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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

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

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

[_]  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, 2002 were
$ 1,885,000.

         At March 19, 2003, the aggregate  market value of the voting stock held
by non-affiliates of the issuer was $ 3,099,754.

         At March 19, 2003,  the issuer had  32,114,978  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 2003
Annual Meeting of  Stockholders  are  incorporated by reference into Part III of
this Report.


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                                     PART I

ITEM 1.  DESCRIPTION OF BUSINESS

                               CORPORATE OVERVIEW

         Brilliant Digital  Entertainment,  Inc. is a company which operates two
distinct lines of business: (1) through our Altnet, Inc. subsidiary,  we operate
a peer-to-peer-based content distribution network, utilizing existing technology
which allows Altnet to securely and efficiently  distribute digital files to end
users, and (2) through our b3d, Inc.  subsidiary,  we are a developer and server
of rich media advertising  campaigns ("rich media" being defined as use of audio
and animation), and a developer of software authoring tools used in the creation
of "three  dimensional",  or "3D",  animated content,  for use on the World Wide
Web.

         Through our Altnet, Inc.  subsidiary,  we operate a  peer-to-peer-based
content  distribution  network  that  allows  us  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 have
created  technologies for 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,  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
commercialize  Altnet by partnering  with third party operators of web sites and
other Internet  applications to enable users of those web sites and applications
to search  for and  download  digital  files from other  Altnet  users.  We also
operate a payment  processing  "gateway" that enables computer users to purchase
content  using  their  credit  cards and,  in the future,  their  telephone  and
pre-paid phone cards.

         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.

         We  generate   revenue  from  our  Altnet   peer-to-peer   business  by
contracting  with content  owners to distribute  and sell their digital files to
computer  users.  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 after it has been downloaded to the users computer.

         During the fourth quarter of 2002, we generated our first revenues from
the  distribution  and sale of digital files  pursuant to our  distribution  and
revenue sharing agreement with Sharman Networks Limited. Sharman distributes the
Kazaa Media  Desktop  file sharing  software  application  (or KMD),  which is a
public, or "open" distributed  peer-to-peer  search engine that allows KMD users
to locate and share  digital  files with other KMD  users.  Our  agreement  with
Sharman allows Altnet to distribute and sell digital files to KMD users.  We pay
Sharman a percentage  of revenue  generated  from the  distribution  and sale of
Altnet files to KMD users.

         In November 2002, we entered into an agreement with NewGenPay,  Inc. to
process   credit  card   payments  for  purchases  of  Altnet  files  using  our
micro-payment  processing  system.  Each credit  card  payment is  processed  by
NewGenPay's subsidiary, AllCharge, Inc., using its proprietary technology.

         During  the  second  half  of  2002,  we  began   performing   business
development  services in the United  States for  Sharman  Networks  Limited.  We
negotiate  with third  parties that desire to enter into a business  transaction
with  Sharman  relating  to the KMD  application,  with a  particular  focus  on
partners that will benefit from the use of our Altnet  peer-to-peer  distributed
network.  These  transactions  include the  placement by third parties of banner
advertisements on the KMD, software bundle transactions whereby a


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third party's  software  product is bundled with downloads of the KMD, and other
partnering transactions.  We are paid a percentage of the gross revenue received
by Sharman for each transaction entered into based on our efforts.

         In  October  2002,  we  licensed  from  Kinetech,  Inc.  rights  to its
TrueNames patent (U.S. patent #5,978,791) and all related intellectual property.
We have a  non-exclusive,  sublicensable  right to the Patent for the purpose of
developing,  marketing, renting and selling products and services which, without
the license, would infringe or contribute to the infringement of the Patent. The
TrueNames  patent  covers a method of  identifying  digital  files  based on the
actual data  contents of the file,  rather than by its name,  origin,  location,
address,  or other information that can easily be changed.  A unique identifier,
or "file  hash," is  assigned  to data of each  file,  using an  algorithm  in a
patented process.  Networking applications,  most notably peer-to-peer networks,
use  the  file  hash  to  identify  files  correctly,   eliminating  unnecessary
redundancies  and allowing the networks to operate more  efficiently.  TrueNames
can also be used to periodically synchronize information on distributed systems.
As consideration for the license, we issued to Kinetech a warrant to purchase up
to 5 million  shares of our common stock at a nominal price of par value ($0.001
per share).

         Through our b3d,  Inc.  subsidiary,  we are a  developer  and server of
"rich   media"   (which   includes   audio  and   animation)   Internet   banner
advertisements, and a developer of software authoring tools used to create three
dimensional (or 3D) animated  content for use on the World Wide Web. We generate
revenue  from our  Internet  advertising  business by  licensing  our ad serving
technology,  which is used to display  our  Brilliant  Banners,  to third  party
operators of web sites and other Internet applications,  and we generate revenue
from our software tools business by selling  licenses to our b3d software tools.
During fiscal 2002, we shifted our emphasis  from our Internet  advertising  and
b3d toolset business to our Altnet peer-to-peer business. This shift in emphasis
occurred  gradually over the course of fiscal 2002, and has come about primarily
due to our limited financial  resources,  which have been unable to support both
businesses.  Until we have sufficient  resources to support both businesses,  we
have indefinitely  suspended  substantially all of our Internet  advertising and
b3d  toolset  operations  and intend to focus  substantially  all of our limited
financial resources and efforts to grow the Altnet business.

         In November 2001, we ceased all internal  production and syndication of
our 3D animated  content,  which  previously had been a substantial  part of our
business.  This content  included the episodic  animations,  called  MultipathTM
Movies, based on such well-known characters as SUPERMAN, XENA: WARRIOR PRINCESS,
KISS,  and ACE  VENTURA.  During  the first  quarter  of 2002,  we  discontinued
operations at Digital Hip Hop, the joint  venture we formed to produce  animated
music videos for the World Wide Web, and discontinued  operations at, and placed
into liquidation,  Brilliant  Interactive Ideas Pty. Ltd., our  Australian-based
production company which employed a team of animators and programmers  dedicated
to animation production.  We discontinued operations at Digital Hip Hop based on
the limited  prospects of additional web video  production work. We discontinued
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 closing
of Digital Hip Hop. The cessation 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 did 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 report.


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                            OUR PEER-TO-PEER BUSINESS

         During the third quarter of 2001, we began  marketing and  distributing
our  Digital  Projector,   the  software  application   necessary  to  view  our
b3d-produced animated content, through two large peer-to-peer networks, Consumer
Empowerment  B.V.,  whose assets were later acquired by Sharman Networks Limited
in February  2002,  which  distributes  the Kazaa  applications,  and StreamCast
Networks,   which   distributes  the  Morpheus   applications.   Both  of  these
applications  form  public,  or "open"  connections  that  allow  users to share
digital  files with other users of the same  applications.  Through our business
relationships with Consumer Empowerment,  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   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 have created  technologies for 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.  During
the fourth quarter of 2002, we began to commercialize  Altnet by partnering with
third party  operators of web sites and other  Internet  applications  to enable
users of those web sites and  applications  to search for and  download  digital
files from other Altnet users.  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.

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 and manage 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.

         The peer-to-peer technology necessary to operate the Altnet network has
been installed on tens of millions of computers worldwide, primarily through our
technology  bundle agreement with Sharman  Networks,  which distributes the very
popular  Kazaa  Media  Desktop  (or KMD) file  sharing  application.  Additional
installations of our peer-to-peer  technology are added with each new successive
download of the KMD. We have been able to leverage our relationship with Sharman
Networks  to  overcome  a  significant  impediment  to  establishing  a  broadly
distributed  peer-to-peer network: the installation of the software necessary to
connect peer computers to that network.

STRATEGY

         Our objective is to develop and deploy an  Internet-based  distribution
platform for digital content, supporting payments, content licensing, and common
carrier or "rent a system" distribution models. In order


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to become a distributor of content, we intend to syndicate our search engine and
Download  Manager,  which are used to search for and download  Altnet files,  to
multiple  web sites  and  applications.  Important  components  of our  strategy
include:

          o    Expanding our content  library to include a large  representation
               of a broad range of content categories in multiple languages;

          o    Establishing   a  user  payment   interface  to  facilitate   the
               convenient purchase of digital content by our users;

          o    Continuing  to  support  all DRM  systems  to  enable  use of our
               network by a broad base of  content  owners and their  technology
               partners; and

          o    Leveraging  our search  agreement  with Sharman  Networks,  which
               allows us to deliver  Altnet  files to millions of KMD users,  to
               attract content owners to Altnet.

         Our   longer-term   goal  is  for  Altnet,   through   multiple  client
relationships,  to  be  the  next  advancement  in  distributed  premium  search
indexing, 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 web sites 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,  by
delivering  the Web  content  and  applications  of our  customers,  through our
private peer-to-peer network,  directly to a peer computer that is significantly
geographically  closer to end users than are the servers operated by distributed
storage and computing companies.

THE ALTNET SERVICE

         Two significant  features of Altnet are its premium  distributed search
index product, called TopSearch,  which contains listings of the content that is
made  available to Altnet  users,  and its ability to  communicate  with the KMD
technology,  an existing  graphical  user interface and  peer-to-peer  transport
protocol  application that is already installed on desktops  worldwide.  Tens of
millions of search  requests each day are being made using the KDM and FastTrack
technology by users worldwide.  These search requests can be accessed by Altnet,
and pursuant to our  agreement  with Sharman  Networks,  relevant  Altnet search
results are  displayed  in the KMD to Kazaa  users in  response to their  search
requests.  This allows KMD users to search for and download  digital  files that
reside in user defined shared folders on both Kazaa and Altnet users' computers.

         TopSearch,  accessed using KMD, operates in the following manner. Users
who have the KMD application open and are connected to the Internet, type one or
more key words in the search box in an effort to search for  digital  files.  If
the search query  matches one or more  available  Altnet  files  included in the
TopSearch  listing,  those match  results are  displayed to the user in the KMD.
Altnet files, which are displayed in the Kazaa Media Desktop, are differentiated
by a gold icon next to the file name,  as opposed to the bluish green icon which
denotes  a  file  available  from  other  KMD  users.  The  user  experience  of
downloading  a file from the  Altnet  network is  substantially  the same as the
procedure of downloading a file from a KMD user, with the following  significant
differences:

          o    The  Altnet  files,  denoted by the gold  icon,  are placed  with
               Altnet  and  made  available  to  users  only  with  the  express
               permission  of the  copyright  owner or  licensee  pursuant to an
               agreement;

          o    A user can usually  download a file from  Altnet  faster than the
               user can download a file from another KMD user  (enabling  Altnet
               to offer  improved  service  to KMD  users),  because  the Altnet
               application  is  more  efficient  and  files  are   automatically
               downloaded from a fallback server if the files cannot be found on
               or accessed timely from the Altnet peer-to-peer network; and


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          o    Pursuant to our agreement with Sharman, Altnet files that match a
               user's  search  query will always be  displayed  in the top three
               positions  within  the  search  results  page of the Kazaa  Media
               Desktop and in every fourth position mingled among other matching
               files available from other KMD users.

         We enter into agreements with owners and licensees of proprietary media
content,  such as  music,  movie  clips,  movie  trailers,  full-length  movies,
computer games, and software  products.  These  agreements  permit us to display
their  authorized  files  to end  users in  response  to the end  user's  search
request.  Pursuant to our agreement with distribution partners,  such as Sharman
Networks,  we offer our  customers  (the  owners of media  files) the ability to
display their media files to users of the  distribution  partners' web sites and
other Internet  applications.  We then  facilitate the secure  delivery of these
files  from the  Altnet  peer-to-peer  system to these  users  upon  request  in
accordance  with  the  parameters  set  by the  content  owner,  including,  for
instance,  the price at which  they want to sell their  content  if the  content
owner desires to offer its media files for sale. To protect the content  owner's
files against  infringement,  we "wrap" each file with DRM  technology  prior to
making the file available to Altnet users.  DRM technology  controls how the end
user can access and use the file once downloaded.  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 a file
has been downloaded),  and/or (iii) a negotiated percentage of the sale price of
such file, to the extent the file is paid for by the end user.

         Users pay for Altnet files using our payment "gateway," a micro-payment
processing system which allows for the individual sale of digital content at any
price point. Currently, we only accept credit card payments, which are processed
by  AllCharge,  Inc., a subsidiary  of  NewGenPay,  Inc., a third party  payment
processing  company.  After  deducting its processing and other fees,  AllCharge
remits the  adjusted  revenue to us.  From this  amount,  we pay any  previously
negotiated fees to the content owner and to the  distribution  partner whose web
site or Internet application was used to search for and obtain the digital file.
In the  future,  we  intend  to  expand  our  payment  gateway  to  offer  users
alternative payment methods, including charging for downloaded files directly to
a  user's  telephone  bill,  pre-paid  phone  cards,   pre-paid  gift  cards  or
private-label debit card.

         For  downloaded  files that do not require any payment  from end users,
the content  owner pays us the  negotiated  distribution  fee (either based on a
price per download or DRM license issued) in accordance with our agreement.

DISTRIBUTION OF ALTNET'S SERVICES

         We have initially  commercialized  TopSearch through a distribution and
revenue sharing agreement with Sharman Networks,  which allows us to display our
files to users of the Kazaa  Media  Desktop in  response  to the  user's  search
query.  Sharman  is our  most  significant  distribution  partner.  We are  also
marketing  TopSearch to operators of web sites and other Internet  applications.
Using our Download Manager, an application that builds upon our proven installer
technology,  our  distribution  partners are able to  interface  with the Altnet
peer-to-peer  applications  to make our catalogue of content  available on their
web sites and Internet  applications,  while taking advantage of the distributed
bandwidth  benefits  afforded  to  content  owners  and web  sites  by  Altnet's
technology.

SALES AND MARKETING OF ALTNET'S SERVICES

         We have engaged outside  business  development  professionals to market
our Altnet service to owners and licensees of proprietary content. Our sales and
marketing  strategy  is to market our  services to  domestic  and  international
content owners to build a content  library that includes a large  representation
of a broad range of content categories in multiple languages.  We have had early
success with using consultants, and will employ an internal sales staff when our
financial resources permit.


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COMPETITION FOR ALTNET'S SERVICES

         There are several  peer-to-peer  file sharing  companies in  existence,
including Sharman Networks,  iMesh, Grokster, Lime Wire, Streamcast Networks and
Bear Share. The application  software provided by these competitors is typically
available for free and can usually be downloaded from www.download.com.  Once an
end  user  has  downloaded  one of these  applications,  they  are then  able to
exchange files with other users.  The files,  which are exchanged among users of
the  applicable  applications,  are typically  provided by the end users.  Often
these users are making  available for  exchange,  files to which they do not own
distribution  rights.  These  public or "free" file  sharing  networks  are very
popular among computer users, as evidenced by Sharman Networks'  statements that
over 185  million  copies  of its  Kazaa  Media  Desktop  application  have been
downloaded  by end users,  and that at any given time  during  each day,  over 4
million  users are  simultaneously  using the Kazaa Media  Desktop.  We directly
compete with these file sharing networks in the distribution and sale of digital
files.

         Additionally,  there are numerous  companies that offer media files for
sale from a central server.  Two of the more popular sites that make music files
available for sale are MusicNet and PressPlay. MusicNet is a joint venture among
RealNetworks,  AOL Time Warner,  Bertelsmann  AG, EMI  Recorded  Music and Zomba
Records,  and  PressPlay is owned and  operated by Sony Music and the  Universal
Music Group.  Other  companies  selling music  downloads  include  Liquid Audio,
Listen.com  and  MP3.com.  These  businesses  offer  a  combination  of  monthly
subscriptions and payments per download. Aside from the music business, numerous
sites are available on the Internet to users who wish to download movies.  These
include  Movies.com  and  CinemaNow.com.  Typically  movie  files are sold on an
ala-carte  basis at a pre-set price.  Also,  many of the large  Internet  portal
sites such as Yahoo! and many of the large brick-and-mortar  retail distributors
of media  now  offer  for sale  music  and  movie  files  online.  In  addition,
Centerspan  Communications  Corporation  offers a  content  distribution  system
called  C-StarOne,  which securely  distributes  digital audio,  video, and data
files,  and  Kontiki,  Inc.  provides  a secure,  managed  delivery  system  for
enterprise media and document control. All of these entities, either directly or
indirectly  compete  with Altnet,  and all have  financial  and other  resources
significantly greater than what currently is available to Altnet.

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 growth.  Our
success will depend, in part, on the following:

          o    acceptance by content owners of our services;

          o    willingness of consumers to pay for content

          o    acceptance  by web sites and other  distribution  partner  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;

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

          o    The   technical   viability   of   the   commercially   available
               micro-payment  processing  software we employ to process  payment
               for the individual sale of content over the Altnet network.


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BUSINESS DEVELOPMENT SERVICES FOR SHARMAN NETWORKS

         During the second half of 2002, we began  performing on a non-exclusive
basis business development services in the United States under an agreement with
Sharman Networks  Limited.  We negotiate with third parties that desire to enter
into a business transaction with Sharman relating to the KMD application.  These
transactions include the placement by third parties of banner  advertisements on
the KMD, software bundle  transactions  whereby a third party's software product
is bundled  with  downloads of the KMD, and other  partnering  transactions.  In
performing  these  services,  we focus our efforts on partners that will benefit
from the use of our peer-to-peer  distributed  network. We are paid a percentage
of the gross revenue received by Sharman for each transaction entered into based
on our  efforts.  Pursuant  to this  arrangement,  we  have  assisted  with  the
following transactions:

          o    In September, 2002, we assisted with an agreement between Sharman
               and  Overture  Services,  Inc.  for the  placement  on the KMD of
               Overtures'  World Wide Web search engine  application that allows
               users of the KMD to search the World Wide Web; and

          o    In February 2003, we assisted with an agreement  between  Sharman
               and MatchNet plc for the placement on the KMD of "dating service"
               application  that  allows  users of the KMD to search  MatchNet's
               online  database of dating  profiles and  subscribe to MatchNet's
               online dating service from the KMD.

THE "TRUENAMES" PATENT

         In  October  2002,  we entered  into a patent  license  agreement  with
Kinetech,  Inc.,  the  co-owner  of U.S.  Patent No.  5,978,791  and all related
intellectual  property,  which we refer to as the "TrueNames Patent," for use in
our   peer-to-peer   business.   Under  the   agreement,   we  have  a  limited,
non-exclusive, non-transferable, revocable, sublicensable right under and to the
patent for the sole purpose of  developing,  marketing,  renting  and/or selling
products  and/or  services  which,  without  this  license,  would  infringe  or
contribute to the  infringement  of any claim of the  TrueNames  patent right to
sub-license use of the TrueNames technology. In consideration for the patent, we
issued to Kinetech a warrant to  purchase  up to 5 million  shares of our common
stock at a nominal price of par value ($0.001 per share).

         The TrueNames Patent is a method of identifying  digital files based on
the actual data contents of the file, rather than by its name, origin, location,
address,  or other information that can easily be changed.  A unique identifier,
or "file  hash",  is assigned to the file data using an  algorithm in a patented
process.  Networking  applications,  most notable peer-to-peer networks, can use
the file hash to identify files correctly,  eliminating unnecessary redundancies
and allowing the networks to operate  more  efficiently.  TrueNames  can also be
used to periodically synchronize information on distributed systems.

         The term of the  license  is for the life of the  patent and covers the
territory of the United States, its territories, and its possessions, as well as
any other country or geographic  region for which a patent  application has been
filed by  Kinetech  or a patent  has been  issued  to  Kinetech  that is, in all
material  respects,  substantially  similar to the patent.  Also,  Kinetech  has
agreed not to develop,  market,  lease and/or  sell,  and not offer or grant any
license  of the  Patent  to any  third  party  for the  purpose  of  developing,
marketing,  leasing and/or selling, products and/or services within the scope of
the permitted use in the territory covered by the license that would,  without a
license of the patent,  infringe  the patent for as long as the rights under the
patent remain enforceable, and to this extent, the license shall be deemed to be
exclusive  to us.  Kinetech  does  reserve  the  right to use the  patent in any
manner, or grant licenses,  assign, convey, transfer, sell or otherwise alienate
the patent to any third party for use  outside the field and scope as  permitted
in the  license,  whether or not such use by  Kinetech or such third party is in
direct competition with our.

         The  "permitted  use" of the  license  is  identifying  peer  PC's with
resident shareable copies of digital music,  video,  images,  files and/or games
and  facilitating  a user's  previewing,  purchase,  performance or use of same,
implemented as an  Internet-wide  public access  peer-to-peer  network,  created
through  contributions  of  unrelated  persons'  residual  background  computing
resources on widely  distributed,  substantially  all non-ISP based, PCs. We use
the patent in our peer-to-peer network.


                                       7


<PAGE>


         In  addition  to using  the  patented  technology  to  operate  our own
peer-to-peer  business,  we intend  to  identify  other  parties  that  might be
infringing  the patent and,  where we deem  appropriate,  seek to sublicense the
patent for a fee.

                   OUR ADVERTISING AND SOFTWARE TOOLS BUSINESS

         During   fiscal  2002,  we  shifted  our  emphasis  from  our  Internet
advertising and b3d toolset business to our Altnet peer-to-peer  business.  This
shift in emphasis  occurred  gradually  over the course of fiscal 2002,  and has
come about  primarily due to our limited  financial  resources,  which have been
unable to support both businesses. Until we have sufficient resources to support
both  businesses,  we  have  indefinitely  suspended  substantially  all  of our
Internet   advertising   and  b3d  toolset   operations   and  intend  to  focus
substantially  all of our limited  financial  resources  and efforts to grow the
Altnet business. We intend to resume efforts once our cash flow improves.

         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  introduced  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.

         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 marketed 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 believed
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 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.


                                       8


<PAGE>


SALES, MARKETING AND DISTRIBUTION OF OUR TECHNOLOGY

         Our b3d products  were made  commercially  available as a download from
our web site in the third  quarter of 2001.  We have also  marketed  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 have  generally  charged a fee to our clients for the  production of
Brilliant Banners, which we have outsourced to third party production firms at a
cost that  generally  equals the fee we received from our client.  Consequently,
the  production  of  Brilliant  Banners is not  profitable  for us. We have also
received  sales  commissions  from the  publishers of web sites on which we have
placed 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.

         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.


                                       9


<PAGE>


         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

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.


                                       10


<PAGE>


         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.

          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.


                                       11


<PAGE>


RECEIVED AND PENDING PATENTS

         We have received two United  States  patents and have two United States
patents  where we have  received a notice of  allowance  with respect to our b3d
tools suite, in the following subject areas:

         PATENTS RECEIVED:

          o    SYSTEM & METHOD FOR OPTIMIZING 3D ANIMATION AND TEXTURES - Patent
               # 9,471,722.

          o    DYNAMIC REPLACEMENT OF 3D OBJECTS IN A 3D OBJECT LIBRARY - Patent
               # 6,476,802.

         PATENTS PENDING:

          o    SYSTEM AND METHOD FOR REAL TIME  SCALABILITY OF 3D GRAPHICS BASED
               ON INTERNET  BANDWIDTH  AND CPU SPEED -- 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.

          o    SYSTEM AND METHOD FOR  CREATING 3D ANIMATED  CONTENT FOR MULTIPLE
               PLAYBACK  PLATFORMS  FROM A  SINGLE  PRODUCTION  PROCESS  -- This
               patent  application  describes a method of storing multiple files
               within a single file for  interactive  streaming  of 3D animation
               data.

         We have previously disclosed that we had a total of eight United States
patents  pending.  If any of these  remaining  applications  are accepted by the
Patent office,  we will  determine at that time whether to pursue  registration.
Given  our shift in  emphasis  from our  Internet  advertising  and b3d  toolset
business to our Altnet peer-to-peer  business,  these remaining applications may
be of limited value.

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., 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


                                       12


<PAGE>


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.

                            RESEARCH AND DEVELOPMENT

         In  fiscal  years  2002 and  2001,  we  spent  $444,000  and  $139,000,
respectively,  on research and development. The costs increased primarily due to
an increase in web development  costs,  research and  development  personnel and
overhead costs associated with our research and development  efforts for Altnet.
During the first  quarter of 2002,  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 to 7 employees.

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

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

          o    Developing  web services  interfaces to media  partners,  payment
               processor  partners  and  points  redemption  partners  to  allow
               Altnet's  servers to  communicate  with our partner's  servers to
               provide integrated billing,  customer relations  management,  and
               reporting services;

          o    Developing  innovative new payment  systems,  allowing the widest
               possible  audience to be able to purchase  Altnet content online,
               even if they don't have credit cards;

          o    Developing the Altnet Points Manager, which allows users to earn,
               view and  redeem  points  for  sharing  Altnet  files via the P2P
               network.

          o    Working with major  advertising,  media and software companies to
               make Altnet a key player in the rapidly  growing  digital content
               delivery space.

          o    Developing  technology  to  improve  delivery  speed,  and reduce
               delivery costs, of digital content over the Internet.

          o    Developing a scalable content distribution and reporting platform
               with multi-partner, multi-user login capability;


                                       13


<PAGE>


         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, 2002,  we had 14 full-time  employees,  of which 7 were
engaged  in  research  and   development,   1  in   production,   4  in  general
administration and finance and 2 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 7  independent  consultants,  1 in software  development,  3 in
administrative  and  business  development  roles and 3 in sales  and  marketing
pursuant to  contractual  relationships.  Seven  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.

ITEM 2.  DESCRIPTION OF PROPERTIES

         Our corporate offices are located in Woodland Hills,  California,  with
annual lease payments of approximately $70,000. In February 2003, we renewed the
lease with our existing landlord for an additional two years.

         Our research and  development is conducted in Australia.  In Australia,
we entered into a two year lease in February 2003 with annual lease  payments of
approximately $31,000.

ITEM 3.  LEGAL PROCEEDINGS

         We are not involved in any material litigation.

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

         None.


                                       14


<PAGE>


                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

COMMON STOCK

         Our Common Stock trades on the American Stock Exchange under the symbol
"BDE." The following table sets forth, for the periods  indicated,  the high and
low  sales  prices  for the  Common  Stock as  reported  by the  American  Stock
Exchange:

                                                          HIGH           LOW
                                                          ----           ---
     YEAR ENDED DECEMBER 31, 2002
          First Quarter .....................          $   0.28       $   0.11
          Second Quarter ....................              0.74           0.14
          Third Quarter .....................              0.31           0.14
          Fourth Quarter ....................              0.38           0.17

     YEAR ENDED DECEMBER 31, 2001
          First Quarter .....................          $   2.12       $   0.65
          Second Quarter ....................              1.00           0.55
          Third Quarter .....................              0.82           0.23
          Fourth Quarter ....................              0.60           0.15

         On March 19,  2003,  the  closing  sales  price of the Common  Stock as
reported on the American  Stock  Exchange  was $0.16 per share.  As of March 26,
2003, there were 95 holders of record of our Common Stock.

DIVIDENDS

         We have never paid any  dividends  on our  Common  Stock.  We intend to
retain any  earnings  for use in our  business and do not intend to pay any cash
dividends on our Common Stock in the foreseeable future.

EQUITY COMPENSATION PLAN INFORMATION

         The following table sets forth certain information regarding our equity
compensation plans as of December 31, 2002.
<TABLE>
<CAPTION>

                           NUMBER OF SECURITIES TO    WEIGHTED-AVERAGE EXERCISE        NUMBER OF SECURITIES
                           BE ISSUED UPON EXERCISE       PRICE OF OUTSTANDING         REMAINING AVAILABLE FOR
                           OF OUTSTANDING OPTIONS,      OPTIONS, WARRANTS AND      FUTURE ISSUANCE UNDER EQUITY
                             WARRANTS AND RIGHTS                RIGHTS                  COMPENSATION PLANS
                           -----------------------    -------------------------    ----------------------------
<S>                               <C>                          <C>                          <C>
Equity compensation
plans approved by
security holders........          6,359,000                    $ 0.9448                     13,395,375

Equity compensation
plans not approved by
security holders........          5,909,286                    $ 0.0354                         --

Total...................         12,268,286                    $ 0.50576                    13,395,375
</TABLE>


                                       15


<PAGE>


MATERIAL  FEATURES  OF  INDIVIDUAL  EQUITY  COMPENSATION  PLANS NOT  APPROVED BY
STOCKHOLDERS

         In February  2002, we issued to VoxPop,  LLC warrants to purchase up to
200,000 shares of our common stock at an exercise price of $0.15 per share.  The
warrants have a term of 4 years.

         In April 2002, we issued to Business Development Experts, Inc. warrants
to purchase  up to 250,000  shares of our common  stock at an exercise  price of
$0.25 per share. The warrants have a term of 4 years.

         In April 2002,  we issued to The Rose Group  warrants to purchase up to
14,823 shares with an exercise price of $0.4385,  20,212 shares with an exercise
price of $0.3216,  and 39,251  shares  with an exercise  price of $0.1656 of our
common stock. The warrants have a term of 3 years.

         In April 2002, we issued to mPRm Public Relations  warrants to purchase
up to 75,000 shares of our common stock at an exercise price of $0.25 per share.
The warrants have a term of 3 years.

         In April  2002,  we issued to KaZaA,  B.V.  warrants  to purchase up to
150,000  shares of our common  stock at an exercise  price of $0.2710 per share.
The warrants have a term of 30 months.

         In July 2002,  we issued to Kayoss  warrants  to  purchase up to 10,000
shares of our common stock at an exercise price of $0.75 per share. The warrants
have a term of 48 months.

         In August 2002, we issued to SRO Consultants, Inc. warrants to purchase
up to  150,000  shares of our  common  stock at an  exercise  price of $0.17 per
share. The warrants have a term of 48 months.

         In October 2002, we issued to Kinetech, Inc. warrants to purchase up to
5,000,000  shares of our common stock at an exercise  price of $0.001 per share.
The warrants have a term of 84 months.


                                       16


<PAGE>


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, 2002
AND DECEMBER 31, 2001. 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 company which operates two
distinct lines of business: (1) through our Altnet, Inc. subsidiary,  we operate
a peer-to-peer-based  content distribution network,  utilizing existing,  proven
technology  which allows Altnet to securely and efficiently  distribute  digital
files to end users, and (2) through our b3d, Inc. subsidiary, we are a developer
and server of rich media  advertising  campaigns  ("rich media" being defined as
use of audio and animation), and a developer of software authoring tools used in
the creation of "three  dimensional",  or "3D", animated content, for use on the
World Wide Web.

         Through our Altnet, Inc.  subsidiary,  we 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. We commercialize Altnet by partnering with third party operators
of web sites and other Internet  applications to enable users of those web sites
and  applications  to search  for and  download  digital  files  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.

         Additionally,  through our b3d, Inc. subsidiary, we are a developer and
server of "rich media" (which  includes  audio and  animation)  Internet  banner
advertisements, and a developer of software authoring tools used to create three
dimensional (or 3D) animated content for use on the World Wide Web.

         During   fiscal  2002,  we  shifted  our  emphasis  from  our  Internet
advertising and b3d toolset business to our Altnet peer-to-peer  business.  This
shift in emphasis  occurred  gradually  over the course of fiscal 2002,  and has
come about  primarily due to our limited  financial  resources,  which have been
unable to support both businesses. Until we have sufficient resources to support
both  businesses,  we  have  indefinitely  suspended  substantially  all  of our
Internet   advertising   and  b3d  toolset   operations   and  intend  to  focus
substantially  all of our limited  financial  resources  and efforts to grow the
Altnet business. We intend to resume efforts once cash flow improves.

         We generate, or intend to generate, revenue in five 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 perform business development services in the United States for
               Sharman  Networks  Limited,  the  distributor  of the Kazaa Media
               Desktop  file  sharing  software  application,   pursuant  to  an
               arrangement  which gives us a portion of the revenue  received by
               Sharman as a result of our efforts;


                                       17


<PAGE>


          o    We  intend  to  sublicense  to third  parties  our  rights to the
               TrueNames patent (U.S.  patent  #5,978,791) which we license from
               Kinetech Inc. The TrueNames patent covers a method of identifying
               digital  files  based on the actual  data  contents  of the file,
               rather  than by its name,  origin,  location,  address,  or other
               information that can easily be changed.

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

         During  the  second  half of 2002,  we  generated  our first  revenues,
$82,000, from the distribution and sale of digital files over the Altnet network
to users of the Kazaa Media Desktop file sharing software  application (or KMD).
Our agreement with Sharman Networks  Limited,  distributor of the KMD, allows us
to distribute and sell digital files from the Altnet network to KMD users. A KMD
user can download an Altnet file from the Altnet  network in  substantially  the
same  manner as the user would  download a digital  file from other users of KMD
applications.  Pursuant to our agreement with Sharman, if a search query matches
the  description  of one or more Altnet  files,  the  matching  Altnet files are
currently  displayed in the top four positions and every seventh file within the
search  results  page of the KMD GUI.  We pay  Sharman a  percentage  of revenue
generated from the distribution and sale of Altnet files to users of the KMD.

         During  the  second  half  of  2002,  we  began   performing   business
development  services  in the United  States  under an  agreement  with  Sharman
Networks  Limited.  We negotiate  with third parties that desire to enter into a
business  transaction  with  Sharman  relating  to the  KMD  application.  These
transactions include the placement by third parties of banner  advertisements on
the KMD, software bundle  transactions  whereby a third party's software product
is bundled with downloads of the KMD, and other partnering transactions.  We are
paid a percentage of the gross revenue  received by Sharman for each transaction
entered  into  based  on our  efforts.  Pursuant  to this  arrangement,  we have
assisted with the following transactions:

          o    In September, 2002, we assisted with an agreement between Sharman
               and  Overture  Services,  Inc.  for the  placement  on the KMD of
               Overtures'  World Wide Web search engine  application that allows
               users of the KMD to search the World Wide Web; and

          o    In February 2003, we assisted with an agreement  between  Sharman
               and MatchNet plc for the placement on the KMD of "dating service"
               application  that  allows  users of the KMD to search  MatchNet's
               online  database of dating  profiles and  subscribe to MatchNet's
               online dating service from the KMD.

         During  fiscal 2002,  we received  $172,000 in revenue from Sharman for
our business development services.

         In  October  2002,  we  licensed  from  Kinetech,  Inc.  rights  to its
TrueNames patent (U.S. patent #5,978,791) and all related intellectual property.
We have a  non-exclusive,  sublicensable  right to the Patent for the purpose of
developing,  marketing, renting and selling products and services which, without
the license,  would infringe or contribute to the infringement of the Patent. As
consideration for the license, we issued to Kinetech a warrant to purchase up to
5 million shares of our common stock at a nominal price of par value ($0.001 per
share),  for which we recorded  $30,000 of warrant expense in the fourth quarter
of 2002.  In  addition  to using the  patented  technology  to  operate  our own
peer-to-peer  business,  we intend  to  identify  other  parties  that  might be
infringing  the patent and,  where we deem  appropriate,  seek to sublicense the
patent for a fee.

         In November 2001, we ceased all internal  production and syndication of
our 3D animated  content,  which  previously had been a substantial  part of our
business.  This content  included the episodic  animations,  called  MultipathTM
Movies, based on such well-known characters as SUPERMAN, XENA: WARRIOR PRINCESS,
KISS,  and ACE  VENTURA.  Additionally,  during  the  first  quarter  of 2002 we
discontinued  operations  at  Digital  Hip Hop,  the joint  venture we formed to
produce animated music videos for the World Wide Web, and discontinued


                                       18


<PAGE>


operations at, and placed into  liquidation,  Brilliant  Interactive  Ideas Pty.
Ltd., our  Australian-based  production company.  The elimination of 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 Altnet
subsidiary.

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,  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  change.  We do not have material  exposure to any
single customer or group of customers at this time. At December 31, 2002, we had
a  reserve  of  $42,000  to cover two  customers  from  whom  collectibility  is
uncertain.

RESULTS OF OPERATIONS

         REVENUE RECOGNITION

         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).  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.

         BUSINESS  DEVELOPMENT  SERVICES.  We generate fee income for performing
business  development  services for Sharman  Networks Limited in accordance with
our  agreement.  We  negotiate  with third  parties  that desire to enter into a
business transaction with Sharman relating to the KMD application. We are paid a
percentage of the gross revenue received by Sharman for each transaction entered
into based on our efforts. We


                                       19


<PAGE>


recognize fee income from individual transactions based on the specific terms of
the  applicable  contract,  which may involve (i) a revenue  share deal,  (ii) a
one-time fee paid at signing or at some other date,  or (iii) a  combination  of
these two arrangements.  Non-refundable  advance fees are recognized on the date
the  payment  is due as  specified  in the  contract.  Revenue  share  fees  are
recognized  as earned.  We reflect  this revenue in the  Operating  Statement as
Development fees and other revenue.

         ALTNET REVENUE: We derive revenue from our Altnet peer-to-peer business
by processing digital media content (music, video games,  software,  movies) for
placement on our  peer-to-peer  network,  and by  promoting,  distributing,  and
selling the content to end users of the network.  We reflect  Altnet  revenue in
the Operating Statement as Development fees and other revenue.

         We  charge  our  clients  a  processing  fee  to  prepare  content  for
distribution  on our network.  The amount of this fee varies based on the number
of files, the size of the files,  digital encoding costs, and the preparation of
collateral  marketing  materials,  such as  artwork.  These  fees are due and we
recognize the revenue upon signing of the contract.

         We charge our clients for content  promotions  on a cost per  specified
number of downloaded files. A customer typically  pre-purchases an agreed number
of  downloaded  files.  The  amounts  we charge  vary  based on  volume  and the
complexity of the campaign.  Content  promotions  generally include a processing
fee.  These  fees are due and we  recognize  the  revenue  upon  signing  of the
contract.

         We charge our clients for content sales based on (a) a revenue  sharing
basis  where we receive an agreed  upon  percentage  of the sales price for each
transaction,  and (b) a  combination  of revenue  share and a cost per specified
number  of  downloaded  files.  Content  sales  campaigns  generally  include  a
processing  fee. We recognize  revenue from content sales when the end user pays
for the content and, where relevant, the file is downloaded by the end user.

         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.


                                       20


<PAGE>


         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 AICPA
Statement  of Position  97-2 (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.

         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  tooset.  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 AICPA  Statement of Position  97-2 (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 AICPA Statement
of Position 97-2 (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.


                                       21


<PAGE>


REVENUES.

         Revenues  increased 34% from $1,410,000 for the year ended December 31,
2001 to  $1,885,000  for the year ended  December  31,  2002.  Distribution  and
technology revenue from related party, which consists of revenue earned from the
e-New media contract, was $917,000 for 2002 and 2001. Development fees and other
revenues increased in 2002 to $968,000 from $484,000 in 2001, due to an increase
in demand for our advertising and development services, resulting in an increase
in revenues of $230,000 in 2002, the addition of $82,000 of revenue derived from
Altnet  sales,  and the  addition  of $172,000  of  revenues  from our  business
development  services for Sharman Networks.  Software sales revenue decreased to
zero in 2002 from $9,000 in 2001, as we ceased DVD and Multipath  Movie sales in
2001.

                                                                          NET
                REVENUES                   2001            2002         CHANGE
                --------                   ----            ----         ------

     E-New Media Technology .....      $  917,000      $  917,000         --
     Sharman Business Development            --        $  172,000        12.2%
     Altnet Sales ...............            --        $   82,000         5.8%
     Advertising and Development       $  484,000      $  714,000        16.3%
     Software and DVD Sales .....      $    9,000            --          (0.6%)
                                       ----------      ----------        -----


     Total Revenue ..............      $1,410,000      $1,885,000        33.7%
                                       ==========      ==========        =====

         COST OF REVENUES.  Cost of revenues consists  primarily of royalties to
third parties and the direct costs, including salaries and benefits, required to
produce content for banner ads and for processing  files for  distribution  over
the Altnet  network.  Cost of  revenues  for  Development  fees and other  costs
increased from $105,000 for the year ended December 31, 2001 to $247,000 for the
year ended December 31, 2002.  This increase is due to the addition of Altnet to
our Company,  with costs of $159,000 for  programmers  working on web design and
software development.

         SALES AND MARKETING.  Sales and marketing  expenses  include  primarily
costs for salaries and benefits,  advertising,  promotions,  Internet  bandwidth
distribution  costs and travel.  Sales and marketing expenses decreased $203,000
or 34% from  $597,000  for the year ended  December 31, 2001 to $394,000 for the
year ended December 31, 2002. In 2001, we incurred $426,000 expense for warrants
issued in  connection  with our  agreement  with Yahoo!  This  expense was fully
amortized  in 2001 and does not apply to 2002.  Also,  the decrease is partially
attributable to the  elimination of outside sales and marketing  consultants who
had been  retained  to market  the b3d tools and the  elimination  of  marketing
efforts by our Australian  subsidiary.  Our sales and marketing  efforts in 2002
were  redirected to promote  Altnet,  where we incurred  $224,000,  primarily in
consulting  fees.  Additionally,  our  Internet  expenses  increased  in 2002 by
$152,000  due to the  bundling  of our  Digital  Projector  with the Kazaa Media
Desktop and due to an increase in costs  associated with Internet  bandwidth for
distribution of Altnet files.

         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
decreased  $370,000 or 10% from  $3,626,000 for the year ended December 31, 2001
to $3,256,000 for the year ended December 31, 2002. The decrease is attributable
to a reduction in  personnel  and  personnel  related  costs such as  insurance,
employee benefits,  rent/space, travel, and computer and office equipment. . The
Brilliant  Digital  expenses were reduced by $1,290,000  principally  due to the
reduction in personnel and associated  costs. The overall decrease was offset by
the addition of Altnet, with costs of $939,000, consisting of personnel costs of
$484,000,  consultant expenses of $177,000, public relation expenses of $84,000,
legal fees of $81,000, and other general and administrative costs of $113,000.

         RESEARCH AND  DEVELOPMENT.  Research and development  expenses  include
salaries and  benefits of  personnel  conducting  research  and  development  of
software products and web design and programming. Research and development costs
also include costs associated with creating our software tools used in various


                                       22


<PAGE>


programs,  banner ads and 3D animated content. The costs increased from $139,000
for the year ended December 31, 2001 to $444,000 for the year ended December 31,
2002. The increase is due to the addition of Altnet with increased costs for web
development

         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.
Depreciation expense increased 27% from $101,000 for the year ended December 31,
2001 to  $128,000  for the  year  ended  December  31,  2002.  The  increase  is
attributable to additional amortized interest on capitalized fixed assets leases
and the final payoff of the associated leases.

         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.  For the year 2002, we incurred  $3,169,000 of debt
discount  expense and interest  expense  attached to the convertible  promissory
notes sold to  investors  in fiscal  2001,  which were amended in fiscal 2002 to
extend the maturity date of the notes. Additionally,  there was interest expense
of $431,000 pertaining to other notes. In all this was an increase of $3,155,000
over  2001.  Other  costs and  benefits  such as the export  grant of  $185,000,
interest income of $291,000 occurred in 2001 only and did not affect 2002.

         NET LOSS ON DISCONTINUED  OPERATIONS.  Brilliant Interactive Ideas Pty.
Ltd., our Australian-based  production company, employed a team of animators and
programmers  dedicated to animation  production.  We discontinued  operations at
Brilliant  Interactive  Ideas  Pty.  Ltd.  because of the under  utilization  of
animators  and  programmers  which  occurred  following the  termination  of the
Company's  production  agreement  with  Warner  Bros.  Online and the closing of
Digital  Hip  Hop.  Following  the  closure,  the  Company  retained  individual
consultants on a project by project basis in 2002 to design banner ads.  Digital
Hip Hop and Brilliant  Interactive  Ideas Pty. Ltd. were  discontinued in fiscal
2002 and have been reported on the 2002 consolidated statement of operations and
comprehensive loss as discontinued operations in accordance with FASB 144.

         For 2002,  we incurred a net loss of $165,000 due to the closure of our
subsidiary,  Brilliant  Interactive  Ideas Pty. Ltd and the closure of our joint
venture,  Digital Hip Hop.  For pro forma  purposes we restated  the 2001 income
statement to reclass the two closing companies as discontinued  operations.  The
loss  of  $3,349,000  is  principally   composed  of  research  and  development
expenditures of $1.8 million and general and administrative expenditures of $1.1
million.  In 2001  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.  We  realized a loss of  $317,000  due to
discontinued operations of The Auction Channel and a net gain of $624,000 on the
disposal of the operation. For pro forma purpose $3,032,000 loss on discontinued
operations  is reflected  in the 2001  financial  statements  to account for the
closure of the two entities in 2002 as if they had been closed in 2001.

LIQUIDITY, CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS

         As of  December  31,  2002,  our  cash  and  cash  equivalents  totaled
approximately  $236,000.  This is an increase of $51,000 as compared to December
31, 2001. The resulting change in cash is the net effect of the infusion of cash
from  financing  activities of $2,685,000  as described  below,  and a net loss,
including non-cash activities and the closure of two operations.

         We primarily  satisfied  our cash needs by raising  $2,285,000  through
equity funding as described below and in the Notes to our Financial  Statements.
We also  raised  $400,000  in 2002  through  the  sale  of  Secured  Convertible
Promissory  Notes tied to the  December  2001  financing  agreement.  A detailed
description  of these notes is provided  below.  Also,  see Notes 5 and 7 to the
Financial Statements.


                                       23


<PAGE>


         Cash flows from operating,  financing and investing  activities for the
years ended  December 31, 2001 and 2002 are  summarized in the  following  table
(dollars in thousands):


               ACTIVITY:                           2001              2002
               ---------                           ----              ----

     Continuing Operations ............          $(2,048)          $(2,660)
     Discontinuing Operations .........          $(3,349)          $  (165)
     Investing ........................          $   (23)          $  --
     Financing ........................          $ 2,541           $ 2,600


         Net cash of  $2,660,000  used in operating  activities  during the year
ended December 31, 2002 was primarily attributable to a net loss from continuing
operations of $6,184,000  and the net loss of $165,000 due to the closure of our
subsidiary,  Brilliant  Interactive  Ideas Pty. Ltd and the closure of our joint
venture,  Digital Hip Hop, which was partially  offset by non-cash  related debt
discount  and interest of  $3,169,000.  This is compared to a net use of cash in
2001 of  $5,397,000  attributable  primarily  to a net loss of  $2,048,000  from
continuing   operating  costs  and  a  loss  from  discontinued   operations  of
$3,349,000.

         Net cash used to  purchase  computer  equipment  amounted to $23,000 in
2001. We placed a moratorium on the purchase of equipment in 2002,  resulting in
no purchases.

         We had two fixed asset  financing  notes (Note 6), which have been paid
and canceled as of December 31, 2002.

         We lease our  facilities  under  operating  lease  agreements  expiring
through 2003. We signed two new, two-year, facility lease agreements in February
2003. Future minimum annual payments for the Australian facility are $31,000 and
$70,000 for the US office. As of February 2003 the commitment under these leases
is as follows:

                 CONTRACTUAL            TOTAL         LESS THAN          1-3
                 OBLIGATIONS                            1 YEAR          YEARS

         Operating Leases              $202,000        $92,500        $109,500
                                       ---------------------------------------

         Total Cash Obligations        $202,000        $92,500        $109,500
                                       =======================================

CONVERTIBLE NOTES AND RELATED WARRANTS

         In May 2001,  pursuant to Note and Warrant  Purchase  Agreements  dated
April 19, 2001, as amended, we sold to Harris Toibb,  Europlay 1, LLC (an entity
in which Mark Dyne,  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 originally had
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, originally could 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.

         In December  2001,  pursuant to Note and  Warrant  Purchase  Agreements
dated  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  2001  financing  transaction,  we sold to
Harris Toibb and Capel Capital Ltd.  secured  convertible  promissory notes (the
"New Notes" and, together with the Original Notes, the "Notes") in the aggregate
principal amount of $750,000.  The principal amount of the New Notes and, at the
option of the holder,  all accrued  interest was  convertible by the holder into
shares of


                                       24


<PAGE>


our Common Stock at a price equal to 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 on 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. on  November  10, 2002 (the  "Conversion  Price").  In
connection  with our sale of the New  Notes,  we issued to the  holders  thereof
warrants (the "New Warrants" and, together with the Original Warrants, the "Debt
Warrants") to purchase up to that number of shares of our Common Stock  obtained
by dividing 200% of the Principal  Amount by the product obtained by multiplying
1.125 by the Conversion  Price,  exercisable at a price per share equal to 1.125
times the Conversion Price. The New Notes mature  simultaneous with the Original
Notes,  which  originally was 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,  was convertible 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 December financing transaction. 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 Conversion Price for the New Notes. In addition, these investors are able to
exercise the Original  Warrants  for a number of shares  determined  by dividing
200% of the principal  amount of the Original  Notes by the product  obtained by
multiplying  1.125 by the  Conversion  Price,  exercisable  at a price per share
equal to 1.125 times the Conversion Price.

         At November 10, 2002, the  Conversion  Price for the Notes was fixed at
$0.1203 per share, which was the lowest volume weighted average price of a share
of our Common Stock on the American Stock Exchange over any five (5) consecutive
trading  days  commencing  on December 14, 2001 and ending on November 10, 2002.
Assuming that all of the principal  amount and accrued  interest on the Notes is
converted  into common  stock on December 31,  2003,  the  maturity  date of the
Notes, the Note holders would acquire 31,141,103 shares of our common stock.

         At November 10, 2002, the exercise price of the Debt Warrants was fixed
at $0.1353 per share, which is equal to 1.125 times the Conversion Price for the
Notes at  November  10,  2002  ($0.1203  per share).  The Debt  Warrants  may be
exercised  to  purchase  up to  44,542,718  shares  of our  common  stock at the
exercise  price.  The number of shares that may be acquired upon exercise of the
warrants was  determined  by dividing  $6,028,300  (200 percent of the aggregate
principal amount of the Notes) by the exercise price.

         In October 2002, the holders of the Notes agreed to extend the maturity
date of the Notes from November 10, 2002 to December 31, 2003. In  consideration
of their  agreement to extend the maturity  date,  we issued to the Note holders
warrants to purchase up to an aggregate of 25,226,028 shares of our common stock
at an exercise price of $0.2091 per share.

2002 PRIVATE PLACEMENTS OF COMMON STOCK AND WARRANTS FOR FINANCING

         In March 2002,  we sold an aggregate of 6,051,437  shares of our common
stock to  Harris  Toibb,  Markev  Services  LLC and  David  Wilson  in a private
placement  at a price per share of  $0.1322,  for  aggregate  proceeds  to us of
$800,000.  In  connection  with the  offering,  we also issued to the  investors
warrants to purchase up to an aggregate of 10,758,110  shares of common stock at
an exercise price of $0.148725 per share.  The warrants  expire on May 23, 2004.
Mark  Dyne,  our  Chairman,  and  Kevin  Bermeister,  a  director  and our Chief
Executive Officer and President, are owners of Markev Services.

         In April and May 2002, we sold an aggregate of 2,276,045  shares of our
common stock to Michael Toibb, Scott Hergott, Ronald Gilefsky,  Samuel McCracken
III, Preston  Millsboro  Automart,  Inc.,  Crestview Capital Fund, LP, Crestview
Capital Fund II, LP, Crestview Capital Offshore Fund, Inc., Julie Schuermann and
Roger  Suyama in private  placements  for net  proceeds to us of  $428,000.  The
prices per share  ranged  from  $0.1731  to $0.25,  and were based on the market
price of our common  stock at the time the  investor  committed  to purchase the
shares.  In  connection  with the  offering,  we also  issued  to the  investors
warrants


                                       25


<PAGE>


to purchase up to an aggregate  of 4,145,921  shares of common stock at exercise
prices ranging from $0.19474 to $0.28125 per share.  The warrants  expire on May
23, 2004.

         In September  2002,  we sold an  aggregate  of 7,123,836  shares of our
common stock to Harris  Toibb,  Markev  Services,  LLC,  Ronald  Lachman,  Scott
Hergot,  David Wilson and Bob Haya, in a private  placement at a price per share
of  $0.1502,  for net  proceeds  to us of  $1,057,000.  In  connection  with the
offering,  we  also  issued  to the  investors  warrants  to  purchase  up to an
aggregate of 12,664,597 shares of common stock at an exercise price of $0.168975
per share. The warrants expire on September 3, 2005.

         Our  operations  generated  negative  cash flow  during the years ended
December 31, 2001 and 2002,  and we expect a significant  use of cash during the
upcoming  2003 fiscal year as we initiate the business  opportunity  for Altnet,
Inc. We anticipate  our current cash reserves,  plus our expected  generation of
cash from existing  operations,  to fund our anticipated  expenditures  into the
second  quarter of 2003.  As such,  we will  require  additional  equity or debt
financing  during  2003,  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  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,  2002  financial  statements  include  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.

NEW ACCOUNTING PRONOUNCEMENTS

         In  April  2002,  the FASB  issued  SFAS No.  145,  Rescission  of FASB
Statements No. 4, 44, and 64,  Amendment of FASB Statement No. 13, and Technical
Corrections.  This statement  eliminates the current  requirement that gains and
losses on debt  extinguishment  must be classified as extraordinary items in the
income  statement.  Instead,  such  gains  and  losses  will  be  classified  as
extraordinary  items only if they are deemed to be unusual  and  infrequent,  in
accordance with the current GAAP criteria for extraordinary  classification.  In
addition,  SFAS 145 eliminates an inconsistency in lease accounting by requiring
that  modifications  of  capital  leases  that  result  in  reclassification  as
operating  leases be accounted for  consistent  with  sale-leaseback  accounting
rules.  The  statement  also  contains  other   nonsubstantive   corrections  to
authoritative accounting literature.  The changes related to debt extinguishment
will be effective for fiscal years beginning after May 15, 2002, and the changes
related to lease  accounting will be effective for  tranactions  occurring after
May 15, 2002.  Adoption of this standard  will not have any immediate  effect on
our consolidated financial statements.

         In June  2002,  the FASB  issued  SFAS No.  146,  Accounting  for Costs
Associated  with Exit or Disposal  Activities,  which  addresses  accounting for
restructuring  and similar costs.  SFAS No. 146 supersedes  previous  accounting
guidance,  principally Emerging Issues Task Force (EITF) Issue No. 94-3. We will
adopt the  provisions  of SFAS No. 146 for  restructuring  activities  initiated
after December 31, 2002. SFAS No. 146


                                       26


<PAGE>


requires  that the  liability  for  costs  associated  with an exit or  disposal
activity be recognized  when the  liability is incurred.  Under EITF No. 94-3, a
liability for an exit cost was recognized at the date of a company's  commitment
to an exit  plan.  SFAS No.  146 also  establishes  that  the  liability  should
initially be measured and recorded at fair value. Accordingly,  SFAS No. 146 may
affect  the  timing of  recognizing  future  restructuring  costs as well as the
amount recognized. Cautionary Statements and Risk Factors.

         In December 2002,  the FASB issued SFAS No. 148. This statement  amends
SFAS No. 123 to provide alternative methods of transition for a voluntary change
to  the  fair  value  based  method  of  accounting  for  stock-based   employee
compensation.  In addition, this statement amends the disclosure requirements of
SFAS No.  123 to  require  prominent  disclosures  in both  annual  and  interim
financial  statements  about the method of accounting for  stock-based  employee
compensation  and the  effect  of the  method  used on  reported  results.  . We
estimate  that the  adoption of SFAS 148 will not be  material to our  financial
position and results of operations.

         In  November  2002,  the  FASB  issued  FASB   Interpretation  No.  45,
"Guarantor's  Accounting and Disclosure  Requirements for Guarantees,  Including
Indirect Guarantees of Indebtedness of Others." This  Interpretation  elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize,  at the inception of a
guarantee,  a  liability  for the fair  value of the  obligation  undertaken  in
issuing the guarantee.  The disclosure  requirements of this  Interpretation are
currently  effective  and did not affect our  financial  position and results of
operations.  The initial recognition and initial measurement  provisions of this
Interpretation  are  applicable on a prospective  basis to guarantees  issued or
modified after December 31, 2002.

         In  January  2003,  the  FASB  issued  FASB   Interpretation   No.  46,
"Consolidation  of Variable Interest  Entities" ("FIN 46"). This  Interpretation
requires that variable  interest  entities  created after January 31, 2003,  and
variable  interest entities in which an interest is obtained after that date, be
evaluated  for  consolidation  into  an  entity's  financial  statements.   This
interpretation  also  applies,  beginning  July 1, 2003 for us, to all  variable
interest  entities in which an  enterprise  holds an  interest  that it acquired
before  February  1,  2003.  We are  in the  process  of  evaluating  all of our
investments  and other  interests in entities under the provisions of FIN 46 and
have not yet determined the effect of its adoption on our financial position and
results of operations.

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.

         THERE IS DOUBT ABOUT OUR ABILITY TO  CONTINUE  AS A GOING  CONCERN.  We
currently  have a number  of  obligations  that we are  unable  to meet  without
generating  additional  revenues  or raising  additional  capital.  If we cannot
generate  additional revenues or raise additional capital in the near future, we
may  become   insolvent.   As  of  December  31,  2002,  our  cash  balance  was
approximately $236,000 and our outstanding accounts payable and accrued expenses
totaled  $1,234,000,  not including the capital  financing  notes,  which have a
convertible feature.  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


                                       27


<PAGE>


losses and negative cash flow, and as of December 31, 2002 we had an accumulated
deficit of $61.3  million.  We  incurred  comprehensive  losses of $6.3 and $6.3
million for the fiscal  year ended  December  31,  2002 and 2001,  respectively.
Additionally, as of the date of this 10-K 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 brand  promotion,  sales  and  marketing,
administration,  and  research  and  development,  all  principally  related  to
deployment of our Altnet peer-to-peer network and operating  infrastructure.  In
fiscal 2002,  we  significantly  reduced the  development  and  marketing of our
proprietary  software authoring tools, and our services for serving "rich media"
Internet  banner  advertisements  (banner  advertisements  that  use  audio  and
animation).   Additionally,   we  have  ceased  all   internal   production   of
three-dimensional  animated  content.  While our past  activities in these areas
will continue to generate some future  revenue,  our business model assumes that
our growth and a significant portion of our future revenues will be derived from
our Altnet  peer-to-peer  business,  which only became operational in the fourth
quarter  of 2002.  This  business  model is not yet  proven  and we cannot  make
assurances  that we will  ever  achieve  or  sustain  profitability  or that our
operating  losses will not  increase in the future or be  inconsistent  with the
expectations  of the  public  market.  Primarily  as a result  of our  continued
losses, our independent public accountants modified the opinion on our financial
statements  to  include  an   explanatory   paragraph   wherein  they  expressed
substantial doubt about our ability to continue as a going concern.

         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
now mature on December  31, 2003,  and accrued  interest may be converted by the
holders at any time into  shares of our common  stock at a price of $0.1203  per
share. The warrants  attached to the promissory notes have an expiration date of
May 23,  2004  and  entitle  the  holders  to  purchase  up to an  aggregate  of
69,768,745  shares of our Common Stock at an exercise  price of  $0.1353375  per
share on 44,542,718  shares,  and at an exercise  price of $0.2091 on 25,226,028
shares.  The  exercise  of the  warrants  would  increase  the  number of shares
outstanding and result in further dilution to our other stockholders.

         The conversion  price of the promissory notes and the exercise price of
warrants  to  purchase up to  44,542,718  shares of Common  Stock are subject to
reduction if we issue additional securities at a price below the then applicable
conversion  price or  exercise  price,  with  exceptions  for  certain  types of
securities  issuances.  If we issue  securities at a price below the  conversion
price or exercise  price,  then the  conversion  price or exercise price will be
adjusted downward to equal the price at which we sold the additional securities.
As a  consequence,  if we trigger the  adjustment  provision for the  promissory
notes,  the holders of the promissory notes could convert them at a lower price,
which would  increase the number of shares of Common  Stock they would  receive.
Similarly,  if we trigger the adjustment provision for the warrants, the holders
of the warrants  could  exercise  the  warrants to purchase a greater  number of
shares for the same aggregate purchase price.

         The table  below sets  forth the  number of shares of our Common  Stock
that could be acquired by the holders upon  conversion of the  promissory  notes
and exercise of the warrants,  and the  percentages  of our  outstanding  Common
Stock that the shares issued upon conversion and exercise would  represent.  The
amounts assume conversion on the maturity date of the promissory notes (December
31, 2003),  and include all interest  that would accrue on the entire  principal
amount  of the  promissory  notes  through  such  date.  The share  amounts  and
percentages are based on our closing share price of $0.16 on March 19, 2003, and
on  assumed  closing  share  prices of  $0.12,  $0.08 and  $0.04,  which  prices
represent  a 25%,  50% and 75%  decline,  respectively,  in our March  19,  2003
closing share price. The table assumes that we would issue additional securities
at these prices,  and thus trigger the price adjustment  provisions of the notes
and  warrants.  The table also assumes that the warrants  would be exercised for
cash, and that the holders would pay us the aggregate exercise price $6,028,300.
The  percentages  are also  based  on  32,114,978  shares  of our  common  stock
outstanding on March 19, 2003.


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<PAGE>


Percentage Decline in                                           Percentage of
   March 19, 2003             Assumed          Shares of         Outstanding
    Closing Price          Closing Price      Common Stock       Common Stock
---------------------      -------------      ------------      -------------
         --                   $ 0.16*          75,683,821           70.2%
         25%                  $ 0.12           81,454,790           71.7%
         50%                  $ 0.08          122,182,184           79.2%
         75%                  $ 0.04          244,364,369           88.4%
----------
* Based on the terms of the notes and  warrants,  if we sold  securities at this
share closing price the conversion  price of the notes and exercise price of the
warrants would be $0.1203 and $0.1353375 per share, respectively.

         Additionally,  during  the 2002,  we raised  an  additional  $2,685,000
through the sale of  15,451,318  shares of common stock at an average  price per
share of $0.15, and in connection therewith issued warrants to purchase up to an
additional  27,568,627  shares of common stock at exercise  prices  ranging from
$0.148725 to $0.28125 per share. We anticipate that during 2003, 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.

         The following  table  illustrates  our  capitalization  as of March 19,
2003,  and  identifies  the number of shares issued and  outstanding  as of such
date,  as well as the  number of shares  that may be issued in the  future  upon
conversion  of  outstanding   convertible   promissory  notes  and  exercise  of
outstanding options and warrants:

                                            SHARES OF        PERCENTAGE OF FULLY
SECURITY                                  COMMON STOCK         DILUTED SHARES
----------------------------------     ------------------    -------------------

Outstanding Common Stock                    32,114,978              36.9%
Convertible Promissory Notes, with
   accrued interest                         29,143,641              33.5%
Outstanding Warrants (1)                    12,557,821              14.4%
Outstanding Options                         13,308,000              15.2%
                                       ------------------    -------------------
  Fully Diluted Shares of Common
     Stock (2)                              87,124,440             100.0%
----------
(1)   For  purposes  of this  table,  we have only  included  warrants  that are
      "in-the-money"  (the exercise  price of the warrants is below the price of
      our common stock), and the number of shares of common stock underlying the
      outstanding  warrants has been calculated on a "cashless"  exercise basis,
      whereby  the holder of each  warrant  receives  upon  exercise a number of
      shares of common  stock with a value  equal to (i) the total  value of the
      shares  underlying the warrants less (ii) the aggregate  exercise price of
      the warrants,  and is  calculated  based on the closing sales price of our
      common stock on the American Stock  Exchange on March 19, 2003,  which was
      $0.16.
(2)   This number  excludes  (i)  6,446,375  shares that have been  reserved for
      issuance  under our 1996 Stock Option Plan that were not the subject of an
      outstanding  stock  option  or other  award at March  17,  2003,  and (ii)
      90,853,837  shares  underlying  warrants that have exercise prices ranging
      from $.1656 to $0.75 per share, and thus not "in-the-money."

         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 maturity in December  2003,  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.


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<PAGE>


         WE DO NOT MEET THE CONTINUED LISTING REQUIREMENTS OF THE AMERICAN STOCK
EXCHANGE,  AND OUR  STOCK  COULD BE  DELISTED  AT ANY  time.  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 $6 million.  We currently  are not in  compliance  with both the bid
price  and  net  tangible  assets  requirements.  Specifically,  we  are  not in
compliance  with the  following  listing  requirements  as set forth in the AMEX
Company Guide:

          o    Section  1003  (a)(i)  with  shareholders'  equity  of less  than
               $2,000,000  and  losses  from  continuing  operations  and/or net
               losses in two of our three most recent fiscal years;

          o    Section  1003  (a)(ii)  with  shareholders'  equity  of less than
               $4,000,000  and  losses  from  continuing  operations  and/or net
               losses in three of our four most recent fiscal years;

          o    Section  1003  (a)(iii)  with  shareholders'  equity of less than
               $6,000,000  and  losses  from  continuing  operations  and/or net
               losses in our five most recent fiscal years; and

          o    Section 1003 (a)(iv) in that we have  sustained  losses which are
               so  substantial  in  relation to our  overall  operations  or our
               existing  financial  resources,  or our  financial  condition has
               become so impaired that it appears  questionable,  in the opinion
               of the  exchange,  as to  whether  we will  be  able to  continue
               operations and/or meet our obligations as they mature.


         We were afforded the  opportunity to submit a plan of compliance to the
exchange,  which we did on  April  30,  2002.  On June 19,  2002,  the  exchange
notified us that it accepted our plan of  compliance  and granted us an informal
extension,  the length of which is at the discretion of the exchange,  to regain
compliance  with the  continued  listing  standards.  We are subject to periodic
reviews by the exchange staff during the extension period.

         We could be delisted from the American Stock Exchange at any time, with
little or no advance notice. 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.  If we are
delisted,  our stock  could also become a "penny  stock." The trading  price per
share of our common stock likely would be reduced as a result.

         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.
We must make improvements to our technology while remaining competitive in terms
of performance and price.  This will require us to make  investments in research
and  development,  often times well in advance of the widespread  release of the
products in the market and any revenues  these  products may generate.  Until we
become profitable,  we will need to fund these research and development  efforts
from  proceeds  we  receive  from  equity  or debt  financings.  We do not  have
sufficient  resources  to fund  long term  research  and  development,  which is
presently on hold.

         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


                                       30


<PAGE>


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

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

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

         DECREASES IN THE PRICE OF OUR COMMON STOCK COULD  INCREASE  SHORT SALES
OF OUR COMMON STOCK BY THIRD PARTIES,  WHICH COULD RESULT IN FURTHER  REDUCTIONS
IN THE PRICE OF OUR COMMON STOCK. Our sales of common stock at a discount to the
market price of our common  stock,  which may be  necessary to raise  additional
capital to fund  operations,  could result in  reductions in the market price of
our common stock.


                                       31


<PAGE>


Downward  pressure on the price of our common stock could  encourage short sales
of the stock by third  parties.  Material  amounts of short  selling could place
further downward  pressure on the market price of the common stock. A short sale
is a sale of stock that is not owned by the seller. The seller borrows the stock
for  delivery at the time of the short sale,  and buys back the stock when it is
necessary  to return  the  borrowed  shares.  If the price of the  common  stock
declines  between  the time the  seller  sells the stock and the time the seller
subsequently repurchases the common stock, then the seller sold the shares for a
higher price than he purchased the shares and may realize a profit.

         WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE  OF OUR  COMMON  STOCK.  Our  ability  to issue up to  700,000  shares  of
preferred  stock and some  provisions of our  certificate of  incorporation  and
bylaws and of  Delaware  law could make it more  difficult  for a third party to
make an unsolicited  takeover  attempt of us. These  anti-takeover  measures may
depress  the price of our  common  stock by making  third  parties  less able to
acquire  us by  offering  to  purchase  shares of our stock at a premium  to its
market price. Our Board of Directors can issue up to 700,000 shares of preferred
stock and determine the price, rights, preferences, privileges and restrictions,
including  voting rights,  of those shares without any further vote or action by
our  stockholders.  Our Board of Directors  could issue the preferred stock with
voting,  liquidation,  dividend and other  rights  superior to the rights of our
common stock.  The rights of holders of our common stock will be subject to, and
may be adversely affected by, the rights of holders of the share purchase rights
and of any  preferred  stock that may be issued in the future.  The  issuance of
preferred  stock,  while  providing  desirable  flexibility  in connection  with
possible acquisitions and other corporate purposes, could make it more difficult
for a third party to acquire a majority of our outstanding voting stock.

RISKS RELATED TO OUR BUSINESS

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

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

         OUR FAILURE TO MAINTAIN A STRATEGIC  RELATIONSHIP WITH SHARMAN NETWORKS
COULD  ADVERSELY  AFFECT  OPERATING  RESULTS.  We  receive  compensation  as the
exclusive representative of Sharman Networks for the sale, license, and/or other
commercial  exploitation  of index  search  results  displayed  on or  otherwise
accessed using the Kazaa Media Desktop in response to end user search  requests.
Additionally,   through  our  business  development   arrangement  with  Sharman
Networks, we receive compensation for the sale of


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<PAGE>


advertising  campaigns and other revenue received by Sharman Networks,  which is
generated  as a result  of our  efforts.  If we do not  maintain  our  strategic
relationship with Sharman  Networks,  these sources of revenue may be eliminated
which would adversely affect our financial condition and results of operations.

         OUR  FAILURE TO  MAINTAIN  STRATEGIC  RELATIONSHIPS  WITH  DISTRIBUTION
PARTNERS COULD REDUCE THE NUMBER OF ALTNET PEER-TO-PEER APPLICATIONS WE ARE ABLE
TO  DISSEMINATE  TO  CONSUMERS,  WHICH WOULD  REDUCE THE NUMBER OF USERS FOR OUR
ALTNET PEER-TO-PEER BUSINESS. We distribute the software necessary to create and
run our Altnet  peer-to-peer  business  primarily  by bundling  it with  Sharman
Networks'  Kazaa Media Desktop.  We rely on computer users' demand for the Kazaa
Media Desktop to increase the installed  base of our Altnet  software,  which is
necessary to connect users to our private  peer-to-peer  network.  Additionally,
through our agreement with Sharman Networks, Altnet distributes and sell digital
files to users of the Kazaa Media Desktop.  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
Altnet software or sales of authorized digital files.

         CURRENT LITIGATION AGAINST SHARMAN NETWORKS LIMITED MAY PREVENT FURTHER
DISTRIBUTION  OF OUR ALTNET  PEER-TO-PEER  SOFTWARE,  AND  ADVERSELY  AFFECT OUR
ABILITY TO SERVE BRILLIANT  BANNERS ON, AND DISTRIBUTE AND SELL DIGITAL FILES TO
USERS OF, THE KAZAA MEDIA DESKTOP. A disruption in the distribution of the Kazaa
Media Desktop or its use by consumers would necessarily adversely impact (1) the
future distribution of our Altnet software,  (2) revenues we derive from serving
Brilliant  Banners  on the  Kazaa  Media  Desktop,  and  (3)  Altnet's  sale  of
authorized  digital  files to users of the Kazaa  Media  Desktop.  For the three
months and fiscal year ended December 31, 2002, we generated approximately 61.6%
and 47.5% of our total revenues from activities  dependent upon the availability
of the Kazaa Media  Desktop to computer  users.  If there is a disruption in the
distribution  of the Kazaa Media Desktop or its use by consumers,  we may not be
able to replace  this  source of revenue in the short term,  or at all.  Sharman
Networks, the Kazaa Media Desktop, and other peer-to-peer software products, are
currently the subject of a lawsuit, METRO-GOLDWYN-MAYER STUDIOS, INC. ET. AL. V.
GROKSTER,  LTD.  ET.  AL.,  filed in the United  States  District  Court for the
Central District of California (Western Division) by twenty-eight  entertainment
companies   claiming  that,   among  other  things,   the  Kazaa  Media  Desktop
facilitates,  contributes to and encourages copyright infringement.  On November
18, 2001, there was an additional  complaint  filed,  LIEBER ET. AL. V. CONSUMER
EMPOWERMENT  B.V. ET. AL. To the extent that Sharman  Networks is precluded from
distributing  the  Kazaa  Media  Desktop  as a result  of this  litigation,  our
business and financial  condition  could be materially  and adversely  affected.
While we understand that Sharman  Networks is vigorously  defending  against the
claims  raised in this  litigation,  we unable to determine at this time whether
Sharman Networks will prevail.

         OUR  BUSINESS  MODEL  CONTEMPLATES  RECEIVING  A 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.  While we significantly  reduced
the  development  and marketing of our Internet  advertising  business in fiscal
2002 in favor of our  Altnet  peer-to-peer  business,  we intend to pursue  some
revenue from this business  during fiscal 2003. We are focusing a portion of our
resources 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.


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<PAGE>


         WE WILL NOT BE ABLE TO GENERATE REVENUES FROM OUR BRILLIANT BANNERS AND
OTHER B3D CONTENT  WITHOUT A BROAD BASE OF  INSTALLED  DIGITAL  PROJECTORS.  Our
Digital  Projector must be installed on a user's computer in order for that user
to view our  Brilliant  Banners and other b3d content.  If we do not achieve and
maintain  widespread  installation of our Digital  Projector,  there will not be
substantial  demand for  b3d-produced  content or our  software  tools.  We have
discontinued  the  production  of  3D  animated   entertainment,   such  as  our
MultipathTM  Movies  and  animated  music  videos.  The  user's  demand for this
entertainment helped drive installation of our Digital Projector. Presently, the
substantial  majority of b3d content  consists of  Brilliant  Banners.  Computer
users are less likely to  voluntarily  install our Digital  Projector or keep it
installed if its use is almost exclusively for viewing Internet  advertisements.
Other  companies,  such as Lavasoft,  market  software  that removes our Digital
Projector  from a user's  computer.  The  widespread  use of this software could
diminish the number of installed  projectors,  which would reduce demand for our
Brilliant Banners by Internet advertisers and correspondingly  reduce the demand
for our b3d toolset by the creators of Internet advertisements.

         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, Eyeblaster 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 web
               sites;

          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.

         WE MAY NOT BE ABLE TO COMPETE  EFFECTIVELY  WITH OTHER  COMPANIES  THAT
OFFER  SOFTWARE  TOOLS AND  SERVICES  SIMILAR TO OURS.  The  markets for our b3d
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. Similarly, we can only deliver digital files over our Altnet
peer-to-peer network to users that have downloaded the Altnet software. If we do
not achieve a widespread distribution of our Altnet software,  there will not be
substantial  demand by content  owners to distribute and sell their content over
the Altnet network.


                                       34


<PAGE>


         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.

         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.

         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 have
been issued two patents and have pending 6 additional patent  applications,  all
relating to our b3d  toolset.  We cannot be certain  that our  reliance on these
laws and  nondisclosure  agreements  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,


                                       35


<PAGE>


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 Digital Projector,  b3d toolset and Altnet software, 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.


                                       36


<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............................38

Consolidated Balance Sheet as of December 31, 2002............................39

Consolidated Statements of Operations and Comprehensive
    Loss for the years ended December 31, 2001 and 2002.......................40

Consolidated Statements of Stockholders' Deficit for the
    years ended December 31, 2001 and 2002....................................41

Consolidated Statements of Cash Flows for the years
    ended December 31, 2001 and 2002..........................................42

Notes to Consolidated Financial Statements....................................44


                                       37


<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  sheet  of
Brilliant  Digital  Entertainment,  Inc. as of December 31, 2002 and the related
consolidated  statements of operations  and  comprehensive  loss,  stockholders'
deficit,  and cash flows for each of the two years in the period ended  December
31, 2002.  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,  2002  and the  results  of its
operations  and its cash  flows  for each of the two years in the  period  ended
December 31, 2002, 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
Company's consolidated financial statements,  the Company has suffered recurring
losses from  operations and at December 31, 2002 has a negative  working capital
and a net capital deficiency. These matters give rise to substantial doubt about
the  Company's  ability to continue as a going  concern.  Management's  plans in
regard to these matters are also described in Note 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 14, 2003


                                       38


<PAGE>


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

                                                               DECEMBER 31, 2002
                                                               -----------------
ASSETS
Current assets:
     Cash and cash equivalents ...............................         $    236
     Accounts receivable, net of allowance
        for doubtful accounts of $42 .........................              604
     Other assets, net .......................................            1,601
                                                                       --------
Total current assets .........................................            2,441
Property, plant and equipment, net (Note 9) ..................               56
Other assets, net ............................................              299
                                                                       --------
Total assets .................................................         $  2,796
                                                                       ========

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
     Accounts payable ........................................         $    867
     Accrued expenses (Note 10) ..............................              367
     Deferred revenue (Note 4) ...............................              917
     Capital financing, including accrued
        interest (Note 5 and 7) ..............................            3,431
                                                                       --------
Total current liabilities ....................................            5,582
Deferred Compensation (Note 11) ..............................            1,201
Deferred Revenue (Note 4) ....................................            1,639
Other long term liabilities ..................................               50
                                                                       --------
Total liabilities ............................................            8,472
Commitments and contingencies (Note 14)
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;
         32,114,978 shares issued and
         outstanding) (Note 7 ) ..............................               32
     Additional paid-in capital ..............................           55,231
     Accumulated deficit .....................................          (60,926)
     Accumulated other comprehensive loss ....................              (13)
                                                                       --------
Total stockholders' deficit ..................................           (5,676)
                                                                       --------
Total liabilities and stockholders' deficit ..................         $  2,796
                                                                       ========

                 See Notes to Consolidated Financial Statements


                                       39


<PAGE>


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

                                                              YEAR ENDED
                                                              DECEMBER 31,
                                                         ----------------------
                                                           2001          2002
                                                         --------      --------
 Revenues:
    Distribution and technology revenue
       from related party ..........................     $    917      $    917
    Development fees and other revenues ............          484           968
    Software sales .................................            9          --
                                                         --------      --------
        Total revenues .............................        1,410         1,885


Cost of revenues:
    Development fees and other costs ...............          105           247
                                                         --------      --------
        Total cost of revenues .....................          105           247


Gross profit .......................................        1,305         1,638
Operating expenses:
    Sales and marketing ............................          597           394
    General and administrative .....................        3,626         3,256
    Research and development .......................          139           444
    Depreciation and amortization ..................          101           128
    Loss on disposal of equipment ..................           50          --
                                                         --------      --------
        Total operating expenses ...................        4,513         4,222
                                                         --------      --------
 Loss from operations ..............................       (3,208)       (2,584)
 Other income (expense):
    Export market development grant ................          185          --
    Gain on foreign exchange transactions ..........            1          --
    Interest income ................................          236          --
    Interest expense ...............................         (817)       (3,600)
                                                         --------      --------
        Total other income (expense) ...............         (395)       (3,600)
                                                         --------      --------
 Loss from continuing operations ...................     $ (3,603)     $ (6,184)
 Loss from discontinued operations (Note 2) ........       (3,349)         (165)
 Gain on disposal of discontinued operations
    (Note 2 & Note 5) ..............................          624          --
                                                         --------      --------
 Net Loss ..........................................     $ (6,328)     $ (6,349)
 Other comprehensive loss:
    Foreign currency translation adjustment ........         (123)          (13)
                                                         --------      --------
 Comprehensive loss ................................     $ (6,451)     $ (6,362)


 Basic and diluted continuing operations ...........     $  (0.21)     $  (0.26)
 Basic and diluted for discontinued
    operations .....................................     $  (0.18)     $  (0.01)
 Basic and diluted net loss per share ..............     $  (0.39)     $  (0.27)
                                                         --------      --------
 Weighted average number of shares used in
    computing basic and diluted net loss
    per share ......................................       16,236        23,467
                                                         ========      ========

                 See Notes to Consolidated Financial Statements


                                       40


<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, 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)
    Grant of warrants...............           --           --             274               --                 --        274
    Issuance of shares to Investors.   15,441,690           16           2,269               --                 --      2,285
    Issuance of shares for services.      210,000           --              21               --                 --         21
    Issuance of warrants for
       patent right.................           --           --              30               --                 --         30
    Beneficial conversion feature..            --           --           2,036               --                 --      2,036
    Foreign exchange translation...            --           --              --               --                276        276
    Net loss.......................            --           --              --           (6,349)                --     (6,349)
                                     -------------  ----------- --------------- ---------------- ------------------  ---------
BALANCE AT DECEMBER 31, 2002           32,114,978        $  32       $  55,231        $ (60,926)             $ (13)   $(5,676)
                                     -------------  ----------- --------------- ---------------- ------------------  ---------
</TABLE>

                 See Notes to Consolidated Financial Statements


                                       41


<PAGE>


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

                                                                 YEAR ENDED
                                                                 DECEMBER 31,
                                                             ------------------
                                                              2001       2002
                                                             -------    -------
OPERATING ACTIVITIES
Net loss .................................................   $(6,328)   $(6,349)
Adjustments to reconcile net loss to net cash
    used in operating activities:
      Depreciation and other amortization ................       365        226
      Debt Discount and financing interest ...............       817      3,169
      Effect of stock options and warrants granted .......      --          278
      Gain on disposal of discontinued operations ........      (624)      --
      Issuance of common stock for services ..............         6         21
      Issuance of common stock for joint venture .........        42       --
      Loss on disposal of equipment ......................        50       --
      Changes in operating assets and liabilities:
        Accounts receivable ..............................       101       (531)
        Other assets .....................................     3,985        573
        Accounts payable and accruals ....................       455        870
        Deferred revenue .................................      (917)      (917)
                                                             -------    -------
Net cash used in continuing activities ...................    (2,048)    (2,660)
Net cash (used) provided in discontinued activities ......    (3,349)      (165)
                                                             -------    -------
Net cash used in operating activities ....................    (5,397)    (2,825)


INVESTING ACTIVITIES
Purchases of equipment ...................................       (23)      --
                                                             -------    -------
Net cash used in investing activities ....................       (23)      --

FINANCING ACTIVITIES
Proceeds from issuance of shares .........................      --        2,285
Proceeds from capital financing ..........................     2,614        400
Repayments of notes ......................................       (73)       (85)
                                                             -------    -------
Net cash provided by financing activities ................     2,541      2,600
NET DECREASE IN CASH AND CASH EQUIVALENTS ................    (2,879)      (225)

Translation adjustments ..................................      (123)       276

Cash and cash equivalents at beginning of period .........     3,187        185
                                                             -------    -------
Cash and cash equivalents at end of period ...............   $   185    $   236
                                                             -------    -------
Supplemental disclosure of cash flow
    information:
    Cash paid during the period for:
      Interest ...........................................   $    20    $    14
                                                             -------    -------

                 See Notes to Consolidated Financial Statements


                                       42


<PAGE>


SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITY:

                                                           2001       2002
                                                          ------     ------

     Issuance of warrants for patent rights .........     $ --       $   30
     Beneficial conversion feature ..................     $2,983     $2,036


                                       43


<PAGE>


                     BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2002

1.       DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

         Brilliant Digital  Entertainment,  Inc. is a company which operates two
distinct lines of business:  (1) through the Altnet, Inc. subsidiary the Company
operates a peer-to-peer-based  content distribution network, utilizing existing,
proven  technology  which allows Altnet to securely and  efficiently  distribute
digital  files to end users,  and (2)  through  the b3d,  Inc.  subsidiary,  the
Company is a developer  and server of rich media  advertising  campaigns  ("rich
media" being defined as use of audio and animation), and a developer of software
authoring tools used in the creation of "three  dimensional",  or "3D", animated
content, for use on the World Wide Web.

         Through  the  Altnet,   Inc.   subsidiary,   the  Company   operates  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, the Company has created a private, or "closed" peer-to-peer network,
which  allows the Company 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).  The  Company's  ability to control  which  files are
distributed over their private network, as well as their use of widely available
digital rights  management  (or DRM)  technologies  from Microsoft  Corporation,
TryMedia  and others to protect  against  copyright  infringement,  prevent  the
distribution  of  unauthorized  files  over  their  network  and help to protect
against the unauthorized use of a digital file distributed over the network once
it  resides  on an end  user's  computer.  Brilliant  commercializes  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 other Altnet users. The Company owns 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 the  Company  license a  substantial
portion of Altnet's peer-to-peer technology.

         The Company's  b3d, Inc.  subsidiary,  develops and serves "rich media"
(which  includes  audio  and  animation)  Internet  banner  advertisements,  and
develops  software  authoring  tools used to create  three  dimensional  (or 3D)
animated  content for use on the World Wide Web. During fiscal 2002, the Company
shifted its emphasis from the Internet  advertising and b3d toolset  business to
the Altnet peer-to-peer business. This shift in emphasis occurred gradually over
the course of fiscal 2002, and came about primarily due to the Company's limited
financial  resources,  which have been unable to support both businesses.  While
the Company has not decided to discontinue its advertising  business altogether,
until the Company has sufficient resources to support both businesses it intends
to focus  substantially  all of its limited  financial  resources and efforts to
grow the Altnet business.

         The Company generates revenue from its Altnet peer-to-peer  business by
contracting  with content  owners to distribute  and sell their digital files to
computer   users.   The  Company  charges  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 after it has been downloaded to the users computer.  The
Company  generates revenue from its Internet  advertising  business by licensing
the  Company's  ad serving  technology,  which is used to display its  Brilliant
Banners, to third party operators of web sites and other Internet  applications,
and the Company  generates  revenue from its software  tools business by selling
licenses to the Company's b3d software tools.


                                       44


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


         The Company also generates revenue by performing  business  development
services in the United States under an agreement with Sharman Networks  Limited,
the  distributor of the Kazaa Media Desktop file sharing  software  application,
and the Company  intends to generate  revenue by  sublicensing  to third parties
rights to the  TrueNames  patent  (U.S.  patent  #5,978,791)  which the  Company
licenses from Kinetech Inc. The TrueNames  patent covers a method of identifying
digital files based on the actual data contents of the file,  rather than by its
name,  origin,  location,  address,  or other  information  that can  easily  be
changed.

         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.

         In 2001, the Company  substantially reduced its internal production and
syndication  of 3D animation.  In 2002, the Company  discontinued  operations at
Digital Hip Hop, the joint venture  formed to produce  animated music videos for
the World Wide Web, and discontinued operations at, and placed into liquidation,
BII  Australia.   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 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  recurring  operating  losses and at
December 31, 2002, has negative working capital of approximately  $3,141,000 and
a  stockholders'  deficit  of  approximately  $5,676,000.  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  Digital  Entertainment,  Inc. and its subsidiaries  after
intercompany balances and transactions have been eliminated.


                                       45


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


DISCONTINUED OPERATIONS

         Brilliant  Interactive Ideas Pty. Ltd., the Company's  Australian-based
production  company,  employed a team of animators and programmers  dedicated to
animation   production.   The  Company  discontinued   operations  at  Brilliant
Interactive  Ideas Pty. Ltd. because of the  under-utilization  of animators and
programmers which occurred following the termination of the Company's production
agreement with Warner Bros. Online and the closing of Digital Hip Hop. Following
the closure, the Company retained individual consultants on a project-by-project
basis in 2002 to design banner ads.  Digital Hip Hop and  Brilliant  Interactive
Ideas Pty. Ltd. were  discontinued  in fiscal 2002 and have been reported on the
2002 consolidated statement of operations and comprehensive loss as discontinued
operations in accordance with FASB 144.

         In December 2001,  operations of Brilliant  Interactive Ideas Pty. Ltd,
the  wholly  owned  Australian  subsidiary,   were  significantly  reduced.  The
Subsidiary  has  subsequently  been put into  liquidation  and is presented as a
discontinued operation for 2002.

         An  administrator  was  appointed  on  December  24, 2001 to manage and
review the financial  affair of Brilliant  Interactive  Ideas,  whose  financial
position was as follows:

         Net realizable value of assets .................  $   108,000
         Unsecured creditors ............................  $    83,000
         Employee Entitlements ..........................  $   889,000
         Loan from Brilliant Digital Entertainment ......  $ 5,729,000

         A creditors' meeting was held on January 25, 2002 and it was decided to
place BII  Australia  into  liquidation.  The assets of the company were used to
meet the fees of the liquidator with the balance going to employee entitlements.
Liquidation in Australia is a protracted process and is still on-going.

         Digital  HipHop  is  presented  as a  discontinued  operation  for 2002
pursuant to  Management's  decision to decrease  operations in November 2001 and
subsequently to cease all operations in the first quarter of 2002.

         As of December 31, 2001 the Subsidiary,  Digital HipHop,  Inc., had the
following assets and liabilities:

         Net assets, accounts receivable ................  $  17,000
         Unsecured creditors ............................  $  14,900
         Loan to Brilliant Digital Entertainment ........  $ 597,000


         After presenting Digital Hip Hop as a discontinued  operation for 2002,
the remaining liability of Digital Hip Hop was $11,000 as of December 31, 2002.

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

         The revenue and net loss of each of the discontinued operations were as
follows:


                                       46


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


                                                       December 31,
                                               ----------------------------
                                                  2002              2001
                                               ----------        ----------
     REVENUES:
       Brilliant Interactive Ideas ....              --          $   26,000
       Digital Hip Hop ................              --          $  380,000
       The Auction Channel ............              --          $    9,000
                                               ----------        ----------
       Total Revenues .................              --          $  415,000
                                               ==========        ==========

     NET LOSS:
       Brilliant Interactive Ideas ....        $  125,000        $2,456,000
       Digital Hip Hop ................        $   40,000        $  576,000
       The Auction Channel ............              --          $  317,000
                                               ----------        ----------
       Total Net Loss .................        $  165,000        $3,349,000
                                               ==========        ==========

REVENUE RECOGNITION

         Under SEC Staff  Accounting  Bulletin  No. 101,  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.

         BUSINESS  DEVELOPMENT  SERVICES.  The Company  generates fee income for
performing  business  development  services  for  Sharman  Networks  Limited  in
accordance  with an agreement.  The Company  negotiates  with third parties that
desire to enter into a business  transaction  with  Sharman  relating to the KMD
application.  The  commission  paid to the Company is a percentage  of the gross
revenue  received  by Sharman  for each  transaction  entered  into based on the
Company's efforts.  Revenue is recognized from individual  transactions based on
the specific terms of the applicable  contract,  which may involve (i) a revenue
share deal,  (ii) a one-time fee paid at signing or at some other date, or (iii)
a  combination  of  these  two  arrangements.  Non-refundable  advance  fees are
recognized on the date the payment is due as specified in the contract.  Revenue
share fees are recognized as earned.  This revenue is reflected in the Operating
Statement as Development fees and other revenue.

         ALTNET   REVENUE:   The  Company   derives   revenue  from  the  Altnet
peer-to-peer  business by processing digital media content (music,  video games,
software,  movies)  for  placement  on  Altnet's  peer-to-peer  network,  and by
promoting,  distributing,  and selling the content to end users of the  network.
Altnet's revenue is reflected in the Operating Statement as Development fees and
other revenue.


                                       47


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


         The Company  charges  clients a processing  fee to prepare  content for
distribution  on the network.  The amount of this fee varies based on the number
of files, the size of the files,  digital encoding costs, and the preparation of
collateral  marketing  materials,  such as  artwork.  These fees are due and are
recognized upon signing of the contract.

         Additionally,  the Company charges clients for content  promotions on a
cost  per  specified   number  of  downloaded   files.   A  customer   typically
pre-purchases  an agreed number of downloaded  files.  The amounts  charged vary
based on volume and the complexity of the campaign. Content promotions generally
include  a  processing  fee.  These  fees  are  recognized  over the life of the
promotion.

         The Company  charges  clients for content  sales based on (a) a revenue
sharing basis where the Company  receives an agreed upon percentage of the sales
price for each  transaction,  and (b) a combination  of revenue share and a cost
per specified  number of downloaded  files.  Content sales  campaigns  generally
include a processing  fee. The revenue from content sales is recognized when the
end user pays for the content and, where relevant, the file is downloaded by the
end user.

         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  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 AICPA  Statement of Position 97-2 (SOP 97-2),  the
minimum  guaranteed  payments are  recognized as revenue when the master file is
delivered for each  Webisode to the  publisher for


                                       48


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


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 Movies. Under some agreements, the fee is fixed non-refundable minimum
guaranteed  payment.  In accordance  with AICPA  Statement of Position 97-2 (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
AICPA  Statement of Position 97-2 (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


                                       49


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


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,
productions   costs  for  music  videos,   advertising   banners  and  technical
programming costs, 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  and,  ad  serving   software.   The  Company  incurred  research  and
development costs of $444,000 and $139,000,  including web development costs for
the years ended December 31, 2002 and 2001,  respectively.  The Company accounts
for web development costs in accordance with the EITF 00-2,  "Accounting for Web
site Development Costs."

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 ($0.5625 at
December 31, 2002),  and revenues and expenses are translated into U.S.  dollars
using an average exchange rate ($0.5422 for the year ended December 31, 2002 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.


                                       50


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


NET LOSS PER SHARE

         The Company  computes and presents  loss per share in  accordance  with
FASB  Statements  No.  128,  EARNINGS  PER SHARE.  Basic  eanings  per share are
computed  based upon the weighted  average  number of common shares  outstanding
during the  period.  Dilutive  earnings  per share are based  upon the  weighted
average number of common shares outstanding and potentially  dilutive securities
during the period.  Options,  warrants and convertible debt representing  common
shares of 5,974,000 and  84,440,000  were  excluded  from the average  number of
common and common equivalent  shares  outstanding in the diluted EPS calculation
for the years ended December 31, 2001 and 2002, 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 bank account is  guaranteed by the
Federal Deposit Insurance  Corporation ("FDIC") up to $100,000.  At December 31,
2002, the Company had  approximately  $236,000 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.

3.       NEW ACCOUNTING PRONOUNCEMENTS

         In  April  2002,  the FASB  issued  SFAS No.  145,  Rescission  of FASB
Statements No. 4, 44, and 64,  Amendment of FASB Statement No. 13, and Technical
Corrections.  This statement  eliminates the current  requirement that gains and
losses on debt  extinguishment  must be classified as extraordinary items in the
income  statement.  Instead,  such  gains  and  losses  will  be  classified  as
extraordinary  items only if they are deemed to be unusual  and  infrequent,  in
accordance with the current GAAP criteria for extraordinary  classification.  In
addition,  SFAS 145 eliminates an inconsistency in lease accounting by requiring
that  modifications  of  capital  leases  that  result  in  reclassification  as
operating  leases be accounted for  consistent


                                       51


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


with  sale-leaseback   accounting  rules.  The  statement  also  contains  other
nonsubstantive  corrections to authoritative accounting literature.  The changes
related to debt  extinguishment  will be effective  for fiscal  years  beginning
after  May 15,  2002,  and the  changes  related  to  lease  accounting  will be
effective  for  transactions  occurring  after May 15,  2002.  Adoption  of this
standard  will not have  any  immediate  effect  on our  consolidated  financial
statements.

         In June  2002,  the FASB  issued  SFAS No.  146,  Accounting  for Costs
Associated  with Exit or Disposal  Activities,  which  addresses  accounting for
restructuring  and similar costs.  SFAS No. 146 supersedes  previous  accounting
guidance,  principally Emerging Issues Task Force (EITF) Issue No. 94-3. We will
adopt the  provisions  of SFAS No. 146 for  restructuring  activities  initiated
after  December 31, 2002.  SFAS No. 146 requires  that the  liability  for costs
associated with an exit or disposal activity be recognized when the liability is
incurred.  Under EITF No. 94-3, a liability  for an exit cost was  recognized at
the  date  of a  company's  commitment  to an  exit  plan.  SFAS  No.  146  also
establishes that the liability should initially be measured and recorded at fair
value.  Accordingly,  SFAS No. 146 may affect the timing of  recognizing  future
restructuring costs as well as the amount recognized.  Cautionary Statements and
Risk Factors.

         In December 2002,  the FASB issued SFAS No. 148. This statement  amends
SFAS No. 123 to provide alternative methods of transition for a voluntary change
to  the  fair  value  based  method  of  accounting  for  stock-based   employee
compensation.  In addition, this statement amends the disclosure requirements of
SFAS No.  123 to  require  prominent  disclosures  in both  annual  and  interim
financial  statements  about the method of accounting for  stock-based  employee
compensation  and the  effect  of the  method  used on  reported  results.  . We
estimate that the adoption of SFAS No. 148 will not be material to our financial
statements.

         In  November  2002,  the  FASB  issued  FASB   Interpretation  No.  45,
"Guarantor's  Accounting and Disclosure  Requirements for Guarantees,  Including
Indirect Guarantees of Indebtedness of Others." This  Interpretation  elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize,  at the inception of a
guarantee,  a  liability  for the fair  value of the  obligation  undertaken  in
issuing the guarantee.  The disclosure  requirements of this  Interpretation are
currently  effective  and did not affect our  financial  position and results of
operations.  The initial recognition and initial measurement  provisions of this
Interpretation  are  applicable on a prospective  basis to guarantees  issued or
modified after December 31, 2002.

         In  January  2003,  the  FASB  issued  FASB   Interpretation   No.  46,
"Consolidation  of Variable Interest  Entities" ("FIN 46"). This  Interpretation
requires that variable  interest  entities  created after January 31, 2003,  and
variable  interest entities in which an interest is obtained after that date, be
evaluated  for  consolidation  into  an  entity's  financial  statements.   This
interpretation  also  applies,  beginning  July 1, 2003 for us, to all  variable
interest  entities in which an  enterprise  holds an  interest  that it acquired
before  February  1,  2003.  We are  in the  process  of  evaluating  all of our
investments  and other  interests in entities under the provisions of FIN 46 and
have not yet determined the effect of its adoption on our financial position and
results of operations.

4.       RELATED PARTY TRANSACTIONS

         In 2002, the Company issued warrants to purchase shares of common stock
in consideration for consulting services,  including options to purchase 500,000
shares of common stock issued to Abe Sher, a member of the board of directors as
of June 20, 2002. In addition, the Company paid Abe Sher $125,000 for consulting
services.


                                       52


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


         The Company recognized $917,000 of revenue for each of the fiscal years
ended  December 31, 2001 and 2002  related to its  distribution  and  technology
agreements  with 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 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,  2002 the  Company  recognized
$417,000 of this fee in revenues.  Deferred revenue includes $417,000 in current
and $972,000 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,  were to 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  had 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 paid the Company a fee of $2,500,000 for this license.  The
revenue is being  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,  2002,  the  Company
recognized  $500,000 in revenue.  Deferred revenue includes  $500,000 in current
and $667,000 in long term.  The Company has not received any  royalties yet from
this joint venture.

5.       SIGNIFICANT AGREEMENTS

KINETECH, INC.

         In October 2002, the Company  entered into a patent  license  agreement
with Kinetech,  Inc. pursuant to which it acquired a license to certain patented
technology of Kinetech,  and in  consideration  for such  license,  it issued to
Kinetech a warrant to purchase up to 5,000,000  shares of our common stock at an
exercise price of $0.001 per share. In connection with the  transaction,  Ronald
Lachman,  a principal  with  Kinetech,  agreed to become and now serves as Chief
Scientist  for our Altnet  subsidiary.  The  warrants  vest in two equal  annual
installments  so  long  as  Ronald  Lachman  continues  to  serve  as our  Chief
Scientist.  Mr. Lachman also is a partner in Kingsport Capital, LLC, the general
partner of Crestview  Capital Fund,  LP and Crestview  Capital Fund II, LP, each
selling  stockholders.  For the year ended  December 31,  2002,  the Company has
recognized  $30,000 of expense  related to the issuance of the warrants based on
valuation of the warrants using a Black Scholes model.


                                       53


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


DIGITAL HIP HOP

         In August 2000, the Company  entered into a joint venture  agreement to
produce  music videos for the Internet.  The joint  venture  required an initial
contribution  of technology  and $100,000 for a 50%  ownership,  while two other
partners each  contributed  $50,000 for a 25% share of the newly formed Company.
In the fiscal year 2000,  the loss incurred  absorbed the initial  contribution.
The Company had full operational control and full funding responsibility. 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  significantly  reduced
operations at Digital Hip Hop based on the limited  prospects of additional  web
video  production  work.  The  Company  does not intend to  actively  market and
promote the future  production  of animated  music  videos for the web.  Digital
HipHop is presented as a discontinued operation for all periods of 2002 pursuant
to   Management's   decision  to  decrease   operations  in  November  2001  and
subsequently  to cease  all  operations  in the  first  quarter  of 2002.  After
presenting Digital Hip Hop as a discontinued operation for 2002, the Company has
remaining liabilities of $11,000 on the balance sheet as of December 31, 2002.

CONVERTIBLE PROMISSORY NOTES

         In May 2001,  pursuant to Note and Warrant  Purchase  Agreements  dated
April 19, 2001, as amended, we sold to Harris Toibb,  Europlay 1, LLC (an entity
in which Mark Dyne,  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 originally had
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, originally could 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.

         In December  2001,  pursuant to Note and  Warrant  Purchase  Agreements
dated  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  2001  financing  transaction,  we sold to
Harris Toibb and Capel Capital Ltd.  secured  convertible  promissory notes (the
"New Notes" and, together with the Original Notes, the "Notes") in the aggregate
principal amount of $750,000.  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 a price equal to 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 on 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. on  November  10, 2002 (the  "Conversion  Price").  In
connection  with our sale of the New  Notes,  we issued to the  holders  thereof
warrants (the "New Warrants" and, together with the Original Warrants, the "Debt
Warrants") to purchase up to that number of shares of our Common Stock  obtained
by dividing 200% of the Principal  Amount by the product obtained by multiplying
1.125 by the Conversion  Price,  exercisable at a price per share equal to 1.125
times the Conversion Price. The New Notes mature  simultaneous with the Original
Notes,  which  originally was on November 10, 2002 and bear interest at the


                                       54


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


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 December financing transaction. 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 Conversion Price for the New Notes. In addition, these investors are able to
exercise the Original  Warrants  for a number of shares  determined  by dividing
200% of the principal  amount of the Original  Notes by the product  obtained by
multiplying  1.125 by the  Conversion  Price,  exercisable  at a price per share
equal to 1.125 times the Conversion Price.

         On November 10, 2002, the  Conversion  Price for the Notes was fixed at
$0.1203 per share, which was the lowest volume weighted average price of a share
of our Common Stock on the American Stock Exchange over any five (5) consecutive
trading  days  commencing  on December 14, 2001 and ending on November 10, 2002.
Assuming that all of the principal  amount and accrued  interest on the Notes is
converted  into common  stock on December 31,  2003,  the  maturity  date of the
Notes, the Note holders would acquire 31,141,103 shares of our common stock.

         On November 10, 2002, the exercise price of the Debt Warrants was fixed
at $0.1353 per share, which is equal to 1.125 times the Conversion Price for the
Notes at  November  10,  2002  ($0.1203  per share).  The Debt  Warrants  may be
exercised  to  purchase  up to  44,542,718  shares  of our  common  stock at the
exercise  price.  The number of shares that may be acquired upon exercise of the
warrants was  determined  by dividing  $6,028,300  (200 percent of the aggregate
principal amount of the Notes) by the exercise price.

         In October 2002, the holders of the Notes agreed to extend the maturity
date of the Notes from November 10, 2002 to December 31, 2003. In  consideration
of their  agreement to extend the maturity  date,  we issued to the Note holders
warrants to purchase up to an aggregate of 25,226,028 shares of our common stock
at an exercise price of $0.2091 per share. The Company recorded prepaid interest
expense of $1,699,000  which represents the estimated fair value of the warrants
issued  determined by using the Black  Scholes model with the following  inputs:
risk  factor  of  return  4.5%;  volatility  50%;  3 year  warrant  life  and no
dividends. This amount is being amortized on a straight-line basis over the life
of the Original Notes.  Thus the Company  expensed  $340,000 of debt discount in
the fourth quarter, with the remainder to be expensed in 2003.

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 connection 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


                                       55


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


plus one final payment equal to 10% of the original  principal amount.  The Note
is collateralized  by office furniture and equipment.  The note was paid-off and
cancelled in November 2002.

         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. The note was paid-off and cancelled in September 2002.

         Additionally,  the Company has an  obligation  to fund a Directors  and
Officers  insurance  policy,  with total  premiums of  $133,322.  The policy was
renewed in November 2002 with 12 months  coverage and is carried as a short term
financing  obligations.  In 2002,  the Company paid $77,250 in December 2002 and
the balance, $56,072, was paid in January 2003.

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.

         In March 2002,  we sold an aggregate of 6,051,437  shares of our common
stock to  Harris  Toibb,  Markev  Services  LLC and  David  Wilson  in a private
placement  at a price per share of $0.1322,  for net proceeds to us of $800,000.
In  connection  with the offering,  we also issued to the investors  warrants to
purchase up to an aggregate of 10,758,110  shares of common stock at an exercise
price of $0.148725 per share.  The warrants  expire on May 23, 2004.  Mark Dyne,
our Chairman,  and Kevin Bermeister,  a director and our Chief Executive Officer
and President, are owners of Markev Services.

         In April and May 2002, we sold an aggregate of 2,276,045  shares of our
common stock to Michael Toibb, Scott Hergott, Ronald Gilefsky,  Samuel McCracken
III, Preston  Millsboro  Automart,  Inc.,  Crestview Capital Fund, LP, Crestview
Capital Fund II, LP, Crestview Capital Offshore Fund, Inc., Julie Schuermann and
Roger  Suyama in private  placements  for net  proceeds to us of  $428,000.  The
prices per share  ranged  from  $0.1731  to $0.25,  and were based on the market
price of our common  stock at the time the  investor


                                       56


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


committed to purchase  the shares.  In  connection  with the  offering,  we also
issued to the  investors  warrants to purchase up to an  aggregate  of 4,145,921
shares of common stock at exercise  prices ranging from $0.19474 to $0.28125 per
share. The warrants expire on May 23, 2004.

         In September  2002,  we sold an  aggregate  of 7,123,836  shares of our
common stock to Harris  Toibb,  Markev  Services,  LLC,  Ronald  Lachman,  Scott
Hergot,  David Wilson and Bob Haya, in a private  placement at a price per share
of  $0.1502,  for net  proceeds  to us of  $1,057,000.  In  connection  with the
offering,  we  also  issued  to the  investors  warrants  to  purchase  up to an
aggregate of 12,664,597 shares of common stock at an exercise price of $0.168975
per share. The warrants expire on September 3, 2005.

         During 2002, the Company rescinded 9,628 shares of common stock,  which
were intended to be issued in connected  with The Auction  Channel.  The Auction
Channel was closed in 2001.

         The Company issued 110,000 shares of common stock for services rendered
during the year ended 2002 and recognized  $21,000 of expense in relation to the
issuance.

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, 2002,  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
$75,000  expense in 2002 with the  balance of the value,  $267,000,  recorded in
Other Assets,  of which  $185,000 is  classified as a long term asset,  with the
balance classified as a short term asset.

         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


                                       57


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


the third and fourth  quarters  2001 each,  the  Company  expensed  $176,000  in
connection with the beneficial  conversion  feature.  The remaining $693,000 was
expensed 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 of $282,000 was expensed  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 $65,000 was  expensed in the 4th Quarter of 2001,  with the balance
of $1,564,000  amortized on a straight-line basis over the remaining life of the
Original Notes in 2002.

         The fair  value of the  warrants  as  examined  at the date of grant is
based  on  a   Black-Scholes   option   pricing   model   with   the   following
weighted-average assumptions for 2002 and 2001, 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 50.0% and 75.0%;  and
expected  life of the warrants of 3 years for both years.  In 2002,  the Company
issued  warrants and options to purchase an  aggregate  of  6,619,286  shares of
common  stock in  consideration  for  consulting  services  provided  by  twelve
consultants, including options to purchase 500,000 shares of common stock issued
to Abe Sher, a member of our board of directors as of June 20, 2002. The Company
expensed $274,000 in connection with these warrants and options.

         The following table summarizes warrant activity:

                                                NUMBER
                                              OF SHARES        OPTION PRICE
                                              ----------      ---------------
         Outstanding at December 31, 2000        705,000      $4.00  -- $6.50
         Granted.........................      2,960,000      $4.00  -- $6.50
         Exercised.......................             --      $  --  -- $  --
         Forfeited.......................       (660,000)     $4.00  -- $6.29
         ---------------------------------------------------------------------
         Outstanding at December 31, 2001      3,005,000      $0.75  -- $5.50
         Granted.........................     75,171,000      $0.001 -- $6.50
         Exercised.......................       (100,000)     $0.00  -- $0.001
         Forfeited.......................        (95,000)     $0.33  -- $6.29
         ---------------------------------------------------------------------
         Outstanding at December 31, 2002     77,981,000      $0.001 -- $6.50



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
20,000,000,  subject to certain  adjustments to prevent dilution.  Any shares of
Common Stock  subject to an award,  which for any reason  expires or  terminates
unexercised  are again  available for issuance  under the 1996 Plan. The maximum
number of shares of Common Stock with respect to which  options or rights may be
granted under the 1996 Plan to any executive or other employee during any fiscal
year was increased at the Annual Meeting of Stockholders to an annual limitation
per  individual of up to one-half of the number of shares  reserved for issuance
under the amended 1996 Plan, subject to certain adjustments to prevent dilution.
Although any


                                       58


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


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, 2000       2,115,000    $1.50  -- $7.00
         Granted.........................       1,681,000    $0.16  -- $2.62
         Exercised.......................              --    $1.50  -- $3.94
         Forfeited.......................        (827,000)   $0.65  -- $5.94
         --------------------------------------------------------------------
         Outstanding at December 31, 2001       2,969,000    $0.16  -- $5.94
         Granted.........................       3,600,000    $0.001 -- $0.82
         Exercised.......................        (110,000)   $0.001 -- $0.82
         Forfeited.......................              --    $  --  -- $  --
         --------------------------------------------------------------------
         Outstanding at December 31, 2002       6,459,000    $0.001 -- $5.94
         Exercisable at December 31, 2002       1,550,000


         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 2002 and 2001,  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 50.0% 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 $0.06 and $1.66 per share for stock  options  granted in
2002 and 2001, 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 2002 and 2001 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:


                                       59


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


                                                      YEAR ENDED     YEAR ENDED
                                                     DECEMBER 31,   DECEMBER 31,
                                                         2001           2002
                                                     -----------    -----------

Net loss, as reported ............................   $(6,328,000)   $(6,349,000)
Employee compensation expense ....................   $  (358,000)   $  (118,000)
Net loss, pro forma ..............................   $(6,686,000)   $(6,467,000)
Basic and diluted loss per share, as reported ....   $     (0.39)   $     (0.27)
Basic and diluted loss per share, pro forma ......   $     (0.41)   $     (0.28)


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, 2002 the Company had cumulative tax losses resulting in
a net operating  loss ("NOL") carry forward of  approximately  $38,705,000.  The
losses will begin to expire in the year 2012.  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, 2002 are as follows:

                                                                    DECEMBER 31,
                                                                        2002
                                                                    -----------
Deferred tax assets:

   Net operating losses ..................................          $ 2,574,000
   Temporary differences .................................             (459,000)
                                                                    -----------
   Total deferred tax assets .............................            2,115,000
   Valuation allowance ...................................           (2,115,000)
                                                                    -----------
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      2002
                                                                ----      ----

Federal income tax rate ....................................      34%       34%
State income tax rate ......................................       6%        6%
Effect of net operating loss and net operating loss
   carry forward ...........................................     (40)      (40)
                                                                ----      ----
Effective income tax rate ..................................       0%        0%
                                                                ====      ====


                                       60


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


9.       PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment consists of the following:

                                                            DECEMBER 31,
                                                               2002
                                                             ---------


         Computers and equipment ....................        $ 241,000
         Leasehold improvements .....................           20,000
         Furniture and fixtures .....................           45,000
                                                             ---------
                                                               306,000
         Less accumulated depreciation ..............         (250,000)
                                                             ---------
                                                             $  56,000
                                                             =========




10.      ACCRUED EXPENSES

         Accrued expenses consist of the following:

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

         Employee compensation .......................         $176,000
         D&O Insurance ...............................           56,000
         Legal expenses ..............................           47,000
         Accrued payroll expenses ....................           26,000
         Other .......................................           62,000
                                                               --------
                                                               $367,000
                                                               --------

11.      DEFERRED COMPENSATION

         Deferred  compensation  is an  accrual  for  the  chairman  and for the
president  and chief  executive  officer of  $1,201,000  for unpaid prior years'
compensation, which includes interest, accrued at 8%.


                                       61


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


12.      GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS

         The  Company's  2002  operations  consist  of  the  operations  of  BDE
Australia in  Australia,  and  Brilliant  in the United  States.  The  following
schedule  sets  forth the  revenues  and  long-lived  assets of the  Company  by
geographic area:

                                                     UNITED
                                                     STATES           AUSTRALIA
                                                   ----------         ----------
YEAR ENDED DECEMBER 31, 2002
   Revenues from unaffiliated customers ..         $  951,000         $   17,000
   Revenues from affiliated customers ....            917,000               --
                                                   ----------         ----------
   Total revenues ........................         $1,868,000         $   17,000
                                                   ==========         ==========
YEAR ENDED DECEMBER 31, 2001:
   Revenues from unaffiliated customers ..         $  493,000               --
   Revenues from affiliated customers ....            917,000               --
                                                   ----------         ----------
   Total revenues ........................         $1,410,000               --
                                                   ==========         ==========
LONG-LIVED ASSETS AS OF:
   December 31, 2001 .....................         $1,379,000         $   15,000
                                                   ==========         ==========


         For  each of the  periods  shown  above,  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, banner ads, 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, 2002,  e-New Media  represented  45% of
the revenues with  distribution and licensing rights of $917,000.  Internet Fuel
contributed 22% ($419,000) of the revenue, with media buys and impressions.  The
Company earned 9% ($174,000) through business  development for Sharman Networks.
Additionally,  the Company earned 6% ($120,000) from Winstar for advertising and
media buys. For the year ended December 31, 2001, e-New Media represented 65% of
the revenues with  distribution and licensing  rights of $917,000.  Warner Bros.
Online  contributed  16%  ($226,000)  of the revenues,  while Warner Bros.  site
"Entertaindom"  contributed  advertising  revenues of 4%  ($59,000).  Infogrames
contributed 7% ($100,000) in advertising revenues.

         Digital  Hip Hop earned  $381,000 of the  revenues in 2001  through the
production  of music videos  primarily for Island Def Jam.  These  revenues have
been included in the loss on discontinued operations.

13.      SEGMENT INFORMATION

         Brilliant Digital  Entertainment,  Inc. is a company which operates two
distinct lines of business: (1) through our Altnet, Inc. subsidiary,  we operate
a   peer-to-peer-based   content  distribution   network,   utilizing  existing,
technology  which allows Altnet to securely and efficiently  distribute  digital
files to end users, and (2) through our b3d, Inc. subsidiary, we are a developer
and server of rich media  advertising  campaigns  ("rich media" being defined as
use of audio and animation), and a developer of software authoring tools used in
the creation of "three  dimensional",  or "3D", animated content, for use on the
World Wide Web.


                                       62


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


         Through  the  Altnet,   Inc.   subsidiary,   the  Company   operates  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, the Company has created a private, or "closed" peer-to-peer network,
which  allows the Company 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).  The  Company's  ability to control  which  files are
distributed over their private network, as well as their use of widely available
digital rights  management  (or DRM)  technologies  from Microsoft  Corporation,
TryMedia  and others to protect  against  copyright  infringement,  prevent  the
distribution  of  unauthorized  files  over  their  network  and help to protect
against the  unauthorized  use of a digital file  distributed over their network
once it resides on an end user's computer.  Brilliant  commercializes  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 other Altnet users.

         The Company  owns 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 the
Company license a substantial portion of Altnet's peer-to-peer technology.

         The Company's  b3d, Inc.  subsidiary,  develops and serves "rich media"
(which  includes  audio  and  animation)  Internet  banner  advertisements,  and
develops  software  authoring  tools used to create  three  dimensional  (or 3D)
animated  content for use on the World Wide Web. During fiscal 2002, the Company
shifted its emphasis from the Internet  advertising and b3d toolset  business to
the Altnet peer-to-peer business. This shift in emphasis occurred gradually over
the course of fiscal 2002, and came about primarily due to the Company's limited
financial  resources,  which have been unable to support both businesses.  While
the Company has not decided to discontinue its advertising  business altogether,
until the Company has sufficient resources to support both businesses it intends
to focus  substantially  all of its limited  financial  resources and efforts to
grow the Altnet business.

                                                                     YEAR ENDED
                                                                    DECEMBER 31,
                                                                        2002
                                                                    -----------
Total Assets:
  Brilliant Digital .....................................           $ 2,623,000
  Altnet ................................................               173,000
                                                                    -----------
       Total assets (1) .................................           $ 2,796,000
                                                                    ===========

Revenues--external customers:
  Brilliant Digital .....................................           $   886,000
  Altnet ................................................                82,000
                                                                    -----------
       Total revenues ...................................           $   968,000
                                                                    ===========

Income (Loss) from Operations:
  Brilliant Digital (2)(3) ..............................           $(4,826,000)
  Altnet ................................................            (1,358,000)
  Discontinued Operations (4) ...........................              (165,000)
                                                                    -----------
       Total income (loss) ..............................           $(6,349,000)
                                                                    ===========
----------
(1)  Transactions  between the two segments are primarily cash transfers to fund
     Altnet operations.
(2)  Includes depreciation of $66,000.
(3)  Includes a debt discount of $3,169,000.
(4)  Digital Hip Hop and BII Australia  were closed as of the beginning of 2002.


                                       63


<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2002


14.      COMMITMENTS AND CONTINGENCIES

         The Company had two fixed asset  financing  notes (Note 6),  which have
been paid and canceled as of December 31, 2002.

         The Company  leases its facilities  under  operating  lease  agreements
expiring  through 2003. The Company has signed 2 new,  two-year,  facility lease
agreements in February 2003.  Future minimum annual  payments for the Australian
facility  are $31,000 and  $70,000  for the US office.  As of February  2003 the
commitment under these leases the obligation is as follows:

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

               2003                                   $92,500
               2004                                   101,000
               2005                                     8,500
                                                 -------------
                                                     $202,000
                                                 =============

         Rent expense was  $176,000 and $65,000 for the year ended  December 31,
2001 and the year ended December 31, 2002, respectively.


                                       64


<PAGE>


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

         None.

                                    PART III

ITEM 9.  DIRECTORS,   EXECUTIVE   OFFICERS,   PROMOTERS  AND  CONTROL   PERSONS;
         COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

         Information  required by this Item 9 will appear in the proxy statement
for the 2003  Annual  Meeting of  Stockholders,  and is  incorporated  herein by
reference.

ITEM 10. EXECUTIVE COMPENSATION

         Information  regarding executive  compensation will appear in the proxy
statement  for the 2003  Annual  Meeting of  Stockholders,  and is  incorporated
herein by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         Information  regarding  security ownership of certain beneficial owners
and management will appear in the proxy statement for the 2003 Annual Meeting of
Stockholders, and is incorporated herein by reference.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         Information  regarding certain  relationships and related  transactions
will appear in the proxy statement for the 2003 Annual Meeting of  Stockholders,
and is incorporated by this reference.

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

         (a) Exhibits:

                  See attached Exhibit Index.

         (b) Reports on Form 8-K.

                  None.

ITEM 14. CONTROLS AND PROCEDURES.

         Within the 90 days prior to the filing date of this  report,  our Chief
Executive  Officer and Chief Financial  Officer,  with the  participation of our
management,  carried out an evaluation of the  effectiveness  of our  disclosure
controls and  procedures  pursuant to Exchange Act Rule 13a-14.  Based upon that
evaluation,  our Chief  Executive  Officer and Chief  Financial  Officer believe
that, as of the date of the evaluation,  our disclosure  controls and procedures
are  effective  in making  known to them  material  information  relating  to us
(including  our  consolidated  subsidiaries)  required  to be  included  in this
report.

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


                                       65


<PAGE>


because of human  failures  such as simple  errors or  mistakes  or  intentional
circumvention of the established process.

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


                                       66


<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/ Robert Chmiel
                                            -----------------------------------
                                            Robert Chmiel
                                   Its:     Chief Financial Officer (Principal
                                            Financial and Accounting Officer)
                                            and Chief Operating Officer

                                POWER OF ATTORNEY

         The   undersigned   directors   and  officers  of   Brilliant   Digital
Entertainment,  Inc. do hereby  constitute  and appoint  Robert Chmiel with full
power of substitution and resubstitution, as their true and lawful attorneys and
agents,  to do any and all  acts  and  things  in our  name  and  behalf  in our
capacities as directors and officers and to execute any and all  instruments for
us and in our names in the capacities  indicated below,  which said attorney and
agent, may deem necessary or advisable to enable said corporation to comply with
the Securities  Exchange Act of 1934, as amended and any rules,  regulations and
requirements of the Securities and Exchange Commission,  in connection with this
Annual Report on Form 10-KSB,  including  specifically  but without  limitation,
power and  authority to sign for us or any of us in our names in the  capacities
indicated below, any and all amendments  (including  post-effective  amendments)
hereto,  and we do hereby ratify and confirm all that said attorneys and agents,
or either of them, shall do or cause to be done by virtue hereof.

         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
      ---------                         -----                         ----

    /s/ Mark Dyne              Chairman of the Board of           April 11, 2003
-----------------------        Directors
      Mark Dyne

/s/ Kevin Bermeister           Chief Executive Officer,           April 11, 2003
-----------------------        President and Director
   Kevin Bermeister

 /s/ Rob Chmiel                Chief Financial Officer            April 11, 2003
-----------------------        (Principal Financial and
      Rob Chmiel               Accounting Officer) and
                               Chief Operating Officer

   /s/ Mark Miller             Director                           April 11, 2003
-----------------------
     Mark Miller


-----------------------        Director                           April 11, 2003
   Russell Simmons

    /s/ Ray Musci              Director                           April 11, 2003
-----------------------
      Ray Musci

  /s/ Garth Saloner            Director                           April 11, 2003
-----------------------
    Garth Saloner

 /s/ Jeff Scheinrock           Director                           April 11, 2003
-----------------------
   Jeff Scheinrock

    /s/ Abe Sher               Director                           April 11, 2003
-----------------------
       Abe Sher


                                       67


<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 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;

         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;

         4. The registrant's other certifying officers and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

                  a) designed such disclosure  controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,  particularly
during the period in which this annual report is being prepared;

                  b) evaluated the effectiveness of the registrant's  disclosure
controls and  procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

                  c) presented in this annual report our  conclusions  about the
effectiveness of the disclosure  controls and procedures based on our evaluation
as of the Evaluation Date;

         5. The  registrant's  other  certifying  officers and I have disclosed,
based on our most recent evaluation,  to the registrant's auditors and the audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent function):

                  a) all significant  deficiencies in the design or operation of
internal  controls  which could  adversely  affect the  registrant's  ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

                  b)  any  fraud,   whether  or  not  material,   that  involves
management or other  employees who have a significant  role in the  registrant's
internal controls; and

         6. The registrant's  other certifying  officers and I have indicated in
this annual  report  whether or not there were  significant  changes in internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date:    April 11, 2003
                                                      /s/ Kevin Bermeister
                                                     -----------------------
                                                     Kevin Bermeister
                                                     Chief Executive Officer


                                       68


<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, Robert Chmiel, certify that:

         1. I have  reviewed  this  annual  report on Form  10-KSB 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;

         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;

         4. The registrant's other certifying officers and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

                  a) designed such disclosure  controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,  particularly
during the period in which this annual report is being prepared;

                  b) evaluated the effectiveness of the registrant's  disclosure
controls and  procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

                  c) presented in this annual report our  conclusions  about the
effectiveness of the disclosure  controls and procedures based on our evaluation
as of the Evaluation Date;

         5. The  registrant's  other  certifying  officers and I have disclosed,
based on our most recent evaluation,  to the registrant's auditors and the audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent function):

                  a) all significant  deficiencies in the design or operation of
internal  controls  which could  adversely  affect the  registrant's  ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

                  b)  any  fraud,   whether  or  not  material,   that  involves
management or other  employees who have a significant  role in the  registrant's
internal controls; and

         6. The registrant's  other certifying  officers and I have indicated in
this annual  report  whether or not there were  significant  changes in internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date:    April 11, 2003
                                                      /s/ Robert Chmiel
                                                     -----------------------
                                                     Robert Chmiel
                                                     Chief Financial Officer


                                       69


<PAGE>


                                  EXHIBIT INDEX

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

3.1             Amended  and  Restated   Certificate  of  Incorporation  of  the
                Registrant,  as amended by that certain Amendment to Amended and
                Restated   Certificate  of   Incorporation  of  the  Registrant.
                Incorporated by reference to Exhibit 3.1 to Quarterly  Report on
                Form 10-QSB for the quarter ended June 30, 2002.

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.

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.

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            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.

10.5            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.

10.6            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.]

10.7            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.

10.8            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.

10.9            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.

10.10           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.

10.11           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.


<PAGE>


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

10.12           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.

10.13           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.

10.14           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.

10.15           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.

10.16           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.

10.17           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.] Incorporated by reference
                to Exhibit  10.40 to Annual  Report on Form  10-KSB for the year
                ended December 31, 2001.

10.18           Note and Warrant Purchase Agreement, dated December 10, 2001, by
                and  between  Registrant  and  Harris  Toibb.   Incorporated  by
                reference to Exhibit  10.41 to Annual  Report on Form 10-KSB for
                the year ended December 31, 2001.

10.19           Note and Warrant Purchase Agreement, dated December 10, 2001, by
                and between  Registrant and Capel Capital Ltd.  Incorporated  by
                reference to Exhibit  10.42 to Annual  Report on Form 10-KSB for
                the year ended December 31, 2001.

10.20           Secured Convertible Promissory Note, dated December 19, 2001, in
                favor of Harris  Toibb.  Incorporated  by  reference  to Exhibit
                10.43  to  Annual  Report  on Form  10-KSB  for the  year  ended
                December 31, 2001.

10.21           Secured Convertible Promissory Note, dated December 19, 2001, in
                favor of Capel Capital Ltd. Incorporated by reference to Exhibit
                10.44  to  Annual  Report  on Form  10-KSB  for the  year  ended
                December 31, 2001.

10.22           Common Stock Purchase  Warrant,  dated December 19, 2001, by and
                between  Registrant and Harris Toibb.  Incorporated by reference
                to Exhibit  10.45 to Annual  Report on Form  10-KSB for the year
                ended December 31, 2001.

10.23           Common Stock Purchase  Warrant,  dated December 19, 2001, by and
                between  Registrant  and  Capel  Capital  Ltd.  Incorporated  by
                reference to Exhibit  10.46 to Annual  Report on Form 10-KSB for
                the year ended December 31, 2001.

10.24           Amendment  Number Two to Note and Warrant  Purchase  Agreements,
                dated  December 19, 2001, by and between  Registrant  and Harris
                Toibb.  Incorporated  by  reference  to Exhibit  10.47 to Annual
                Report on Form 10-KSB for the year ended December 31, 2001.

10.25           Amendment Number One to Secured  Convertible  Promissory  Notes,
                dated December 19, 2001, in favor of Harris Toibb.  Incorporated
                by  reference to Exhibit  10.48 to Annual  Report on Form 10-KSB
                for the year ended December 31, 2001.


<PAGE>


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

10.26           Amendment  No. 1 to  Warrant to  Purchase  Common  Stock,  dated
                December 19, 2001, by and between  Registrant  and Harris Toibb.
                Incorporated  by reference to Exhibit  10.49 to Annual Report on
                Form 10-KSB for the year ended December 31, 2001.

10.27           Amendment  No. 1 to  Warrant to  Purchase  Common  Stock,  dated
                December 19,  2001,  by and between  Registrant  and Europlay 1,
                LLC. Incorporated by reference to Exhibit 10.50 to Annual Report
                on Form 10-KSB for the year ended December 31, 2001.

10.28           Amendment  No. 1 to  Warrant to  Purchase  Common  Stock,  dated
                December 19, 2001, by and between  Registrant  and Preston Ford,
                Inc. Incorporated by reference to Exhibit 10.51 to Annual Report
                on Form 10-KSB for the year ended December 31, 2001.

10.29           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.
                Incorporated  by reference to Exhibit  10.52 to Annual Report on
                Form 10-KSB for the year ended December 31, 2001.

10.30           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.  Incorporated  by reference to
                Exhibit 10.53 to Annual Report on Form 10-KSB for the year ended
                December 31, 2001.

10.31           Investor Rights  Agreement,  by and between  Registrant,  Harris
                Toibb,  Europlay 1, LLC,  Preston  Ford,  Inc. and Capel Capital
                Ltd. Incorporated by reference to Exhibit 10.54 to Annual Report
                on Form 10-KSB for the year ended December 31, 2001.

10.32           Guaranty,  dated  December  19,  2001,  made  by B3D,  Inc.  and
                Brilliant  Studios,  Inc.  in favor of Harris  Toibb,  as agent.
                Incorporated  by reference to Exhibit  10.55 to Annual Report on
                Form 10-KSB for the year ended December 31, 2001.

10.33           Acknowledgement,  Consent and Reaffirmation,  dated December 19,
                2001, by Brilliant Studios,  Inc. and B3D, Inc.  Incorporated by
                reference to Exhibit  10.56 to Annual  Report on Form 10-KSB for
                the year ended December 31, 2001.

10.34           Form of Warrant to Purchase  Common Stock from March 7, 2002 and
                March 20, 2002 financings.  Incorporated by reference to Exhibit
                10.1 to  Quarterly  Report on Form 10-QSB for the quarter  ended
                June 30, 2002.

10.35           Form of  Warrant  to  Purchase  Common  Stock from April 2, 2002
                financing.   Incorporated   by  reference  to  Exhibit  10.2  to
                Quarterly  Report on Form 10-QSB for the quarter  ended June 30,
                2002.

10.36           Form of Warrant to  Purchase  Common  Stock from April 23,  2002
                financing.   Incorporated   by  reference  to  Exhibit  10.3  to
                Quarterly  Report on Form 10-QSB for the quarter  ended June 30,
                2002.

10.37           Warrant to Purchase Common Stock, dated February 1, 2002, issued
                in favor of VoxPop,  LLC.  Incorporated  by reference to Exhibit
                10.4 to  Quarterly  Report on Form 10-QSB for the quarter  ended
                June 30, 2002.

10.38           Form of Warrant to Purchase  Common Stock,  dated April 5, 2002,
                issued in favor of The Rose Group.  Incorporated by reference to
                Exhibit 10.5 to Quarterly  Report on Form 10-QSB for the quarter
                ended June 30, 2002.

10.39           Warrant to Purchase Common Stock,  dated April 15, 2002,  issued
                in favor of Business Development Experts,  Inc.  Incorporated by
                reference to Exhibit 10.6 to Quarterly Report on Form 10-QSB for
                the quarter ended June 30, 2002.


<PAGE>


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

10.40           Warrant to Purchase Common Stock,  dated April 15, 2002,  issued
                in favor of mPRm Public Relations.  Incorporated by reference to
                Exhibit 10.7 to Quarterly  Report on Form 10-QSB for the quarter
                ended June 30, 2002.

10.41           Warrant to Purchase Common Stock,  dated April 22, 2002,  issued
                in favor of KaZaA,  B.V.  Incorporated  by  reference to Exhibit
                10.7 to  Quarterly  Report on Form 10-QSB for the quarter  ended
                June 30, 2002.

10.42           Common  Stock and Warrant  Purchase  Agreement  dated August 26,
                2002, by and among Registrant and Harris Toibb, Markev Services,
                LLC, Ronald Lachman,  David Wilson,  Bob Haya and Scott Hergott.
                Incorporated by reference to Exhibit 10.1 to Quarterly Report on
                Form 10-QSB for the quarter ended September 30, 2002.

10.43           Form of Warrant to  Purchase  Common  Stock from August 26, 2002
                financing.   Incorporated   by  reference  to  Exhibit  10.2  to
                Quarterly  Report on Form 10-QSB for the quarter ended September
                30, 2002.

10.44           Warrant to Purchase Common Stock,  dated August 28, 2002, issued
                in favor of SRO  Consulting,  Inc.  Incorporated by reference to
                Exhibit 10.3 to Quarterly  Report on Form 10-QSB for the quarter
                ended September 30, 2002.

10.45           Letter Agreement,  dated August 19, 2002, between Registrant and
                Europlay  Capital  Advisors,  LLC.  Incorporated by reference to
                Exhibit 10.4 to Quarterly  Report on Form 10-QSB for the quarter
                ended September 30, 2002.

10.46           Letter  Agreement,  dated October 2, 2002,  among Registrant and
                the  holders  of  Registrant's  Secured  Convertible  Promissory
                Notes.  Incorporated  by  reference to Exhibit 10.5 to Quarterly
                Report on Form 10-QSB for the quarter ended September 30, 2002.

10.47           Form of Amendment Number One to Secured  Convertible  Promissory
                Note dated as of December 19, 2001. Incorporated by reference to
                Exhibit 10.6 to Quarterly  Report on Form 10-QSB for the quarter
                ended September 30, 2002.

10.48           Form of Amendment Number Two to Secured  Convertible  Promissory
                Note dated as of May 23,  2001.  Incorporated  by  reference  to
                Exhibit 10.7 to Quarterly  Report on Form 10-QSB for the quarter
                ended September 30, 2002.

10.49           Form of Warrant issued in connection  with extension of maturity
                date of Secured  Convertible  Promissory Notes.  Incorporated by
                reference to Exhibit 10.8 to Quarterly Report on Form 10-QSB for
                the quarter ended September 30, 2002.

10.50           Contractor,   Confidential   Information  and   Non-Solicitation
                Agreement, dated as of February 2002, between Registrant and Abe
                Sher.  Incorporated  by  reference  to Exhibit 10.9 to Quarterly
                Report on Form 10-QSB for the quarter ended September 30, 2002.