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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                 AMENDMENT NO. 2
                                       TO
                                  FORM 10-KSB/A

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

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

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

                         COMMISSION FILE NUMBER 0-22250

                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                 (Name of Small Business Issuer In Its Charter)

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

                    6355 TOPANGA CANYON BOULEVARD, SUITE 120
                        WOODLAND HILLS, CALIFORNIA 91367
              (Address of Principal Executive Offices and Zip Code)

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

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

                                                          Name of Each Exchange
     Title of Each Class                                   on which Registered
COMMON STOCK, $.001 PAR VALUE                            AMERICAN STOCK EXCHANGE

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

                                      NONE

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

                                 Yes [X]   No [_]

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

         The issuer's  revenues for the fiscal year ended December 31, 2001 were
$1,816,000.

         At June 24, 2003,  the aggregate  market value of the voting stock held
by non-affiliates of the issuer was $11,236,608.

         At June 24, 2003,  the issuer had  40,114,978  shares of Common  Stock,
$0.001 par value, issued and outstanding.

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

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions  of the  issuer's  Proxy  Statement  with  respect to its 2002
Annual Meeting of  Stockholders  are  incorporated by reference into Part III of
this Report.

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                                 AMENDMENT NO. 2
                  TO THE ANNUAL REPORT ON FORM 10-KSB FILED BY
             BRILLIANT DIGITAL ENTERTAINMENT, INC. ON APRIL 1, 2002

         The  following  amends  the  Annual  Report  on Form  10-KSB  filed  by
Brilliant  Digital  Entertainment,  Inc.  (the  "Company") on April 1, 2002 (the
"Form  10-KSB"),  as permitted by the rules and  regulations  promulgated by the
Securities  and Exchange  Commission.  The Form 10-KSB is hereby  amended as set
forth herein.

                                     PART I

ITEM 1.    DESCRIPTION OF BUSINESS

                               CORPORATE OVERVIEW

         Brilliant  Digital  Entertainment,  Inc. is a  developer  of rich media
advertising serving technologies, software authoring tools and content for three
dimensional,  or 3D,  animation on the World Wide Web. During the third quarter,
2001 we began marketing and  distributing  our player,  the "Digital  Projector"
(required for the playback of our rich media content and advertisements) through
two large peer-to-peer,  or P2P, networks,  Sharman Networks, which operates the
KaZaA network (formerly  operated by Consumer  Empowerment B.V.), and StreamCast
Networks, which operates the Morpheus network. Previously, our primary method of
distribution  was  through  the  bundling  of the  Digital  Projector  with  our
animation  content which we syndicated to third party web sites. At December 31,
2001, we estimate that our Digital  Projector  had been  distributed  to tens of
millions of users based on KaZaA's weekly downloads as reported on Download.com,
as additional  P2P  connected  computers and other users have accessed the KaZaA
and Morpheus networks.  Sharman Networks continues to distribute our player, and
StreamCast  Networks  unilaterally  decided to discontinue its distribution.  We
commercialize  our  advertising  technology  in two primary ways. We license our
rich media advertising server technologies to websites to enable the selling and
serving of our proprietary  rich media  advertising  format,  and we license our
rich media  content  authoring  tools - "b3d  Studio"  and "b3d Studio Pro" - to
production studios.

         We launched our rich media 3D advertising banners - Brilliant Banners -
into the market  during the first quarter of 2001 to offer  advertisers  and web
sites an alternative to the current Graphics Interchange Format, or GIF, banners
that are prevalent on web sites today.  Rich media  advertising  banners are web
site banner ads that have full audio and motion  animation.  We believe that our
animated 3D banner  advertisements  perform better than GIF banners because they
include motion animation and full audio,  which is more engaging to a viewer. We
have  introduced  the  Brilliant  Banner  to  our  syndication  partners,  other
significant advertisers and websites, making the technologies available for them
to commence selling and serving this rich media advertising format.

         In February 2002, we formed  Brilliant P2P, Inc., later renamed Altnet,
Inc., to operate a  peer-to-peer-based  content distribution network that allows
Altnet to securely and efficiently  distribute a content  owner's music,  video,
software and other digital files to computer users.  Using internally  developed
and licensed technology, we intend to create a private, or "closed" peer-to-peer
network,  which allows us to  centrally  control the  distribution  of a digital
file,  which has been  authorized by its owner,  directly from one computer user
(peer) to another  (peer).  Our ability to control  which files are  distributed
over our private network,  as well as our use of widely available digital rights
management (or DRM) technologies from Microsoft Corporation, TryMedia and others
to protect  against  copyright  infringement,  will prevent the  distribution of
unauthorized files over our network and help to protect against the unauthorized
use of a digital  file  distributed  over our network  once it resides on an end
user's  computer.  We intend to exploit  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 from the
Altnet network. We own 51% of the outstanding capital stock of Altnet and manage
all of its day-to-day operations, and the remaining 49% is owned by Joltid, Ltd.
(formally  known as  Blastoise,  Ltd.),  the  company  from  whom we  license  a
substantial portion of Altnet's peer-to-peer technology.


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         We have  licensed  some of the world's  best known  characters  for the
production  and web  distribution  of episodic  animations,  called  MultipathTM
Movies,  that include SUPERMAN,  XENA: WARRIOR PRINCESS,  KISS, and ACE VENTURA,
and have  produced  animated  music videos of top selling  artists  including Ja
Rule,  Ludacris,  DMX and Li'l Romeo. These full-screen  productions,  developed
using our proprietary  suite of b3d software tools,  have small files for faster
download  relative to full video files.  Currently we distribute select animated
content through Internet  syndication  partners  including Warner Bros.  Online,
Roadrunner and selected sites from the Universal Music Group.

         In  2001,  we  substantially   reduced  our  internal   production  and
syndication  of 3D animation,  which we used primarily to distribute our Digital
Projector,  in  order to  reduce  our  costs  and our cash  burn  rate.  We have
substantially  reduced  operations  at Digital Hip Hop,  the entity we formed to
produce  animated  music videos for the World Wide Web,  and have  substantially
reduced   operations   at   Brilliant   Interactive   Ideas   Pty.   Ltd.,   our
Australian-based  production  company  which  employs  a team of  animators  and
programmers  dedicated  to  animation   production.   We  substantially  reduced
operations at Digital Hip Hop based on the limited  prospects of additional  web
video  production  work.  We  substantially   reduced  operations  at  Brilliant
Interactive  Ideas Pty. Ltd.  because of the under  utilization of animators and
programmers which occurred following the termination of our production agreement
with Warner Bros.  Online and the reduction of Digital Hip Hop. The  significant
reduction of operations at Brilliant Interactive Ideas Pty. Ltd. and Digital Hip
Hop has reduced costs in business  segments that were not generating,  and which
we concluded do not have the potential to generate,  significant  revenues.  The
reduction in our content production and syndication activities has allowed us to
focus our efforts and allocate  our  resources  to the further  development  and
exploitation of our advertising  serving and authoring tools businesses,  and to
pursue the development of a private,  peer-to-peer  network business through our
Altnet subsidiary.

         We are a Delaware  corporation  that was  incorporated in July 1996. We
were formed through the  combination of two  businesses:  Brilliant  Interactive
Ideas, Pty. Ltd., an Australian  entertainment  software developer and producer,
and Sega Australia New  Developments,  a research and development  operation for
leading edge software tools.  Our executive  offices are located at 6355 Topanga
Canyon Boulevard, Suite 120, Woodland Hills, California 91367, and our telephone
number is (818) 615-1500. Information on our web sites, www.brilliantdigital.com
and www.b3d.com, does not constitute part of this Form 10-KSB.

                               TECHNOLOGY BUSINESS

         We license our rich media advertising server  technologies to web sites
to enable  advertisers  and web sites to display  our rich media 3D  advertising
banners - Brilliant  Banners - as an alternative to the current two dimensional,
or 2D, GIF banners that are prevalent on web sites today.  Tests conducted by us
have  shown  that  small  advertising   campaigns  created  and  served  in  our
advertising  format have generally  provided click through rates higher than the
industry norm for static,  2D GIF banner ads.  Specifically,  we tested the same
advertised product in two banner ads; one produced as a Brilliant Banner and the
other as a 2D, GIF banner.  The  click-through  percentages  (the  percentage of
users who saw the ad and then  clicked the  banner),  which we used to determine
the effectiveness of the ads, were 3.3% for the Brilliant Banner ad and 0.2% for
the 2D GIF ad, on a total of  approximately  2 million  banner  ads  served.  We
believe that, based on this test, our rich media animated, 3D banner ads perform
better than GIF banners  because they include  motion  animation and full audio,
which is more  engaging to a viewer.  We are also  introducing  our  advertising
format to third party ad serving  companies,  making our technologies  available
for them to commence selling and serving this new rich media advertising format.
In November 2001, we became a Rich Media Silver Vendor of DoubleClick, Inc. This
rich media certification was awarded after our technology passed the DoubleClick
tests for  functionality,  impression  tracking and click  tracking.  We believe
DoubleClick  to be the  technological  leader for ad serving on Web, and believe
that having our rich media ad serving  technology  certified by DoubleClick is a
significant  achievement.  According to a March 14, 2002 press release issued by
DoubleClick,  "The DART rich media  vendor  certification  program  launched  in
October  2001,  provides  confidence  to any  advertiser  or publisher  that the
relevant  technology has passed stringent  requirements.  The certification is a
seal of  approval  that  guarantees  that  rich  media  creatives  meet the high
standards  of   functionality   and  reporting   required  of  all   DoubleClick
technologies."  At December 31, 2001,  we were one of only seven vendors to have
received the Rich Media Silver Vendor certification from DoubleClick.


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<PAGE>


         Our proprietary,  copyright-protected, rich media authoring tools - B3D
STUDIO  and B3D STUDIO  PRO - were  developed  to be the  optimal  software  for
creating digital animation that could be streamed easily and efficiently via the
Internet.  b3d  Studio is  designed  to work as a  plug-in  with  Discreet's  (a
division of Autodesk,  Inc.) 3D STUDIO MAX and Alias|Wavefront's  MAYA animation
software.  We have licensed our software  tools to other content  developers and
studios  interested in creating content for the Internet.  We have also used our
tools to create our  MultipathTM  Movies and  animated  music  videos,  with the
intent that users would desire to view this engaging b3d content. We believe the
demand by users for b3d-produced content would cause a demand for our tools from
producers of such content, and thus make our tools the de facto standard for the
production,  distribution  and viewing of 3D animation  over the Internet.  This
strategy  however  has been met with  little  success,  and  given  our  limited
financial resources, our ability to continue this strategy has been diminished.

         The primary components of our rich media technologies include:

         o        Digital  Projector - a playback  device  used to view  content
                  created  with  our  b3d  software  tools  that  is  seamlessly
                  downloaded and transparently installed to a user's computer.

         o        b3d Studio and b3d Studio Pro - the  authoring  tools used for
                  the  lay-up,  directing,  producing  and  editing of real time
                  animation  designed for output to the World Wide Web and other
                  media.

         o        Brilliant  Banner Ad Server - a  technology  that  enables the
                  serving of Brilliant Banner  advertisements to third party web
                  sites.

         o        b3d  Installer  -  a  technology   that  enables  our  Digital
                  Projector and content to be installed  without taking the user
                  out of their Internet browser.

         o        b3d  Reporting - a reporting  technology  used to analyze,  in
                  real  time,   the   performance   of   content,   particularly
                  advertising banners, produced using b3d Studio.

SALES, MARKETING AND DISTRIBUTION OF OUR TECHNOLOGY

         We have engaged the services of two outside  consultants  whose primary
responsibilities  are to promote and sell our technology.  Senior  management is
also  marketing  and  promoting  the  advantages  of our  b3d  products.  We are
marketing our rich media advertising  solutions to advertising  agencies,  third
party  advertising  representative  firms and directly to  advertisers.  Our b3d
products were made commercially  available as a download from our website in the
third quarter of 2001 and we are also marketing our content  authoring  tools to
production  companies,  including those that  participated in a beta test of the
tools during 2000.  Animation  content generated using b3d Studio can be applied
to the production of training, artistic rendering,  educational,  architectural,
engineering,  e-commerce, and other solutions that require animation. We believe
that broad use of our tools in the creation of animated  content will  encourage
greater use of the Digital  Projector,  and establish  broader demand for our ad
serving technologies.

         We  generally  charge  a fee to  our  clients  for  the  production  of
Brilliant Banners,  which we outsource to third party production firms at a cost
that  generally  equals the fee we receive  from our client.  Consequently,  the
production of Brilliant  Banners is not profitable for us. We also receive sales
commissions from the publishers of web sites on which we place Brilliant Banners
advertisements.  Our  long-term  strategy,  however,  is to  derive  revenue  by
licensing our ad-serving product,  which is required to serve Brilliant Banners.
Our ability to derive significant licensing revenue, however, depends in part on
the market's acceptance of the Brilliant Banner as viable rich media advertising
solution.

CONTENT PRODUCTION TOOLS

         We have developed several  integrated  proprietary  software tools that
enable us to produce Internet-ready, high-quality animated content.


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         B3D STUDIO AND B3D STUDIO PRO.  b3d  Studio is the  centerpiece  of the
content  development and production  process.  b3d Studio is an  object-oriented
environment  that  collects  and  integrates  source  files  from  ScripNav  and
TalkTrack  with  graphics,  sound and  animation,  and makes them  available for
lay-up,  editing and final output.  ScripNav was developed  specifically for the
writing of complex,  interactive 3D animated content,  including our MultipathTM
Movies  and  interactive  banner ad  scripts.  It is used to  compose,  edit and
finalize a script using a commercially  available word  processing  package.  It
provides for the insertion of various subplots into scenes in order to adapt the
script to the interactive format of the MultipathTM Movie, game or online banner
ad.  TalkTrack  automatically  synchronizes  a character's  lip  movements  with
corresponding  dialogue tracks.  TalkTrack does this by examining wave files and
generating output files that contain references to the appropriate mouth shapes.
TalkTrack  allows  for low cost  modification  of the  animated  content  to any
language without the awkward  appearance of dubbed movies. b3d Studio provides a
multi-window editing environment in which the developer can preview, analyze and
edit the final  product.  b3d Studio  includes a Shot Based Editing  System that
enables movie "clips" to be  incorporated  into a scene. It also allows cuts and
edits to take place,  as in a traditional  film  environment.  For example,  the
specific  scene data (sets and props) can be loaded  into memory and viewed from
different camera positions.

         b3d Studio, through its Data Compression Wizard, builds, integrates and
compresses  the data  files to  create a b3d file to be  played  on our  Digital
Projector.  The Data Compression Wizard arranges,  assembles and, using licensed
technology,  compresses  thousands  of audio and bitmap  files that are  created
during the development of a MultipathTM Movie or other b3d animation in a manner
that optimizes the playing of the title. The Data Compression  Wizard compresses
files allowing up to five hours of branching content to be captured in less than
60 megabytes of disk space, as compared with  conventional  technologies,  which
presently would require at least one gigabyte of storage.

         DIGITAL  PROJECTOR.  The Digital  Projector  contains all the necessary
components to load and play b3d animations or any animation files that have been
designed using our b3d technology.  The Digital Projector is the software engine
that the system uses to play everything from a Brilliant Banner to a music video
to a MultipathTM  Movie,  each produced in our b3d format,  and is generally the
only software tool that we must continually  modify to permit the b3d content to
be adapted to new platforms. The Digital Projector was developed exclusively for
the PC. Presently,  we have no intention of developing the Digital Projector for
use on other platforms.

         In addition to our proprietary software tools and engines, we and other
b3d content  producers  use certain  commercially  available  sound and graphics
tools in the production process.

CONTENT TOOLS APPLICATIONS

         The  b3d   software   tools   suite   allows   for  the   creation   of
three-dimensional  objects that function within a three-dimensional  environment
that can be updated in real time.  Examples  of the  applications  for the tools
suite include:

         o        Entertainment   content   delivered  over  the  Internet,   on
                  traditional  broadcast and cable  television and on CD-ROM and
                  DVD

         o        Internet advertisements

         o        Virtual storefronts with database enabled e-commerce

         o        Educational programming

         o        Sports instruction

         o        Personal online persona

         o        Virtual   reality   content   applications   and   environment
                  management


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B3D STUDIO TOOLS ADVANTAGES

         We believe our b3d  technology  is one of only a few known  methods for
creating  high-quality  linear and  interactive  programming  for the  Internet,
traditional  television   broadcasting,   DVD  and  CD-ROM  utilizing  a  single
production process. Our current b3d technology offers the following  significant
advantages over competing rich media or 3D real time animation technologies:

         SMALLER DATA  TRANSMISSION  REQUIREMENTS.  While certain media requires
the  compression  and  transmission of each frame in a video image (there are 25
frames  per  second  of  video  image),  our b3d  technology  requires  only the
transmission of animation instructions,  which consist of commands such as "move
the left arm upwards by 12  degrees." As a result,  b3d files  require much less
data to be  transmitted,  which allows b3d files to be streamed more easily over
the Internet.

         SMALL FILES AND FAST RENDERING.  b3d files are highly compressed binary
images with simple  command  sets,  requiring  small files and resulting in fast
rendering.

         INTERACTIVITY.  b3d files  offer  interactivity.  We have  developed  a
unique  pre-load  system to enable story or interactive  branching to take place
seamlessly and without interruption to the story or visual representations.

         STREAMING  DURING  PLAYBACK.  b3d files allow  content to begin playing
after  only a  portion  of the  program  has been  downloaded,  with  sound  and
animation  continuing  to stream  over the  Internet  while the  content  plays.
Competing formats generally require that the entire program be downloaded before
the user can begin to play the content.

         SCALABLE  SCREEN  SIZE.  b3d files can scale from small  thumbnails  to
full-screen  movies without  degradation.  Competing  formats  generally  either
pixelate as users enlarge the screen, or are restricted to a partial screen.

         SCALES WITH INTERNET BANDWIDTH. Our Digital Projector can automatically
detect Internet  bandwidth and selects the best-quality  soundtrack and textures
that can be streamed within this bandwidth.  This is superior to those competing
products,  which offer bandwidth scalability,  but generally require the user to
manually select their bandwidth requirements.

         LOW SERVER IMPACT. The continuous stream of video data served on demand
to viewers worldwide continues to present a significant challenge.  In contrast,
much of the data  required  to view b3d files  resides on the  user's  computer.
Consequently, less data is required to be streamed to the user while the content
plays.  In  addition,  b3d  files  compress  to  under  10% of a  similar  video
advertisement.

         SERVER-CLIENT  SIDE  CONTROL.  b3d  technology  has  evolved  to enable
control  over  images  delivered  to the  viewer  in  real  time  by  the  party
responsible  for serving the image.  Images  related to 3D geometry or animation
can be managed by the host to be directly  responsive to  decisions,  choices or
the  interaction  of the viewer.  This  enables  the party  serving the image to
change the client's view in real-time in accordance  with  demographic  data and
profiling  intelligence.  All data on the client and server  side is managed via
the b3d file format.

         USER  FRIENDLY.  To  achieve  acceptance  with  the  broadest  possible
audience,  we strive to make our products more  user-friendly  than those of our
competitors, as follows:

         o        VERSATILE PLAYABILITY. b3d files play with just a double-click
                  of the mouse and in a number of different formats,  such as on
                  a web page,  inside an e-mail,  in a word processor  document,
                  spreadsheet or PowerPoint  presentation.  With  self-contained
                  b3d files,  everything  needed to view the animated content is
                  contained  in a  single  b3d  file,  eliminating  the need for
                  program installation.


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<PAGE>


         o        WEB SITE  OPERATORS.  b3d files do not require  special server
                  software with attendant  license fees. b3d files can be placed
                  on  any  HTTP  web   server   without   any   special   server
                  requirements.  Their ease of use and low bandwidth requirement
                  appeal to web site operators.

         o        ANIMATORS.  While using our b3d Studio plug-in for Maya and 3D
                  Studio Max,  animators  using these popular 3D design packages
                  can quickly and easily  output  their work as a small b3d file
                  and play it on a web page in a full  screen  window  with high
                  clarity.

         o        ADVERTISERS.   The  current  standard  advertising   mechanism
                  features silent,  animated Graphics  Interchange  Format (GIF)
                  files.  Our  technology  allows  for  the  use  of  real-time,
                  3D-based  banner  advertisements  with  animated  graphics and
                  streaming sound. More  significantly,  b3d  advertisements are
                  interactive.   We  believe  that  interactive   advertisements
                  improve the likelihood  that viewers will be interested in the
                  ads, remember the product being advertised and are more likely
                  to click on the ads.  We believe  that b3d created ads will be
                  desirable to web site operators, who will encourage their use,
                  because of the greater effectiveness of the ads.

         o        E-COMMERCE.  b3d  designers  may  program  the  files  so that
                  consumers can only play certain content from within a specific
                  web site or only on one  occasion,  even though the viewer has
                  already  downloaded  the  data  to  their  personal  computer.
                  Because  b3d  content  is   interactive,   e-commerce  can  be
                  integrated  into the  content to produce  sales  opportunities
                  online.  Furthermore,  the  capacity to control  images on the
                  viewers'  personal  computer  enables  product  placement  and
                  responsive content to be created.

THE B3D INSTALLER

         We have  developed  installation  technology  that  enables our Digital
Projector  and  content  to be  installed  without  taking the user out of their
Internet browser. The installer works in conjunction with encrypted installation
scripts  and a  backend  database  to  manage  objects  on the  user's PC and to
synchronize  assets on the user's PC with those on the server.  This will enable
the future integration of e-commerce  components into content and enable content
to  be  updated  on  a  regular  basis.  For  instance,  in a  virtual  shopping
application,  with each visit to the virtual  supermarket,  the  Installer  will
detect objects and automatically update the user's PC with the files required to
display items in the order pre-determined by the vendor.

PENDING PATENTS

         The technology  involved in creating and maintaining a state-of-the-art
tools  suite  represents  a  significant  barrier  to  entry  for new  and  less
technologically advanced competitors. We have eight pending patents with respect
to our tools suite, which, if issued, will include the following subject areas:

         o        Streaming Internet Data -- This patent application describes a
                  method  of  streaming  data  over the  Internet  for real time
                  playback of 3D animated interactive movies.

         o        Automated  Lip Sync -- This patent  application  describes how
                  mouth  shapes are created by lip sync  recognition  algorithms
                  and applied to 3D objects as gestures.

         o        Controlling  3D Object  Gestures  -- This  patent  application
                  describes a method of assigning  and  applying  gestures to 3D
                  animated objects.

         o        Preloading,  Caching and Look Ahead of Internet  Streamed Data
                  -- This  patent  application  describes  a method  of  storing
                  multiple files within a single file for interactive  streaming
                  of 3D animation data.

         o        Real Time  Scalability of Real Time 3D Graphics -- This patent
                  application  describes the method of creating and playing back
                  animated  content such that the content  scales with available
                  playback CPU power and available Internet bandwidth.


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<PAGE>


COMPETITION FOR OUR RICH MEDIA AD FORMAT AND SOFTWARE TOOLS

         The market for products and services in the online advertising industry
is very competitive.  We expect this competition to continue to increase because
there are low barriers to entry as well as expected industry  consolidation.  We
believe that our ability to compete  depends on many factors,  some of which are
beyond our control,  including  the  following:

         o        Enhancements to existing ad serving solutions developed either
                  by us or our competitors;

         o        New ad serving  solutions  developed by our  competitors  with
                  superior attributes;

         o        Our ability to provide adequate support for our customers;

         o        Our sales and marketing efforts;

         o        Patents granted to competitors  which may limit our ability or
                  our  partners'  ability to compete in certain ad markets or to
                  use certain techniques;

         o        Market acceptance of our Brilliant Banner; and

         o        General improvement in the online advertising environment.

         There are a number of  companies  that  provide  ad  serving  services,
including  many which are focused on  establishing  their format as the de facto
standard for ad serving on the Web, including  DoubleClick,  Inc., Engage,  Inc.
(through its Accipiter product), and Real Media (a unit of 24/7 Real Media).

         We compete for Internet  advertising revenues with large Web publishers
and Web portals,  such as AOL Time Warner,  Microsoft Corporation and Yahoo!. We
also compete with the traditional advertising media of television,  radio, cable
and  print  for a share  of  advertisers'  total  advertising  budgets.  We also
encounter  competition  from  a  number  of  other  sources,  including  content
aggregation   companies,   companies  engaged  in  advertising  sales  networks,
advertising agencies and other companies that facilitate Internet advertising.

         We expect the market for rich media  advertising  technologies  to grow
given  that  consumer  response  to, and thus the value to  advertisers  of, two
dimensional,  static GIF banner ads on the Internet has  declined  rapidly.  The
decline in value of 2D GIF  advertisements  has caused  both large and small web
advertisers  to seek viable  alternatives.  Rich media  alternatives,  including
Brilliant Banners, are being considered by advertisers and web site operators as
solutions to 2D GIF banner advertisements,  where the standard click through has
declined  to less  than  one  half of one  percent.  We  believe  our  principal
competitors in the delivery of rich media advertisements are those vendors whose
technologies,   like  ours,   have   received  the  Rich  Media  Silver   Vendor
certification  from  DoubleClick,  Inc. These vendors include Enliven,  Unicast,
eyeblaster,  eyeReturn and Poindexter.  We are at a competitive  disadvantage to
many of our competitors  because their rich media  advertisements  can be viewed
without special software programs,  unlike our Brilliant Banners, which can only
be viewed by users who have previously  downloaded our Digital Projector.  Given
that  Brilliant  Banners  and  other  forms  of rich  media  advertisements  are
performing  much  better  than  2D GIF  advertisements,  we  believe  additional
competitors will enter the rich media advertisement market.

         The markets for our content  production  software tools are competitive
and subject to rapid change  characterized  by both the constant  demand for new
product features at reduced prices and the pressure to accelerate the release of
new features and tool enhancements.  Companies  competing in this market include
established  companies  like  Macromedia,   Inc.,  Adobe  Systems,  Inc.,  Pulse
Entertainment,  Inc. and Viewpoint  Corporation.  Certain of our competitors are
focused on  two-dimensional  technologies as can be seen in the Macromedia FLASH
toolset,  while others offer three dimensional  animation.  We expect additional
competitors  to enter  the  market  as the  demand  for  Internet-ready  content
increases.


                                       7


<PAGE>


                       CONTENT PRODUCTION AND SYNDICATION

         We  built  our  content  production  and  syndication   businesses  and
associated  technologies  in part to increase  the use and  availability  of our
Digital Projector.  Viewers watch Brilliant Banners,  music videos,  animations,
MultipathTM  Movies  (movies  produced with multiple  endings,  depending on the
"path"  chosen by the user) and other  b3d-produced  content  using the  Digital
Projector,  which resides on a user's hard drive.  Increasing the installed base
of  Digital  Projectors  increases  the  number  of  users  who are able to view
b3d-produced  content,  such as Brilliant Banners,  which makes b3d content more
appealing to  advertisers  as well as content  developers who may be inclined to
license our tools.

         Historically,  our Digital Projector  distribution strategy has been to
create appealing entertainment content, such as our MultipathTM Movies and music
videos,  and  syndicate  that  content to third  party web sites for  viewing by
computer users.  The initial viewing of the content would initiate a download of
our Digital Projector.  This strategy was only moderately successful,  requiring
expensive and time consuming  production of entertainment  content and resulting
in approximately  four to five million actively  installed Digital Projectors at
June 30, 2001.  Commencing in September  2001, we changed our Digital  Projector
distribution strategy and began bundling our Digital Projector with downloads of
Sharman Networks' KaZaA Media Desktop and StreamCast Network's Morpheus network.
Due to the popularity of these file-sharing  networks,  at December 31, 2001, we
estimate that our Digital  Projector had been distributed to tens of millions of
users as additional  P2P  connected  computers and other users have accessed the
KaZaA and Morpheus networks. Sharman Networks continues to distribute our player
and StreamCast Networks has discontinued its distribution.  The weekly downloads
of the KaZaA Media Desktop and, consequently, our Digital Projector continued to
average  approximately  two million during January and February 2002, and can be
initiated  from  both  the  home  page,  www.kazaa.com,  and  from  the web site
www.download.com,  operated by CNET  Networks,  Inc.  Due to the success of this
distribution  channel,  as well as the fact that our internal content production
facilities  were  operating  on a  negative  cash flow  basis,  we are no longer
pursuing content  production and syndication as a primary means for distribution
of our Digital Projector.

         We also  pursued our content  production  and  syndication  business to
generate  revenue by sharing  advertising  revenues  with  syndication  partners
displaying  our  content.  Because of the  significant  decline  in  advertising
revenues generated by "content only" web sites, who were our primary syndication
partners, we have also discontinued pursuing this business.

         Due to these changes in our business strategies,  in 2001 we eliminated
our  internal   production  of  3D  animation  and  substantially   reduced  our
syndication of existing content.  We have  substantially  reduced  operations at
Digital Hip Hop, the entity we formed to produce  animated  music videos for the
World  Wide  Web,  and  have  substantially   reduced  operations  at  Brilliant
Interactive  Ideas Pty.  Ltd.,  our  Australian-based  production  company which
employs a team of animators and programmers  dedicated to animation  production.
We  substantially  reduced  operations  at Digital  Hip Hop based on the limited
prospects of additional  web video  production  work. We  substantially  reduced
operations  at  Brilliant  Interactive  Ideas  Pty.  Ltd.  because  of the under
utilization  of  animators  and   programmers   which  occurred   following  the
termination  of our  production  agreement  with  Warner  Bros.  Online  and the
significant  reduction  of Digital  Hip Hop.  The  reduction  of  operations  at
Brilliant  Interactive  Ideas Pty. Ltd. and Digital Hip Hop has reduced costs in
business  segments that were not generating,  and which we concluded do not have
the potential to generate, significant revenues. We now outsource the production
of b3d content,  primarily  Brilliant Banners,  to a number of facilities in the
United  States and  overseas  that have already  licensed  our tools.  It is our
intention to expand the number of third  parties  capable of creating  Brilliant
Banners, including the production departments of advertising agencies.

CONTENT PRODUCTION

         Historically,  we developed a broad range of b3d animation  designed to
appeal to a variety of viewer demographics.  We placed greater emphasis on using
characters from familiar  licensed content in order to aid our online technology
distribution  efforts.  Some of our  previous  production  efforts  included the
development of titles in the following categories:


                                       8


<PAGE>


         MUSIC.  Through  our  Digital Hip Hop  venture,  we produced  animated,
online music videos for top selling artists from Island Def Jam (a subsidiary of
Universal Music Group), Priority Records and DreamWorks Music, some of which may
still be viewed at web sites operated by these companies.

         MULTIPATHTM WEBISODES. Our MultipathTM Movie webisode series, including
SUPERMAN, ACE VENTURA, XENA: WARRIOR PRINCESS and KISS IMMORTALS,  among others,
were made available by our syndication  partners.  Warner Bros. Online continues
to make available the Superman series,  which may generate future revenue for us
depending on the success of Warner's  internal  sales team to sell the available
advertising space.

         CHOOSE YOUR OWN NIGHTMARE SERIES.  The CHOOSE YOUR OWN NIGHTMARE series
of MultipathTM  Movies were targeted to children,  eight to twelve years of age.
All of these titles are based upon Bantam  Doubleday  Dell's popular  children's
book series, CHOOSE YOUR OWN ADVENTURE and CHOOSE YOUR OWN NIGHTMARE.

         MULTIPATHTM MOVIES FOR KIDS.  MultipathTM Movies for Kids were targeted
to children three to twelve years of age. The first title we developed was QUEST
FOR THE WOOLLY  MAMMOTH,  followed by THE SUNKEN  TREASURE  and THE RESCUE,  all
featuring Popeye.

         We are now focused on the production of rich media advertising banners,
primarily  through  outsource  agreements with third party production  companies
which have already  licensed our  software  tools.  We believe that the superior
performance  of rich media  advertisements  as  compared to  traditional  2D GIF
advertisements  will drive the demand for our Brilliant Banners.  The rich media
components of our Brilliant  Banners  include sound and high quality  animation,
which serve to increase  click through rates and increase the  efficiency of the
advertising message being delivered, making Brilliant Banners significantly more
saleable and at higher prices than 2D GIF advertisements.

         We  announced  in  July  2001  that  Warner  Bros.  Online  ordered  an
additional 30 webisodes of The MultipathTM  Adventures of SUPERMAN.  In December
2001, however,  the production  agreement with Warner Bros. was terminated after
the delivery of the first 12  additional  webisodes,  which  Warner Bros.  began
making available on Warner Bros.  Online in February 2002. This brings the total
number of SUPERMAN webisodes ordered and delivered to Warner Bros Online to 57.

CONTENT DISTRIBUTION

         Historically,  we distributed  our MultipathTM  Movies,  animated music
videos  and  other  entertainment  content  through  a  network  of  syndication
partners, including:

         WARNER  BROS.  ONLINE.  Warner  Bros.  Online  continues to feature our
content. Our SUPERMAN MultipathTM Movie Webisodes are on the Warner Bros. Online
website.  Previously  Warner  Bros.  Online  also  displayed  some of the  other
selected  MultipathTM  Movie content,  including KISS IMMORTALS,  XENA:  WARRIOR
PRINCESS and the CHOOSE YOUR OWN NIGHTMARE series, as well as hosted some of the
web videos we produced including Li'l Romeo.

         YAHOO!.  We  entered  into  a  content   distribution  and  promotional
agreement  with  Yahoo!  Inc.  Through  the  agreement,  we provided 3D animated
programming based on, and co-produced in conjunction with, the popular rock band
KISS as part of our KISS  IMMORTALS  series.  In  addition  to  making  the KISS
Webisodes  available  on  Yahoo!  Entertainment,   we  developed  a  customized,
co-branded  version  of  our  3-D  Digital  Projector,  which  linked  to  other
properties on the Yahoo! network, including Yahoo! Shopping and Yahoo! Music.

         STUDIOS USA. We entered into an agreement  with Studios USA to place 3D
animated  content on their Web sites  including  SCIFI.COM,  USANetwork.com  and
StudiosUSA.com.  We shared in the advertising revenue generated by the Webisodes
placed on their  sites and the other  third party  broadcast  sites,  if any, to
which Studios USA syndicated.


                                       9


<PAGE>


         VH1. We entered into a revenue share  distribution  agreement  with VH1
whereby the KISS IMMORTALS series was featured on their website - VH1.com.

         ROAD  RUNNER.  We  entered  into a  non-exclusive  agreement  with Road
Runner,  the  high-speed  online  service,  whereby  some  of  our  content  was
distributed  and promoted to Road Runner  subscribers.  We also  participated in
Road Runner's off-line  marketing and promotions  campaign,  and our content was
promoted within the Road Runner Service.

         While  we have  ceased  to  produce  new  entertainment  content,  some
existing  content is still  available  on some  syndication  partner  web sites,
including  SUPERMAN,  and XENA: WARRIOR PRINCESS,  as well as the animated music
videos of artists JA RULE, DMX, LI'L ROMEO and REDMAN/LADY LUCK. This content is
available on web sites operated or controlled by Warner Bros. Online, Roadrunner
and  Universal  Music  Group.  Revenue,  if any, is split with the  distribution
partner  according  to  various  deal  structures,  many of  which  are  traffic
dependent.

DIGITAL HIP HOP

         We entered into an agreement with Russell  Simmons and Stan Lathan that
provided for the formation of Los  Angeles-based  Digital Hip Hop, Inc., a joint
venture  production  studio headed by Stan Lathan.  Digital Hip Hop produced and
distributed  full screen  animated music videos and other content  primarily for
Internet and broadband  distribution.  Digital Hip Hop produced  animated  music
videos  for top  selling  artists  including  JA  RULE,  SUM41,  LUDACRIS,  DMX,
REDMAN/LADY  LUCK and LI'L ROMEO  pursuant  to  production  agreements  with the
record  labels  (Island  Def Jam,  DreamWorks  Records,  Priority  Records,  and
others).  As our internal costs  typically  exceeded the agreed upon  production
fees,  our strategy was to recapture the  differential  with our share of the ad
revenue,  as well as  gain an  additional  means  of  distributing  our  Digital
Projector.  The  distribution  of  our  Digital  Projector  was  only  partially
successful, and our portion of the ad revenue fell short of our projections.

         During the fourth quarter of 2001, we substantially  reduced operations
at  Digital  Hip Hop based on the  limited  prospects  of  additional  web video
production work. Past clients,  including the Universal Music Group and Priority
Records, were reluctant to make future commitments for incremental web videos at
prices  which were higher  than  previously  paid.  We do not intend to actively
market and promote the production of animated music videos for the Web. However,
to the extent that previous  customers request a quote for additional work or we
are  approached  to produce  additional  web videos,  we intend to outsource the
production  work to existing third party  licensees of b3d Studio and b3d Studio
Pro, and/or to our staff at Brilliant  Interactive  Ideas in Australia,  many of
whom (staff and licensees) are currently producing Brilliant Banners, and charge
a fee for overseeing the project.  We have substantially  reduced the operations
of Brilliant  Interactive  Ideas to coincide with reduction in animation  design
work.

SALES AND MARKETING OF OUR B3D CONTENT

         We have discontinued all sales and marketing of our MultipathTM  Movies
and music  videos,  which  historically  were a  primary  focus of our sales and
marketing  efforts.  We continue to market Brilliant Banners with our ad serving
and b3d authoring  tools.  To facilitate the broad  acceptance of our rich media
banners  and  software  tools,  we are  pursuing a strategy  that  includes  the
following elements:

         ADVERTISING.  We are actively promoting advertising impressions,  known
as  inventory,  for  sale on  Sharman  Networks'  KaZaA  Media  Desktop.  We are
promoting  this  inventory  through  third party  advertising  rep firms such as
Interep, Advertising.com and DoubleClick's media division; directly to potential
clients;  and to ad agencies which represent  advertising clients. Our marketing
position is that Brilliant Banners perform better than regular 2D GIF banner ads
and can be sold at higher CPM prices.  We are  generally  charging a fee for the
banner  ads and  coordinating  their  production.  These  fees are offset by the
expenditures  to the outside  production  firms  actually doing the work, and as
such,  the  production is not  profitable for us. Long term, we intend to derive
our revenue through the licensing of our ad serving  product,  which is required
for the serving of Brilliant  Banners.  We are also receiving a sales commission


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<PAGE>


from the web publishers,  including KaZaA, if advertising is placed on their web
sites due to our direct  efforts  (which we are doing as an additional  means of
promoting our Brilliant Banner rich media ad format).

         DVD RETAIL CHANNEL. We began a limited release of selected  MultipathTM
Movie titles to the DVD market in the fourth quarter of 2000 pursuant to a March
1999  agreement  with  SlingShot,  Inc.,  a special  purpose DVD  publisher  and
distributor.  Additional titles may be released into the market in 2002, however
it is unlikely that other DVDs will be developed in the future, as our DVD title
have met with very limited success in the market.

OUR OTHER DIGITAL ANIMATION AND INTERNET BUSINESSES

         E-BRILLIANT.  In February  2000,  we entered into a joint  venture with
e-New Media Company Limited, a Hong Kong-based  telecommunications,  information
services and Internet company. Pursuant to our agreement, e-New Media opened and
agreed to fund a 3D animation  studio in Singapore,  known as  e-Brilliant  Pty.
Limited, which was dedicated to the creation of interactive animated content for
the converging multi-media markets in Asia. In November, 2001 e-Brilliant ceased
operations due, in part, to e-New Media's decision to stop funding the studio.

         THE  AUCTION  CHANNEL.  In July 1999,  we  acquired  Trojan  Television
Limited.  Trojan Television Limited was a London-based company doing business as
The Auction  Channel.  Founded in 1996,  The  Auction  Channel  integrated  live
satellite,  cable TV and Web broadcasts of auction  events  conducted by auction
houses,  allowing  participants  to watch events on television and the Internet,
and use the  Internet  or their  telephone  to bid  simultaneously  with  people
actually  present at the  auction  house.  In late 2000,  we decided to sell The
Auction  Channel.  The Auction  Channel has been accounted for as a discontinued
operation in fiscal 2001 pursuant to  Management's  formal  adoption on December
31, 2000 of a plan to dissolve the  business  unit.  On April 30, 2001,  we sold
substantially  all of the assets of The Auction Channel to Metro  Channels,  LLC
and closed The Auction Channel's New York and London offices.

                                  ALTNET, INC.

         During the third quarter of 2001, we began  marketing and  distributing
our Digital Projector through two large peer-to-peer networks, Sharman Networks,
which operates the KaZaA network,  and StreamCast  Networks,  which operates the
Morpheus  network.  Both of these networks are public,  or "open"  networks that
allow any of their  respective  users to share  digital  files with other users.
Through our business  relationships with Sharman and StreamCast,  we perceived a
business opportunity to create a private, or "closed" peer-to-peer network which
would allow us to centrally control the distribution of digital files, which has
been authorized by files' owners, directly from one computer user to another.

         In February 2002, we formed  Brilliant P2P, Inc., later renamed Altnet,
Inc., to operate a  peer-to-peer-based  content distribution network that allows
Altnet to securely and efficiently  distribute a content  owner's music,  video,
software and other digital files to computer users.  Using internally  developed
and licensed  technology,  we intend to create a private peer-to-peer network to
centrally control the authorized distribution of digital files over the network.
Our ability to control which files are distributed over our private network,  as
well  as our  use  of  widely  available  digital  rights  management  (or  DRM)
technologies from Microsoft Corporation,  TryMedia and others to protect against
copyright infringement, will prevent the distribution of unauthorized files over
our network and help to protect against the  unauthorized  use of a digital file
distributed  over our  network  once it resides on an end  user's  computer.  We
intend to exploit 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 from the Altnet network.
We own 51% of the  outstanding  capital  stock of Altnet  and  manage all of its
day-to-day operations,  and the remaining 49% is owned by Joltid, Ltd. (formally
known as  Blastoise,  Ltd.),  the  company  from whom we  license a  substantial
portion of Altnet's peer-to-peer technology.


                                       11


<PAGE>


CREATION OF THE ALTNET NETWORK

         Peer-to-peer  computing  is  the  sharing  of  computer  resources  and
services by direct exchange between computer systems,  and not through a central
server.  Peer-to-peer  computing  applications  include the  exchange of digital
files and other  information,  processing  cycles  (the  cycles by which data is
processed  in  the  central  processing  unit  of  a  computer),  cache  storage
(temporary storage of files in the central  processing unit of a computer),  and
disk  storage.  Peer-to-peer  computing  takes  advantage  of  existing  desktop
computing  power and  networking  connectivity,  allowing  users to  access  the
collective  power of  individual  computers  to benefit  the entire  enterprise.
Millions of computers are logged onto the Internet at any given time,  each with
excess processing power,  excess storage capacity and unused bandwidth.  Through
Altnet,  we intend to create a private  peer-to-peer  network which allows us to
centrally  control the distribution of a digital file, which has been authorized
by its owner,  directly from one computer user to another, thus taking advantage
of the excess  computer  storage  capacity  and unused  bandwidth of our network
users.
         To develop the Altnet private peer-to-peer  network, each computer that
comprises  the network must be equipped with a software  program.  To distribute
the program, we bundled it in a package, that we call ALTNET SECUREINSTALL, with
our  Digital  Projector.   Pursuant  to  an  agreement  with  Sharman  Networks,
SecureInstall,   along  with  the  Digital   Projector,   is  being   downloaded
automatically  as part of  Sharman  Networks  KaZaA  Media  Desktop,  which  has
consistently been averaging in excess of two million downloads per week since we
began  bundling our software in the fall,  2001.  Users that  download the KaZaA
Media Desktop are not given the opportunity to reject download of SecureInstall,
and these users are most likely not aware that  SecureInstall has been installed
on  their  computer.  The  basis  of  the  SecureInstall  is our  b3d  Installer
technology.  The Installer technology connects to file servers and P2P networks,
via  "connectors",  for the purpose of  distributing  files  across the network.
These  "connectors"  consist of small  amounts of  JavaScript  code plus  small,
encrypted  install  scripts  used  by  the  Installer.   These  components  help
facilitate the delivery of files -music files, documents, software files, etc. -
across the network.  Apart from facilitating Altnet SecureInstall  connectivity,
the Installer is a full-fledged  software installation system, with key features
including  file  compression,  file  patching  and  file  encryption.  The  file
compression reduces download sizes, the file patching allows software updates to
be made available as `patches'  rather than full downloads,  and file encryption
provides protection from tampering for files on the network, even if they are on
the hard drives of thousands of user's PCs connected to a P2P network.

         A  significant  feature  of  the  Altnet  network  is  its  ability  to
communicate with FastTrack  technology already installed on desktops  worldwide.
Tens of millions  of search  requests  each day are being made on the  FastTrack
Network via the KaZaA Graphical User Interface (GUI).  These search requests can
be intercepted by Altnet and returned to the FastTrack  Network and displayed in
the KaZaA GUI such that secure  content  provided via Altnet can be made visible
to KaZaA users.  Altnet has reached an agreement with Sharman  Networks to allow
KaZaA users who are  connected to the Internet to search for digital  files that
reside on both the KaZaA  network  and the Altnet  network by typing one or more
key words in a search box located on the KaZaA GUI. If the search query  matches
the description of one or more available  Altnet files,  the Altnet  application
will  display the identity of the  matching  Altnet files in the search  results
page of the KaZaA GUI. A KaZaA user will be able to download an Altnet file from
the Altnet network in substantially the same manner as the user would download a
digital file from the KaZaA network.

         Our   longer-term   goal  is  for  Altnet,   through   multiple  client
relationships,  to be the next advancement in distributed bandwidth, storage and
computing.  Currently,  distributed  storage and  computing  companies,  such as
Akamai,  operate as content  delivery network service  providers,  whereby their
services improve the speed, quality,  reliability and scalability of Websites by
delivering  the Web  content  and  applications  of their  customers,  through a
distributed  worldwide network of servers, to a server  geographically closer to
end users. Altnet intends to go the next step, which is directly to the end user
in a private, peer-to-peer network.

SALES AND MARKETING OF ALTNET'S SERVICES

         We currently  intend to engage outside  consultants to market  Altnet's
peer-to-peer  file  distribution  services to content owners.  These consultants
will  negotiate  with content owners to obtain from them the


                                       12


<PAGE>


right  to  distribute  and  sell  their  music,  movie  clips,  movie  trailers,
full-length movies,  computer games, software products,  and other digital files
on Altnet.  We intend to approach as many content owners as our resources permit
to promote Altnet as a distribution  and selling  partner.  We intend to rely on
sales and marketing  consultants until our operations  generate  sufficient cash
flow to permit us to hire an internal sales staff.

         We intend to enter into  agreements with content owners to obtain their
express  permission to include their digital files on the Altnet network,  to be
distributed  and, if the owner  desires,  sold to users of the network.  We will
also  partner  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  the  content  owners'  digital  files  from the  Altnet  network.
Initially,  we intend to partner  with  Sharman  Networks to make  Altnet  files
available to users of the KaZaA Media Desktop.

COMPETITION FOR ALTNET'S SERVICES

         There  are  a  number  of  peer-to-peer,   file  sharing  companies  in
existence,  and several have either  launched or are planning to launch business
competitive  with the  services  to be  offered by  Altnet,  however  widespread
distribution  remains a significant barrier to success.  These companies include
Red  Swoosh,  Blue  Falcon,  Kontiki,  Evernet,  Uprizer  and  numerous  others.
Additionally in the file sharing market, StreamCast Networks, iMesh, Bear Share,
Lime Wire,  Grokster  and KaZaA are all  potential  competitors  to the services
Altnet plans to introduce. In the event that Altnet is successful in its initial
efforts,  we anticipate  that some or all of these companies will increase their
respective capital  development  expenditures to protect their position in their
respective  industries.  Additionally,  industry  consolidation is expected.  As
such,  if one or  more  of  these  companies  were to  merge,  their  collective
resources  would  significantly  exceed  Altnet's and would allow them to pursue
positions, which may be to the detriment of Altnet.

ALTNET'S COMPETITIVE ADVANTAGE

         We believe that Altnet is well positioned to compete  effectively  with
companies  currently  providing  peer-to-peer  file distribution  services.  The
software necessary to operate Altnet's  peer-to-peer  network has been installed
on tens of millions of computers  worldwide,  and additional computers are added
with each new  successive  download  of the KaZaA  Media  Desktop,  providing  a
competitive  advantage over other P2P competitors that have not achieved similar
success in mass distribution of their software application. We have been able to
leverage our relationship with Sharman Networks,  distributor of the KaZaA Media
Desktop,  to quickly  and  efficiently  install  our Altnet  software on tens of
millions of computers  worldwide.  Our  competitors may not be able to achieve a
similar   installed   based  of  their  software   application  as  quickly  and
cost-effectively as Altnet.  Additionally,  Altnet's ability to communicate with
FastTrack  technology,  which  runs  the  KaZaA  Media  Desktop  and is  already
installed  on desktops  worldwide,  also  presents a  significant  advantage  by
allowing our content owners the  opportunity to distribute and sell their secure
content to the tens of millions of users who perform  search  requests  each day
via the KaZaA GUI.

ALTNET'S UNPROVEN BUSINESS MODEL AND FINANCIAL 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. Additionally, our limited financial resources
may not allow  Altnet to compete  effectively  against  companies  with  greater
financial resources or greater access to capital necessary for grow. Its success
will depend, in part, on the following:

         o        acceptance by content owners of our services;

         o        the  technical  viability of the  commercially  available  DRM
                  software we employ to protect  the  proprietary  content  that
                  will  pass  through  the  Altnet  network  and will  reside on
                  network computers;

         o        our underlying peer-to-peer technology; and


                                       13


<PAGE>


         o        our  ability to raise the  funding  necessary  to support  the
                  sales,  marketing,   research  and  development  necessary  to
                  establish the business of Altnet.

                            RESEARCH AND DEVELOPMENT

         In fiscal  years 2000 and 2001,  we spent  $3,855,000  and  $1,892,000,
respectively,  on research and  development.  The costs  decreased by $1,963,000
primarily due to a decrease in web development  costs,  research and development
personal  and  overhead  costs  associated  with our  research  and  development
efforts. In December 2001, we commenced the liquidation of Brilliant Interactive
Ideas, Pty. Ltd., and formed Brilliant Digital  Entertainment  Pty. Ltd. for the
purposes of continuing our research and  development  efforts in Australia.  The
result was we  decreased  the  headcount in Sydney from 53 employees at December
31, 2000 to 7 employees at December 31, 2001.

         Presently, our research and development efforts are principally focused
on the following tasks:

         o        Developing  technology to improve  delivery and performance of
                  Brilliant Banners;

         o        Developing new b3d Digital Projector  features,  including new
                  transparency  overlays  that allow  banner ads to move outside
                  the  banner ad space and  animate  over the entire web page or
                  desktop,  plus new anti-aliasing  features to provide improved
                  visual  quality of  product  representations  and text  within
                  rich-media ads;

         o        Enhancing  the b3d  tools  suite,  documentation  and  Digital
                  Projector   by   increasing   performance,   and   adding  new
                  interactivity features;

         o        Developing  enhanced  Internet  delivery  capabilities  of our
                  content,  including new content serving techniques,  reduction
                  of content file sizes though new compression  technology,  and
                  streaming of animation data;

         o        Providing   a   fully   scalable   reporting   platform   with
                  multi-partner, multi-user login capability;

         o        Providing additional integration and compatibility between our
                  statistics and reporting  functions and the reporting packages
                  of DoubleClick and others,  with the goal of making it as easy
                  for any advertiser or web site to run a Brilliant Banner as it
                  is for them to run a regular GIF campaign; and

         o        Developing  technology  pursuant  to  our  initiatives  in the
                  peer-to-peer market, through Altnet.

         We may  determine  to alter the  course and scope of our  research  and
development efforts and to abandon any one or more of these projects.  As is the
case with most research and development efforts,  there can be no assurance that
our  research  will  prove to be  successful  or result in  commercially  viable
developments.

                                  OUR EMPLOYEES

         At December 31, 2001,  we had 18 full-time  employees,  of which 7 were
engaged  in  research  and   development,   1  in   production,   6  in  general
administration and finance and 4 in sales,  marketing and business  development.
None of our  employees  are covered by a  collective  bargaining  agreement.  We
consider our  relationship  with our employees to be good. We currently  utilize
the  services of 6  independent  consultants,  1 in software  development,  3 in
administrative  and  business  development  roles and 2 in sales  and  marketing
pursuant to contractual  relationships.  Eleven  employees,  including the Chief
Executive  Officer/President,  and the Chief Operating  Officer/Chief  Financial
Officer are based in Woodland Hills, California.  Seven employees operate out of
a facility located in Sydney, Australia.


                                       14


<PAGE>


                                     PART II

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

         The following  discussion and analysis should be read together with our
consolidated  financial  statements and the notes to the consolidated  financial
statements included elsewhere in this Form 10-KSB.

         THIS  DISCUSSION  SUMMARIZES  THE  SIGNIFICANT  FACTORS  AFFECTING  THE
CONSOLIDATED OPERATING RESULTS, FINANCIAL CONDITION AND LIQUIDITY AND CASH FLOWS
OF BRILLIANT DIGITAL  ENTERTAINMENT,  INC. FOR THE YEARS ENDED DECEMBER 31, 2001
AND DECEMBER 31, 2000. EXCEPT FOR HISTORICAL INFORMATION,  THE MATTERS DISCUSSED
IN THIS MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF  OPERATIONS   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  developer  of rich media
advertising serving technologies, software authoring tools and content for three
dimensional, or 3D, animation on the World Wide Web. During the third quarter of
2001, we began marketing and  distributing our player,  the "Digital  Projector"
(required for the playback of our rich media content and advertisements) through
two large peer-to-peer,  or P2P, networks,  Sharman Networks, which operates the
KaZaA network (formerly  operated by Consumer  Empowerment B.V.), and StreamCast
Networks, which operates the Morpheus network. Previously, our primary method of
distribution  was  through  the  bundling  of the  Digital  Projector  with  our
animation  content which we syndicated to third party web sites. At December 31,
2001, we estimate that our Digital  Projector  had been  distributed  to tens of
millions of users based on KaZaA's weekly downloads as reported on Download.com,
as additional  P2P  connected  computers and other users have accessed the KaZaA
and Morpheus  networks.  Sharman Networks continues to distribute our player and
StreamCast  Networks has discontinued  its  distribution.  We commercialize  our
technology  in two primary ways.  We license our rich media  advertising  server
technologies  to websites  to enable the selling and serving of our  proprietary
rich media advertising  format,  and we license our rich media content authoring
tools - "b3d  Studio" and "b3d Studio Pro" - to  production  studios and content
developers interested in creating content for the Internet.

         We launched our rich media 3D advertising banners - Brilliant Banners -
into the market  during the first quarter of 2001 to offer  advertisers  and web
sites an alternative to the current Graphics Interchange Format, or GIF, banners
that are prevalent on web sites today.  Rich media  advertising  banners are web
site banner ads that have full audio and motion  animation.  We believe that our
animated 3D banner  advertisements  perform better than GIF banners because they
include motion animation and full audio,  which is more engaging to a viewer. We
license  our rich  media  ad  serving  technologies,  through  our  wholly-owned
subsidiary  B3D,  Inc.,  to high traffic  websites,  including  the P2P network,
Sharman Networks,  for the serving of Brilliant Banners. We are also introducing
our ad format to third  party ad  serving  companies,  making  our  technologies
available  for them to  commence  selling  and  serving  this new rich  media ad
format.  In November 2001, we became a Rich Media Silver Vendor of  DoubleClick,
Inc. This rich media  certification  was awarded after our technology passed the
DoubleClick tests for functionality, impression tracking and click tracking.

         In February 2002, we formed  Brilliant P2P, Inc., later renamed Altnet,
Inc.,  to create a private,  peer-to-peer  network  utilizing  existing,  proven
technology  to leverage  the  processing,  storage and  distribution  power of a
peer-to-peer  network comprised of tens of millions of users.  Altnet intends to
license commercially  available digital rights management  technology to protect
against  infringement  of the  proprietary  rights of the owners of the  content
distributed over the Altnet network. Altnet licensed the peer-to-peer technology
necessary to operate the network from Blastoise,  Ltd. doing business as Joltid.
Blastoise  is  owned  and  operated  by  the  developers  of the  FastTrack  P2P
technology,  the underlying technology which operates the KaZaA and Grokster P2P
networks.  Pursuant to our agreement,  Blastoise acquired 49% of the outstanding
common stock of Altnet.


                                       15


<PAGE>


         Peer-to-peer  computing  is  the  sharing  of  computer  resources  and
services by direct exchange between computer systems,  and not through a central
server.  Peer-to-peer  computing  applications  include the  exchange of digital
files and other  information,  processing  cycles  (the  cycles by which data is
processed  in  the  central  processing  unit  of  a  computer),  cache  storage
(temporary storage of files in the central  processing unit of a computer),  and
disk  storage.  Peer-to-peer  computing  takes  advantage  of  existing  desktop
computing  power and  networking  connectivity,  allowing  users to  access  the
collective  power of  individual  computers  to benefit  the entire  enterprise.
Millions of computers are logged onto the Internet at any given time,  each with
excess processing power,  excess storage capacity and unused bandwidth.  Through
Altnet, we intend to create a private peer-to-peer network to enable our clients
to access and utilize this excess processing power,  storage capacity and unused
bandwidth for multiple applications.

         We have  licensed  some of the world's  best known  characters  for the
production  and web  distribution  of episodic  animations,  called  MultipathTM
Movies,  that include SUPERMAN,  XENA: WARRIOR PRINCESS,  KISS, and ACE VENTURA,
and have  produced  animated  music videos of top selling  artists  including Ja
Rule,  Ludacris,  DMX and Li'l Romeo. These full-screen  productions,  developed
using our proprietary  suite of b3d software tools,  have small files for faster
download  relative to full video  files.  Currently we  distribute  our animated
content through Internet  syndication  partners  including Warner Bros.  Online,
Roadrunner and selected sites from the Universal Music Group.

         In  2001,  we  substantially   reduced  our  internal   production  and
syndication  of 3D animation,  which we used primarily to distribute our Digital
Projector,  in  order to  reduce  our  costs  and our cash  burn  rate.  We have
substantially  reduced  operations  at Digital Hip Hop,  the entity we formed to
produce  animated  music videos for the World Wide Web,  and have  substantially
reduced   operations   at   Brilliant   Interactive   Ideas   Pty.   Ltd.,   our
Australian-based  production  company  which  employs  a team of  animators  and
programmers  dedicated  to  animation   production.   We  substantially  reduced
operations at Digital Hip Hop based on the limited  prospects of additional  web
video  production  work.  We  substantially   reduced  operations  at  Brilliant
Interactive  Ideas Pty. Ltd.  because of the under  utilization of animators and
programmers which occurred following the termination of our production agreement
with Warner Bros.  Online and the reduction of Digital Hip Hop. The reduction of
operations  at  Brilliant  Interactive  Ideas Pty.  Ltd. and Digital Hip Hop has
reduced  costs in  business  segments  that  were not  generating,  and which we
concluded  do not have the  potential  to generate,  significant  revenues.  The
reduction in our content production and syndication activities has allowed us to
focus our efforts and allocate  our  resources  to the further  development  and
exploitation of our advertising  serving and authoring tools businesses,  and to
pursue the development of a private,  peer-to-peer  network business through our
Altnet subsidiary.

         We entered into an agreement with Russell  Simmons and Stan Lathan that
provided for the formation of Los  Angeles-based  Digital Hip Hop, Inc., a joint
venture  production  studio headed by Stan Lathan.  Digital Hip Hop produced and
distributed  full screen  animated music videos and other content  primarily for
Internet and broadband  distribution.  Digital Hip Hop produced  animated  music
videos  for top  selling  artists  including  JA  RULE,  SUM41,  LUDACRIS,  DMX,
REDMAN/LADY  LUCK and LI'L ROMEO  pursuant  to  production  agreements  with the
record  labels  (Island  Def Jam,  DreamWorks  Records,  Priority  Records,  and
others).  As our internal costs  typically  exceeded the agreed upon  production
fees,  our strategy was to recapture the  differential  with our share of the ad
revenue,  as well as  gain an  additional  means  of  distributing  our  Digital
Projector.  The  distribution  of  our  Digital  Projector  was  only  partially
successful, and our portion of the ad revenue fell short of our projections.

         During the fourth quarter of 2001, we substantially  reduced operations
at  Digital  Hip Hop based on the  limited  prospects  of  additional  web video
production work. Past clients,  including the Universal Music Group and Priority
Records, were reluctant to make future commitments for incremental web videos at
prices  which were higher  than  previously  paid.  We do not intend to actively
market and promote the production of animated music videos for the Web. However,
to the extent that previous  customers request a quote for additional work or we
are  approached  to produce  additional  web videos,  we intend to outsource the
production  work to existing third party  licensees of b3d Studio and b3d Studio
Pro, and/or to our staff at Brilliant  Interactive  Ideas in Australia,  many of
whom (staff and licensees) are currently producing Brilliant


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<PAGE>


Banners,  and charge a fee for  overseeing  the project.  We have  substantially
reduced the operations of Brilliant Interactive Ideas to coincide with reduction
in animation design work.

         During  fiscal 2002, we are shifting our emphasis from our music videos
and b3d  toolset  business  to our Altnet  peer-to-peer  business  and  Internet
advertising.  We  generate,  or  intend to  generate  in 2002,  revenue  in four
principal ways:

         o        We contract with content  owners to distribute  and sell their
                  digital files to computer  users over our Altnet  peer-to-peer
                  network.   We  charge  the  content   owner  a  placement   or
                  distribution fee based on one or more of the following:  (i) a
                  negotiated fee for each file downloaded, (ii) a negotiated fee
                  for each  license  issued  once the end user tries to play the
                  file the first time after it has been downloaded,  and (iii) a
                  negotiated  percentage of the sales price a computer user pays
                  to purchase a digital file.

         o        We license our ad serving technology, which is used to display
                  our Brilliant  Banners,  to third party operators of web sites
                  and other Internet applications; and

         o        In conjunction with our creative team in Australia,  we create
                  and produce Brilliant Banner ads, using our b3d software tools
                  to produce the 3-dimensional ads,  generating a production fee
                  from our advertising clients; and

         o        We license  our b3d  software  tools to  creators  of animated
                  content.

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.

         Our  critical  accounting  policies  are  described  in  Note  2 to the
consolidated  financial  statements  included in Item 7 of this Form 10-KSB.  We
believe our most critical accounting policies include revenue  recognition,  the
corresponding  accounts receivable and our use of the consolidation  method when
accounting for our subsidiaries.  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. 101 and AICPA  Statement  of
Position  97-2  (SOP  97-2),  generally  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


                                       17


<PAGE>


change.  We do not have  material  exposure  to any single  customer or group of
customers at this time.  At December  31,  2001,  we had a reserve of $53,000 to
cover three customers from whom collectibility is uncertain.

RESULTS OF OPERATIONS

         REVENUES.

         ADVERTISING  REVENUE:  We derive  advertising  revenue by  serving  our
Brilliant Banner  advertisements on web sites and other Internet applications on
behalf of our advertiser  clients.  Our clients pay us a fee based on a cost per
thousand  impressions  (CPM)  or  specified   conversions  delivered  (CPA).  In
accordance with SOP 97-2 we recognize this revenue when the impressions are made
or conversions delivered, and reflect this revenue in the Operating Statement as
Development fees and other revenue.

         DISTRIBUTION FEES: We have granted distribution rights to our Multipath
Movie products and b3d Toolset to distributors in exchange for a  non-refundable
minimum  fixed fee and a  percentage  of sales of the  products  within  certain
territories.

         In  accordance  with SOP 97-2,  revenue  related to the  non-refundable
minimum  fixed  fee is  recognized  when the  master  file is  delivered  to the
customer,  the terms of the sale are considered  fixed,  and  collectibility  is
probable. Additional revenue, based on a percentage of sales, is recognized upon
notification  by the  distributor  that a royalty  has been  earned  by us.  For
distribution agreements,  which cover a period of time in excess of one year and
are  exclusive  for  a  geographic   territory,   we  recognize   revenue  on  a
straight-line  basis  over  the  life  of  the  agreement.  In the  case  of our
distribution  agreement with e-New Media,  e-New Media paid us a  non-refundable
advance  for   distribution   rights  to  our  Multipath   Movies  in  specified
territories.  This  advance is being  recognized  as revenue on a  straight-line
basis over the six-year  term of the  agreement.  We reflect this revenue in the
Operating Statement as Distribution and technology revenue from a related party.

         PRODUCTION  FEES:  We have  received  revenue for the  development  and
creation  of  Music  Videos  for  Digital  Hip Hop and for 3D  Brilliant  Banner
advertisements.  We receive  production fees in exchange for the development and
creation of animated content including banner ads and animated music web videos,
in accordance with customer specifications. The development agreements generally
specify certain "milestones",  such as completion of the script or incorporation
of the music, which must be achieved throughout the production process. As these
milestones  are  achieved,  we  recognize  the  portion of the  development  fee
allocated to each milestone.  In the case of music videos, the production period
is 6 to 12 weeks and the customer  signs off on the  milestones as they are met,
and the customer is invoiced for that stage of production. In the case of banner
ads, the  production  period is much shorter,  perhaps two weeks,  so we usually
require 50% payment up front and 50% upon  completion.  We recognize the revenue
upon  delivery  of the  file to the  client.  We  reflect  this  revenue  in the
Operating Statement as Development fees and other revenue.

         DEVELOPMENT  FEES: We have received  revenue for the development of new
animated content for viewing in short segments,  or Webisodes,  on the Internet.
We  are no  longer  developing  Webisodes.  We  have  entered  into  development
contracts for series of Webisodes developed over a period of time under which we
are entitled to fixed minimum guaranteed payments.  In accordance with SOP 97-2,
the minimum  guaranteed  payments are recognized as revenue when the master file
is delivered for each Webisiode to the publisher for use on their web sites, the
terms of the sale are  considered  fixed  (upon  signing of the  contract),  and
collectibility  is  probable.  We develop or create the  Webisodes  based on the
publishers' scripted storyboards. The publishers have approval rights and review
the Webisodes as they are developed. The publisher reviews the content, look and
feel or style of the Webisode, script, music, voice-overs,  and all other facets
of the  Webisode.  We recognize  revenue  from these sales upon  delivery of the
master  file.  Additionally,  we receive an agreed  upon  percentage  of revenue
received by the publisher from advertising  attached to the Webisodes,  which we
recognize  when the  publisher  notifies us that a royalty has been  earned.  We
reflect this revenue in the Operating  Statement as  Development  fees and other
revenue.


                                       18


<PAGE>


         SOFTWARE  SALES:  We receive or have received  revenue from the sale or
license of our software as follows:

                  b3d tools, our software products which enable a user to create
3D animation,  are downloaded over the internet.  We recognize  revenue once the
product is delivered and paid for by the end user.  Upon  payment,  the end user
receives  a key to  unlock  the  toolset,  which  the  end  user  can use for an
unlimited period. We reflect this revenue in the Operating Statement as Software
sales.

                  Multipath  Movies are 3D animated movies developed by us using
of b3d toolset.  We no longer  produce  copies of existing  Multipath  Movies or
develop  new  Multipath  Movies.  All  Multipath  Movie  development  costs were
capitalized  and have since been  expensed.  The master  file for each movie was
delivered to our Woodland  Hills  office and CD-ROMs were  duplicated,  boxed in
jewel cases and shipped to wholesalers.  We recognized  revenue upon delivery of
the CD-ROMs to the wholesaler.  The wholesalers  delivered the product to retail
stores for sale to end users.  We  provided a reserve for returns and bad debts.
We reflected  Multipath  Movie  revenues in the Operating  Statement as Software
sales.

                  We have  entered  into  licensing  agreements  with  web  site
publishers for the display of Webisodes and Multipath  Movies on the publishers'
web sites.  We  received an agreed upon  percentage  of revenue  received by the
publisher from advertising attached to the Webisodes and Multipath Movies. Under
some agreements,  we received a fixed non-refundable minimum guaranteed payment.
In accordance with SOP 97-2, the minimum guaranteed  payments were recognized as
revenue when the master file was  delivered to the  publisher,  the terms of the
sale  were   considered   fixed  (upon  the  signing  of  the   contract),   and
collectibility  was probable.  We recognized  revenues for advertising  when the
publisher  notified us that a royalty had been earned. We reflect these revenues
in the Operating  Statement as Development fees and other revenue.  We no longer
license Multipath Movies to publishers, and only license Webisodes to publishers
on a very limited basis.

                  We have entered into licensing  agreements  with  distributors
for conversion of our Multipath Movies to the DVD format and for distribution to
retailers.   We  entered  into   contracts   under  which  we  received   fixed,
non-refundable  minimum  guaranteed  payments.  In accordance with SOP 97-2, the
minimum guaranteed  payments were recognized as revenue when the master file was
delivered to the distributor,  the terms of the sale were considered fixed (upon
signing of the  contract),  and  collectibility  was probable.  We reflect these
revenues in the Operating  Statement as Development  fees and other revenue.  We
are o longer selling our Multipath Movies in the DVD format.

                  In the case of our  software  licensing  agreement  with e-New
Media,  e-New  Media  paid us a  non-refundable  advance  for  rights to our b3d
toolset to produce its own  Multipath  Movies and to resell the  toolset  within
specified  territories.  We  are  recognizing  this  advance  as  revenue  on  a
straight-line  basis over the five-year term of the  agreement.  We reflect this
revenue in the Operating Statement as Distribution and technology revenue from a
related party.

         Revenues  increased 76% from $1,030,000 for the year ended December 31,
2000 to  $1,816,000  for the year ended  December  31,  2001.  The  increase  is
primarily due to (i) the increase in production  fees related to the  production
of  animated  music  videos by  Digital  Hip Hop,  (ii) a full year of  revenues
recognized through our distribution and technology  agreements with e-New Media,
and (iii) an increase in  advertising  revenues  due to  increased  demand.  The
increase was partially offset by a decrease in software and DVD sales.

              REVENUES                     2001            2000       NET CHANGE
              --------                     ----            ----       ----------

Animated Music Videos ............      $  381,000            --         36.9%
E-New Media Technology ...........      $  917,000      $  612,000       29.6%
                                        ----------      ----------     ------
Advertising and Development ......      $  509,000      $  309,000       20.4%
                                        ----------      ----------     ------
Software and DVD Sales ...........      $    9,000      $  109,000      (10.6%)
                                        ----------      ----------     ------

Total Cash Obligations ...........      $1,816,000      $1,030,000       76.3%
                                        ==========      ==========     ======


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<PAGE>


         Revenues  for 2001  include  $917,000  earned  under a  technology  and
distribution  agreement  with e-New  Media,  advertising  and other  revenues of
$518,000, and production revenues of $381,000 for digital animated music videos.
Revenues for 2000 include  $612,000 earned under an agreement with  e-New-media,
advertising  and  development  revenues  of  $309,000,  and  software  sales  of
$109,000.

         COST  OF  REVENUES.   Cost  of  revenues  consists   primarily  of  the
amortization  and write-down of capitalized  movie software costs for previously
released  titles,  royalties to third  parties and the direct  costs,  including
salaries and benefits,  and manufacturing  overhead required to produce content,
including  MultipathTM  Movies,  animated music videos and banner ads, reproduce
and package software products.  Cost of revenues increased from $268,000 for the
year ended  December 31, 2000 to $463,000 for the year ended  December 31, 2001.
This  represents an increase of $195,000,  or 73%, which is primarily due to the
development of animated music videos during 2001, at a cost of $352,000.


          COST OF REVENUES                 2001           2000       NET CHANGE
          -----------------                ----           ----       ----------

Animated Music Videos ............       $352,000           --          131.3%
Royalty and Development ..........       $111,000       $224,000        (42.2%)
                                         --------       --------      -------
Software Sales ...................           --         $ 44,000        (16.4%)
                                         --------       --------      -------

Total Cash Obligations ...........       $463,000       $268,000         72.7%
                                         ========       ========      =======


         This  increase is offset by a reduction in software and motion  capture
costs in 2001 as compared to the prior year.  Also adding to this  increase,  in
2001, we amortized  $105,000 of royalty expense in connection with our licensing
rights  compared to $53,000 in 2000. In 2000,  we fully  amortized the remaining
capitalized  movie software costs of $158,000,  for previously  released titles,
and incurred direct costs of $44,000 for software sales,  and other  development
costs of $41,000.

         SALES AND MARKETING.  Sales and marketing  expenses  include  primarily
costs for salaries and benefits, advertising,  promotions, and travel. Sales and
marketing  expenses decreased $812,000 or 49% from $1,651,000 for the year ended
December 31, 2000 to $839,000 for the year ended December 31, 2001. The decrease
is  primarily  attributable  to the  reduction  in outside  sales and  marketing
consultants  who had been  retained  to market the b3d tools.  Also in 2001,  we
elected not to participate  in the Siggraph  trade show,  which cost $264,000 in
2000. In 2001, we incurred  $426,000  expense for warrants  issued in connection
with our agreement with Yahoo!, while incurring $596,000 in 2000.

         GENERAL AND ADMINISTRATIVE. General and administrative expenses include
primarily  salaries and benefits of  management  and  administrative  personnel,
rent, insurance costs and professional fees. General and administrative expenses
increased  $86,000 or 2% from $4,324,000 for the year ended December 31, 2000 to
$4,410,000  for the year ended  December 31, 2001.  Although  there were cuts in
some areas,  overall expenses  increased due to the addition of Digital Hip Hop,
which contributed $572,000 to our general and administrative expenses.

         RESEARCH AND  DEVELOPMENT.  Research and development  expenses  include
salaries and  benefits of  personnel  conducting  research  and  development  of
software products.  Research and development costs also include costs associated
with creating our software tools used to develop MultipathTM Movies and other 3D
animated  content.  The costs  decreased 51% from  $3,855,000 for the year ended
December 31, 2000 to $1,892,000  for the year ended  December 31, 2001 primarily
due to a decrease in web development  costs,  research and development  personal
and overhead costs  associated with research and  development.  We decreased the
headcount  in Sydney from 53 employees at December 31, 2000 to 7 at December 31,
2001.

         DEPRECIATION  AND   AMORTIZATION.   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.


                                       20


<PAGE>


Depreciation expense decreased 11% from $319,000 for the year ended December 31,
2000 to  $284,000  for the  year  ended  December  31,  2001.  The  decrease  is
attributable  to some fixed assets being fully  depreciated  and the disposal of
other fixed assets.

         OTHER INCOME AND EXPENSE.  Other income and expense  includes  interest
income and interest expense,  gains and losses on foreign exchange transactions,
and export  development  grants paid to our  subsidiary,  Brilliant  Interactive
Ideas Pty. Ltd., by the Australian  Trade  Commission for its  participation  in
certain  export  activities.  Other income and expense  decreased from income of
$179,000 in 2000 to a loss of $563,000 in 2001. The decrease is primarily due to
a non-cash debt discount expense of $467,000 and interest expense of $118,000 in
association with the financing  agreement.  Additionally,  we wrote off $264,000
recorded as a loss on investment  for the joint venture in Digital Hip Hop. This
expense  is  partially  offset  by the  increase  in the trade  export  grant of
$69,000.

         NET LOSS ON  DISCONTINUED  OPERATIONS.  The  Auction  Channel  has been
accounted  for as a  discontinued  operation  pursuant  to  Management's  formal
adoption on  December  31, 2000 of a plan to dissolve  the  business  unit.  Net
liabilities to be disposed of, at their expected  realizable  values,  have been
separately classified in the accompanying balance sheet at December 31, 2000.

         The  Company  recognized  a gain of $327,000 in 2001 due to the sale of
substantially all of the assets of The Auction Channel in April 2001.

LIQUIDITY, CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS

         As of  December  31,  2001,  our  cash  and  cash  equivalents  totaled
approximately $185,000. This is a decrease of $3,216,000 as compared to December
31, 2000, resulting primarily from a net loss of $6,328,000.

         We  primarily  satisfied  our cash  needs in 2001  through  the sale of
Secured Convertible  Promissory Notes and related Common Stock Purchase Warrants
in the aggregate  principal  amounts of $2,264,000 in May 2001,  and $350,000 in
December 2001 with subsequent  funding in 2002, of $400,000 tied to the December
financing  agreement.  A detailed  description of these notes is provided below.
Also, see Notes 5, 7 and 14 to the Financial Statements.

         Cash flows from operating,  financing and investing  activities for the
years ended  December 31, 2001 and 2000 are  summarized in the  following  table
(dollars in thousands):

               ACTIVITY:                             2001            2000
               ---------                             ----            ----

     Continuing Operations ................       $ (5,003)       $(15,669)
     Discontinuing Operations .............       $   (394)       $  5,079
     Investing ............................       $   --          $ (1,860)
     Financing ............................       $  2,541        $ 12,146

         Net cash of  $5,397,000  used in operating  activities  during the year
ended December 31, 2001 was primarily attributable to a net loss from continuing
operations of $6,635,000  partially offset by the sale of  substantially  all of
the assets of The Auction  Channel and subsequent  closure of the London and New
York  offices.  This is  compared  to a net  use of cash in 2000 of  $10,590,000
attributable primarily to a net loss of $21,916,000.

         Net cash used to  purchase  computer  equipment  amounted to $23,000 in
2001 as  compared  to  $760,000  in 2000.  In 2001,  cash of $73,000 was used in
financing  activities  for the  repayment  of notes for the  financing of office
furniture and computer equipment,  and financing costs related to our Director's
and Officer's  insurance.  In 2000 we paid $76,000 on the repayment of notes for
the financing of office furniture and computer equipment.

         We have an  obligation  under our  joint  venture  agreement  with KISS
Digital,  LLC to  fund  75% of the  development  of a  MultipathTM  Movie  up to
$900,000. As of December 31, 2000 we had contributed


                                       21


<PAGE>


$917,000 to the project. We do not expect to contribute additional funds to this
project.  We also are required as of December 31, 2001 to make minimum  payments
of $37,000 under various licensing agreements.

         At December 31, 2001, we had rental commitments for our office facility
of $90,000 and two  promissory  notes for the financing of office  furniture and
computer  equipment in the amount of $54,000 and $31,000 payable over the next 2
years. Our contractual obligations are as follows:

               CONTRACTUAL                            LESS THAN       1-3
               OBLIGATIONS                TOTAL        1 YEAR        YEARS
               -----------                -----        ------        -----

     Capital Leases ................     $ 85,000     $ 54,000     $ 31,000
     Operating Lease ...............     $ 90,000     $ 83,000     $  7,000
                                         --------     --------     --------

     Total Cash Obligations ........     $175,000     $137,000     $ 38,000
                                         ========     ========     ========


         As  reported  in our  Quarterly  Report on Form  10-QSB  filed with the
Securities  and Exchange  Commission on August 14, 2001, in May 2001, we sold to
Harris Toibb,  Europlay 1, LLC (an entity in which our Chairman has an ownership
interest) and Preston  Ford,  Inc.  secured  convertible  promissory  notes (the
"Original Notes") in the aggregate principal amount of $2,264,150 and three-year
warrants (the  "Original  Warrants") to purchase up to an aggregate of 2,850,393
shares of our common stock at exercise  prices of $0.793 per share (with respect
to 2,792,118  shares) and $0.858 per share (with respect to 58,275  shares).  We
sold  these  securities  for an  aggregate  purchase  price of  $2,264,150.  The
Original  Notes have a term of eighteen  months from the date of issuance and an
interest rate of 10% per annum, payable at maturity. The principal amount of the
Original Notes and, at the option of the holder,  all accrued  interest,  may be
converted by the holder into shares of our common stock at a conversion price of
$0.706 per share.  The  Original  Notes are secured by all of our assets and the
assets  of  our  subsidiaries,  B3D,  Inc.  and  Brilliant  Studios,  Inc.,  and
guaranteed by B3D, Inc. and Brilliant  Studios,  Inc. The Original Notes and the
Original Warrants were amended in our recent financing transaction, as described
below.

         On December 19, 2001, we entered into a financing  transaction that was
structured similar to the financing we conducted in May 2001 and involved one of
the same investors.  In the December  financing  transaction,  we sold to Harris
Toibb and Capel  Capital Ltd.  secured  convertible  promissory  notes (the "New
Notes") in the aggregate  principal amount of $750,000 (the "Principal  Amount")
and warrants (the "New Warrants") to purchase up to that number of shares of our
common stock obtained by dividing 200% of the Principal  Amount by the lesser of
(i) $0.20,  or (ii) the volume  weighted  average price of a share of our Common
Stock on the American Stock Exchange,  or any exchange on which the Common Stock
is then  traded,  over any five  (5)  consecutive  trading  days  commencing  on
December  14,  2001 and  terminating  at 5:00 p.m.  (Pacific  Standard  Time) on
November  10,  2002  (we  refer  to  items  (i)  and  (ii)  collectively  as the
"Conversion Price"). The New Warrants are exercisable at a price per share equal
to 1.125 times the Conversion Price. The New Notes mature  simultaneous with the
Original  Notes on November  10,  2002 and bear  interest at the rate of 10% per
annum.  The principal  amount of the New Notes and, at the option of the holder,
all accrued  interest,  may be converted by the holder into shares of our Common
Stock at the Conversion Price. As with the May 2001 financing, the New Notes are
secured by all of our assets and the assets of our two  subsidiaries,  B3D, Inc.
and Brilliant Studios,  Inc., and guaranteed by B3D, Inc. and Brilliant Studios,
Inc.

         As a condition to the December 2001 financing transaction, the Original
Notes and the Original  Warrants  were amended to correspond to all the terms of
the New Notes and New Warrants. As a consequence,  Harris Toibb, Europlay 1, LLC
and Preston Ford,  Inc. are able to convert the aggregate  purchase price of the
Original  Notes and all accrued  interest into shares of our common stock at the
much lower  Conversion  Price for the New Notes.  In  addition,  these  original
investors are able to exercise the Original  Warrants at a price per share equal
to 1.125 times the much lower Conversion Price from the December 2001 financing.


                                       22


<PAGE>


         The issuance of the  additional  shares of Common Stock pursuant to the
terms of the 2001 financing transactions, if so issued, could result in a change
in control of the Company. As of December 19, 2001, upon conversion and exercise
of his notes and  warrants,  Harris  Toibb  would own  approximately  68% of our
issued and outstanding common stock,  assuming a Conversion Price of $0.20. As a
consequence,  following  the  conversion  and exercise by him of the  promissory
notes and warrants,  Mr. Toibb would own a majority of our voting securities and
would be able to approve any matter  presented to the  stockholders for approval
at a meeting,  including  the ability to elect all of the  nominees for director
presented to the stockholders for election at each annual meeting.  The Board of
Directors of the Company is divided into three classes, with each class to serve
a staggered term of three years.  One class of the Board of Directors is elected
at each  annual  meeting  of the  stockholders.  Accordingly,  upon Mr.  Toibb's
conversion and exercise of his promissory notes and warrants,  he would have the
ability, within two annual meetings of stockholders,  to elect a majority of the
Company's Board of Directors.

         On March 7, 2002,  we entered into a Common Stock and Warrant  Purchase
Agreement among us, Harris Toibb, a current investor, and MarKev Services,  LLC,
an entity co-owned by our Chairman and our Chief Executive Officer and President
(collectively,  the  "Purchasers"),  whereby we sold (i) 5,673,222 shares of our
common stock at $0.1322 per share (the "Purchase  Price"),  a price per share of
our common stock based on the volume  weighted  average  price of a share of our
common  stock on the  American  Stock  Exchange  over  the five (5)  consecutive
trading days  immediately  preceding March 7, 2002, for an aggregate  investment
amount of  $750,000,  and (ii)  warrants  (the  "Warrants")  to  purchase in the
aggregate up to 10,085,728  shares of our common stock at an exercise  price per
share of $0.148725, which represents a price paid per share equal to 1.125 times
the Purchase Price.  Each of the Purchasers  received  "piggyback"  registration
rights with respect to the common stock they  purchased  and with respect to the
common stock issuable upon exercise of the Warrants.

         The March 2002 financing  transaction,  was unanimously  approved by an
independent  committee of the Board, as well as by the Board of Directors,  with
only our Chairman and our Chief  Executive  Officer and President,  who are also
Directors,  abstaining  because of their interest in the transaction.  The Board
approved the sale of up to $1,250,000 worth of common stock.

         On March 20, 2002, we entered into a Common Stock and Warrant  Purchase
Agreement  between us and David Wilson,  a current investor who controls Preston
Ford,  Inc.  and  participated  in the May 2001  financing,  whereby we sold (i)
378,215 shares of our common stock at $0.1322 per share (the "Purchase  Price"),
a price per share of our common stock based on the volume weighted average price
of a share of our common stock on the American  Stock Exchange over the five (5)
consecutive  trading days immediately  preceding March 7, 2002, for an aggregate
investment  amount of $50,000,  and (ii)  warrants  (the "Wilson  Warrants")  to
purchase  in the  aggregate  up to  672,382  shares  of our  common  stock at an
exercise price per share of $0.148725,  which  represents a price paid per share
equal to 1.125  times  the  Purchase  Price.  Mr.  Wilson  received  "piggyback"
registration  rights  with  respect to the common  stock he  purchased  and with
respect to the common stock issuable upon exercise of the Wilson Warrants.

         Our  operations  generated  negative  cash flow  during the years ended
December 31, 2000 and 2001,  and we expect a significant  use of cash during the
upcoming  2002 fiscal year as we initiate the business  opportunity  for Altnet,
Inc.,  as well as  continue  to develop  our  software  tools and  continue  our
marketing efforts for our tools and 3D rich media banners ads. We anticipate our
current  cash  reserves,  plus our  expected  generation  of cash from  existing
operations, to fund our anticipated expenditures into the third quarter of 2002.
As such, we will require  additional  equity or debt financing  during 2002, the
amount and timing depending in large part on our spending program. If additional
funds are raised through the issuance of equity securities, our stockholders may
experience  significant  dilution.  Furthermore,  there can be no 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 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  Internal  Revenue  Code.   Please  see
"Cautionary


                                       23


<PAGE>


Statements and Risk Factors - IF WE ARE UNABLE TO RAISE ADDITIONAL FUNDS, WE MAY
BE REQUIRED TO DELAY  IMPLEMENTATION  OF OUR BUSINESS  PLAN AND REDUCE  OVERHEAD
SIGNIFICANTLY."

         The accompanying  consolidated  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  amounts of assets and  liabilities  presented in the
financial  statements  do not  purport to  represent  realizable  or  settlement
values.  The report of our  Independent  Certified  Public  Accountants  for the
December  31,  2001  financial  statements  included  an  explanatory  paragraph
expressing substantial doubt about our ability to continue as a going concern.

         We  are  seeking  additional  funding  and  believe  that,  if  we  are
successful in raising additional capital,  this may result in improved operating
results. There can be no assurance, however, that with any additional financing,
higher cash flows will be generated by operations.

ACCOUNTING TREATMENT FOR DEVELOPMENT COSTS AND RESEARCH EXPENDITURES

         Our  accounting  policy  follows  Statement  of  Financial   Accounting
Standards  No. 86 ("SFAS No.  86"),  which  provides for the  capitalization  of
software  development costs once technological  feasibility is established.  The
capitalized  costs are then amortized  beginning on the date the product is made
available for sale either on a  straight-line  basis over the estimated  product
life or on a ratio of current  revenues  to total  projected  product  revenues,
whichever  results  in  the  greater  amortization  amount.  Prior  to  reaching
technological  feasibility,  we expense all costs related to the  development of
both our software  tools and  MultipathTM  Movie  titles.  The Company  achieved
technological  feasibility of its original  Digital  Projector  during the third
quarter of 1997.  Since the date of  achieving  technological  feasibility,  the
costs of  developing  MultipathTM  Movies  intended to be viewed on the original
projector have been  capitalized in accordance  with SFAS No. 86. We continue to
develop new Digital  Projectors  with  enhanced  functionality  such as improved
compression  technology.  Costs  incurred  in the  development  of  new  Digital
Projectors are expensed until technological feasibility is reached.  MultipathTM
Movies that are developed for new Digital  Projectors  that have not yet reached
technological  feasibility are capitalized in accordance with SFAS No. 86 to the
extent that they are  compatible  with an existing  Digital  Projector.  Amounts
incurred for  MultipathTM  Movies that are developed for new Digital  Projectors
that are not compatible with an existing projector and would require substantial
revision in order to achieve compatibility are expensed as incurred.

ACCOUNTING GUIDANCE FOR REVENUE RECOGNITION FOR SOFTWARE TRANSACTIONS

         Software  sales entered into prior to December 15, 1997 were  accounted
for in  accordance  with AICPA  Statement of Position  ("SOP")  91-1,  "Software
Revenue  Recognition." For transactions entered into after December 15, 1997 the
Company  recognizes  revenue  from the sale of software in  accordance  with SOP
97-2, "Software Revenue Recognition". SOP 97-2 provides guidance on when revenue
should be recognized and in what amounts for  licensing,  selling,  leasing,  or
otherwise marketing computer software.

NEW ACCOUNTING PRONOUNCEMENTS

         In December  1999,  the  Securities  and  Exchange  Commission  ("SEC")
released Staff  Accounting  Bulletin  ("SAB") No. 101,  "Revenue  Recognition in
Financial Statements," which provides guidance on the recognition,  presentation
and  disclosure  of  revenue  in  financial   statements  filed  with  the  SEC.
Subsequently,  the SEC released SAB 101B, which delayed the implementation  date
of SAB 101 for  registrants  with fiscal years that begin  between  December 16,
1999  and  March  15,  2000.  We were  required  to be in  conformity  with  the
provisions  of SAB 101, as amended by SAB 101B,  no later than  October 1, 2000.
The adoption of SAB 101, as amended by SAB 101B, has not had a material  adverse
effect on our financial position, results of operations or cash flows.

         In October 2000, we adopted the Financial  Accounting  Standards  Board
SFAS No. 133,  "Accounting for Derivative  Instruments and Hedging  Activities."
This statement  establishes  accounting and


                                       24


<PAGE>


reporting  standards  requiring  that  every  derivative  instrument,  including
certain derivative  instruments embedded in other contracts,  be recorded in the
balance sheet as either an asset or liability,  measured at its fair value.  The
statement  also  requires  that  changes  in  the  derivative's  fair  value  be
recognized in earnings  unless specific hedge  accounting  criteria are met. The
adoption  of  SFAS  No.  133  has not had a  material  effect  on our  financial
statements.

         In March 2000, the FASB issued  Interpretation  No. 44, "Accounting for
Certain  Transactions  Involving Stock  Compensation,  and Interpretation of APB
Opinion No. 25" (FIN.  44). The  Interpretation  is intended to clarify  certain
problems  that  have  arisen  in  practice  since the  issuance  of APB No.  25,
"Accounting   for  Stock  Issued  to  Employees."  The  effective  date  of  the
interpretation  was July 1, 2000.  The  provisions of the  interpretation  apply
prospectively,  but they will also cover certain events occurring after December
15,  1998 and after  January  12,  2000.  The  adoption of FIN. 44 has not had a
material  adverse  effect on our current or  historical  consolidated  financial
statements,   but  may  affect   future   accounting   regarding   stock  option
transactions.

         In March 2000, EITF 00-2  "Accounting for Web Site  Development  Costs"
was released.  EITF 00-2 provides  guidance on how an entity should  account for
costs involved in such areas as planning, developing software to operate the web
site, graphics,  content, and operating expenses. EITF 00-2 is effective for web
site  development  costs incurred for fiscal  quarters  beginning after June 30,
2000.  We adopted EITF 00-2 during the year ending  December  31, 2000,  and all
amounts  associated  with our web sites were  expensed in  accordance  with EITF
00-2.

         In June 2001, the Financial  Accounting  Standards Board finalized FASB
Statements No. 141, BUSINESS  COMBINATIONS (SFAS 141), and No. 142, GOODWILL AND
OTHER  INTANGIBLE  ASSETS (SFAS 142).  SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business  combinations  initiated  after June 30, 2001.  SFAS 141
also requires that we recognize  acquired  intangible assets apart from goodwill
if the acquired intangible assets meet certain criteria. SFAS 141 applies to all
business  combinations  initiated after June 30, 2001 and for purchase  business
combinations  completed on or after July 1, 2001.  It also requires  that,  upon
adoption of SFAS 142, we reclassify  the carrying  amounts of intangible  assets
and goodwill based on the criteria in SFAS 141.

         SFAS 142  requires,  among  other  things,  that  companies  no  longer
amortize  goodwill,  but instead test goodwill for impairment at least annually.
In addition, SFAS 142 requires that we identify reporting units for the purposes
of assessing potential future impairments of goodwill, reassess the useful lives
of other  existing  recognized  intangible  assets,  and cease  amortization  of
intangible  assets with an indefinite  useful life. An intangible  asset with an
indefinite  useful life should be tested for  impairment in accordance  with the
guidance  in SFAS 142.  SFAS 142 is  required  to be  applied  in  fiscal  years
beginning  after December 15, 2001 to all goodwill and other  intangible  assets
recognized  at  that  date,  regardless  of when  those  assets  were  initially
recognized.  SFAS 142 requires us to complete a transitional goodwill impairment
test nine months from the date of adoption. We are also required to reassess the
useful lives of other  intangible  assets within the first interim quarter after
adoption of SFAS 142.

         In August  2001,  the FASB issued SFAS No. 143,  "Accounting  for Asset
Retirement Obligations". SFAS No. 143 requires the fair value of a liability for
an asset  retirement  obligation  to be  recognized in the period in which it is
incurred  if a  reasonable  estimate of fair value can be made.  The  associated
asset  retirement  costs are  capitalized as part of the carrying  amount of the
long-lived  asset.  SFAS No. 143 is effective for fiscal years  beginning  after
June 15, 2002. We believe the adoption of this  Statement  will have no material
impact on our financial statements.

         In October  2001,  the FASB issued SFAS No.  144,  "Accounting  for the
Impairment  or Disposal of  Long-Lived  Assets".  SFASB 144 requires  that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell,  whether  reported in  continuing  operations  or in  discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable  value or include  amounts  for  operating  losses  that have not yet
occurred.  SFASB 144 is effective  for  financial  statements


                                       25


<PAGE>


issued for fiscal years beginning after December 15, 2001 and, generally, are to
be applied prospectively. We believe the adoption of this Statement will have no
material impact on our financial statements.

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.

         IF WE ARE UNABLE TO RAISE ADDITIONAL FUNDS, WE MAY BE REQUIRED TO DELAY
IMPLEMENTATION  OF OUR BUSINESS PLAN,  REDUCE OVERHEAD  SIGNIFICANTLY OR SUSPEND
OPERATIONS. 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 December 31, 2001, our cash balance was
approximately  $185,000 and our outstanding  accounts payable,  accrued expenses
and current debt totaled approximately $1,814,000.  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.

         WE HAVE A HISTORY OF LOSSES,  A NEGATIVE NET WORTH AND MAY NEVER ATTAIN
PROFITABILITY.  We have a  limited  operating  history  and  have  not  attained
profitability. Since inception, we have incurred significant losses and negative
cash flow,  and as of December 31, 2001 we had an  accumulated  deficit of $54.6
million.  Additionally,  as of the date of this report, our current  liabilities
exceed our current  assets.  We have not  achieved  profitability  and expect to
continue  to  incur  operating  losses  for the  foreseeable  future  as we fund
operating and capital  expenditures in the areas of software tools  development,
brand promotion, sales and marketing,  administration,  deployment of our Altnet
peer-to-peer  network and operating  infrastructure.  Our business model assumes
that consumers and advertisers  will be attracted to our rich media  advertising
formats  (Brilliant  Banners),  and that  animators and those who produce banner
advertisements will use our b3d tools and technology in the development of other
b3d-produced content. Our business model also assumes that a significant portion
of our future  revenues will be derived from our Altnet  peer-to-peer  business,
which is not  operational.  This business  model is not yet proven and we cannot
assure  you 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  modified the opinion on our December
31, 2001 financial  statements to include an explanatory  paragraph wherein they
expressed substantial doubt about our ability to continue as a going concern.

         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,  in the
aggregate  principal  amount of $3.0 million.  If a default occurs,  all amounts
owed to the holders of the notes would  immediately  become due and payable.  If
the debt becomes due before its stated maturity in November 2002, we likely will
not have  sufficient  funds to repay the  indebtedness,  which will  entitle the
holders of the notes 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.

         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 successful.  The success of the
business will depend,  in part, on our ability to enter into end user agreements


                                       26


<PAGE>


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 DRM
software we employ to protect the proprietary content that will pass through the
Altnet network and reside on network computers,  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
launch and fund Altnet 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.

         OUR BUSINESS MODEL CONTEMPLATES  RECEIVING A SIGNIFICANT PORTION OF OUR
FUTURE  REVENUES FROM RICH MEDIA  INTERNET  ADVERTISEMENTS  DEVELOPED AND SERVED
USING  OUR  SOFTWARE  TOOLS AND FROM  INTERNET  ADVERTISING  SERVICES.  INTERNET
ADVERTISING  IS  DEPENDENT  ON THE ECONOMIC  PROSPECTS  OF  ADVERTISERS  AND THE
ECONOMY IN GENERAL  AND  RECENTLY  HAS  EXPERIENCED  A  SIGNIFICANT  DECLINE.  A
CONTINUED DECREASE IN EXPENDITURES BY ADVERTISERS OR A PROLONGED DOWNTURN IN THE
ECONOMY  COULD  CAUSE US TO FAIL TO  ACHIEVE  OUR  REVENUE  PROJECTIONS.  We are
increasing  our emphasis on  generating  revenues from the sale of our b3d tools
for the  creation  of rich media  Internet  advertisements  and from the sale of
technologies   and  services  to  Web   publishers,   third  party   advertising
representation firms,  advertisers and agencies. In recent quarters,  the market
for  Internet  advertising  has  experienced  lower  demand,  lower  prices  for
advertisements  and the reduction of marketing  and  advertising  budgets.  As a
consequence,  expenditures for Internet advertisements have decreased. We cannot
be certain that future  decreases  will not occur and that  spending on Internet
advertisement  will return to  historical  levels.  A  continued  decline in the
economic  prospects of  advertisers  or the economy in general could cause us to
fail to achieve our advertising-related revenue projections.

         WE WILL NOT BE ABLE TO GENERATE  REVENUES FROM OUR BRILLIANT BANNERS IF
THEY DO NOT ACHIEVE MARKET ACCEPTANCE.  The success of our Brilliant Banner rich
media ad format and our ability to generate revenues through sale and serving of
these advertisements will be determined by consumer reaction and acceptance.  To
generate revenues, we must develop advertisements that appeal to the advertising
community and the consumer, which is unpredictable.  Additionally, our Brilliant
Banner  advertisements face competition from other online advertising  companies
like Unicast and Viewpoint. Other factors that influence our ability to generate
revenues from our Brilliant Banners include:

         o        Acceptance  of the  Brilliant  Banner  advertising  format  by
                  websites;

         o        Performance  of the  Brilliant  Banner versus other rich media
                  advertising formats and traditional 2D advertisements; and

         o        Our  ability to broadly  disseminate  our  Digital  Projector,
                  which is necessary to view our Brilliant Banners.

         OUR  FAILURE TO  MAINTAIN  STRATEGIC  RELATIONSHIPS  WITH  DISTRIBUTION
PARTNERS  COULD  REDUCE  THE  NUMBER  OF  DIGITAL  PROJECTORS  WE  ARE  ABLE  TO
DISSEMINATE  TO CONSUMERS,  WHICH WOULD REDUCE THE NUMBER OF USERS THAT ARE ABLE
TO VIEW OUR MEDIA  CONTENT,  DECREASE  THE  VALUE OF OUR  BRILLIANT  BANNERS  TO
ADVERTISERS AND LIMIT THE NUMBER OF USER'S FOR OUR ALTNET PEER-TO-PEER BUSINESS.
We distribute our Digital Projector and the software necessary to create and run
our Altnet peer-to-peer business primarily by bundling it with Sharman Networks'
KaZaA  Media  Desktop.  We rely on  computer  users'  demand for the KaZaA Media
Desktop to increase the installed  base of our (1) Digital  Projector,  which is
necessary to view b3d-produced  content such as our Brilliant  Banners,  and (2)
Altnet software, which is necessary to connect users to our private peer-to-peer
network.  Our business,  results of operations and financial  condition could be
materially   adversely   affected  if  we  do  not  maintain  our   distribution
relationship  with Sharman Networks on acceptable terms or if this  relationship
does not achieve the projected  distribution of our Digital Projector and Altnet
software.  Additionally,  a disruption  in the  distribution  of the KaZaA Media
Desktop or a  decrease  in demand for the  product  by users  would  necessarily
impact the future  distribution of our technology.  The KaZaA Media Desktop,  as
well as other  peer-to-peer  software  products,  is currently  the subject of a
lawsuit;  Metro-Goldwyn-Mayer  Studios, Inc. et. al. v. Grokster,  Ltd. et. al.,
filed in the United


                                       27


<PAGE>


States District Court for the Central District of California  (Western Division)
by twenty-eight  entertainment  companies claiming that, among other things, the
KaZaA  Media  Desktop  facilitates,  contributes  to  and  encourages  copyright
infringement.  On November 18, 2001, there was an additional  complaint filed by
the National Music Publishers  Association.  To the extent that Sharman Networks
is  precluded  from  distributing  the KaZaA  Media  Desktop as a result of this
litigation,  it would prevent the further  distribution of the Digital Projector
and Altnet  peer-to-peer  software  with the KaZaA  product  which  could have a
material adverse affect on our business and financial condition.

         OUR STOCK PRICE MAY DECLINE  SIGNIFICANTLY  IF WE ARE DELISTED FROM THE
AMERICAN STOCK  EXCHANGE.  Our common stock  currently is quoted on the American
Stock Exchange.  For continued inclusion on the American Stock Exchange, we must
meet certain  tests,  including  maintaining  a sales price for our common stock
above  $1.00 per  share,  and net  tangible  assets of at least $4  million.  We
currently are not in compliance  with both the bid price and net tangible assets
requirements.

         If we continue to fail to satisfy the listing standards on a continuous
basis,  the American  Stock  Exchange  may, at its sole  discretion,  delist our
common stock from the exchange. If this occurs,  trading of our common stock may
be conducted  on (i) the NASDAQ  SmallCap  Market,  if we qualify for listing at
that time, which we currently do not, (ii) in the over-the-counter market on the
"pink sheets", or (iii) if available, the NASD's "Electronic Bulletin Board." In
any of those cases, investors could find it more difficult to buy or sell, or to
obtain  accurate  quotations  as to the value of our common  stock.  The trading
price per share of our common stock likely would be reduced as a result.

         WE MAY NOT BE ABLE TO COMPETE  EFFECTIVELY  WITH OTHER  COMPANIES  THAT
OFFER SOFTWARE TOOLS AND SERVICES  SIMILAR TO OURS. The markets for our software
tools are highly  competitive and  characterized  by pressure to incorporate new
features and  accelerate the release of new and enhanced  products.  A number of
companies currently offer content development products and services that compete
directly or  indirectly  with one or more of our tools sets.  These  competitors
include,  among others,  Macromedia,  Inc., Adobe Systems, Inc. as well as Pulse
Entertainment,  Inc.  and  Viewpoint  Corporation.  As we  compete  with  larger
competitors  such as  Macromedia  across a broader  range of  product  lines and
different platforms, we may face increasing competition from such companies.

         WE MAY BE UNABLE TO SUCCESSFULLY COMPETE WITH MICROSOFT,  REAL NETWORKS
AND OTHER  COMPANIES IN THE MEDIA DELIVERY  MARKET.  The market for software and
services for the delivery of media over the Internet is constantly  changing and
highly competitive.  Companies such as Microsoft  Corporation and Real Networks,
Inc.  have   substantial   penetration  in  the  media  delivery   market,   and
significantly  greater  resources  than we do. More  companies  are entering the
market for,  and  expending  increasing  resources  to develop,  media  delivery
software and services.  We expect that  competition  will continue to intensify.
Because our b3d content, such as our Brilliant Banners, can only be viewed using
our Digital  Projector,  if we do not achieve a widespread  distribution  of our
media player,  there will not be substantial demand for b3d-produced  content or
our software tools.

         IF WE DO NOT IMPROVE OUR SOFTWARE  TOOLS TO PRODUCE NEW,  MORE ENHANCED
3D ANIMATED CONTENT, OUR REVENUES WILL BE ADVERSELY AFFECTED. The software tools
that enable us to create 3D content,  such as our Brilliant  Banners,  have been
developed  over the past five  years.  Additional  refinement  of these tools is
necessary  to  continue  to  enhance  the  b3d  format.  If  we  cannot  develop
improvements  to these  software  tools,  our  Brilliant  Banners  and all other
b3d-produced  content  may not  obtain or  maintain  market  acceptance  and our
revenues will be adversely affected.

         ERRORS OR DEFECTS IN OUR  SOFTWARE  TOOLS AND PRODUCTS MAY CAUSE A LOSS
OF MARKET ACCEPTANCE AND RESULT IN FEWER SALES OF OUR PRODUCTS. Our products are
complex and may contain undetected errors or defects when first introduced or as
new versions are released.  In the past, we have  discovered  software errors in
some of our new  products and  enhancements  after their  introduction  into the
market. Because our products are complex, we anticipate that software errors and
defects will be present in new products or releases in the future. While to date
these errors have not been  material,  future errors and defects could result in
adverse  product  reviews and a loss of, or delay in,  market  acceptance of our
products.


                                       28


<PAGE>


         TO DEVELOP  PRODUCTS THAT CONSUMERS  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  consumers  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.
For  instance,  for the twelve  months ended  December 31, 2001,  we reduced our
expenditures  on research and  development  by $1.96  million as compared to the
same period in 2000,  due  primarily  to our capital  constraints.  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.

         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  American  Stock  Exchange,  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.

         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;

         o        the use by animators  of our  toolsets to create  b3d-produced
                  content;

         o        the market's acceptance of our 3D Brilliant Banner advertising
                  format; and


                                       29


<PAGE>


         o        our  ability to launch  and  operate  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  WILL  NOT  BE  ABLE  TO  GENERATE  SIGNIFICANT  REVENUES  FROM  OUR
TECHNOLOGY  BUSINESS IF OUR B3D TOOLSET DOES NOT ACHIEVE MARKET ACCEPTANCE.  Our
b3d toolset may have programming errors, may be incompatible with other software
or hardware  products in the market,  may face slow adoption in the  marketplace
and may face competition from other toolmakers. Other factors that influence our
ability to generate revenues from our b3d toolset include:

         o        our marketing strategies;

         o        the quality of our products and competing products;

         o        critical reviews;

         o        the  availability of alternative  forms of  entertainment  and
                  leisure time activities;

         o        our  ability  to sell  advertising  and  sponsorships  for the
                  content;

         o        our  ability to  increase  the  installed  base of our Digital
                  Projector, which is necessary to view b3d-produced content;

         o        our  b3d  toolset  may  contain  features,   functionality  or
                  workflow  conventions  that may not be widely  accepted by our
                  target audience;

         o        our ability to  continue  to develop,  enhance and deliver the
                  toolset in accordance with established milestones; and

         o        the marketplace's reluctance to adopt a new toolset.

         WE MAY NOT BE ABLE TO  GENERATE  SIGNIFICANT  DEMAND  FOR OUR  PRODUCTS
VIEWED  ON THE  INTERNET  UNLESS  THERE IS A  REDUCTION  IN THE TIME IT TAKES TO
DOWNLOAD  THE  LARGE  AMOUNTS  OF DATA  NECESSARY  TO VIEW OUR  PRODUCTS  ON THE
INTERNET.  Our revenue  growth  depends in part on our ability to distribute our
products for viewing on the Internet.  We believe that without reductions in the
time to download animated content over the Internet, b3d-produced content may be
unable to gain wide consumer acceptance. This reduction in download time depends
in part upon advances in compression technology.  We have previously experienced
delays in the  development  of  compression  technologies,  which,  we  believe,
materially and adversely affected our online sales and results of operations. We
believe that large,  time-consuming downloads for both our Digital Projector and
b3d content have  previously  deterred  potential users of our products and have
reduced the effectiveness of our marketing  campaigns.  The development of these
technologies  continues to be a significant  component of our business  strategy
and a primary focus of our research and development efforts.


                                       30


<PAGE>


         OUR  PROPRIETARY  TECHNOLOGY  MAY  NOT  BE  ADEQUATELY  PROTECTED  FROM
UNAUTHORIZED  USE BY OTHERS,  WHICH  COULD  INCREASE  OUR  LITIGATION  COSTS AND
ADVERSELY  AFFECT OUR SALES.  Our  ability to compete  with other  entertainment
software companies depends in part upon our proprietary technology. Unauthorized
use by others of our  proprietary  technology  could  result in an  increase  in
competing  products and a reduction in our sales. We rely on trademark,  patent,
trade  secret and  copyright  laws to protect  our  technology,  and require all
employees and third-party developers to sign nondisclosure agreements. We cannot
be certain,  however,  that these precautions will provide meaningful protection
from unauthorized use by others. We do not copy-protect our software,  so it may
be possible for  unauthorized  third  parties to copy our products or to reverse
engineer or otherwise  obtain and use information that we regard as proprietary.
Our  customers  may take  inadequate  precautions  to  protect  our  proprietary
information.  If we  must  pursue  litigation  in  the  future  to  enforce  our
intellectual  property rights,  to protect our trade secrets or to determine the
validity and scope of the proprietary  rights of others,  we may not prevail and
will likely make  substantial  expenditures  and divert valuable  resources.  In
addition,  many foreign  countries' laws may not protect us from improper use of
our proprietary  technologies overseas. We may not have adequate remedies if our
proprietary rights are breached or our trade secrets are disclosed.

         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
products,  including  our software  tools,  do 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.

         WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE OF OUR COMMON  STOCK.  Our adoption of a  stockholders'  rights plan,  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
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.

         OUR  RECENT  CAPITAL  RAISING  EFFORTS  HAVE  RESULTED  IN  SUBSTANTIAL
DILUTION TO OUR  STOCKHOLDERS  AND OUR FUTURE  CAPITAL NEEDS WOULD INCREASE THIS
DILUTION.  During 2001, we raised $3.0 million  through the sale of  convertible
promissory notes and common stock purchase warrants. The promissory notes, which
mature on November  10,  2002,  and accrued  interest  may be  converted  by the
holders at any time into a number of shares of our common  stock  determined  by
dividing the amount due under the notes, including interest, by a price equal to
the  lesser of $.20 and the lowest 5 day volume  weighted  average  price of our
common stock as reported by the American  Stock  Exchange at any time during the
term of the notes.  At March 22, 2002,  the principal  and interest  outstanding
under the Notes could be  converted  by the holders  into  26,624,194  shares of
common  stock,  which would  represent  54.1% of our  outstanding  common  stock
immediately  following the  conversion.  The warrants have an expiration date of
May 23, 2004 and entitle the holders to purchase up to an  aggregate  of 200% of
their  invested  capital in shares of our Common  Stock at a per share  exercise
price equal to 112.5% of the  conversion  price.  The  exercise of the  warrants
would increase the number of shares  outstanding and result in further  dilution
to our other  stockholders.  Additionally,  during the first quarter of 2002, we
raised an  additional  $800,000  through the sale of 6,051,437  shares of common
stock and common stock purchase warrants. These warrants have an expiration date
of May 23,


                                       31


<PAGE>


2004 and entitle the holders to purchase up to an aggregate of 10,758,110 shares
of our Common Stock at a per share  exercise  price of $0.148725.  We anticipate
that during remainder of 2002, we will need to raise additional  capital, as our
current  operations do not generate  positive cash flow. As such, any additional
capital raising efforts would cause further dilution to stockholders.


                                       32


<PAGE>


ITEM 7.    FINANCIAL STATEMENTS

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                            PAGE
                                                                            ----

CONSOLIDATED FINANCIAL STATEMENTS OF BRILLIANT DIGITAL ENTERTAINMENT, INC.

Report of Independent Certified Public Accountants............................34

Consolidated Balance Sheet as of December 31, 2001............................35

Consolidated Statements of Operations for the years ended
   December 31, 2000 and 2001.................................................36

Consolidated Statements of Stockholders' Deficit for the
   years ended December 31, 2000 and 2001.....................................37

Consolidated Statements of Cash Flows for the years ended
   December 31, 2000 and 2001.................................................38

Notes to Consolidated Financial Statements....................................40


                                       33


<PAGE>


               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS



To the Board of Directors and
Stockholders of Brilliant Digital Entertainment, Inc.:


         We  have  audited  the  accompanying  consolidated  balance  sheets  of
Brilliant  Digital  Entertainment,  Inc. as of December 31, 2001 and the related
consolidated statements of income and comprehensive loss, stockholders' deficit,
and cash flows for each of the two years in the period ended  December 31, 2001.
These financial  statements are the responsibility of the Company's  management.
Our responsibility is to express an opinion on these financial  statements based
on our audits.

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

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material  respects,  the financial  position of Brilliant
Digital  Entertainment,  Inc.  at  December  31,  2001 and the  results of their
operations  and their cash  flows for each of the two years in the period  ended
December 31, 2001, in conformity with accounting  principles  generally accepted
in the United States of America.

         The accompanying  financial statements have been prepared assuming that
the Company  will  continue as a going  concern.  As  discussed in Note 1 to the
consolidated  financial  statements,  the Company has suffered  recurring losses
from operations and has a net capital  deficiency that raise  substantial  doubt
about its ability to continue as a going concern.  Management's  plans in regard
to these  matters  are also  described  in Note 1.  The  consolidated  financial
statements do not include any adjustments  that might result from the outcome of
this uncertainty.


/s/ BDO Seidman, LLP
-----------------------

Los Angeles, California
March 26, 2002


                                       34


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                           CONSOLIDATED BALANCE SHEET
                      (In thousands, except per share data)

                                                               DECEMBER 31, 2001
                                                               -----------------
ASSETS
Current assets:
     Cash and cash equivalents ..................................      $    185
     Accounts receivable, net ...................................            69
     Accounts receivable, related party .........................             4
     Other assets, net ..........................................           278
                                                                       --------
Total current assets ............................................           536
Property, plant and equipment, net (Note 9) .....................           139
Other assets, net ...............................................           443
                                                                       --------
Total assets ....................................................      $  1,118
                                                                       ========

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
     Accounts payable ...........................................      $    387
     Accrued expenses (Note 10) .................................         1,032
     Deferred revenue (Note 5) ..................................           917
     Notes payable, related parties .............................            27
     Capital financing, net of discount (Note 5) ................           194
     Current portion of note payable (Note 6) ...................           174
                                                                       --------
Total current liabilities .......................................         2,731
Note payable, less current portion (Note 6) .....................            32
Deferred Revenue (Note 5) .......................................         2,554
Other long term liabilities .....................................            50
                                                                       --------
Total liabilities ...............................................         5,367
Commitments and contingencies (Note 13)
Stockholders' deficit:
     Preferred Stock ($0.001 par value; 1,000,000
         shares authorized; no shares issued or
         outstanding) (Note 7) ..................................          --
     Common Stock ($0.001 par value; 150,000,000 shares
         authorized; 16,463,288 shares issued and
         outstanding) (Note 7 & Note 14) ........................            16
     Additional paid-in capital .................................        50,601
     Accumulated deficit ........................................       (54,577)
     Accumulated other comprehensive loss .......................          (289)
                                                                       --------
Total stockholders' deficit .....................................        (4,249)
                                                                       --------
Total liabilities and stockholders' deficit .....................      $  1,118
                                                                       ========

                 See Notes to Consolidated Financial Statements


                                       35


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
          CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
                      (In thousands, except per share data)

                                                                YEAR ENDED
                                                               DECEMBER 31,
                                                           --------------------
                                                             2001        2000
                                                           --------    --------
Revenues:
    Software sales .....................................   $      9    $    109
    Distribution and technology revenue from related
       party ...........................................        917         612
    Development fees and other revenues ................        890         309
                                                           --------    --------
       Total revenues ..................................      1,816       1,030

Cost of revenues:
    Software sales .....................................       --            44
    Development fees and other costs ...................        463         224
                                                           --------    --------
       Total cost of revenues ..........................        463         268

Gross profit ...........................................      1,353         762
Operating expenses:
    Sales and marketing ................................        839       1,651
    General and administrative .........................      4,410       4,324
    Research and development ...........................      1,892       3,855
    Depreciation and amortization ......................        284         319
                                                           --------    --------
       Total operating expenses ........................      7,425      10,149
                                                           --------    --------
Loss from operations ...................................     (6,072)     (9,387)
Other income (expense):
    Export market development grant ....................        185         116
    Gain on foreign exchange transactions ..............         44          (1)
    Loss on disposal of equipment ......................         (2)       --
    Loss on investment in joint venture ................       (264)       (100)
    Interest income ....................................        291         257
    Interest expense ...................................       (817)        (93)
                                                           --------    --------
       Total other income (expense) ....................       (563)        179
                                                           --------    --------
Loss from continuing operations ........................   $ (6,635)   $ (9,208)
Loss from discontinued operations (Note 2) .............       (317)    (12,708)
Gain on disposal of discontinued operations
    (Note 2 & Note 5) ..................................        624        --
                                                           --------    --------
Net loss ...............................................   $ (6,328)   $(21,916)

Other comprehensive loss:
     Foreign currency translation adjustment ...........       (123)        (15)
                                                           --------    --------
Comprehensive loss .....................................   $ (6,451)   $(21,931)
                                                           ========    ========


Basic and diluted continuing operations ................   $  (0.41)   $  (0.62)
Basic and diluted for discontinued operations ..........   $   0.02    $  (0.85)
Basic and diluted net loss per share ...................   $  (0.39)   $  (1.47)
                                                           --------    --------

Weighted average number of shares used in
      computing basic and diluted net loss
      per share ........................................     16,236      14,931
                                                           ========    ========
                 See Notes to Consolidated Financial Statements


                                       36


<PAGE>

<TABLE>
                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
                        (In thousands, except share data)

<CAPTION>
                                            COMMON STOCK                                   ACCUMULATED
                                      -----------------------   ADDITIONAL                    OTHER
                                        NO. OF                   PAID-IN     ACCUMULATED  COMPREHENSIVE
                                        SHARES       AMOUNT      CAPITAL       DEFICIT        LOSS          TOTAL
                                      ----------   ----------   ----------   -----------    ----------    ----------
<S>                                   <C>          <C>          <C>          <C>           <C>           <C>
BALANCE AT DECEMBER 31, 1999 ......   12,598,874   $       12   $   31,908   $  (26,333)   $     (151)   $    5,436
    Grant of stock options ........         --           --          1,642         --            --           1,642
    Exercise of stock options and
       warrants ...................      288,000         --          1,170         --            --           1,170
    Issuance of shares for joint
      venture investment ..........    2,554,589            3       11,087         --            --          11,090
    Shares issued for convertible
      debenture ...................      612,825            1        1,499         --            --           1,500
    Foreign exchange translation
       (net of tax of $0) .........         --           --           --           --             (15)          (15)
    Net loss ......................         --           --           --        (21,916)         --         (21,916)
                                      ----------   ----------   ----------   ----------    ----------    ----------
BALANCE AT DECEMBER 31, 2000 ......   16,054,288           16       47,306      (48,249)         (166)       (1,093)
    Grant of warrants .............         --           --             42         --            --              42
    Issuance of shares to Investors      400,000         --            264         --            --             264
    Issuance of shares for services        9,000         --              6         --            --               6
    Beneficial conversion feature .                                  2,983         --            --           2,983
    Foreign exchange translation ..         --           --           --           --            (123)         (123)
    Net loss ......................         --           --           --         (6,328)         --          (6,328)
                                      ----------   ----------   ----------   ----------    ----------    ----------
BALANCE AT DECEMBER 31, 2001 ......   16,463,288   $       16   $   50,601   $  (54,577)   $     (289)   $   (4,249)
                                      ----------   ----------   ----------   ----------    ----------    ----------
</TABLE>

                 See Notes to Consolidated Financial Statements


                                       37


<PAGE>


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

                                                                 YEAR ENDED
                                                                DECEMBER 31,
                                                           --------------------
                                                             2001        2000
                                                           --------    --------
OPERATING ACTIVITIES
Net loss ...............................................   $ (6,328)   $(21,916)
Adjustments to reconcile net loss to the net cash
    provided by (used in) operating activities:
      Depreciation and other amortization ..............      1,182       2,404
      Loss on investment in joint venture ..............        264         100
      Effect of stock options and warrants granted .....       --           849
      Gain on disposal of discontinued operations ......       (624)       --
      Issuance of common stock for services ............          6        --
      Issuance of common stock for joint venture .......         42        --
      Loss on disposal of equipment ....................        125        --
      Changes in operating assets and liabilities:
        Accounts receivable ............................        101          61
        Other assets ...................................        691      (1,341)
        Accounts payable and accruals ..................        455        (183)
        Deferred revenue ...............................       (917)      4,357
                                                           --------    --------
Net cash used in continuing activities .................     (5,003)    (15,669)
Net cash (used) provided in discontinued activities ....       (394)      5,079
                                                           --------    --------
Net cash used in operating activities ..................     (5,397)    (10,590)


INVESTING ACTIVITIES
Investment in joint venture ............................       --          (100)
Purchases of equipment .................................        (23)       (760)
                                                           --------    --------
Net cash used in investing activities ..................        (23)       (860)


FINANCING ACTIVITIES
Proceeds from issuance of shares .......................       --        12,222
Proceeds from capital financing ........................      2,614        --
Repayments of notes ....................................        (73)        (76)
                                                           --------    --------
Net cash provided by financing activities ..............      2,541      12,146
NET INCREASE (DECREASE) IN CASH AND
    CASH EQUIVALENTS ...................................     (2,879)        696

Translation adjustments ................................       (123)        (15)
Cash and cash equivalents at beginning of period .......      3,187       2,506
                                                           --------    --------
Cash and cash equivalents at end of period .............   $    185    $  3,187
                                                           --------    --------

Supplemental disclosure of cash flow
    information:
    Cash paid during the period for:
      Interest .........................................   $     20    $     63
                                                           --------    --------
                 See Notes to Consolidated Financial Statements


                                       38


<PAGE>


SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITY:

         We issued 200,000 shares of our common stock to each of Russell Simmons
and Stan  Lathan for an  increased  ownership  in Digital  Hip Hop,  raising our
ownership percentage in Digital Hip Hop from 50% to 75%.

         We  issued  9,000  shares  of our  common  stock  during  the  year  in
connection  with a  consulting  agreement  and  incurred  $6,000  in  consulting
expense.

         In May 2001,  we issued  $2,264,150 of Secured  Convertible  Promissory
Notes (the  "Original  Notes")  with  warrants to purchase  shares of our common
stock. A beneficial  conversion feature of $1,056,000 was recorded in connection
with this  transaction,  which is being amortized on a straight-line  basis over
the life of the  Original  Notes.  We incurred a beneficial  conversion  feature
expense of $10,690 for the second quarter 2001. In the third and fourth quarters
2001 each,  we expensed  $176,000 in  connection  with the  amortization  of the
beneficial  conversion  feature.  This will continue in future quarters  through
November 10, 2002.

         In December  2001, we issued  another  $350,000 of Secured  Convertible
Promissory  Notes as part of an overall  financing of  $750,000,  the balance of
which was funded in 2002 (the "New Notes"),  with warrants to purchase shares of
our common stock.  A beneficial  conversion  feature of $295,000 was recorded in
connection  with this  transaction,  which is being amortized on a straight-line
basis  over the life of the New  Notes.  We  incurred  a  beneficial  conversion
feature  expense of $13,400 for the fourth quarter 2001.  The remaining  balance
will be amortized in future quarters through November 10, 2002.

         Also in December 2001, the  conversion  feature and warrants  issued in
connection  with the Original  Notes were  adjusted to the same terms as the New
Notes. As such, an additional  beneficial  conversion  feature of $1,632,000 was
recorded and will also be amortized on a straight-line  basis over the remaining
life of the Original Notes.

         In the first half of 2001,  the  Company  issued  120,000  warrants  in
consideration for consulting services for three outside consultants and expensed
$42,000 in the 2nd Quarter of 2001.


                                       39


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

1.       DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

         Brilliant Digital Entertainment, Inc. ("Brilliant" or the "Company") is
a developer of rich media advertising serving  technologies,  software authoring
tools and content for three dimensional, or 3D, animation on the World Wide Web.
During the third quarter,  2001 the Company began marketing and distributing its
player,  the "Digital  Projector"  (required  for the playback of our rich media
content and advertisements)  through two large  peer-to-peer,  or P2P, networks,
Sharman  Networks,  which  operates  the KaZaA  network  (formerly  operated  by
Consumer Empowerment B.V.), and StreamCast Networks, which operates the Morpheus
network.  Previously,  the Company's  primary method of distribution was through
the  bundling of the Digital  Projector  with its  animation  content  which was
syndicated to third party web sites. At December 31, 2001, the Company estimated
that its Digital  Projector  had been  distributed  to tens of millions of users
based on KaZaA's weekly downloads as reported on Download.com, as additional P2P
connected  computers  and other  users  have  accessed  the  KaZaA and  Morpheus
networks.  Sharman  Networks  continues to distribute  our player and StreamCast
Networks  has  discontinued  its  distribution.   Brilliant  commercializes  its
technology in two primary ways: they license their rich media advertising server
technologies to websites to enable the selling and serving of their  proprietary
rich media  advertising  format,  and they  license  their  rich  media  content
authoring  tools - "b3d Studio" and "b3d Studio Pro". In July 1996,  the Company
incorporated  in the State of Delaware and, in August 1996,  issued an aggregate
of 1,000,000 shares of its Common Stock in exchange for all of the capital stock
of Brilliant  Interactive Ideas, Pty. Ltd., a company  incorporated in the State
of  New  South  Wales,  Australia  ("BII  Australia")  and  Sega  Australia  New
Developments  ("SAND") a  division  of Sega  Ozisoft  Pty.  Ltd.,  which was the
Australian  subsidiary of Sega of Japan  ("SEGA").  Historically,  BII Australia
produced  and  marketed  interactive  multimedia  titles for the  education  and
entertainment  markets.  SAND had developed and owned the rights to  proprietary
software  tools,  which were designed to allow the Company to both develop a new
genre  of  digital  entertainment  products,  and to cost  effectively,  produce
ancillary  products.  In exchange  for the issue of common stock in the Company,
SEGA transferred the intellectual  property rights for the software tools to the
Company,  which  continued to develop the  technology  using the funding  raised
through its listing on the American Stock Exchange.

         During the fourth  quarter of 2001, the Company  substantially  reduced
operations at Digital Hip Hop based on the limited  prospects of additional  web
video  production  work.  Past clients,  including the Universal Music Group and
Priority Records,  were reluctant to make future commitments for incremental web
videos at prices,  which were higher than previously  paid. The Company does not
intend to actively  market and promote the  production of animated  music videos
for the Web.  However,  to the extent that previous partners request a quote for
additional  work or the Company is approached to produce  additional web videos,
the Company  intends to outsource the  production  work to existing  third party
licensees  of b3d  Studio  and b3d  Studio  Pro,  and/or  to staff at  Brilliant
Interactive Ideas in Australia, many of whom (staff and licensees) are currently
producing  Brilliant Banners,  and charge a fee for overseeing the project.  The
Company has substantially reduced the operations of BII in Australia to coincide
with the reduction in animation design work.

         The reduction in the content production and syndication  activities has
allowed  the  Company to focus its efforts and  allocate  its  resources  to the
further development and exploitation of the creation of Brilliant Banner ads and
its ad serving and authoring tools businesses,  and to pursue the development of
a private, peer-to-peer network business through its Altnet subsidiary.

GOING CONCERN UNCERTAINTY

         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


                                       40


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

recurring  operating losses and at December 31,2001 has negative working capital
of  approximately  $2,200,000  and  a  stockholders'  deficit  of  approximately
$4,200,000. These factors raise substantial doubt about the Company's ability to
continue as a going concern.

         The Company is seeking  additional  funding and believes that this will
result in improved operating results.  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  of the  Company  include  the
accounts of  Brilliant  and its  subsidiaries  after  intercompany  balances and
transactions have been eliminated.

DISCONTINUED OPERATIONS

         The  Auction  Channel was  accounted  for as a  discontinued  operation
pursuant to  Management's  formal  adoption  on  December  31, 2000 of a plan to
dissolve the business unit. The Company sold substantially all of the net assets
on April 1, 2001, closed the London and New York offices and is now dissolved.


REVENUE RECOGNITION

         Under SEC Staff  Accounting  Bulletin  No. 101 and AICPA  Statement  of
Position 97-2 (SOP 97-2),  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 our product  and  service  lines we
establish  a contract  or  insertion  order  with our  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.

         REVENUE RECOGNITION

         ADVERTISING REVENUE: The Company derives advertising revenue by serving
Brilliant Banner  advertisements on web sites and other Internet applications on
behalf of the  Company's  advertiser  clients.  The clients pay a fee based on a
cost per thousand  impressions (CPM) or specified  conversions  delivered (CPA).
The revenue is recognize when the impressions are made or conversions delivered,
and is  reflected  in the  Operating  Statement  as  Development  fees and other
revenue.

         DISTRIBUTION FEES: The Company has granted  distribution  rights to for
Multipath  Movie  products  and b3d Toolset to  distributors  in exchange  for a
non-refundable  minimum fixed fee and a percentage of sales of the products sold
within certain territories.

         In  accordance  with SOP 97-2,  revenue  related to the  non-refundable
minimum  fixed  fee is  recognized  when the  master  file is  delivered  to the
customer,  the terms of the sale are considered  fixed,  and  collectibility  is
probable.  Additional  revenue,  based on a percentage of sales,  is recognized,
upon  notification  by the  distributor,  that, a royalty has been earned by the
Company. For distribution agreements,  which cover a period of time in excess of
one year and are exclusive for a geographic territory, the revenue is recognized
on a  straight-line  basis  over the life of the  agreement.  In the case of our
distribution  agreement  with  e-New  Media,  e-New  Media  paid the  Company  a
non-refundable  advance  for  distribution  rights  to our  Multipath


                                       41


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

Movies in specified territories.  This advance is being recognized as revenue on
a straight-line  basis over the six-year term of the agreement.  This revenue is
included in the Operating  Statement as Distribution and technology revenue from
a related party.

         PRODUCTION  FEES: The Company has received  revenue for the development
and  creation of Music  Videos for Digital Hip Hop and for 3D  Brilliant  Banner
advertisements. Production fees are received in exchange for the development and
creation of animated content including banner ads and animated music web videos,
in accordance with customer specifications. The development agreements generally
specify certain "milestones",  such as completion of the script or incorporation
of the music, which must be achieved throughout the production process. As these
milestones are achieved,  the Company  recognizes the portion of the development
fee allocated to each  milestone.  In the case of music videos,  the  production
period is 6 to 12 weeks and the customer signs off on the milestones as they are
met, and the customer is invoiced for that stage of  production.  In the case of
banner ads, the  production  period is much shorter,  perhaps two weeks,  so the
Company  usually  require  50%  payment  up front and 50% upon  completion.  The
revenue is recognized  upon delivery of the file to the client.  This revenue is
reflected in the Operating Statement as Development fees and other revenue.

         DEVELOPMENT  FEES: The Company has received revenue for the development
of new animated  content for viewing in short  segments,  or  Webisodes,  on the
Internet. The Company is no longer developing Webisodes. In the past the Company
had entered into development  contracts for series of Webisodes developed over a
period of time under which the Company was entitled to fixed minimum  guaranteed
payments.  In  accordance  with SOP 97-2,  the minimum  guaranteed  payments are
recognized as revenue when the master file is delivered for each Webisode to the
publisher for use on their web sites, the terms of the sale are considered fixed
(upon signing of the  contract),  and  collectibility  is probable.  The Company
develops or creates the Webisodes based on the publishers' scripted storyboards.
The  publishers  have  approval  rights  and review  the  Webisodes  as they are
developed.  The  publisher  reviews the  content,  look and feel or style of the
Webisode, script, music, voice-overs,  and all other facets of the Webisode. The
revenue  is  recognized  from  these  sales upon  delivery  of the master  file.
Additionally, the Company receives an agreed upon percentage of revenue received
by the publisher from advertising attached to the Webisodes, which is recognized
when the  publisher  notifies the Company  that a royalty has been earned.  This
revenue is recognized in the Operating  Statement as Development  fees and other
revenue.

         SOFTWARE SALES:  The Company  receives or has received revenue from the
sale or license of software as follows:

                  b3d  tools,  the  software  products,  which  enable a user to
create 3D animation, are downloaded over the internet. The revenue is recognized
once the product is delivered and paid for by the end user.  Upon  payment,  the
end user receives a key to unlock the toolset, which the end user can use for an
unlimited  period.  This  revenue is  reflected  in the  Operating  Statement as
Software sales.

                  Multipath  Movies  are 3D  animated  movies  developed  by the
Company using of b3d tooset.  The Company no longer  produces copies of existing
Multipath  Movies  nor  develops  new  Multipath  Movies.  All  Multipath  Movie
development costs were capitalized and have since been expensed. The master file
for each movie was  delivered  to the  Woodland  Hills  office and CD-ROMs  were
duplicated,  boxed in jewel  cases and  shipped to  wholesalers.  The revenue is
recognized  upon  delivery of the  CD-ROMs to the  wholesaler.  The  wholesalers
delivered  the  product  to retail  stores for sale to end  users.  The  Company
provides a reserve for  returns  and bad debts.  Multipath  Movie  revenues  are
reflected in the Operating Statement as Software sales.

                  The Company has entered  into  licensing  agreements  with web
site  publishers  for the  display  of  Webisodes  and  Multipath  Movies on the
publishers' web sites. The Company receives an agreed upon percentage of revenue
received  by the  publisher  from  advertising  attached  to the  Webisodes  and
Multipath


                                       42


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

Movies. Under some agreements, the fee is fixed non-refundable minimum
guaranteed payment. In accordance with SOP 97-2, the minimum guaranteed payments
were  recognized as revenue when the master file was delivered to the publisher,
the terms of the sale were considered  fixed (upon the signing of the contract),
and  collectibility  was probable.  The revenues are recognized for  advertising
when the  publisher  notified the Company that a royalty had been earned.  These
revenues are reflected in the Operating  Statement as Development fees and other
revenue. The Company no longer licenses Multipath Movies to publishers, and only
license Webisodes to publishers on a very limited basis.

                  The  Company  has  entered  into  licensing   agreements  with
distributors  for  conversion of the Multipath  Movies to the DVD format and for
distribution to retailers. The Company entered into contracts under which fixed,
non-refundable  minimum guaranteed payments are received. In accordance with SOP
97-2, the minimum guaranteed payments were recognized as revenue when the master
file was  delivered to the  distributor,  the terms of the sale were  considered
fixed (upon signing of the contract),  and  collectibility  was probable.  These
revenues are reflected in the Operating  Statement as Development fees and other
revenue.  The  Company  is no longer  selling  our  Multipath  Movies in the DVD
format.

                  In the case of the  software  licensing  agreement  with e-New
Media,  e-New Media paid the Company a non-refundable  advance for rights to the
b3d  toolset  to produce  its own  Multipath  Movies and to resell the  toolsets
within specified territories. The Company is recognizing this advance as revenue
on a straight-line  basis over the five-year term of the agreement.  The revenue
is reflected in the Operating  Statement as Distribution and technology  revenue
from a related party.

COST OF REVENUES

         Cost of revenues  consists  primarily of  royalties  to third  parties,
amortization of capitalized  movie software costs,  the direct costs required to
reproduce and package software products, and productions costs for music videos,
advertising  banners  and  MultipathTM  movie,  including  direct  salaries  and
benefits.

RESEARCH AND DEVELOPMENT COSTS

         The Company  incurs  research  and  development  costs  relating to the
development of its three dimensional authoring tools, development of its Digital
Projector,  ad serving  software and traditional  CD-ROM  software tools,  which
provide the technical  infrastructure  for the production of MultipathTM  Movies
and CD-ROM  titles.  The Company  incurred  research  and  development  costs of
$3,855,000 and $1,892,000,  including web  development  costs for the year ended
December  31,  2000 and the year ended  December  31,  2001,  respectively.  The
Company  accounts for web  development  costs in accordance  with the EITF 00-2,
"Accounting for Web site Development Costs."

MOVIE SOFTWARE COSTS

         Movie software costs consist of the costs of development and production
of  digitally  animated   MultipathTM  Movies  including  labor,   material  and
production overhead. These costs were fully amortized in 2000.

         The  Company's   accounting   policy  follows  Statement  of  Financial
Accounting   Standards  No.  86  ("SFAS  No.  86"),   which   provides  for  the
capitalization of software  development costs once technological  feasibility is
established.  The capitalized costs are then amortized beginning on the date the
product is made  available  for sale  either on a  straight-line  basis over the
estimated  product  life or on a ratio of current  revenues  to total  projected
product revenues, whichever results in the greater amortization amount. Prior to
reaching  technological  feasibility,  the Company expenses all costs related to
the  development of both its software tools and  MultipathTM  Movie titles.  The
Company achieved  technological  feasibility of its original  Digital  Projector
during the third  quarter  of 1997.  Since the date of  achieving  technological
feasibility, the


                                       43


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

costs of  developing  MultipathTM  Movies  intended to be viewed on the original
projector  have been  capitalized  in  accordance  with SFAS No. 86. The Company
continues to develop new Digital Projectors with enhanced  functionality such as
improved  compression  technology.  Costs  incurred  in the  development  of new
Digital  Projectors  are expensed  until  technological  feasibility is reached.
MultipathTM  Movies that are developed for new Digital  Projectors that have not
yet reached  technological  feasibility  are capitalized in accordance with SFAS
No.  86 to the  extent  that  they  are  compatible  with  an  existing  Digital
Projector.  Amounts  incurred for MultipathTM  Movies that are developed for new
Digital  Projectors that are not compatible with an existing projector and would
require substantial  revision in order to achieve  compatibility are expensed as
incurred.  To the extent  capitalized  movie software costs are  attributable to
titles  which have begun to ship,  they are subject to  amortization.  Amortized
amounts  of  $158,000  are  included  in costs of  revenues  for the year  ended
December 31, 2000.

CASH EQUIVALENTS

         The Company  considers all highly liquid  investments  with maturity of
three months or less when acquired to be "cash and cash equivalents".

PROPERTY, PLANT AND EQUIPMENT

         Property,  plant and  equipment  are stated at cost.  Depreciation  and
amortization are provided using the  straight-line  method over estimated useful
lives or lease life ranging up to five years.

INCOME TAXES

         The Company uses the asset and  liability  method to account for income
taxes as  required by  Statement  of  Financial  Accounting  Standards  No. 109,
"Accounting for Income Taxes" ("SFAS No. 109"). Under this method,  deferred tax
assets and liabilities  are determined  based on differences  between  financial
reporting and tax bases of assets and liabilities and are measured using enacted
tax rules and laws that will be in effect when the  differences  are expected to
reverse.

FOREIGN CURRENCY TRANSLATION

         The  functional  currency  of  BII  Australia  is its  local  currency,
Australian dollars.  Assets and liabilities of BII Australia are translated into
U.S. dollars (the reporting  currency) using a current exchange rate ($0.5117 at
December 31, 2001),  and revenues and expenses are translated into U.S.  dollars
using an average exchange rate ($0.5819 for the year ended December 31, 2000 and
$0.5163 for the year ended December 31, 2001).

         The effects of foreign  currency  translation  adjustments are deferred
and  included  as "other  comprehensive  loss" as a component  of  stockholders'
deficit, on an accumulated basis.

         Foreign currency transaction gains and losses result from the effect of
exchange rate changes on transactions  denominated in currencies  other than the
functional  currency.  Foreign currency  transaction  losses are included in the
statements of operations.

NET LOSS PER SHARE

         SFAS  No.  128   "Earnings   Per  Share",   revised  the   computation,
presentation, and disclosure requirements of earnings per share. Principal among
computation  revisions  is the  replacement  of primary  earnings per share with
basic earnings per share, which does not consider common stock  equivalents.  In
addition, SFAS No. 128 modifies certain dilutive computations and replaces fully
diluted  earnings per share with diluted earnings per share.  Common  equivalent
shares from stock  options and warrants  (using the treasury  stock method) have
been  included  in  this  computation   when  dilutive.   Options  and  warrants


                                       44


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

representing  common shares of 2,820,000  and  5,974,000  were excluded from the
average number of common and common equivalent shares outstanding in the diluted
EPS  calculation  for the years ended December 31, 2000 and 2001,  respectively,
because they were anti-dilutive.

STOCK OPTIONS

         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 new 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 7 for
supplemental disclosure.

CONCENTRATION OF CREDIT RISK

         Financial  instruments,   which  potentially  subject  the  Company  to
concentrations  of credit risk,  consist primarily of cash, cash equivalents and
accounts receivable.  The Company has investment policies that limit investments
to short-term  investment grade securities.  Accounts receivable are principally
from distributors and retailers of the Company's products.  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. The account at the bank is guaranteed by
the Federal Deposit Insurance  Corporation ("FDIC") up to $100,000.  At December
31, 2001, the Company had approximately  $145,000 at a bank, which was in excess
of the FDIC insurance limit.

USE OF ESTIMATES

         The  preparation of financial  statements in conformity  with generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  materially  affect  the  amounts  reported  in the  financial
statements and accompanying  notes.  Actual results could materially differ from
those estimates.

IMPAIRMENT OF LONG-LIVED ASSETS

         Statement of Financial  Accounting  Standards No. 121,  "Accounting for
the Impairment of Long-Lived  Assets and  Long-Lived  Assets to be Disposed Of,"
establishes  guidelines  regarding when impairment losses on long-lived  assets,
which  include plant and  equipment,  should be  recognized  and how  impairment
losses  should be  measured.  The Company  periodically  reviews such assets for
possible impairments and expected losses, if any, are recorded currently.

         In  2000,   the   Company   decided   to  sell  its   subsidiary,   The
Auctionchannel,  Inc. The Company  estimated the fair value of the business held
for sale based on discussions  with  prospective  buyers and adjusted the value,
taking into  consideration  the selling costs.  The Company reduced its carrying
value of  goodwill  by  $4,189,000  to record  assets  held for sale at the fair
value. The  Auctionchannel,  Inc. was sold on April 1, 2001 and the New York and
London offices were closed.


                                       45


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

3.       NEW ACCOUNTING PRONOUNCEMENTS

         In December  1999,  the  Securities  and  Exchange  Commission  ("SEC")
released Staff  Accounting  Bulletin  ("SAB") No. 101,  "Revenue  Recognition in
Financial Statements," which provides guidance on the recognition,  presentation
and  disclosure  of  revenue  in  financial   statements  filed  with  the  SEC.
Subsequently,  the SEC released SAB 101B, which delayed the implementation  date
of SAB 101 for  registrants  with fiscal years that begin  between  December 16,
1999 and March 15, 2000.  The Company was required to be in conformity  with the
provisions  of SAB 101, as amended by SAB 101B,  no later than  October 1, 2000.
The Company  believes the  adoption of SAB 101, as amended by SAB 101B,  has not
had an adverse effect on the Company's financial position, results of operations
or cash flows.

         In October 2000, the Company adopted the Financial Accounting Standards
Board  SFAS  No.  133,  "Accounting  for  Derivative   Instruments  and  Hedging
Activities."  This  statement  establishes  accounting  and reporting  standards
requiring  that  every  derivative  instrument,   including  certain  derivative
instruments  embedded in other  contracts,  be recorded in the balance  sheet as
either an asset or liability,  measured at its fair value.  The  statement  also
requires that changes in the  derivative's  fair value be recognized in earnings
unless specific hedge accounting  criteria are met. The adoption of SFAS No. 133
has no effect on the Company's financial statements.

         In March 2000, the FASB issued  Interpretation  No. 44, "Accounting for
Certain  Transactions  Involving Stock  Compensation,  and Interpretation of APB
Opinion No. 25" (FIN.  44). The  Interpretation  is intended to clarify  certain
problems  that  have  arisen  in  practice  since the  issuance  of APB No.  25,
"Accounting   for  Stock  Issued  to  Employees."  The  effective  date  of  the
interpretation  was July 1, 2000.  The  provisions of the  interpretation  apply
prospectively,  but they will also cover certain events occurring after December
15, 1998 and after January 12, 2000.  The Company  believes the adoption of FIN.
44 has not had a material adverse effect on the Company's  current or historical
consolidated  financial  statements,  but may affect future accounting regarding
stock option transactions.

         In March 2000, EITF 00-2  "Accounting for Web Site  Development  Costs"
was released.  EITF 00-2 provides  guidance on how an entity should  account for
costs involved in such areas as planning, developing software to operate the web
site, graphics,  content, and operating expenses. EITF 00-2 is effective for web
site  development  costs incurred for fiscal  quarters  beginning after June 30,
2000.  The Company  adopted EITF 00-2 during the year ending  December 31, 2000,
and all amounts  associated  with the Web Site were expensed in accordance  with
EITF 00-2.

      In June 2001,  the Financial  Accounting  Standards  Board  finalized FASB
Statements No. 141, BUSINESS  COMBINATIONS (SFAS 141), and No. 142, GOODWILL AND
OTHER  INTANGIBLE  ASSETS (SFAS 142).  SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business  combinations  initiated  after June 30, 2001.  SFAS 141
also requires that the Company recognize  acquired  intangible assets apart from
goodwill if the  acquired  intangible  assets meet  certain  criteria.  SFAS 141
applies to all  business  combinations  initiated  after  June 30,  2001 and for
purchase  business  combinations  completed  on or after July 1,  2001.  It also
requires  that,  upon adoption of SFAS 142, the Company  reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.

      SFAS 142 requires,  among other things,  that companies no longer amortize
goodwill,  but instead  test  goodwill  for  impairment  at least  annually.  In
addition,  SFAS 142 requires that the Company  identify  reporting units for the
purposes of assessing  potential  future  impairments of goodwill,  reassess the
useful  lives  of  other  existing  recognized   intangible  assets,  and  cease
amortization of intangible  assets with an indefinite useful life. An intangible
asset  with an  indefinite  useful  life  should be  tested  for  impairment  in
accordance  with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal  years  beginning  after  December  15,  2001 to all  goodwill  and other
intangible assets recognized at that date,  regardless of when those assets were
initially  recognized.  SFAS 142 requires the Company to complete a transitional
goodwill


                                       46


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

impairment  test nine  months  from the date of  adoption.  The  Company is also
required to reassess  the useful  lives of other  intangible  assets  within the
first interim quarter after adoption of SFAS 142.

      In August  2001,  the FASB  issued  SFAS No.  143,  "Accounting  for Asset
Retirement Obligations". SFAS No. 143 requires the fair value of a liability for
an asset  retirement  obligation  to be  recognized in the period in which it is
incurred  if a  reasonable  estimate of fair value can be made.  The  associated
asset  retirement  costs are  capitalized as part of the carrying  amount of the
long-lived  asset.  SFAS No. 143 is effective for fiscal years  beginning  after
June 15, 2002. The Company  believes the adoption of this Statement will have no
material impact on its financial statements.

         In October  2001,  the FASB issued SFAS No.  144,  "Accounting  for the
Impairment  or Disposal of  Long-Lived  Assets".  SFASB 144 requires  that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell,  whether  reported in  continuing  operations  or in  discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable  value or include  amounts  for  operating  losses  that have not yet
occurred.  SFASB 144 is effective  for  financial  statements  issued for fiscal
years  beginning  after  December  15,  2001 and,  generally,  are to be applied
prospectively.  The Company believes the adoption of this Statement will have no
material impact on its financial statements.

4.       RELATED PARTY TRANSACTIONS

E-NEW MEDIA

         In February  2000,  the Company  entered into an  agreement  with e-New
Media Digital  Entertainment  Limited ("e-New Media"), a wholly owned subsidiary
of  e-New  Media  Company.  The  agreement  with  e-New  Media  provides  for  a
Distribution  Agreement,  a Production  Joint  Venture  Agreement,  a Technology
License Agreement and an Investment Agreement.

         The  Distribution  Agreement  stipulates  that  e-New  Media  will have
Internet  distribution  rights to English  and Asian  language  versions  of the
Company's  MultipathTM  Movie  webisodes  in selected  Asian  territories,  with
exclusive  rights  to the  Asian  language  versions.  e-New  Media has paid the
Company a fee of  $2,500,000  for these  rights.  The revenue will be recognized
over a 6-year period, which commenced in the 2nd quarter of 2000. e-New Media is
entitled to a  distribution  fee of 20% of gross  revenues  generated  under the
Distribution  Agreement.  During the year ended  December  31,  2001 the Company
recognized $417,000 of this fee in revenues.  Deferred revenue includes $417,000
in current and $1,388,000 in long term.

         The Production Joint Venture Agreement  provides for the formation of a
joint  venture  studio,  known as  e-Brilliant,  to create new content using the
Company's b3d technology for  distribution  in the Asian  territories  for which
e-New Media has  distribution  rights.  These  projects,  developed by the joint
venture,  will be fully  funded by e-New  Media.  The joint  venture is owned in
equal parts by e-New Media and Brilliant Digital  Entertainment.  As of December
31,  2001,  the  Company  has not  received  any  revenue  from this part of the
agreement,  and in November 2001 e-Brilliant  ceased operations due, in part, to
e-New Media's decision to stop funding the studio.

         The Technology Licensing Agreement provides for the Company to grant to
the  joint  venture,  owned  equally  by e-New  Media  and  Brilliant,  a 5-year
exclusive alpha license to the Company's b3d technology for  exploitation by the
joint  venture in those Asian  territories  where  e-New Media has  distribution
rights.  e-New Media has paid the Company a fee of $2,500,000  for this license.
The revenue will be recognized  over a 5-year  period,  and commenced in the 2nd
quarter of 2000.  The  Company is also  entitled  to a 10%  royalty on all joint
venture  revenues.  During  the  year  ended  December  31,  2001,  the  Company
recognized  $500,000 in revenue.  Deferred revenue includes  $500,000 in current
and $1,166,000 in long term. The Company has not received any royalties yet from
this joint venture.


                                       47


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

         Pursuant to the  Investment  Agreement  in 2000,  e-New Media  acquired
666,667 shares of the Company's  common stock at $6.00 per share,  for aggregate
proceeds to the Company of $4,000,000.

         On September  9, 2000 e-New Media  purchased  an  additional  1,130,000
shares  of the  Company's  common  stock at $4.28  per  share  for  proceeds  of
$4,837,000.

5.       SIGNIFICANT AGREEMENTS

DIGITAL HIP HOP

         In August 2000,  the Company  formed an entity to produce  music videos
for the Internet.  The Company made an initial  contribution  of technology  and
$100,000 for a 50% ownership and operating  control of the entity.  In May 2001,
the Company  acquired an  additional  25% of Digital Hip Hop by issuing  400,000
shares of the  Company's  common  stock to the other two partners in Digital Hip
Hop. Digital Hip Hop also received from the Company's  wholly-owned  subsidiary,
B3D, Inc., a 5-year  exclusive  Alpha level license to its b3d  production  tool
suite for the production of hip hop content for non-Asian markets.

         During the fourth  quarter of 2001, the Company  substantially  reduced
operations at Digital Hip Hop based on the limited  prospects of additional  web
video  production  work.  Past clients,  including the Universal Music Group and
Priority Records,  were reluctant to make future commitments for incremental web
videos at prices,  which were higher than previously  paid. The Company does not
intend to actively  market and promote the  production of animated  music videos
for the Web.  However,  to the extent that previous partners request a quote for
additional  work or the Company is approached to produce  additional web videos,
the Company  intends to outsource the  production  work to existing  third party
licensees  of b3d  Studio  and b3d  Studio  Pro,  and/or  to staff at  Brilliant
Interactive Ideas in Australia, many of whom (staff and licensees) are currently
producing Brilliant Banners, and charge a fee for overseeing the project.

CONVERTIBLE PROMISSORY NOTES

         In May 2001,  the  Company  sold to Harris  Toibb,  Europlay 1, LLC (an
entity in which the  Company's  Chairman has an ownership  interest) and Preston
Ford, Inc. secured  convertible  promissory notes (the "Original  Notes") in the
aggregate  principal amount of $2,264,150 and three-year warrants (the "Original
Warrants")  to purchase up to an aggregate of 2,850,393  shares of the Company's
Common Stock at exercise  prices of $0.793 per share (with  respect to 2,792,118
shares) and $0.858 per share (with respect to 58,275 shares).  These  securities
were sold for an aggregate purchase price of $2,264,150. The Original Notes have
a term of eighteen  months from the date of issuance and an interest rate of 10%
per annum, payable at maturity.  The principal amount of the Original Notes and,
at the option of the  holder,  all accrued  interest,  may be  converted  by the
holder into shares of the Company's Common Stock at a conversion price of $0.706
per share. The Original Notes are secured by all of the Company's assets and the
assets of the Company's subsidiaries, B3D, Inc. and Brilliant Studios, Inc., and
guaranteed  by B3D,  Inc. and Brilliant  Studios,  Inc. In  connection  with the
Original  Notes,  and in accordance  with EITF 98-5 and EITF 00-27,  the Company
recorded a beneficial conversion feature of $1,056,000, which is being amortized
on a straight-line basis over the life of the Original Notes. The Original Notes
and  the  Original   Warrants  were  amended  in  the  December  2001  financing
transaction, as described below.

         On December 19, 2001, the Company entered into a financing  transaction
that was  structured  similarly  to the  financing  conducted  in May 2001,  and
involved one of the same investors.  In the December financing transaction,  the
Company  sold to  Harris  Toibb  and  Capel  Capital  Ltd.  secured  convertible
promissory notes (the "New Notes") in the aggregate principal amount of $750,000
(the  "Principal  Amount") and warrants  (the "New  Warrants") to purchase up to
that number of shares of the Company's Common Stock obtained by dividing 200% of
the  Principal  Amount by the lesser of (i) $0.20,  or (ii) the volume  weighted
average  price of a share of the  Company's  Common Stock on the American  Stock
Exchange,  or any


                                       48


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

exchange on which the Common Stock is then traded, over any five (5) consecutive
trading  days  commencing  on  December  14, 2001 and  terminating  at 5:00 p.m.
(Pacific  Standard  Time) on November  10, 2002 (items (i) and (ii)  hereinafter
referred to  collectively  as the  "Conversion  Price").  The New  Warrants  are
exercisable at a price per share equal to 1.125 times the Conversion  Price. The
New Notes mature  simultaneous  with the Original Notes on November 10, 2002 and
bear  interest  at the rate of 10% per annum.  The  principal  amount of the New
Notes and, at the option of the holder,  all accrued interest,  may be converted
by the holder into shares of the Company's Common Stock at the Conversion Price.
As with the Original  Notes,  the New Notes are secured by all of the  Company's
assets and the assets of the two subsidiaries,  B3D, Inc. and Brilliant Studios,
Inc., and guaranteed by B3D, Inc. and Brilliant Studios, Inc. In connection with
the New Notes,  and in  accordance  with EITF 98-5 and EITF  00-27,  the Company
recorded a beneficial  conversion feature of $295,000,  which is being amortized
on a straight-line basis over the life of the New Notes.

         As a condition to the December 2001 financing transaction, the Original
Notes and the Original  Warrants  were amended to correspond to all the terms of
the New Notes and New Warrants. As a consequence,  Harris Toibb, Europlay 1, LLC
and Preston Ford,  Inc. are able to convert the aggregate  purchase price of the
Original  Notes and all accrued  interest  into shares of the  Company's  Common
Stock at the much lower Conversion  Price for the New Notes. In addition,  these
original  investors  are able to exercise the  Original  Warrants at a price per
share equal to 1.125  times the much lower  Conversion  Price from the  December
2001  financing.  Pursuant to this  amendment to the Original Notes and Original
Warrants,  the Company recorded an additional  beneficial  conversion feature of
$1,632,000, which is being amortized on a straight-line basis over the remaining
life of the Original Notes The estimated  fair value of the warrants  issued was
determined by using the Black Scholes model with the following inputs: risk free
rate of return 4.5%; volatility 50%; 3 year warrant life and no dividends.

THE AUCTION CHANNEL

         On April 30, 2001 the Company sold  substantially  all of the assets of
The  Auction  Channel  to Metro  Channels,  LLC, a  division  of  Rainbow  Media
Holdings,  Inc. The Auction Channel and the Company's  London based  subsidiary,
Trojan Television, Ltd., has ceased operations. In connections with the disposal
of the assets and discontinuance of the related operations, the Company realized
a gain of $624,000.


6.       NOTES PAYABLE

         On July 17, 1998, the Company entered into a Senior Secured  Promissory
Note (the "Note"). The original principal amount of $103,893, plus interest at a
rate of 15.18%, is due in 60 equal monthly payments plus one final payment equal
to 10% of the original  principal  amount.  The Note is collateralized by office
furniture and  equipment.  At December 31, 2001 the balance due was $31,385,  of
which $27,702 is classified as short term.

         On October 3, 2000, the Company  entered into a capital lease agreement
with Crocker  Capital  Inc.  The  principal  amount of the lease  obligation  is
$58,421 plus interest of $19,081 due in 36 monthly  payments of $2,152.  A final
payment of $100 will buy out the lease  obligation,  which is  collateralized by
computer equipment used as a web server, and is located at Exodus, a third party
web hosting facility. At December 31, 2001 the balance due was $53,536, of which
$25,834 is classified as short term.

         Additionally,  the Company has an  obligation  to fund a Directors  and
Officers insurance policy, with total premiums of $163,401 and financing charges
of $5,222. The policy was renewed in November 2001 with 12 months coverage.  The
balance due on the policy at December 31, 2001 was $120,175, which is classified
as short term.


                                       49


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

7.       STOCKHOLDERS' EQUITY

COMMON STOCK

         The  holders of Common  Stock are  entitled  to one vote for each share
held of record on all matters on which the holders of Common  Stock are entitled
to vote. The holders of Common Stock are entitled to receive  dividends when, as
and if  declared  by the  Board  of  Directors  out of funds  legally  available
therefore.  In the  event  of  liquidation,  dissolution  or  winding  up of the
Company,  the  holders of Common  Stock are  entitled,  subject to the rights of
holders of Preferred  Stock issued by the Company,  if any, to share  ratably in
all  assets  remaining  available  for  distribution  to them  after  payment of
liabilities, and after provision is made for each class of stock, if any, having
preference over the Common Stock.

         In March 1998, the Company adopted a stockholder's  rights plan and, in
connection  therewith,  distributed  one preferred share purchase right for each
outstanding  share of the Company's  Common Stock  outstanding on April 2, 1998.
Upon the occurrence of certain events,  each purchase right not owned by certain
hostile  acquirers  will entitle its holder to purchase  shares of the Company's
Series A Preferred  Stock,  which is convertible  into Common Stock,  at a value
below the then  current  market  value of the  Common  Stock.  The rights of the
holders of Common  Stock will be subject to, and may be  adversely  affected by,
the rights of the  holders  of the share  purchase  rights and of any  Preferred
Stock that may be issued in the future.

         The holders of Common Stock have no preemptive or conversion rights and
they are not subject to further calls or assessments  by the Company.  There are
no redemption  or sinking fund  provisions  applicable to the Common Stock.  The
outstanding shares of Common Stock are fully paid and non-assessable.

         We  issued  9,000  shares  of our  Common  Stock  during  the  year  in
connection  with a  consulting  agreement  and  incurred  $6,000  in  consulting
expense.

PREFERRED STOCK

         The Company is authorized to issue 1,000,000 shares of Preferred Stock,
par value $0.001 per share.  As of December  31, 2000,  no shares were issued or
outstanding.  The Board of Directors has the  authority to issue the  authorized
and  unissued  Preferred  Stock in one or more  series  with such  designations,
rights and  preferences  as may be determined  from time to time by the Board of
Directors. Accordingly, the Board of Directors is empowered, without stockholder
approval,  to issue  Preferred  Stock with  dividend,  liquidation,  conversion,
voting or other  rights,  which may  adversely  affect the voting power or other
rights of the holders of the Company's Common Stock.

WARRANTS

         On February 17, 2000, the Company issued 307,692  warrants  exercisable
at $6.50 per share to e-New Media as partial  consideration  for a licensing and
distribution  agreement.  The warrants are being expensed over the 6 year-period
of the agreements. The warrants expired in November 2000. The Company recognized
$82,000  expense in 2001 with the  balance of the value,  $342,000,  recorded in
Other Assets,  of which  $260,000 is  classified as a long term asset,  with the
balance classified as a short term asset.

         On March 1, 2000, warrants, exercisable at $6.00 per share, were issued
to a  consultant  for  30,000  shares  of  Common  Stock.  The  warrants  vested
immediately  upon issuance and expire on February 28, 2002. The Company incurred
$96,000 of expense in connection with the issuance.

         On May 23, 2000, the Company issued 350,076 warrants at $6.29 per share
as partial consideration for an agreement with Yahoo! These warrants,  valued at
$1,022,222,  are  currently  exercisable  at $6.29 and


                                       50


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

expired in May 2001. The Company recognized $596,295 of warrant expense in 2000,
with the remaining value of $425,927 expensed in the first half of 2001.

         On May 23,  2001,  the  Company  issued,  in  connection  with  Secured
Convertible  Promissory Notes (the "Original Notes"), to Harris Toibb,  Europlay
1, LLC and Preston Ford, Inc. (the "Investors")  warrants to purchase  2,850,393
shares of Common Stock at exercise  prices of $0.793 per share (with  respect to
2,792,118  shares) and $0.858 per share  (with  respect to 58,275  shares).  The
number of shares  underlying  each warrant  issued to each  Investor is equal to
100% of the principal  amount of the note  acquired by that Investor  divided by
112.5% of the average  closing sales price of the Company's  Common Stock on the
American  Stock  Exchange  over the 10 trading  days prior to  execution  by the
Investor  of a note  purchase  agreement.  In  December  2001,  the terms of the
Original Notes were amended such that the number of warrants to be issued to the
Investors  relative to the Original Notes and the warrants  issued in connection
with Secured  Convertible  Promissory  Notes  pursuant to the December 2001 (the
"New Notes")  financing will only be finally  determined  upon conversion of the
notes. (See Footnote 5 SIGNIFICANT AGREEMENTS - CONVERTIBLE PROMISSORY NOTES).

         In connection  with the issuance of warrants from the Original Notes, a
beneficial  conversion feature of $1,056,000 was recorded and is being amortized
on a  straight-line  basis  over the life of the  Original  Notes.  The  Company
incurred a  beneficial  conversion  feature  expense  of $10,690  for the second
quarter 2001. In the third and fourth  quarters 2001 each, the Company  expensed
$176,000  in  connection  with the  beneficial  conversion  feature.  This  will
continue in future quarters through November 10, 2002.

         In connection  with the December 2001 issuance of warrants from the New
Notes,  a  beneficial  conversion  feature of $295,000 was recorded and is being
amortized on a straight-line  basis over the life of the New Notes.  The Company
incurred a  beneficial  conversion  feature  expense  of $13,400  for the fourth
quarter 2001. The remaining balance will be amortized in future quarters through
November 10, 2002.

         The fair value of the all warrants  issued,  as examined at the date of
grant,  is based on a  Black-Scholes  option  pricing  model with the  following
weighted-average assumptions for 2001 and 2000, respectively:  interest rates of
5.5% and 5.5%;  dividend yields of 0% for both years;  volatility factors of the
expected  market price of the  Company's  common  stock of 75.0% and 75.0%;  and
expected life of the warrants of 3 years for both years.

         Also in December 2001, the  conversion  feature and warrants  issued in
connection  with the Original  Notes were  adjusted to the same terms as the New
Notes. As such, an additional  beneficial  conversion  feature of $1,632,000 was
recorded and will also be amortized on a straight-line  basis over the remaining
life of the Original Notes.

         In the first half of 2001,  the  Company  issued  120,000  warrants  in
consideration for consulting services for three outside consultants and expensed
$42,000 in the 2nd Quarter of 2001.

         The following table summarizes warrant activity:


                                       51


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

                                                NUMBER
                                              OF SHARES        OPTION PRICE
                                             ----------       --------------
Outstanding at December 31, 1999 ........       805,000       $4.00 -- $8.00
Granted .................................       698,000       $5.94 -- $6.50
Exercised ...............................      (250,000)      $4.00 -- $5.50
Forfeited ...............................      (548,000)      $5.00 -- $8.00
                                             ----------       --------------
Outstanding at December 31, 2000 ........       705,000       $4.00 -- $6.50
Granted .................................     2,960,000       $4.00 -- $6.50
Exercised ...............................          --         $0.00 -- $0.00
Forfeited ...............................      (660,000)      $4.00 -- $6.29
                                             ----------       --------------
Outstanding at December 31, 2001 ........     3,005,000       $0.75 -- $5.50



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
3,500,000,  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 100,000,  subject to certain  adjustments to prevent dilution.  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 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 following table summarizes stock option activity:

                                                NUMBER
                                              OF SHARES        OPTION PRICE
                                              ----------      --------------
Outstanding at December 31, 1999 ........      1,441,000      $1.50 -- $3.94
Granted .................................        915,000      $4.81 -- $7.00
Exercised ...............................        (38,000)     $1.50 -- $3.94
Forfeited ...............................       (203,000)     $1.50 -- $7.00
                                              ----------      --------------
Outstanding at December 31, 2000 ........      2,115,000      $1.50 -- $7.00
Granted .................................      1,681,000      $2.62 -- $0.16
Exercised ...............................           --
Forfeited ...............................       (827,000)     $5.94 -- $0.65
                                              ----------      --------------
Outstanding at December 31, 2001 ........      2,969,000      $5.94 -- $0.16
Exercisable at December 31, 2001 ........        862,000

         As  discussed  in Note 2, the Company  has adopted the  disclosure-only
provisions of SFAS No. 123, which requires the use of an option  valuation model
to provide  supplemental  information  regarding options granted after 1994. Pro
forma  information  regarding  net  loss  and loss per  share  shown  below  was
determined as if the Company had accounted for its employee  stock options using
the fair value method pursuant to SFAS No. 123.


                                       52


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

         The fair value of the options as examined at the date of grant is based
on a  Black-Scholes  option  pricing model with the  following  weighted-average
assumptions  for 2001 and 2000,  respectively:  interest rates of 5.5% and 5.5%;
dividend yields of 0% for both years;  volatility factors of the expected market
price of the Company's common stock of 75.0% and 75.0%; and expected life of the
options of 3 years for both  years.  These  assumptions  resulted  in a weighted
average  fair  value of $1.66 and $2.95 per share for stock  options  granted in
2001 and 2000, respectively.

         The  Black-Scholes  option  valuation  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.

         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 2001 and 2000 is
not  representative  of the pro forma effect on net loss in future years because
it reflects expense for only one year's 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:

                                                           YEAR ENDED
                                                          DECEMBER 31,
                                                -------------------------------
                                                      2001             2000
                                                -------------    --------------
Net loss, as reported .......................   $  (6,328,000)   $  (21,916,000)
Net loss, pro forma .........................   $  (6,686,000)   $  (22,893,000)
Basic and diluted loss per share, as reported   $       (0.39)   $        (1.47)
Basic and diluted loss per share, pro forma .   $       (0.41)   $        (1.53)


8.       INCOME TAXES

         The Company has adopted the asset and  liability  method of  accounting
for income taxes.  Income tax expense  shown in the  statements of operations is
calculated on the operating profit before tax, adjusted for items, which, due to
treatment under income tax  legislation,  create permanent  differences  between
accounting  profit and taxable  income.  Deferred income taxes under FAS No. 109
reflect  the net tax  effects of  temporary  differences  between  the  carrying
amounts of assets and  liabilities  for  financial  reporting  purposes  and the
amounts used for income tax purposes.

         At December 31, 2001 the Company had cumulative tax losses resulting in
a net operating  loss ("NOL") carry forward of  approximately  $36,131,000.  The
losses will begin to expire in the year 2011.  No tax benefit has been  recorded
for these NOL's.

         The  significant   components  of  the  net  deferred  tax  assets  and
liabilities  recorded  in the  accompanying  consolidated  balance  sheet  as of
December 31, 2001 are as follows:


                                       53


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

                                                                    DECEMBER 31,
                                                                        2001
                                                                    -----------
Deferred tax assets:

   Net operating losses ..................................            6,001,000
   Temporary differences .................................              327,000
                                                                    -----------
   Total deferred tax assets .............................            6,328,000
   Valuation allowance ...................................           (6,328,000)
                                                                    -----------
Net deferred tax assets (liabilities) ....................          $      --
                                                                    ===========



         The  reconciliation  of the  effective  income tax rate to the  Federal
statutory rate is as follows:

                                                                  YEAR ENDED
                                                                 DECEMBER 31,
                                                                --------------
                                                                2001      2000
                                                                ----      ----

Federal income tax rate ....................................      34%       34%
Foreign and U. S. tax effect attributable to
   foreign operations ......................................     --        --
Effect of net operating loss and net operating loss
   carry forward ...........................................     (34)      (34)
                                                                ----      ----
Effective income tax rate ..................................       0%        0%
                                                                ====      ====

9.       PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment consists of the following:

                                                      DECEMBER 31, 2001
                                                      -----------------


Computers and equipment............................          $1,322,000
Leasehold improvements.............................             185,000
Furniture and fixtures.............................             123,000
                                                      -----------------
                                                              1,630,000
Less accumulated depreciation......................          (1,491,000)
                                                      -----------------
                                                               $139,000
                                                      =================


                                       54


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

10.      ACCRUED EXPENSES

         Accrued expenses consist of the following:

                                                       DECEMBER 31, 2001
                                                       -----------------

Employee compensation..............................             $825,000
Accrued Payroll Expenses...........................              143,000
Licensing..........................................               37,000
Other .............................................               27,000
                                                       -----------------
                                                              $1,032,000
                                                       =================

         The employee  compensation includes an accrual for the chairman and for
the president and chief executive officer of $825,000.


11.      GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS

         The  Company's  2001  operations  consist  of  the  operations  of  BII
Australia in Australia,  and Brilliant in the United States. The Auction Channel
was the United  Kingdom.  The  following  schedule  sets forth the  revenues and
long-lived assets, including those of the discontinued operations of The Auction
Channel, of the Company by geographic area:

                                              UNITED                   UNITED
                                              STATES      AUSTRALIA    KINGDOM
                                            ----------   ----------   ----------

YEAR ENDED DECEMBER 31, 2000
   Revenues from unaffiliated customers .   $  301,000   $  117,000   $  280,000
   Revenues from affiliated customers ...      612,000         --           --
                                            ----------   ----------   ----------
   Total revenues .......................   $  913,000   $  117,000   $  280,000
                                            ==========   ==========   ==========
YEAR ENDED DECEMBER 31, 2001:
   Revenues from unaffiliated customers .   $  873,000   $   26,000         --
   Revenues from affiliated customers ...      917,000         --           --
                                            ----------   ----------   ----------
   Total revenues .......................   $1,790,000   $   26,000         --
                                            ==========   ==========   ==========
LONG-LIVED ASSETS AS OF:
   December 31, 2001 ....................   $  793,000   $   53,000         --
                                            ==========   ==========   ==========


         For each of the  periods  shown  above,  the movie  software  costs,  a
portion of the operating expenses and most of the research and development costs
of the  Company  were  incurred  and paid in  Australia.  The  production  costs
associated with the web music videos,  duplication and packaging,  royalties due
to third parties,  a major portion of the sales and marketing costs, and certain
corporate expenses were incurred and paid in the United States.

         For the year ended December 31, 2001,  e-New Media  represented  51% of
the revenues with distribution and licensing rights of $917,000. Digital Hip Hop
earned 21%  ($381,000)  of the revenues  through the  production of music videos
primarily for Island Def Jam. Warner Bros. Online  contributed 12% ($226,000) of
the revenues,  while Warner Bros. site  "Entertaindom"  contributed  advertising
revenues of 3% ($59,000).  Infogrames  contributed  6% ($100,000) in advertising
revenues.  For the year ended December 31, 2000, e-New Media  represented 59% of
revenues with distribution and licensing rights of $612,000.


                                       55


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

Slingshot  provided DVD revenues of 11% ($116,000) and Warner Bros.  contributed
9% ($88,000) in advertising revenues.

12.      SEGMENT INFORMATION

         With the  discontinuation  of The Auction Channel,  the Company has one
operating segment:  digital animation.  Brilliant Digital Entertainment,  in the
United  States,  together with its  subsidiary  Australia,  is a production  and
development studio that uses its proprietary software tool set to create digital
entertainment  for  distribution  over the  Internet,  on  CD-ROM  and  DVD,  as
television  programming and for home video. Brilliant Digital Entertainment also
offers for sale its proprietary  authoring tools, b3d Studio and b3d Studio Pro.
The Altnet business is not yet operational.

13.      COMMITMENTS AND CONTINGENCIES

         At December 31, 2001, the Company was obligated under certain licensing
agreements  to make  additional  payments  totaling  $37,000  for use of certain
properties and characters in development of its products through August 2003.

         The Company has two fixed  asset  financing  notes (Note 6) with future
minimum payments as of December 31, 2001 under these leases are as follows:

               YEAR                                  AMOUNT
         -----------------                       -------------

               2002                                    54,000
               2003                                    31,000
                                                 -------------
                                                      $85,000
                                                 =============

         The Company leases its facilities  under an operating  lease  agreement
expiring in 2003.  Future  minimum  payments  as of December  31, 2001 under the
lease are as follows:

              YEAR                                  AMOUNT
         ----------------                       -------------

              2002                                    83,000
              2003                                     7,000
                                                -------------
                                                     $90,000
                                                =============

         Rent expense was $728,000 and $176,000 for the year ended  December 31,
2000 and the year ended December 31, 2001, respectively.

14.      SUBSEQUENT EVENT

         The Company  completed a financing  round and has raised  $800,000 in a
private  placement of its common stock to Harris Toibb,  MarKev Services LLC and
David  Wilson,  all  investors  in the  Company  prior  to the  closing  of this
financing.  The Company sold $750,000 to Harris Toibb and MarKev Services LLC on
March 7, 2002,  and sold $50,000 to David Wilson on March 20, 2002.  Pursuant to
the terms of certain Common Stock and Warrant Purchase  Agreements,  the Company
sold 6,051,437 shares of its common stock at a price per share equal to $0.1322,
which  represents the volume weighted  average price of a share of the Company's
common stock on the American  Stock Exchange over the five  consecutive  trading
days immediately  preceding March 7, 2002, the date the Company entered into the
Purchase  Agreement with Harris Toibb and MarKev Services LLC. In addition,  the
purchasers  in the  transaction  received  warrants to  purchase  an  additional
10,758,110  shares of the  Company's  Common Stock at a purchase  price equal to


                                       56


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2001

$0.148725,  which  represents  a price paid per share  equal to 1.125  times the
price paid per share in this transaction.  These warrants will expire on May 23,
2004.

         On February  22, 2002,  the Company  filed a  Certificate  of Amendment
which amended its Amended and Restated  Certificate of Incorporation to increase
the number of shares of Common Stock, par value $0.001,  authorized to be issued
from 30,000,000 to 150,000,000.


                                       57


<PAGE>


                                    PART III

ITEM 13.      EXHIBITS, LIST AND REPORTS ON FORM 8-K.

         (a) Exhibits:

                  See attached Exhibit Index.

         (b) Reports on Form 8-K.

                  None.


                                       58


<PAGE>


                                   SIGNATURES

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

                              BRILLIANT DIGITAL ENTERTAINMENT, INC.

                              By:     /s/ Tyler Tarr
                                    --------------------------
                                    Tyler Tarr
                              Its:  Chief Financial Officer (Principal Financial
                                    and Accounting Officer)

                              SIGNATURES

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

       Signature                          Title                        Date
       ---------                          -----                        ----

           *                      Chairman of the Board            July 3, 2003
--------------------------           of Directors
       Mark Dyne

 /s/ Kevin Bermeister             Chief Executive Officer,         July 3, 2003
--------------------------           President and
    Kevin Bermeister                 Director

  /s/ Tyler Tarr                  Chief Financial Officer          July 3, 2003
--------------------------           (Principal Financial
       Tyler Tarr                    and Accounting Officer)

           *                      Director                         July 3, 2003
--------------------------
      Mark Miller

           *                      Director                         July 3, 2003
--------------------------
    Russell Simmons

           *                      Director                         July 3, 2003
--------------------------
       Ray Musci

           *                      Director                         July 3, 2003
--------------------------
     Garth Saloner

           *                      Director                         July 3, 2003
--------------------------
    Jeff Scheinrock

           *                      Director                         July 3, 2003
--------------------------
        Abe Sher

* By: /s/ Kevin Bermeister
     ---------------------
     Kevin Bermeister
     As Attorney-In-Fact


                                       59



<PAGE>


                        Certification of CEO Pursuant to
                 Securities Exchange Act Rules 13a-14 and 15d-14
                             as Adopted Pursuant to
                  Section 302 of the Sarbanes-Oxley Act of 2002

I, Kevin Bermeister, certify that:

         1. I have  reviewed  this annual  report on Form  10-KSB/A of Brilliant
Digital Entertainment, Inc.;

         2. Based on my  knowledge,  this  annual  report  does not  contain any
untrue  statement of a material fact or omit to state a material fact  necessary
to make the  statements  made,  in light of the  circumstances  under which such
statements  were made, not misleading with respect to the period covered by this
annual report; and

         3. Based on my knowledge, the financial statements, and other financial
information  included  in this annual  report,  fairly  present in all  material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report.

Date:    July 3, 2003

                                                      /s/ Kevin Bermeister
                                                     -----------------------
                                                     Kevin Bermeister
                                                     Chief Executive Officer


                                       60


<PAGE>


                        Certification of CFO Pursuant to
                 Securities Exchange Act Rules 13a-14 and 15d-14
                             as Adopted Pursuant to
                  Section 302 of the Sarbanes-Oxley Act of 2002

I, Tyler Tarr, certify that:

         1. I have  reviewed  this annual  report on Form  10-KSB/A of Brilliant
Digital Entertainment, Inc.;

         2. Based on my  knowledge,  this  annual  report  does not  contain any
untrue  statement of a material fact or omit to state a material fact  necessary
to make the  statements  made,  in light of the  circumstances  under which such
statements  were made, not misleading with respect to the period covered by this
annual report; and

         3. Based on my knowledge, the financial statements, and other financial
information  included  in this annual  report,  fairly  present in all  material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report.

Date:    July 3, 2003

                                                      /s/ Tyler Tarr
                                                     -----------------------
                                                     Tyler Tarr
                                                     Chief Financial Officer


                                       61


<PAGE>


                                  EXHIBIT INDEX

EXHIBIT NUMBER                        EXHIBIT DESCRIPTION
--------------                        -------------------

     3.1        Amended   and   Restated   Certificate   of   Incorporation   of
                Registrant.*
     3.2        Amended  and  Restated  Bylaws of  Registrant.  Incorporated  by
                reference  to  Exhibit  3.2 to Form S-1 filed on  September  17,
                1996, and the amendments thereto.
     3.3        Certificate of Designation of Rights, Preferences and Privileges
                of Preferred  Stock.  Incorporated  by reference to Exhibit A to
                the Rights  Agreement  filed as Exhibit 4.1 to Current Report on
                Form 8-K filed as of April 6, 1998.
     4.1        Specimen  Stock  Certificate  of  Common  Stock  of  Registrant.
                Incorporated  by  reference  to Exhibit 4.1 to Form S-1 filed on
                September 17, 1996, and the amendments thereto.
     4.2        Rights Agreement, dated as of March 30, 1998, between Registrant
                and  U.S.   Stock   Transfer   Corporation   as  Rights   Agent.
                Incorporated  by reference  to Exhibit 4.1 to Current  Report on
                Form 8-K filed as of April 6, 1998.
     4.3        Form of Rights Certificate. Incorporated by reference to Exhibit
                B to the Rights Agreement filed as Exhibit 4.1 to Current Report
                on Form 8-K filed as of April 6, 1998.
     10.1       Registrant's Second Amended and Restated 1996 Stock Option Plan.
                Incorporated  by reference to Exhibit 10.1 to Form 10-KSBfor the
                year ended December 31, 2000.
     10.2       Form of Registrant's Stock Option Agreement (Non-Statutory Stock
                Option).  Incorporated  by reference to Exhibit 10.2 to Form S-1
                filed on September 17, 1996, and the amendments thereto.
     10.3       Form of Registrant's  Stock Option  Agreement  (Incentive  Stock
                Option).  Incorporated  by reference to Exhibit 10.3 to Form S-1
                filed on September 17, 1996, and the amendments thereto.
     10.4       [Intentionally Omitted]
     10.5       Form of Registrant's Indemnification Agreement.  Incorporated by
                reference to Exhibit  10.28 to Form S-1 filed on  September  17,
                1996, and the amendments thereto.
     10.6       Form  of  Registrant's  Employee  Confidential  Information  and
                Non-Solicitation Agreement. Incorporated by reference to Exhibit
                10.29  to  Form  S-1  filed  on  September  17,  1996,  and  the
                amendments thereto.
     10.7       Standard  Form  Lease  Agreement,  dated May 16,  1997,  between
                Topanga & Victory Partners L.P. and Registrant.  Incorporated by
                reference to Exhibit 10.1 to Quarterly Report on Form 10-QSB for
                the quarter ended June 30, 1997.  [Portions of this Exhibit have
                been  deleted  and  filed  separately  with the  Securities  and
                Exchange   Commission   pursuant  to  a  grant  of  Confidential
                Treatment.]
     10.8       [Intentionally Omitted]
     10.9       [Intentionally Omitted]
    10.10       [Intentionally Omitted]
    10.11       [Intentionally Omitted]


                                       62


<PAGE>


    10.12       [Intentionally Omitted]
    10.13       [Intentionally Omitted]
    10.14       [Intentionally Omitted]
    10.15       [Intentionally Omitted]
    10.16       [Intentionally Omitted]
    10.17       [Intentionally Omitted]
    10.18       [Intentionally Omitted]
    10.19       [Intentionally Omitted]
    10.20       [Intentionally Omitted]
    10.21       [Intentionally Omitted]
    10.22       [Intentionally Omitted]
    10.23       [Intentionally Omitted]
    10.24       Securities  Purchase  Agreement closed as of September 19, 2000,
                by and between Registrant and e-New Media Digital  Entertainment
                Limited.  Incorporated  by reference to Exhibit 99.1 to Form 8-K
                filed on September 27, 2000.
    10.25       Stock Purchase  Agreement,  dated as of January 1, 2000, between
                Registrant  and  Continental   Capital  &  Equity   Corporation.
                Incorporated  by  reference to Exhibit 10.1 to Form S-3 filed on
                April 14, 2000, as amended.
    10.26       Strategic  Partner  Agreement,  dated as of February  17,  2000,
                between   Registrant  and  e-New  Media  Digital   Entertainment
                Limited.  Incorporated by reference to Exhibit 10.1 to Quarterly
                Report on Form 10-QSB for the quarter ended December 31, 1998.
    10.27       [Intentionally Omitted]
    10.28       Executive Employment  Agreement,  dated as of December 18, 2000,
                by and between  Registrant  and Robert Chmiel.  Incorporated  by
                reference to Exhibit 10.1 to Quarterly Report on Form 10-QSB for
                the quarter ended March 31, 2001.
    10.29       Executive Employment Agreement,  dated as of January 1, 2001, by
                and between  Registrant and Kevin  Bermeister.  Incorporated  by
                reference to Exhibit 10.2 to Quarterly Report on Form 10-QSB for
                the quarter ended March 31, 2001.
    10.30       Asset  Purchase  Agreement,  dated as of March 16, 2001,  by and
                among Registrant,  The Auction Channel,  Inc., Trojan Television
                Limited and Metro  Channel,  LLC,  as amended by the  Amendment,
                dated April 27, 2001, as further amended by the Amendment, dated
                April 30,  2001.  Incorporated  by  reference to Exhibit 10.1 to
                Current Report on Form 8-K filed as of May 15, 2001.
    10.31       Note and Warrant Purchase Agreement, dated as of April 19, 2001,
                between   Registrant  and  Europlay  I,  LLC.   Incorporated  by
                reference to Exhibit 10.1 to Quarterly Report on Form 10-QSB for
                the quarter ended June 30, 2001.
    10.32       Note and Warrant Purchase Agreement, dated as of April 19, 2001,
                between  Registrant and Harris Toibb.  Incorporated by reference
                to  Exhibit  10.2 to  Quarterly  Report on Form  10-QSB  for the
                quarter ended June 30, 2001.


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<PAGE>


    10.33       Note and Warrant Purchase Agreement, dated as of April 26, 2001,
                between  Registrant  and  Preston  Ford,  Inc.  Incorporated  by
                reference to Exhibit 10.3 to Quarterly Report on Form 10-QSB for
                the quarter ended June 30, 2001.
    10.34       Amendment to Note and Warrant Purchase  Agreements,  dated as of
                May  23,  2001,   between   Registrant   and  Harris  Toibb  and
                acknowledged  ad consent to by Europlay 1, LLC and Preston Ford,
                Inc.  Incorporated  by  reference  to Exhibit  10.4 to Quarterly
                Report on Form 10-QSB for the quarter ended June 30, 2001.
    10.35       Form of Secured Convertible Promissory Note of Registrant, dated
                May 23,  2001.  Incorporated  by  reference  to Exhibit  10.5 to
                Quarterly  Report on Form 10-QSB for the quarter  ended June 30,
                2001.
    10.36       Form of Warrant to Purchase  Common Stock of  Registrant,  dated
                May 23,  2001.  Incorporated  by  reference  to Exhibit  10.6 to
                Quarterly  Report on Form 10-QSB for the quarter  ended June 30,
                2001.
    10.37       Security  and  Pledge  Agreement,  dated May 23,  2001,  made by
                Registrant,  B3D, Inc., and Brilliant Studios,  Inc. in favor of
                Harris  Toibb,  as agent.  Incorporated  by reference to Exhibit
                10.7 to  Quarterly  Report on Form 10-QSB for the quarter  ended
                June 30, 2001.
    10.38       Guaranty,  dated May 23, 2001,  made by B3D,  Inc. and Brilliant
                Studios,  Inc. in favor of Harris Toibb, as agent.  Incorporated
                by reference to Exhibit 10.8 to Quarterly  Report on Form 10-QSB
                for the quarter ended June 30, 2001.
    10.39       Rights  Agreement  Amendment,  dated as of May 9, 2001,  between
                Registrant and U.S. Stock Transfer Corporation, as Rights Agent.
                Incorporated  by reference  to Exhibit 4.1 to Current  Report on
                Form 8-K filed as of December 21, 2001.
    10.40       Technology  Bundle  License  Agreement,  dated as of  October 2,
                2001, by and between Registrant and Consumer Empowerment B.V., a
                company  organized under the laws of The Netherlands.  [Portions
                of this Exhibit have been omitted and filed  separately with the
                Securities  and  Exchange  Commission  pursuant to a request for
                confidential treatment by Registrant.]*
    10.41       Note and Warrant Purchase Agreement, dated December 10, 2001, by
                and between Registrant and Harris Toibb.*
    10.42       Note and Warrant Purchase Agreement, dated December 10, 2001, by
                and between Registrant and Capel Capital Ltd.*
    10.43       Secured Convertible Promissory Note, dated December 19, 2001, in
                favor of Harris Toibb.*
    10.44       Secured Convertible Promissory Note, dated December 19, 2001, in
                favor of Capel Capital Ltd.*
    10.45       Common Stock Purchase  Warrant,  dated December 19, 2001, by and
                between Registrant and Harris Toibb.*
    10.46       Common Stock Purchase  Warrant,  dated December 19, 2001, by and
                between Registrant and Capel Capital Ltd.*
    10.47       Amendment  Number Two to Note and Warrant  Purchase  Agreements,
                dated  December 19, 2001, by and between  Registrant  and Harris
                Toibb.*


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<PAGE>


    10.48       Amendment Number One to Secured  Convertible  Promissory  Notes,
                dated December 19, 2001, in favor of Harris Toibb.*
    10.49       Amendment  No. 1 to  Warrant to  Purchase  Common  Stock,  dated
                December 19, 2001, by and between Registrant and Harris Toibb.*
    10.50       Amendment  No. 1 to  Warrant to  Purchase  Common  Stock,  dated
                December 19,  2001,  by and between  Registrant  and Europlay 1,
                LLC.*
    10.51       Amendment  No. 1 to  Warrant to  Purchase  Common  Stock,  dated
                December 19, 2001, by and between  Registrant  and Preston Ford,
                Inc.*
    10.52       Amendment Number One to Security and Pledge Agreement,  dated as
                of December 19, 2001, by and between Registrant,  B3D, Inc., and
                Brilliant Studios, Inc. in favor of Harris Toibb, as agent.*
    10.53       Security  and Pledge  Agreement,  dated as of December 19, 2001,
                made by Registrant,  B3D, Inc., and Brilliant  Studios,  Inc. in
                favor of Harris Toibb, as agent.*
    10.54       Investor Rights  Agreement,  by and between  Registrant,  Harris
                Toibb,  Europlay 1, LLC,  Preston  Ford,  Inc. and Capel Capital
                Ltd.*
    10.55       Guaranty,  dated  December  19,  2001,  made  by B3D,  Inc.  and
                Brilliant Studios, Inc. in favor of Harris Toibb, as agent.*
    10.56       Acknowledgement,  Consent and Reaffirmation,  dated December 19,
                2001, by Brilliant Studios, Inc. and B3D, Inc.*
     21.1       List of Subsidiaries.*
     23.1       Consent of BDO Seidman, LLP
     24.1       Power of Attorney.*
     99.1       Certificate of our Chief  Executive  Officer and Chief Financial
                Officer  pursuant  to Section 906 of the  Sarbanes-Oxley  Act of
                2002.

      *         Previously reported on Form 10-KSB.


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