pay  damages,  redesign  the  products  or
discontinue  their sale. Any of these outcomes,  individually  or  collectively,
could have a material adverse effect on our business and financial condition.

         TO DEVELOP  PRODUCTS THAT CONSUMER'S  DESIRE,  WE MUST MAKE SUBSTANTIAL
INVESTMENTS IN RESEARCH AND DEVELOPMENT TO KEEP UP WITH THE RAPID  TECHNOLOGICAL
DEVELOPMENTS  THAT ARE TYPICAL IN OUR INDUSTRY.  The software  market and the PC
industry are subject to rapid  technological  developments.  To develop products
that consumer's  desire,  we must  continually  improve and enhance our existing
products  and  technologies  and  develop new  products  and  technologies  that
incorporate these technological developments.  We cannot be certain that we will
have the financial and technical resources available to make these improvements.
We must make improvements to our technology while remaining competitive in terms
of performance and price.  This will require us to make  investments in research
and  development,  often times well in advance of the widespread  release of the
products in the market and any revenues  these  products may generate.  Until we
become profitable,  we will need to fund these research and development  efforts
from  proceeds  we  receive  from  equity  or debt  financings.  We do not  have
sufficient  resources  to fund  long term  research  and  development,  which is
presently on hold.

ITEM 3.  CONTROLS AND PROCEDURES.

         As of September 30, 2004, the end of the period covered by this report,
our Chief Executive Officer and Chief Financial Officer,  with the participation
of our  management,  carried  out an  evaluation  of  the  effectiveness  of our
disclosure controls and procedures  pursuant to Exchange Act Rule 13a-15.  Based
upon that evaluation,  our Chief Executive  Officer and Chief Financial  Officer
believe  that, as of the date of the  evaluation,  our  disclosure  controls and
procedures are effective in making known to them material  information  relating
to us (including our consolidated  subsidiaries) required to be included in this
report.

         Disclosure  controls and  procedures,  no matter how well  designed and
implemented,  can provide  only  reasonable  assurance  of achieving an entity's
disclosure  objectives.  The likelihood of achieving such objectives is affected
by limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal  control can occur  because of human  failures such as simple errors or
mistakes or intentional circumvention of the established process.


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<PAGE>


         There were no significant  changes in our internal controls or in other
factors that could  significantly  affect internal controls,  known to our Chief
Executive  Officer and Chief  Financial  Officer,  subsequent to the date of the
evaluation.


                                       33
<PAGE>


                                     PART II

                                OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         In March  2004,  in the  Federal  Court of  Australia,  New South Wales
District  Registry,  Brilliant  Digital  Entertainment,  Inc., our  subsidiaries
Altnet,  Inc.  and  Brilliant  Digital  Entertainment  Pty.  Limited,  and Kevin
Bermeister and Anthony Rose, our Chief  Executive  Officer and Chief  Technology
Officer, respectively,  were joined as defendants in the suit by Universal Music
Australia  Pty.  Ltd.  and  other  record  labels  against   Sharman  and  other
defendants,   alleging   infringement  of  the  copyright  in  sound  recordings
controlled by the  plaintiffs.  The  plaintiffs  allege that due to our business
dealings with Sharman,  we are integrally involved in the operation of the Kazaa
Media  Desktop  and  therefore  liable for the  alleged  copyright  infringement
occasioned by its  development  and  distribution.  The  plaintiffs  are seeking
damages  under  the  Australian  Copyright  Act of 1968,  recovery  of costs and
interest,  and a permanent  injunction  restraining  us from  making  copies of,
communicating to the public,  or distributing  their sound recordings  without a
license.  We  believe  these  allegations  are  without  merit,  and  intend  to
vigorously  defend  against these claims.  The lawsuit is scheduled for trial in
December 2004.

ITEM 2.  CHANGES IN SECURITIES  AND SMALL  BUSINESS  ISSUER  PURCHASES OF EQUITY
         SECURITIES

         In  November  2004,  in  consideration  of an  agreement  to extend the
maturity date of our secured convertible promissory notes to September 26, 2005,
we (i)  reduced  the  conversion  price of the  notes to $0.07 per  share,  (ii)
extended the expiration date of related warrants to purchase  73,787,613  shares
of our  common  stock held by the note  holders  to  October 4, 2008,  and (iii)
reduced the exercise price of the these warrants to $0.07 per share.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         On September 26, 2004, we failed to pay  $4,209,000 of the  outstanding
principal  amount,  accrued  interest,  fees and  costs  that  were then due and
payable to our secured  convertible  note holders pursuant to our senior secured
convertible  promissory  notes.  In November  2004, we entered into an agreement
with the note holders to extend the maturity date of the secured indebtedness to
September 26, 2005.

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

         On September 14, 2004, we held our 2004 Annual Meeting of Stockholders.
At the annual  meeting,  there were  42,857,153  shares  entitled  to vote,  and
35,481,807  (82.8%)  were  represented  at the  meeting  in  person or by proxy.
Immediately  prior to and  following  the meeting,  the Board of  Directors  was
comprised of Kevin  Bermeister,  Mark Miller,  Russell  Simmons,  Ray Musci, Abe
Sher, and Vincent Bitetti.

         The following  summarizes  vote results for those matters  submitted to
our stockholders for action at the annual meeting:


                                       34
<PAGE>


         1.       Proposal  to elect  Mark  Miller and Ray Musci to serve as our
Class II directors for three years and until their successors have been elected.

          DIRECTOR                     FOR                        WITHHELD
          --------                     ---                        --------
        Mark Miller                 35,265,634                    216,173
         Ray Musci                  35,355,384                    126,423

         2.       Proposal to amend our 1996 Stock  Option Plan to increase  the
number of authorized shares to 35,000,000.

   FOR                 AGAINST           ABSTAIN         BROKER NON-VOTES
   ---                 -------           -------         ----------------
22,526,301             420,447            5,734             12,529,322


         3.       Proposal  to amend our  Amended and  Restated  Certificate  of
Incorporation  to increase the  aggregate  number of shares of common stock from
250,000,000 to 350,000,000.

   FOR                 AGAINST           ABSTAIN         BROKER NON-VOTES
   ---                 -------           -------         ----------------
35,213,598             261,682            6,527                 --


ITEM 6.  EXHIBITS

THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS REPORT:

         3.1      Amended  and  Restated  Certificate  of  Incorporation  of the
                  Registrant, as amended.

         10.1     Registrant's  Fourth  Amended and  Restated  1996 Stock Option
                  Plan.

         31.1     Certificate  of  Chief  Executive  Officer  pursuant  to  Rule
                  13a-14(a)  under the  Securities  and Exchange Act of 1934, as
                  amended.

         31.2     Certificate  of  Chief  Financial  Officer  pursuant  to  Rule
                  13a-14(a)  under the  Securities  and Exchange Act of 1934, as
                  amended.

         32.1     Certificate  of Chief  Executive  Officer and Chief  Financial
                  Officer  pursuant to Rule  13a-14(b)  under the Securities and
                  Exchange Act of 1934, as amended.


                                       35
<PAGE>


                                   SIGNATURES

         In accordance  with the  requirements  of the Exchange Act of 1934, the
Registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereunto duly authorized.

                                   BRILLIANT DIGITAL ENTERTAINMENT, INC.


Date: November 15, 2004              /S/ TYLER TARR
                                   -------------------------------------------
                                   By:    Tyler Tarr
                                   Its: Chief Financial Officer
                                   (Principal Financial and Accounting Officer)


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