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

                                   FORM 10-KSB

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

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

[_]      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.)

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

                                 (818) 386-2180
                          (Issuer's telephone Number)

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

                                      None

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

                          Common Stock, $.001 par value
                                (Title of Class)

         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, 2004 were
$8,775,000.

         At March 8, 2005,  the aggregate  market value of the voting stock held
by non-affiliates of the issuer was $1,301,438.

         At March 8, 2005,  the issuer had  42,857,153  shares of Common  Stock,
$0.001 par value, issued and outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions  of the  issuer's  Proxy  Statement  with  respect to its 2005
Annual Meeting of  Stockholders  are  incorporated by reference into Part III of
this Report.

         Transitional Small Business Disclosure Format (check one):

                                Yes [_]      No [X]

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                     BRILLIANT DIGITAL ENTERTAINMENT, INC.
                              INDEX TO FORM 10-KSB

PART I                                                                      PAGE

Item 1.       Description of Business...................................       1
Item 2.       Description of Properties.................................       9
Item 3.       Legal Proceedings.........................................       9
Item 4.       Submission of Matters to a Vote of Security Holders.......       9


PART II

Item 5.       Market for Common Equity and Related Stockholder Matters..      10
Item 6.       Management's Discussion and Analysis of Financial
                 Condition and Results of Operations....................      11
Item 7.       Financial Statements

              Report of Independent Registered Public Accounting Firm...      28
              Report of Independent Registered Public Accounting Firm...      29
              Consolidated Balance Sheet................................      30
              Consolidated Statements of Operations and Comprehensive
                 Loss...................................................      31
              Consolidated Statements of Stockholders' Deficit..........      32
              Consolidated Statements of Cash Flows.....................      33
              Notes to Consolidated Financial Statements................      34

Item 8.       Changes in and Disagreements with Accountants
                 on Accounting and Financial Disclosure.................      53
Item 8A.      Controls and Procedures...................................      53
Item 8B.      Other Information.........................................      53


PART III

Item 9.       Directors, Executive Officers, Promoters and Control
                 Persons; Compliance With Section 16(a) of the
                 Exchange Act...........................................      53
Item 10.      Executive Compensation....................................      53
Item 11.      Security Ownership of Certain Beneficial Owners and
                 Management and Related Stockholder Matters.............      53
Item 12.      Certain Relationships and Related Transactions............      53
Item 13.      Exhibits..................................................      54
Item 14.      Principal Accountant Fees and Services....................      54


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                                     PART I

         This Annual Report on Form 10-KSB contains  forward-looking  statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the  Securities  Exchange Act of 1934,  as amended.  We use words
such as "believes", "intends", "expects", "anticipates",  "plans", "may", "will"
and similar  expressions  to identify  forward-looking  statements.  Discussions
containing  forward-looking  statements  may be found in the  material set forth
under "Business,"  "Management's  Discussion and Analysis of Financial Condition
and  Results  of  Operations"   and  in  other  sections  of  the  report.   All
forward-looking  statements,  including,  but not  limited  to,  projections  or
estimates  concerning  our  business,  including  demand  for our  products  and
services,  mix of revenue  streams,  ability to control and/or reduce  operating
expenses,  anticipated  operating  results,  cost savings,  product  development
efforts, general outlook of our business and industry, international businesses,
competitive  position,  adequate  liquidity to fund our  operations and meet our
other  cash  requirements,  are  inherently  uncertain  as they are based on our
expectations and assumptions  concerning  future events.  These  forward-looking
statements  are subject to numerous  known and unknown risks and  uncertainties.
You should not place undue  reliance on these  forward-looking  statements.  Our
actual  results  could  differ   materially   from  those   anticipated  in  the
forward-looking  statements  for many reasons,  including our ability to attract
content for distribution over our network, our ability to increase the number of
distribution  partners through which our customers content can be accessed,  and
all other risks described below in the section entitled  "Cautionary  Statements
and  Risk  Factors"  appearing  in  "Management's  Discussion  and  Analysis  of
Financial  Condition and Risk of Operations"  and elsewhere in this report.  All
forward-looking  statements  in this  document  are made as of the date  hereof,
based on  information  available to us as of the date  hereof,  and we assume no
obligation to update any forward-looking statement.

ITEM 1.       DESCRIPTION OF BUSINESS

GENERAL

         Brilliant Digital  Entertainment,  Inc. is a company which, through our
Altnet, Inc.  subsidiary,  operates 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 via the
Internet.  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, with  authorization  from
the copyright  owner,  directly from one computer user (peer) to another (peer).
Our ability to control files  distributed over our private  network,  as well as
our use of widely available digital rights management (or DRM) technologies from
Microsoft  Corporation,  TryMedia Systems,  Softwrap Limited and others prevents
the  distribution  of  unauthorized  files over our network and helps to protect
against the  unauthorized use of a digital file once it resides on an end user's
computer.  We  commercialize  Altnet by partnering with third party operators of
web sites and other Internet applications to enable users of those web sites and
applications to search for and download  digital files available over the Altnet
network.  We also operate a payment  processing  "gateway" that enables computer
users to purchase content distributed over our network.

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

         Our revenues are derived principally from marketing services, licensing
and other services,  and digital content  revenue.  During 2003, we also derived
revenue from the  amortization  of  non-refundable  advances we received in 2000
related to a software  licensing  and  distribution  agreement  with e-New Media
Company.

         Marketing   services   revenues   are  derived  from  paid  search  and
advertising services.  Under the terms of our agreement with The Excite Network,
Inc., now owned by Ask Jeeves, Inc., we are paid a non-refundable bounty for the
installation of each Excite My Search toolbar bundled for distribution  with our


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Altnet Loyalty Points Manager on an English speaking user's computer, and we are
paid a  percentage  of the  gross  profit  earned  as a result of clicks on paid
search  results by any end users of these  toolbars.  We recently  announced  an
online advertising  revenue-sharing fund that will be split with top independent
labels  including  V-2,  Artemis,   Epitaph/Anti,   Side  One  Dummy  and  Palm,
Simmons/Latham,  and Koch Media., all Altnet music licensors.  These labels will
share the revenue  generated from advertising that appears in the user interface
of popular  Peer to Peer  applications.  The fund will be split  proportionately
based on content  licenses issued whether the music content is offered for sale,
trial or for free.  In exchange for  services  performed by us we will receive a
fee from the fund.

         Licensing and other  services  revenues are derived from our sublicense
of rights to the TruNames patent,  business  development  services,  and payment
processing  services.  Under the terms of our patent  sublicense  agreement with
Sharman Networks, we recognize sublicense payments as revenue on a monthly basis
as earned.  We negotiate with third parties that desire to enter into a business
transaction with Sharman  Networks  relating to the Kazaa Media Desktop (or KMD)
software  application.  We receive a percentage of the gross revenue received by
Sharman Networks for each transaction  entered into based solely on our efforts.
We also  generate  fees from  processing  payments  for the  purchase of digital
content  using the  Altnet  payment  processing  gateway.  In the early  part of
February 2005, we stopped  processing  payments for Kazaa Plus for which we were
receiving a payment processing fee.

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

         We are a Delaware  corporation  that was incorporated in July 1996. Our
executive  offices are located at 14011 Ventura Blvd.,  Suite 501, Sherman Oaks,
California 91423, and our telephone number is (818) 386-2180. Information on our
web sites, www.brilliantdigital.com and www.altnet.com, does not constitute part
of this report.

SIGNIFICANT DEVELOPMENTS IN 2004

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

         In June 2004, we entered into a Settlement Agreement and Mutual Release
with Big Seven  Entertainment,  LLC, a distributor  of digital  content over the
Altnet network, and Detershan Pty. Ltd. Big Seven is owned by Michael Toibb, the
son of Harris Toibb,  our largest secured  creditor and  stockholder.  Under the
terms of the agreement,  we agreed to acquire from Michael  Toibb,  on or before
the first  anniversary  of the agreement,  all of his ownership  interest in Big
Seven in  exchange  for the  issuance to him of  6,666,667  shares of our common
stock or, in lieu of such issuance, the payment to him of $0.15 in cash for


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each such share (for aggregate proceeds of $1,000,000). Prior to our acquisition
of Mr. Toibb's ownership interest in Big Seven, we agreed to operate Big Seven's
business and are responsible for all of Big Seven's liabilities and are entitled
to retain  all of its  revenues.  We also  agreed  to  reimburse  Michael  Toibb
$150,000 in legal and professional  fees and pay him a management fee of $15,000
per month until we consummate our  acquisition  of Big Seven.  We also agreed to
indemnify Mr. Toibb for all losses, damages and expenses that may arise from our
operation of Big Seven.

         In September  2004,  through our  subsidiary  Altnet,  we filed a civil
lawsuit in the United  States  District  Court  Central  District of  California
against  a number  of  companies  and  organizations,  including  the  Recording
Industry  Association of America,  alleging the breach of the "TrueNames" patent
which we license from  Kinetech,  Inc. In that filing we allege that some of the
defendants  infringe on the patent to "spoof"  peer-to-peer  users with bogus or
corrupted media files,  which inhibits the growth of peer-to-peer for legitimate
file sharing and thereby has injured our business.

THE ALTNET SECURE PEER-TO-PEER NETWORK

         Peer-to-peer  computing  is  the  sharing  of  computer  resources  and
services  by direct  exchange of file data  between  computer  systems,  and not
through a central server. Our Altnet peer-to-peer  computing application permits
its users to exchange authorized digital files directly.  Peer-to-peer computing
takes advantage of existing desktop computing power and networking connectivity,
allowing users to access and download files from other users.  We have created a
private  and  secure   peer-to-peer   network  of  users  where  we  manage  the
distribution  of digital  files that have been  authorized  for placement on our
network by their owners, directly from one computer user to another, thus taking
advantage of the computer storage capacity and bandwidth of the network's users.

         The  peer-to-peer  technology  necessary  to  operate  Altnet  has been
installed  on tens of millions of  computers  worldwide,  primarily  through our
technology  bundle agreement with Sharman  Networks,  which distributes the very
popular  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.  Our  distribution  agreement  with  Grokster has  increased  the
distribution  of our  peer-to-peer  technology  to  users of that  file  sharing
application.

THE ALTNET SERVICE

         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 of the Altnet application in response to the
end  user's  search  request.  Pursuant  to  our  agreements  with  distribution
partners,  such as  Sharman  Networks,  MetaMachine,  Grokster  and  The  Excite
Network,  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  network  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 may  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.

         A  significant  feature  of  the  Altnet  service  is  its  ability  to
communicate with the KMD technology, an existing graphical user interface to the
Fasttrack  peer-to-peer  software  application  that  is  already  installed  on
desktops  worldwide.  The KMD permits end users to exchange files with other KMD
users over the


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Fasttrack network. Millions of search requests each day are being made using the
KMD by users  worldwide.  These search  requests are sent to Altnet's  TopSearch
technology, and pursuant to our agreement with Sharman Networks, relevant Altnet
search results are displayed in the KMD to end users in response to their search
requests.  Altnet files that are  displayed in the KMD are  differentiated  by a
gold icon next to the file  name,  as  opposed  to the  bluish  green icon which
denotes a file available from a Fasttrack user. This allows end users of the KMD
to search for and download  digital files from users of the Fasttrack and Altnet
peer-to-peer applications. The user experience of downloading a file from Altnet
is  substantially  the  same  as the  procedure  of  downloading  a file  from a
Fasttrack 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 a  Fasstrack  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

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

STRATEGY

         We  intend  to  continue  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
to become a distributor of content, we syndicate our TopSearch engine and Altnet
Download  Manager,  which are used to search for and download  Altnet files,  to
multiple web sites and Internet  applications.  We then market our  distribution
services to the owners of music,  PC games,  software,  movies and other digital
media content. Important components of our strategy include:

         o        Expanding   our   content   library   to   include   a   large
                  representation  of a broad  range  of  content  categories  to
                  attract distribution partners and end users;

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

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

         o        Leveraging  our  search   agreements  with  Sharman  Networks,
                  MetaMachine,  Grokster and The Excite Network,  which allow us
                  to  deliver  Altnet  files to  millions  of users,  to attract
                  content owners to Altnet; and

         o        Exploring the viability of advertising  from the Altnet Points
                  Manager to fund the  availability  of selected,  free content,
                  primarily  music,  to end  users.  In  exchange  for  watching
                  advertising,  users  will be given  free  content,  prizes and
                  participation in drawings.

OUR DISTRIBUTION PARTNERS

         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 KMD in response to the user's search query. Sharman is our
most  significant   distribution   partner.   We   significantly   expanded  our
distribution  reach when we entered  into  agreements  with The Excite  Network,
Grokster and MetaMachine to distribute our search  listings to their  respective
user bases. We will continue to pursue distribution



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agreements with partners who provide us access to a large user base and who have
the  ability  to  effectively  market  our  product  to their  users.  Potential
distribution partners include:

         o        peer-to-peer  application  providers  seeking to commercialize
                  their applications;

         o        web sites with traffic  seeking an easy way to manage  content
                  provisioning solutions; and

         o        content  oriented web sites with targeted  traffic  seeking to
                  sell content.

         Using our Altnet Download Manager,  our distribution  partners are able
to  interface  with the Altnet  peer-to-peer  network to make our  catalogue  of
content  available  on their web sites and Internet  applications,  while taking
advantage of the distributed bandwidth benefits afforded them through our Altnet
peer-to-peer technology.

SALES AND MARKETING OF ALTNET SERVICES TO CONTENT OWNERS

         We market our Altnet  service to owners and  licensees  of  proprietary
content,  including  music,  videos and digital  films,  PC games,  and software
applications.  Our sales and  marketing  strategy  is to market our  services to
domestic and  international  content  providers to build a content  library that
includes a large representation of a broad range of content categories. We offer
our  customers  flexibility  in how they  promote  and  sell  their  content  to
consumers.  Our Altnet  service  enables  customers to control  their  marketing
efforts at all times during the marketing  campaign.  Unlike competitors such as
iTunes and Rhapsody,  who operate as retailers of digital  files,  we serve as a
distributor  of our customers'  content where our customers  retain control over
the retail  function.  This permits each of our  customers to decide on the best
manner in which to promote and sell their particular content to consumers.

         Our efforts to license  content from the major  musical  recording  and
filmed entertainment  companies has been hampered by the litigation  surrounding
our largest  distribution  partner,  Sharman Networks,  over the legality of the
KMD.  In  March  2004,  Brilliant  Digital  Entertainment  and  certain  of  our
subsidiaries  and  executives  were  joined  as  defendants  in  the  Australian
litigation  against  Sharman  Networks.  We have been unable to obtain  download
licenses for music files from the major musical recording companies, even though
these companies have granted licenses to our competitors.  As a consequence,  we
have focused our efforts on other content  providers,  and have  contracted with
numerous companies for the distribution of their downloadable  digital assets on
the Altnet network.  At December 31, 2004, we had contracts,  either directly or
through third party aggregators and  distributors,  to provide download services
to more than 45 independent  music labels,  15 video and film  companies,  60 PC
game  developers and  publishers,  and 60 software  developers  and  publishers,
offering to consumers approximately 25,000 downloadable media files.

CONSUMERS OF ALTNET FILES

         Consumers  of  Altnet  files  are  the  end-users  of our  distribution
partners' web sites and other Internet applications.  We provide these consumers
high-quality, virus-free, licensed media content. We brand our Altnet files with
a gold icon logo next to the file  name,  which  distinguishes  them from  other
digital files.

         We  encourage  consumer  loyalty and repeat  purchases  by offering the
following services:

         o        We provide  large  amounts of relevant  and privacy  protected
                  content on demand from a single search box;

         o        We offer the Altnet Loyalty Points Manager that recognizes the
                  most active users with personalized and exclusive benefits;

         o        We provide  customers with several  secure payment  options to
                  improve convenience; and

         o        We provide reliable customer service and support.


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         We rely on our distribution partners to market our services directly to
their  users.  Therefore,  we do not  incur  significant  direct  marketing  and
customer acquisition costs.

UNDERLYING TECHNOLOGIES

         We utilize the following internally developed and licensed technologies
in our Altnet content distribution business:

         PEERENABLER. PeerEnabler is the underlying peer-to-peer technology that
powers the Altnet content distribution network. PeerEnabler is the software that
enables the  distribution  of a digital file  directly from one computer user to
another. We license PeerEnabler from Joltid Ltd.

         ALTNET DOWNLOAD  MANAGER.  The Altnet Download Manager is an internally
developed, browser plug-in software application that facilitates the download of
an Altnet file to an end user from either a central  server or from  another end
user connected to the Altnet peer-to-peer network. This allows users to download
Altnet files even if they do not have the Altnet peer-to-peer software installed
and running on their computer.  The application  also provides  operators of web
sites and other Internet applications with the following benefits:

         o        a  download  progress  display  that  gives an  improved  user
                  experience when downloading media files, providing an easy way
                  to download  multiple  files and to view the progress of those
                  downloads;

         o        a  brand-able  user  interface  that  improves web site reach,
                  providing   increased  brand  awareness  by  having  customers
                  continue  to see the site's logo long after they may have left
                  the site;  consumers  will  associate  the site's  logo in the
                  Altnet  Download  Manager with the source of the quality media
                  that they are downloading; and

         o        an  optional  plug-in  of  the  Altnet  peer-to-peer   network
                  software  which  provides  for  bandwidth  cost  reduction  by
                  enabling   the  download  of  Altnet  files  from  the  Altnet
                  peer-to-peer network rather than from a central server.

         TRUE NAMES PATENT.  We license the "TrueNames  Patent" (U.S. Patent No.
5,978,791) and all related  intellectual  property from its co-owner,  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.  A unique identifier,
or "file  hash",  is assigned to the file data using an  algorithm in a patented
process.  Networking  applications,  most notably peer-to-peer networks, can use
the file hash to identify files correctly,  eliminating unnecessary redundancies
and allowing the networks to operate more efficiently. The TrueNames Patent also
covers  a  method  of  periodically  synchronizing  information  on  distributed
systems.  We use each of these  processes  in our  Altnet  content  distribution
business.

         ALTNET  LOYALTY  POINTS  MANAGER.  In June  2003,  Altnet  developed  a
platform to provide incentives and reward consumers for sharing licensed digital
content.  The Altnet Loyalty Points Manager is an internally  developed software
application that meters Altnet file uploads and issues Altnet Peer Points, which
compensate  participants  for the use of their computer  resources.  Altnet Peer
Points may be redeemed for prizes or to enter sweepstakes for cash or prizes.

         TOPSEARCH  INDEX AND ALTNET BACK OFFICE.  An integral  component of the
Altnet content distribution system is the TopSearch  distributed index, which is
responsible  for directing an end user's search request to relevant Altnet files
located on another Altnet  network  user's  computer or on an Altnet content web
server.  An Altnet user searches for an Altnet file at a distribution  partner's
web site or Internet  application.  The  TopSearch  index  locates a copy of the
relevant  Altnet file,  and if selected,  the file is  downloaded to that user's
computer. When the user opens the file, the associated digital rights management
(or DRM)  technology  initiates a connection to the Altnet Back Office  database
where the transaction rules for that file, uniquely


                                       6
<PAGE>


associated to that user's computer,  are applied to the transaction.  Within the
Altnet Back Office,  file transaction  rules can be manipulated and monitored in
real time to achieve optimal  performance.  Some file association  rules include
price point, graphics, special offers, subscriptions and other packaging options
including  the use of Altnet  Peer Points to acquire a license to play the media
content.

         PAYMENT  PROCESSING.  Users pay for  Altnet  files  using  our  payment
gateway, a licensed and internally developed  micro-payment  processing software
application  that 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 may 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 card,  pre-paid gift card or private-label debit
card.

COMPETITION FOR ALTNET'S SERVICES

         The market for our  services is new,  rapidly  evolving  and  intensely
competitive.  We expect  competition  in our markets to continue to intensify in
the  future.  While we do not  currently  compete  against  any one entity  with
respect to all aspects of our services, we do compete with various companies and
technologies in regards to specific elements of our services.

         There  are many  peer-to-peer  file  sharing  companies  in  existence,
including Sharman Networks,  iMesh,  Grokster,  eDonkey,  Lime Wire,  Streamcast
Networks and Bear Share. The application  software  necessary to "log onto" each
of these networks 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 of the same
application. The files, which are exchanged amongst users of these applications,
are  typically  provided by the end users free of charge to other  users.  These
public or "free" file  sharing  applications  are very  popular  among  computer
users, and whilst we partner with file-sharing  application  providers,  we also
directly compete with the digital media files made available for free by many of
the users of these file sharing applications.

         Additionally,  there are numerous  companies that offer media files for
sale  from a  central  server.  Over  the  past  two  years,  there  has  been a
significant  increase in the number of companies  offering music files for sale.
We expect that trend to level off in 2005.  Some of the more popular  sites that
make music files available for sale are iTunes,  Napster,  Yahoo! MusicMatch and
RealNetwork's   Rhapsody.   Other  companies  selling  music  downloads  include
BuyMusic.com,  Liquid  Audio,  and  CNET's  MP3.com.  These  businesses  offer a
combination of monthly subscriptions,  payments per download or a combination of
both.  Aside  from the  music  business,  numerous  sites are  available  on the
Internet to users who wish to download movies.  These include  Movielink.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, such as Wal-Mart and
Best Buy, now offer for sale music and movie files online.

         In addition,  Loudeye  Corporation,  Liquid Digital Media and FullAudio
offer content  distribution  systems,  which securely  distribute digital audio,
video,  and data files.  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.

         Further,  the major  recording  labels and movie  studios  utilize  the
services of large scale computer network operators whose primary  businesses are
designed to spoof,  interdict  and track the transfer of files  between users of
the popular file sharing  applications.  In many cases,  these companies plan to
deploy DRM files to users of these applications.  These DRM files would directly
compete with the distribution and sale of Altnet files.


                                       7
<PAGE>


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,  and research and development  necessary to
                  grow the Altnet business;

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

         o        our ability to withstand the financial costs of litigation and
                  the distractions to management arising from these actions.

RESEARCH AND DEVELOPMENT

         In  fiscal  years  2004 and  2003,  we  spent  $473,000  and  $394,000,
respectively, on research and development.

         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 service  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 do not 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; and

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


                                       8
<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.

EMPLOYEES

         At December 31, 2004,  we had 14 full-time  employees,  of which 4 were
engaged  in  research  and   development,   2  in   production,   5  in  general
administration and finance and 3 in sales,  marketing and business  development.
None of our  employees  are covered by a  collective  bargaining  agreement.  We
consider our  relationship  with our employees to be good. We currently  utilize
the services of 6 independent  consultants,  4 in software development,  1 in an
administrative  role  and 1 in  sales  and  marketing  pursuant  to  contractual
relationships.  Seven  employees,  including  the  Vice  President  of  Business
Development are based in Sherman Oaks,  California.  Seven employees,  including
the  Chief  Executive  Officer  and Chief  Technical  Officer  operate  out of a
facility located in Sydney, Australia.

ITEM 2.       DESCRIPTION OF PROPERTIES

         Our  corporate  offices are  located in Sherman  Oaks,  California.  In
October  2004,  we negotiated a one-year  lease,  with annual lease  payments of
approximately $24,000.

         Our research and  development is conducted in Australia,  and our Chief
Executive Officer resides there. In Australia,  we entered into a two-year lease
in February 2003 with annual lease payments of approximately $42,000 and are now
leasing the premises on a month to month basis while we explore the  possibility
of leasing alternative premises.

ITEM 3.       LEGAL PROCEEDINGS

         In March  2004,  in the  Federal  Court of  Australia,  New South Wales
District  Registry,  Brilliant  Digital  Entertainment,  Inc., our  subsidiaries
Altnet  Inc.  and  Brilliant  Digital  Entertainment  Pty.  Limited,  and  Kevin
Bermeister and Anthony Rose, our Chief  Executive  Officer and Chief  Technology
Officer, respectively,  were joined as defendants in the suit by Universal Music
Australia Pty. Ltd. and other record labels against Sharman Networks Limited and
other  defendants,  alleging  infringement of the copyright in sound  recordings
controlled by the  plaintiffs.  The  plaintiffs  allege that due to our business
dealings  with  Sharman  Networks  Limited,  we are  integrally  involved in the
operation  of the Kazaa  Media  Desktop  and  therefore  liable for the  alleged
copyright  infringement  occasioned by its  development  and  distribution.  The
plaintiffs  are seeking  damages  under the  Australian  Copyright  Act of 1968,
recovery of costs and interest,  and a permanent injunction  restraining us from
making  copies of,  communicating  to the public,  or  distributing  their sound
recordings  without a license.  A decision in this matter is expected during the
second quarter of 2005.

         In September  2004,  through our  subsidiary  Altnet,  we filed a civil
lawsuit in the United  States  District  Court  Central  District of  California
against  a number  of  companies  and  organizations,  including  the  Recording
Industry  Association of America,  alleging the breach of the "TrueNames" patent
which we license from  Kinetech,  Inc. In that filing we allege that some of the
defendants  infringe on the patent to "spoof"  peer-to-peer  users with bogus or
corrupted media files,  which inhibits the growth of peer-to-peer for legitimate
file  sharing and thereby has  injured  our  business.  We are seeking  damages,
recovery of costs and  interest,  and an order  barring the  defendants  in this
action from further breach of the "TrueNames" patent.

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

         No matters  were  submitted  to a vote of security  holders  during the
fourth quarter of 2004.


                                       9
<PAGE>


                                     PART II

ITEM 5.       MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

COMMON STOCK

         During 2003,  our common stock  traded on the American  Stock  Exchange
under the symbol "BDE." On February 25, 2004, our common stock ceased trading on
the American Stock Exchange  because we failed to meet the exchange's  continued
listing requirements.  On February 25, 2004, our common stock began to be quoted
on the Over the  Counter  Bulletin  Board  (OTCBB),  with a new stock  symbol of
"BDEI". 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
or the OTCBB:

                                                        HIGH         LOW
                                                      --------    --------
         YEAR ENDED DECEMBER 31, 2004
              First Quarter ...................       $   0.38    $   0.10
              Second Quarter ..................           0.15        0.07
              Third Quarter ...................           0.16        0.09
              Fourth Quarter ..................           0.12        0.04

         YEAR ENDED DECEMBER 31, 2003
              First Quarter ...................       $   0.23    $   0.13
              Second Quarter ..................           0.78        0.15
              Third Quarter ...................           0.67        0.35
              Fourth Quarter ..................           0.69        0.31

         The OTCBB is a regulated  quotation  service  that  displays  real-time
quotes,  last sale  prices and volume  information  in  over-the-counter  equity
securities.  OTCBB  securities  are traded by a community of  registered  market
makers that enter quotes and trade reports through a computer network.

         On March 8,  2005,  the  closing  sales  price of the  Common  Stock as
reported on the OTCBB was $0.06 per share.  As of March 8, 2005,  there were 240
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.

RECENT SALES OF UNREGISTERED SECURITIES

         None.


                                       10
<PAGE>


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

         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, 2004
and December 31, 2003.  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.

OVERVIEW

         Brilliant Digital  Entertainment,  Inc. is a company which, through our
Altnet, Inc.  subsidiary,  operates 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 via the
Internet.  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, with  authorization  from
the copyright  owner,  directly from one computer user (peer) to another (peer).
Our ability to control files  distributed over our private  network,  as well as
our use of widely available digital rights management (or DRM) technologies from
Microsoft Corporation, TryMedia Systems, Softwrap Limited and others prevent the
distribution of unauthorized  files over our network and help to protect against
the  unauthorized  use of a  digital  file  once  it  resides  on an end  user's
computer.  We  commercialize  Altnet by partnering with third party operators of
web sites and other Internet applications to enable users of those web sites and
applications  to search for and download  digital files over the Altnet network.
We also operate a payment  processing  "gateway" that enables  computer users to
purchase content distributed over our network.

         We own 75.5% of the outstanding  capital stock of Altnet and manage all
of its day-to-day operations,  and the remaining 24.5% is owned by Joltid, Ltd.,
the company from whom we license a substantial portion of Altnet's  peer-to-peer
technology.  We increased  our ownership of Altnet from 51% to the present 75.5%
in May 2003,  when we acquired  1,102,500  shares of Altnet's  common stock from
Joltid in exchange for 7,000,000  shares of  Brilliant's  common stock.  We also
issued to Joltid 1,000,000  shares of Brilliant's  common stock as consideration
for an option to purchase Joltid's remaining shares of Altnet. The option, which
expires in May 2005, entitles us to purchase Joltid's remaining 1,102,500 shares
of Altnet common stock in exchange for 7,000,000  shares of  Brilliant's  common
stock. Prior to these  transactions,  we received 51% of the outstanding capital
stock and Joltid,  Ltd.  received 49% of the capital  stock.  Neither  party was
required to make a capital  contribution  in  connection  with the  formation of
Altnet.  At the time of the  transaction,  the only  significant  asset owned by
Altnet was its technology.

         Our revenues are derived principally from marketing services, licensing
and other services, and digital content revenue.

         Marketing   services   revenues   are  derived  from  paid  search  and
advertising services.  Under the terms of our agreement with The Excite Network,
Inc., now owned by Ask Jeeves, Inc., we are paid a non-refundable bounty for the
installation of each Excite My Search toolbar bundled for distribution  with our
Altnet Loyalty Points Manager on an English speaking user's computer, and we are
paid a  percentage  of the  gross  profit  earned  as a result of clicks on paid
search  results by any end users of these  toolbars.  We recently  announced  an
online advertising  revenue-sharing fund that will be split with top independent
labels  including  V-2,  Artemis,   Epitaph/Anti,   Side  One  Dummy  and  Palm,
Simmons/Latham,  and Koch Media., all Altnet music licensors.  These labels will
share the revenue  generated from advertising that appears in the user interface
of popular  Peer to Peer  applications.  The fund will be split  proportionately
based on content  licenses issued whether the music content is offered for sale,
trial or for free.  In exchange for  services  performed by us we will receive a
fee from the fund.

         Licensing and other  services  revenues are derived from our sublicense
of rights to the TruNames patent,  business  development  services,  and payment
processing  services.  Under the terms of our patent  sublicense  agreement with
Sharman Networks,  we recognize sublicense revenue on a monthly basis as earned.
We negotiate with third parties that desire to enter into a business transaction
with Sharman Networks


                                       11
<PAGE>


relating to the Kazaa Media Desktop (or KMD) software application.  We receive a
percentage  of  the  gross  revenue   received  by  Sharman  Networks  for  each
transaction entered into based solely on our efforts. We also generate fees from
processing payments for the purchase of digital content using the Altnet payment
processing  gateway.  In the early part of February 2005, we stopped  processing
payments for Kazaa Plus for which we were receiving a payment processing fee.

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

RECENT DEVELOPMENTS AND KEY FACTORS AFFECTING OUR BUSINESS

         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  and we continue to face numerous  challenges.
In  2004  we  saw  an  increase  in  the  total  number  of  My  Search  toolbar
installations  which, in conjunction  with reporting a full year worth of search
related  revenue  from The Excite  Network,  accounted  for the  majority of our
revenue gains year over year. However,  the number of installations is declining
on a monthly  basis,  as a result of a decline in the  number of KMD users,  and
will likely result in a drop in search related  revenue in 2005. The key factors
affecting  our future  success  include  our  ability to license  large  content
libraries and our ability to expand our  distribution  network to an ever larger
audience for our services.

         Our revenues  increased 55% from $5,655,000 for the year ended December
31, 2003 to  $8,775,000  for the year ended  December 31, 2004.  The increase is
primarily  the result of search  related  and patent  sublicensing  revenue.  We
expect these two components of revenue to comprise a significant  portion of our
total revenues for 2005.  Our agreement with The Excite Network  expires in July
2005. If we are unable to renew our agreement  with The Excite  Network or enter
into a new agreement  with another party,  our search related  revenues for 2005
will be substantially lower than in 2004. Our patent sublicensing agreement with
Sharman  Networks  provides  for a fixed  monthly  fee and  therefore  will  not
fluctuate in 2005.

         We expect to devote a  substantial  portion of our resources in 2005 to
further our efforts in the area of content  licensing.  In 2004, we were able to
successfully  market music, games and other software  applications to consumers,
and we expect to increase the amount of content  available to consumers in 2005.
Our business is dependent upon the successful  licensing of large  entertainment
content  libraries from the independent  and major musical  recording and filmed
entertainment  companies  around the world.  To date, our efforts in this regard
have been  hampered  by the  litigation  surrounding  our  largest  distribution
partner, Sharman Networks, over the legality of the KMD. Despite our efforts, we
have been  unable to obtain  download  licenses  for music  files from the major
musical recording  companies,  even though these companies have granted licenses
to our competitors. Several of these musical recording companies have sued us in
the Federal Court of Australia for activities  relating to our business dealings
with Sharman  Networks.  There can be no assurance  that we will be granted such
licenses at any time in the future.

         In 2004, we saw a significant decrease in the number of active users of
the KMD, and  correspondingly  the number of consumers to whom we can market our
content.  In  addition  to the  distribution  partners  that we  added  in 2003,
including  The  Excite  Network,  Inc.,  developer  of  the My  Search  toolbar,
MetaMachine,  Inc.,  developer  of leading  peer-to-peer  networks  Overnet  and
eDonkey 2000, we also added Grokster,  Ltd.,  developer of leading  peer-to-peer
network Grokster,  during early 2004. These added distribution partners were not
able to offset the  decrease in users to the Altnet  network in 2005 as a result
of the decline in KMD users.


                                       12
<PAGE>


         In March  2004,  in the  Federal  Court of  Australia,  New South Wales
District  Registry,  Brilliant  Digital  Entertainment,  Inc., our  subsidiaries
Altnet  Inc.  and  Brilliant  Digital  Entertainment  Pty.  Limited,  and  Kevin
Bermeister and Anthony Rose, our Chief  Executive  Officer and Chief  Technology
Officer, respectively,  were joined as defendants in the suit by Universal Music
Australia Pty. Ltd. and other record labels against Sharman Networks Limited and
other  defendants,  alleging  infringement of the copyright in sound  recordings
controlled by the  plaintiffs.  The  plaintiffs  allege that due to our business
dealings  with  Sharman  Networks  Limited,  we are  integrally  involved in the
operation  of the Kazaa  Media  Desktop  and  therefore  liable for the  alleged
copyright infringement occasioned by its development and distribution.  While we
believe these claims are without  merit,  if we are unable to have these charges
dismissed,  defending  against these claims could  require a significant  use of
cash during 2004 and  beyond.  A decision in this matter is expected  during the
second quarter of 2005.

         In September  2004,  through our  subsidiary  Altnet,  we filed a civil
lawsuit in the United  States  District  Court  Central  District of  California
against  a number  of  companies  and  organizations,  including  the  Recording
Industry  Association of America,  alleging the breach of the "TrueNames" patent
which we license from  Kinetech,  Inc. In that filing we allege that some of the
defendants  infringe on the patent to "spoof"  peer-to-peer  users with bogus or
corrupted media files,  which inhibits the growth of peer-to-peer for legitimate
file sharing and thereby has injured our business. The defendants in the lawsuit
are  attempting to invalidate  the patent.  If they are  successful,  we will no
longer generate revenues from our sublicense of the "TrueNames" patent.

         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. However, we have suffered recurring operating losses and at December 31,
2004,  had  negative  working  capital of  approximately  $5,449,000  (excluding
non-cash prepaid expense of $2,660,000  related to the issuance of warrants) and
a  stockholders'  deficit  of  approximately  $1,985,000.  These  factors  raise
substantial  doubt  about  our  ability  to  continue  as a  going  concern.  We
anticipate that our current cash reserves,  plus our expected generation of cash
from existing  operations in 2005, may not be sufficient to fund our anticipated
expenditures.  Consequently,  we may require additional equity or debt financing
during  2005,  the amount  and timing of which will  depend in large part on our
spending  program.  The report of our Independent  Registered  Public Accounting
Firm for the  December  31, 2004  financial  statements  include an  explanatory
paragraph expressing  substantial doubt about our ability to continue as a going
concern.

SIGNIFICANT CHALLENGES AND RISKS

         Our future success will depend on our ability to overcome the following
operational challenges:

         o        Our ability to acquire  in-demand content from independent and
                  major musical recording and filmed entertainment companies;

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

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

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

         o        Our ability to either pay or restructure  our secured debt and
                  unsecured trade payables;

         o        Our ability to renew the Excite  agreement on similar terms to
                  the existing agreement; and

         o        Our ability to fund litigation in which Altnet is involved.


                                       13
<PAGE>


         We intend to continue to aggressively  pursue content  acquisition with
both  the  major  and  smaller   independent   musical   recording   and  filmed
entertainment  companies  in order to address our content  needs and to increase
revenue from the distribution of content.

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

         We intend to  continue  our pursuit of  additional  capital to fund our
expansion  efforts and to pay both our secured debt holders and unsecured  trade
creditors. At December 31, 2004, we were indebted to our secured note holders in
the amount of $4,033,000,  and our trade payables,  including  related  parties,
were  $4,024,000.  We are also  working  with both our secured  debt holders and
certain of our unsecured trade  creditors to restructure  amounts owed them into
long-term arrangements.  There can be no assurance that we will be successful in
raising additional capital to pay these obligations,  or in restructuring  these
obligations to avoid a payment default.

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 long-lived asset impairment.  We believe
the following critical accounting policies affect our more significant judgments
and estimates used in preparation of our consolidated financial statements.

         Under  SEC  Staff  Accounting  Bulletin  No.  101 (SAB  104) and  AICPA
Statement  of Position  97-2 (SOP 97-2),  we  recognize  revenue when all of the
following  criteria are met: (1) persuasive  evidence of an arrangement  exists,
(2) delivery has occurred or services have been rendered, (3) the seller's price
to the buyer is fixed or  determinable,  and (4)  collectibility  is  reasonably
assured.  In the case of each of our product and  service  lines we  establish a
contract or insertion order with our customers with specifics for  requirements,
a fixed price, a delivery schedule,  and terms for payment.  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,  2004,  we had a reserve  of  $127,000  to cover a few  customers  from whom
collectibility is uncertain.

         Long-lived  assets and intangible  assets with  determinable  lives are
reviewed for impairment  quarterly or whenever events or circumstances  indicate
that the carrying amounts of assets may not be recoverable in


                                       14
<PAGE>


accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long
Lived  Assets".  We  evaluate  recoverability  of  assets to be held and used by
comparing the carrying amount of an asset to future net undiscounted  cash flows
to be generated by the asset. If such assets are considered to be impaired,  the
impairment  to be  recognized  is measured  as the amount by which the  carrying
amount of the assets  exceeds the fair value of the assets.  Such reviews assess
the fair value of the assets  based upon our  estimates of the future cash flows
we expected  the assets to  generate.  In  response  to changes in industry  and
market conditions,  we may be required to strategically realign our resources in
the future, which could result in an impairment of long lived assets.

RESULTS OF OPERATIONS

         REVENUES.  Revenues  increased 55% from  $5,655,000  for the year ended
December 31, 2003 to $8,775,000 for the year ended  December 31, 2004.  Revenues
by groups of similar service were as follows:

               REVENUES                    2003          2004       NET CHANGE
------------------------------------    ----------    ----------    ----------
Marketing services .................    $2,926,000    $6,218,000           113%
Licensing and other services .......    $1,758,000    $2,068,000            18%
Distribution and technology ........    $  459,000          --            (100%)
revenue from related party
Digital content ....................    $  512,000    $  489,000            (5%)

                                        ----------    ----------    ----------
Total Revenue ......................    $5,655,000    $8,775,000            55%
                                        ==========    ==========    ==========

         Marketing  services  revenue  increased  in  2004  to  $6,218,000  from
$2,926,000 in 2003,  primarily as a result of revenue  earned from our agreement
with The Excite  Network,  Inc. which was entered into in April 2003.  Licensing
and other services  revenues  increased in 2004 to $2,068,000 from $1,758,000 in
2003, due primarily to increased  patent  sublicense  revenue.  Digital  content
revenue  decreased  from $512,000 in 2003 to $489,000 in 2004 as a result of the
decrease  in the sale of digital  content,  primarily  PC games,  over  Altnet's
peer-to-peer  network.  Distribution and technology revenue from a related party
earned  through June 2003 was $459,000,  as we fulfilled all of our  obligations
under our contract with e-New Media Company during 2003.

         Our agreement with The Excite  Network  expires in July 2005. If we are
unable  to renew our  agreement  with The  Excite  Network  or enter  into a new
agreement  with  another  party,  our search  related  revenues for 2005 will be
substantially lower than in 2004.

         COST OF REVENUES. Cost of revenues increased from $755,000 for the year
ended December 31, 2003 to $1,155,000 for the year ended December 31, 2004. This
represents an increase of $400,000, or 53%, which is primarily due to a $683,000
increase in the costs  associated  with the  operation  of our  payment  gateway
services for twelve months during 2004 versus six months during 2003,  offset by
a $231,000  decrease in royalty  payments for licensed  technology and a $52,000
decrease in bandwidth costs.

         SALES  AND  MARKETING.  Sales and  marketing  expenses  decreased  from
$1,211,000 for the year ended December 31, 2003 to $1,190,000 for the year ended
December  31,  2004.  This  decrease  of $21,000 in 2004 was the net result of a
$270,000  decrease on  promotional  costs  associated  with the Altnet  network,
offset by a $249,000 increase in commissions paid for securing new business.

         GENERAL  AND  ADMINISTRATIVE.   General  and  administrative   expenses
primarily  include  salaries  and  benefits  of  management  and  administrative
personnel,  rent,  insurance  costs,  professional  fees  and  non-cash  warrant
expense.  General and administrative  expenses decreased $666,000,  or 11%, from
$6,085,000 for the year ended December 31, 2003 to $5,419,000 for the year ended
December  31,  2004.  This  decrease  is largely  attributable  to a decrease of
$1,147,000 in non-cash  warrant  expense during 2004. As a result of the FAS 144
conducted in 2003,  the value of the deferred  assets  related to our agreements
with Sharman Networks, and Ziffren, Brittenham, Branca, Fischer, Gilbert-Lurie &
Stiffelman (discussed below) were determined to be


                                       15
<PAGE>


impaired and were written off in 2003.  Thus,  during 2004, there was no warrant
amortization expense related to these deferred assets.

         Under  the  terms  of  our  Joint  Enterprise  Agreement  with  Sharman
Networks,  we issued warrants to purchase up to 14,000,000  shares of our common
stock,  par value  $0.001 per share,  at an  exercise  price of $0.61 per share,
expiring in June 2008. The fair value of these  warrants  determined at the date
of grant  was  $2,951,000  based on a  Black-Scholes  model  with the  following
weighted-average  assumptions for 2003:  interest rates of 4.5%;  dividend yield
rates of 0;  volatility  factors of the expected  market price of the  Company's
common stock of 50.0%; and expected life of the warrants. We reflected the total
value of these warrants,  net of amortized warrant expense, as License Rights on
the balance sheet and amortized the license rights over three years, the life of
the  agreement.  We recognized  $574,000 of warrant  expense in 2003 and none in
2004.

         Under the terms of our  Patent  License  Agreement  with  Kinetech,  we
issued to Kinetech  warrants to purchase up to 5,000,000  shares of common stock
(the"  Warrant to Purchase  Common  Stock") at an  exercise  price of $0.001 per
share.  In July 2003,  we modified  the terms of the Warrant to Purchase  Common
Stock with Kinetech, Inc., which accelerated the vesting of the then outstanding
warrants in exchange  for  additional  consulting  services.  As a result of the
accelerated  vesting  and the fact that we now  recognize  revenue  on a monthly
basis from  sub-licensing  the TruNames patent,  we determined that the warrants
granted to Kinetech as  consideration  for the patent rights had a  determinable
value.  The  fair  value  of  the  warrants  was  re-examined  at  the  date  of
modification based on a Black-Scholes  model with the following weighted average
assumptions  for  2003:  interest  rates of  4.5%;  dividend  yield  rates of 0;
volatility  factors of expected market price of our common stock of 50%; and the
expected  life of the  warrants,  or 6 years.  The value of these  warrants  was
determined to be $2,095,631  which is being amortized over the remaining  useful
life of the patent  license  agreement,  or 3 years.  We recorded  $698,000  and
$349,000 of  amortization  expense related to this patent during the years ended
December 31, 2004 and 2003, respectively.

         Under  the  terms  of  our   Representation   Agreement  with  Ziffren,
Brittenham,  Branca, Fischer, Gilbert-Lurie & Stiffelman, a legal consultant, we
issued  warrants to purchase up to  5,000,000  shares of our common  stock at an
exercise price equal to $0.54 per share,  expiring on October 15, 2008. The fair
value of warrants as  examined  at the date of grant was  $1,319,000  based on a
Black-Scholes  model with the following  weighted-average  assumptions for 2003:
interest  rates of 4.5%;  dividend yield rates of 0;  volatility  factors of the
expected market price of our common stock of 50.0%; and the expected life of the
warrants,  or 5 years.  The value of these warrants was being amortized over the
life of the agreement, or 12 months. During the year ended December 31, 2003, we
recorded $550,000 of amortization expense related to this agreement.

         During 2004 we  increased  our efforts to support our Altnet  business,
which  resulted in increases in payroll  expense of $422,000.  In addition legal
expense increased by $331,000.  These were offset by decreases in consulting and
insurance costs.

         In late 2004 and early 2005, we began the process of reducing personnel
in the US office in an attempt to reduce our operating costs.  This included the
termination of three employees, with an additional three employees continuing to
work on a part time  consultancy  basis with reduced hours.  We will continue to
evaluate our needs in this area and expect that additional reductions may occur.

         RESEARCH AND  DEVELOPMENT.  Research and development  expenses  include
salaries and benefits of personnel  conducting research and development relating
to our Internet web site, payment gateway and related information database,  and
the development of the Altnet Peer Points Manager  software  application.  These
costs  increased  from $394,000 for the year ended December 31, 2003 to $473,000
for the year  ended  December  31,  2004.  This  increase  was  related to costs
associated with the ongoing development of the Alnet network.

         DEPRECIATION  AND   AMORTIZATION.   Depreciation   expense  relates  to
depreciation  of property and equipment such as computer  equipment and cabling,
furniture and fixtures and leasehold improvements.  These property and equipment
are depreciated  over their estimated  useful lives (up to five years) using the


                                       16
<PAGE>


straight-line method. In 2003, amortization expense pertains to the amortization
of purchased  technology  related to our acquisition of an additional  ownership
interest in Altnet,  Inc.  from Joltid,  Ltd. , as well as the  amortization  of
license rights associated with agreements signed in previous years. There was no
amortization  expense  during  2004.  Depreciation  expense was $37,000 for both
years ended December 31, 2004 and 2003.

         LOSS  ON  IMPAIRMENT  OF  LONG-LIVED  ASSETS.  An  impairment  loss  is
recognized when the sum of the expected  undiscounted future net cash flows over
the remaining useful life, is less than the carrying amount of the asset.  Prior
to the impairment  evaluation we capitalized  and reflected on our balance sheet
as assets the following;  Purchased  Technology  associated with our purchase of
additional  shares  of our  Altnet  subsidiary  from  Joltid  ,  License  Rights
associated  with the  PeerEnabler  license  from  Joltid,  the Joint  Enterprise
Agreement  signed  with  Sharman  Networks,   and  Deferred   Marketing  Expense
associated with the  Representation  Agreement with Ziffren.  As a result of the
independent  evaluation  of these assets,  we recorded a significant  impairment
charge of $5,709,000 during 2003 as follows:

         License Rights.....................      $ (3,277,000)
         Purchased Technology...............        (1,484,000)
         Deferred Marketing Expense.........          (948,000)
                                                  ------------
            Total...........................      $ (5,709,000)
                                                  ============

         OTHER INCOME AND EXPENSE. Other income and (expense) were as follows:

                                             2003              2004
                                         -----------       -----------
         Other income .............      $ 2,097,000       $    (8,000)
         Interest income ..........           10,000             7,000
         Interest expense .........       (2,687,000)       (5,283,000)
                                         -----------       -----------
            Total .................      $  (580,000)      $(5,284,000)
                                         ===========       ===========

         Other  expense  increased  from a net expense of $580,000  for the year
ended  December  31,  2003 to a net  expense  of  $5,284,000  for the year ended
December 31, 2004.  The increase from 2003 to 2004 of  $4,704,000  was primarily
due to the recognition of $2,097,000 of deferred  revenues,  in 2003,  under the
agreement with e-New Media. As part of this agreement,  we received  advances of
$2,500,000  that we were  recognizing  over six years,  which is the term of the
agreement.  In June 2003, we determined  that we had met all of our  obligations
under the agreement with e-New Media,  and  recognized the remaining  balance of
the deferred  revenue  relating to this agreement as Other Income.  In addition,
there was a  $2,596,000  increase  in  interest  expense  during 2004 due to the
amortization  of  non-cash  warrant  expense  related to the  extensions  of the
secured indebtedness.

LIQUIDITY AND CAPITAL RESOURCES

         As  of  December  31,  2004,  our  cash  and  cash   equivalents   were
approximately $313,000, a decrease of $567,000 as compared to December 31, 2003.
As of December 31, 2004 we had a working capital deficit of $5,449,000.  Prepaid
expense of $2,660,000,  a non-cash  account related to the issuance of warrants,
was excluded in the  computation  of working  capital.  Included in this working
capital deficit are accounts  payable of $2,049,000  which are over 90 days past
due.

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


                                       17
<PAGE>


         CASH FLOW

         Cash flows from operating,  financing and investing  activities for the
twelve months ended  December 31, 2004 and 2003 are  summarized in the following
table:

         ACTIVITY:                              2003            2004
         ------------------------------      ---------       ---------

         Continuing Operations ........      $ 820,000       $(378,000)
         Investing ....................        (86,000)        (40,000)
         Financing ....................        (60,000)       (232,000)

         During the twelve months ended December 31, 2004, we had a net decrease
in cash of $567,000.  The net cash used in operating  activities of $378,000 was
primarily the net result of additional  payments of accounts payable,  offset by
$5,331,000 of non-cash expenses related to the amortization of warrants.

         We expect a  significant  use of cash during the 2005 fiscal year as we
continue  to develop  the  business  opportunity  for  Altnet,  Inc.  We are not
generating  sufficient  cash flow to meet our  monthly  obligations  and pay our
existing current liabilities and secured debt which is due in September 2005. We
are working with our secured debt holders and unsecured creditors to restructure
our obligations, but there can be no guarantee that we will be successful in our
efforts. Consequently, we may require additional equity or debt financing during
2005,  the amount and timing of which will depend in large part on our  spending
program  and  our  success  in  restructuring   our  secured  debt  and  current
liabilities.  Our previous  financings have been  significantly  dilutive to our
stockholders  and if additional  funds are raised through the issuance of equity
securities,  our stockholders may experience  significant  additional  dilution.
Furthermore,  there  can be no  assurance  that  additional  financing  will  be
available  when needed or that if available,  such  financing will include terms
favorable to our  stockholders  or us. If such  financing is not available  when
required or is not  available on acceptable  terms,  we may be unable to pay our
secured  debt holders as their debt  matures in  September  2005,  pay our trade
creditors under our contractual terms with them, develop or enhance our products
and services, take advantage of business opportunities or respond to competitive
pressures,  any of which could have a material  adverse  effect on our business,
financial  condition and results of operations,  and would most likely result in
our having to file for bankruptcy protection under the Bankruptcy Code.

         During 2004, 69% of our revenue and a substantial  majority of our cash
flow was generated under our agreement with The Excite Network, Inc. relating to
its My Search toolbar.  In 2005, we expect the number of installations of the My
Search  toolbar to  continue  to decline  on a monthly  basis,  as a result of a
decline in the number of Kazaa Media Desktop users,  which will likely result in
a drop in search related revenue and resulting cash in 2005.  Additionally,  our
agreement  with The Excite  Network  expires  in July 2005.  If we are unable to
renew  our  agreement  with The  Excite  Network  or enter  into a new  bundling
agreement with another party,  our cash from continuing  operations in 2005 will
be substantially lower than in 2004.

         We have incurred expenses in 2004, and expect this to continue in 2005,
as a result of our filing in September 2004, through our subsidiary Altnet, of a
civil lawsuit in the United States District Court Central District of California
against  a number  of  companies  and  organizations,  including  the  Recording
Industry  Association of America,  alleging the breach of the "TrueNames" patent
which we license from Kinetech, Inc.

         CONTRACTUAL OBLIGATIONS

         The following  summarizes our  contractual  obligations at December 31,
2004 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:


                                       18
<PAGE>


<TABLE>
<CAPTION>
                                                   Payments Due by Period
                              ------------------------------------------------------------------
                                           Less than        1-3           4-5          After
  Contractual Obligations        Total       1 Year        Years         Years        5 Years
                              ----------   ----------   ----------   ------------   ------------
<S>                           <C>          <C>          <C>          <C>            <C>
Secured notes payable .....   $4,033,000   $4,033,000   $     --     $       --     $       --
Minimum royalty payments ..      570,000      360,000      210,000           --             --
Operating lease commitments       25,000       25,000         --             --             --
                              ----------   ----------   ----------   ------------   ------------
Total .....................   $4,628,000   $4,418,000   $  210,000   $       --     $       --
                              ==========   ==========   ==========   ============   ============
</TABLE>

         At December 31, 2004,  we were  indebted to our secured debt holders in
the amount of $4,033,000.  This  indebtedness is convertible by the holders into
our common stock at price $0.07 per share, for a total 57,614,286  shares of our
common stock at December 31, 2004. In connection with this  financing,  the note
holders  received  warrants to purchase  up to  73,787,613  shares of our common
stock at an exercise price of $0.07 per share.

         In  connection  with the  extension of the maturity  date of our senior
secured notes,  we agreed to make the following  payments to the note holders in
repayment  of the  indebtedness:  (i)  $50,000  per month,  plus (ii) 50% of any
quarterly EBITDA in excess of $600,000,  plus (iii) 50% of any increased revenue
received from existing sources of revenue or from new sources of revenue.

RELATED PARTY TRANSACTIONS

         In June 2004, we entered into a Settlement Agreement and Mutual Release
with Big Seven  Entertainment,  LLC, a distributor  of digital  content over the
Altnet network, and Detershan Pty. Ltd. Big Seven is owned by Michael Toibb, the
son of Harris Toibb,  our largest secured  creditor and  stockholder.  Under the
terms of the agreement,  we agreed to acquire from Michael  Toibb,  on or before
the first  anniversary  of the agreement,  all of his ownership  interest in Big
Seven in exchange for the  issuance of 6,666,667  shares of our common stock or,
in lieu of such issuance,  the payment of $0.15 in cash for each such share (for
aggregate  proceeds of  $1,000,000).  Prior to our  acquisition  of Mr.  Toibb's
ownership  interest in Big Seven,  we agreed to operate  Big  Seven's  business,
wherein we are responsible  for all of Big Seven's  liabilities and are entitled
to retain  all of its  revenues.  We also  agreed  to  reimburse  Michael  Toibb
$150,000 in legal and professional  fees and pay him a management fee of $15,000
per month until we consummate our  acquisition  of Big Seven.  We also agreed to
indemnify Mr. Toibb for all losses, damages and expenses that may arise from our
operation  of Big Seven.  As of the date of this Report,  no losses,  damages or
expenses have been incurred in connection with our operation of Big Seven giving
rise to any indemnification obligation to Mr. Toibb.

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

         See Item 12 of this Form 10-KSB -- "Certain  Relationships  and Related
Transactions"  and Note 4 -  "Related  Party  Transactions"  of the notes to the
consolidated   financial   statements   for  further   information   related  to
transactions with related parties.

OFF-BALANCE SHEET ARRANGEMENTS

         At December 31, 2004 and 2003, we did not have any  relationships  with
unconsolidated  entities  or  financial  partnerships,  such as  entities  often
referred to as structured finance or special purpose entities,  which would have
been established for the purpose of facilitating  off-balance sheet arrangements
or other contractually  narrow or limited purposes.  As such, we are not exposed
to any  financing,  liquidity,  market or credit risk that could arise if we had
engaged in such relationships.


                                       19
<PAGE>


NEW ACCOUNTING PRONOUNCEMENTS

         In an effort to expand upon and strengthen existing accounting guidance
that addresses  when a company  should  include in its financial  statements the
assets,  liabilities and activities of another entity, the FASB issued Financial
Interpretation  No. 46,  "Consolidation of Variable Interest Entities" (FIN 46).
Many   variable   interest   entities   have   commonly   been  referred  to  as
special-purpose  entities or  off-balance  sheet  structures,  but the  guidance
applies to a larger  population  of entities.  In general,  a variable  interest
entity is a corporation,  partnership,  trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting
rights or (b) has equity  investors  that do not  provide  sufficient  financial
resources for the entity to support its  activities.  The objective of FIN 46 is
not to restrict the use of variable  interest  entities but to improve financial
reporting by companies involved with variable interest entities.  Until now, one
company  generally has included  another  entity in its  consolidated  financial
statements only if it controlled the entity through voting interests. FIN 46 now
requires  a variable  interest  entity to be  consolidated  by a company if that
company is subject to a majority of the risk of loss from the variable  interest
entity's  activities or entitled to receive a majority of the entity's  residual
returns or both.  To further  assist  financial  statement  users in assessing a
company's  risks,  FIN 46 also  requires  disclosures  about  variable  interest
entities that the company is not required to  consolidate  but in which it has a
significant  variable interest.  The consolidation  requirements of FIN 46 apply
immediately to variable  interest  entities  created after January 31, 2003. The
consolidation  requirements  apply to older entities in the first fiscal year or
interim  period  beginning  after  June  15,  2003.  Certain  of the  disclosure
requirements  apply in all financial  statements  issued after January 31, 2003,
regardless of when the variable  interest  entity was  established.  The Company
does not have any interests in variable interest entities,  and, therefore,  the
adoption of FIN 46 did not have a significant  impact on our financial  position
or results of operations.

         In May 2003,  the FASB  issued SFAS No.  150,  "Accounting  for Certain
Financial Instruments with Characteristics of both Liabilities and Equity" (SFAS
No. 150). This Statement affects the classification,  measurement and disclosure
requirements of the following three types of freestanding financial instruments:
1) manditorily  redeemable shares, which the issuing company is obligated to buy
back with cash or other assets; 2) instruments that do or may require the issuer
to buy back  some of its  shares in  exchange  for cash or other  assets,  which
include put options and forward purchase contracts;  and 3) obligations that can
be settled with shares,  the monetary value of which is fixed, or tied solely or
predominantly to a variable such as a market index, or varies inversely with the
value of the issuers'  shares.  In general,  SFAS No. 150 is  effective  for all
financial instruments entered into or modified after May 31, 2003, and otherwise
was effective at the beginning of the first interim period  beginning after June
15, 2003.  The adoption of SFAS No. 150 did not have an impact on the  Company's
consolidated financial position or disclosures.

         In November  2002,  the FASB issued FASB  Interpretation  (FIN) No. 45,
GUARANTOR'S  ACCOUNTING AND DISCLOSURE  REQUIREMENTS  FOR GUARANTEES,  INCLUDING
INDIRECT  GUARANTEES  OF  INDEBTEDNESS  OF OTHERS.  FIN No. 45 elaborates on the
existing disclosure requirements for most guarantees,  including loan guarantees
such as standby letters of credit.  It also clarifies that at the time a company
issues a guarantee, the company must recognize an initial liability for the fair
value,  or market value,  of the obligations it assumes under that guarantee and
must disclose that information in its interim and annual  financial  statements.
The  adoption of FIN No. 45 did not have any  material  effect on the  Company's
consolidated financial position, results of operations or liquidity.

         In  December  2002,  the FASB  issued  SFAS  No.  148,  ACCOUNTING  FOR
STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE. This Statement amends SFAS
No. 123,  ACCOUNTING FOR STOCK BASED COMPENSATION 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  Statement  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.  The provisions of SFAS No. 148 had no material effect
on the Company's consolidated financial position or results of operation for the
year ended December 31, 2004.

         In December 2004,  the FASB issued SFAS No. 123  (revised),  ACCOUNTING
FOR STOCK BASED COMPENSATION, which supersedes Accounting Principles Board (APB)
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES,


                                       20
<PAGE>


and its related implementation guidance. This Statement requires a public entity
to measure the cost of employee  services  received in exchange  for an award of
equity instruments based on the grant date fair value of the award (with limited
exceptions);  the fair value of that award will be  remeasured  subsequently  at
each reporting date through the settlement  date. This Statement is effective as
of the  beginning of the first  interim or annual  reporting  period that begins
after  December  15, 2005 for small  business  issuers.  The  Company  currently
applies  APB  Opinion  No. 25 in  accounting  for its stock  based  compensation
(options).  We are  currently  evaluating  what  effects  the  adoption  of this
pronouncement will have on our results of operations and financial position.

CAUTIONARY STATEMENTS AND RISK FACTORS

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

RISKS RELATED TO OUR COMMON STOCK

         THERE IS DOUBT ABOUT OUR ABILITY TO  CONTINUE  AS A GOING  CONCERN.  We
currently  have a number  of  obligations  that we are  unable  to meet  without
generating  additional  revenues  or raising  additional  capital.  If we cannot
generate  additional revenues or raise additional capital in the near future, we
may  become   insolvent.   As  of  December  31,  2004,  our  cash  balance  was
approximately  $313,000  and we had a working  capital  deficit  of  $5,449,000,
excluding a non-cash  prepaid  expense,  related to the  issuance  of  warrants.
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 realized a comprehensive
loss of  $4,701,000  for the  twelve  months  ended  December  31,  2004.  Since
inception, we have incurred significant losses and negative cash flow, and as of
December 31, 2004 we had an accumulated  deficit of  $75,200,000.  We anticipate
that we will continue to generate operating losses for the foreseeable future as
we fund  operating  and capital  expenditures  in the areas of brand  promotion,
sales  and  marketing,   administration,   and  research  and  development,  all
principally  related to the development of our Altnet  peer-to-peer  network and
operating  infrastructure.  Additionally,  as of the  date of this  report,  our
current liabilities significantly exceed our current assets.

         Our business model assumes that our growth and substantially all of our
future  revenues will be derived from our Altnet  peer-to-peer  business,  which
only became  operational in the fourth  quarter of 2002.  This business model is
not yet  proven  and we cannot  make  assurances  that we will ever  achieve  or
sustain  profitability  or that our  operating  losses will not  increase in the
future or be inconsistent with the expectations of the public market.  Primarily
as a result of our continued losses, our independent public accountants included
an explanatory  paragraph in their opinion on our financial  statements  wherein
they  expressed  substantial  doubt  about our  ability to  continue  as a going
concern.

         WE HAVE A  SUBSTANTIAL  NUMBER  OF  OUTSTANDING  DERIVATIVE  SECURITIES
WHICH,  IF EXERCISED OR CONVERTED INTO COMMON STOCK,  WILL RESULT IN SUBSTANTIAL
DILUTION TO OUR STOCKHOLDERS

         At December 31, 2004, we had  outstanding  $4,033,000 of senior secured
indebtedness  which is evidenced by convertible  promissory  notes due September
26, 2005,  which  indebtedness is convertible by the note holders into shares of
our common stock at a price of $0.07 per share. The conversion of the


                                       21
<PAGE>


promissory  notes would increase the number of shares  outstanding and result in
dilution to our other stockholders.

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

         The table  below sets  forth the  number of shares of our common  stock
that could be acquired by the holders upon  conversion of the  principal  amount
and accrued interest of promissory notes, and the percentages of our outstanding
common stock that the shares issued upon conversion would represent. The amounts
assume  conversion on the maturity date of the promissory notes on September 26,
2005, and include all interest that would accrue on the entire  principal amount
of the promissory notes through such date. The share amounts and percentages are
based on our  closing  share  price of $0.06 on March 29,  2005,  and on assumed
closing share prices of $0.045,  $0.03 and $0.015, which prices represent a 25%,
50% and 75% decline,  respectively,  in our March 29, 2005 closing  share price.
The table assumes that we would issue additional securities at these prices, and
thus trigger the price  adjustment  provisions of the notes. The percentages are
also based on  42,857,153  shares of our common stock  outstanding  on March 29,
2005.

PERCENTAGE DECLINE IN                                              PERCENTAGE OF
   MARCH 29, 2005              ASSUMED            SHARES OF          OUTSTANDING
    CLOSING PRICE           CLOSING PRICE       COMMON STOCK       COMMON STOCK
---------------------       -------------       ------------       -------------
         --                     $0.06             71,298,955            62.5%
         25%                    $0.045            95,065,274            68.9%
         50%                    $0.03            142,597,911            76.9%
         75%                    $0.015           285,195,821            86.9%

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

         The following  table  illustrates  as of March 29, 2005,  the number of
shares  issued and  outstanding  as, as well as the number of shares that may be
issued  in  the  future  upon  conversion  of  outstanding  secured  convertible
promissory notes and exercise of outstanding options and warrants:

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

Outstanding Common Stock....................        42,857,153       33.2%
Secured Convertible Promissory Notes,
  with accrued interest.....................        61,113,390       47.3%
Outstanding Warrants(1).....................              --           --
Outstanding Options.........................        25,142,976       19.5%
                                                  ------------    -------------
  Fully Diluted Shares of Common Stock(2)...       129,113,519        100%
----------
(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


                                       22
<PAGE>


         based on the closing  sales  price of our common  stock on the Over the
         Counter Bulletin Board on March 29, 2005, which was $0.06.
(2)      This number  excludes (i) 8,305,799  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 29, 2005, and (ii)
         112,736,145  shares  underlying  warrants  that  have  exercise  prices
         ranging from $0.07 to $0.6096 per share, and thus not "in-the-money."

         The following  table  illustrates  as of March 29, 2005,  the number of
shares  issued  and  outstanding,  as well as the  number of shares  that may be
issued in the future upon conversion of outstanding convertible promissory notes
and exercise of outstanding options and warrants. For the purposes of this table
we have included all warrants  whether they are  "in-the-money"  or not, and the
number of shares of common stock  underlying the  outstanding  warrants has been
calculated on a "paid-for"  exercise  basis,  whereby the holder of each warrant
receives upon exercise a number of shares of common stock equal to the number of
warrants held:

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

Outstanding Common Stock....................        42,857,153         17.7%
Secured Convertible Promissory Notes,
  with accrued interest.....................        61,113,390         25.3%
Outstanding Warrants........................       112,736,145         46.6%
Outstanding Options.........................        25,142,976         10.4%
                                                  ------------    --------------
  Fully Diluted Shares of Common Stock......       241,849,664        100.0%

         IF WE  BECOME  INSOLVENT,  WE  WILL BE IN  DEFAULT  UNDER  OUR  SECURED
CONVERTIBLE  PROMISSORY  NOTES,  WHICH  COULD  RESULT IN OUR  OBLIGATION  TO PAY
IMMEDIATELY ALL AMOUNTS THEN OUTSTANDING UNDER THE NOTES. If we generally do not
pay, or become  unable to pay, our debts as such debts become due, we will be in
default  under  our  outstanding  Secured  Convertible  Promissory  Notes,  with
aggregate  principal and accrued interest and fees of $4,033,000 at December 31,
2004.  If a default  occurs,  all amounts owed to the holders of the notes would
immediately become due and payable. If we are not able to repay the indebtedness
when due,  the holders of the notes will be  entitled  to exercise  all of their
rights and remedies,  including  foreclosure  on all of our assets we pledged as
collateral to secure repayment of the debt.

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

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

         o        variations in quarterly operating results;

         o        the gain or loss of significant contracts;


                                       23
<PAGE>


         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;

         o        short sales and hedging of our common stock; and

         o        adverse legal rulings.

         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 of 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        our  ability  to operate  and  expand our Altnet  peer-to-peer
                  business;

         o        our ability to fund our legal fees; and

         o        our ability to renew our Excite agreement on favorable terms.

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

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

         WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE OF OUR  COMMON  STOCK.  Our  ability  to issue up to  1,000,000  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


                                       24
<PAGE>


premium to its market  price.  Our Board of Directors  can issue up to 1,000,000
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 existing 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

         WE DERIVE A SUBSTANTIAL  AMOUNT OF OUR REVENUE FROM OUR AGREEMENT  WITH
THE EXCITE NETWORK,  INC.,  WHICH AGREEMENT  EXPIRES IN JULY 2005. Our Strategic
Alliance,  Marketing and  Distribution  Agreement with The Excite Network,  Inc.
expires in July 2005. We recognized  installation  bounties and search  revenues
related to this agreement,  totaling $6,076,000 and $2,466,000 in 2004 and 2003,
respectively,  representing  69%  and  44% of our  total  revenues  during  such
periods.  If we are unable to renew our  agreement  with The  Excite  Network or
enter into a new  agreement  with another party upon  substantially  the same or
better  terms,  our  revenues  and cash flows from  operations  for 2005 will be
substantially lower than in 2004.

         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 and sale of our customers' digital content
to millions of users.  Our ability to  commercialize  Altnet  could be 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 material  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,  we receive compensation for the sale of advertising campaigns and
other revenue received by Sharman Networks,  as a result of our efforts. We also
receive a monthly  license  fee from  Sharman  networks in  connection  with our
sub-licensing  of the  TrueNames  patent  to  them.  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.


                                       25
<PAGE>


         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 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  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 adversely  impact (1) the future  distribution of our Altnet
software,  and (2) Altnet's  sale of  authorized  digital  files to users of the
Kazaa Media Desktop. For the twelve months ended December 31, 2003, we generated
approximately  90.9% of our total  revenues from  activities  dependent upon the
availability  of the  Kazaa  Media  Desktop.  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,
currently are the subject of multiple  lawsuits,  including  METRO-GOLDWYN-MAYER
STUDIOS,  INC.  ET. AL. V.  GROKSTER  LTD. ET. AL.,  filed in the United  States
District  Court for the Central  District of  California  (Western  Division) by
twenty-eight  entertainment  companies  claiming that,  among other things,  the
Kazaa  Media  Desktop  facilitates,  contributes  to  and  encourages  copyright
infringement. 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 are  unable to  determine  at this time  whether
Sharman Networks will prevail.

         WE HAVE  BEEN  SUED IN  AUSTRALIAN  FEDERAL  COURT AS A  RESULT  OF OUR
BUSINESS DEALINGS WITH SHARMAN NETWORKS  LIMITED.  In March 2004, in the Federal
Court of  Australia,  New  South  Wales  District  Registry,  Brilliant  Digital
Entertainment,   Inc.,  our  subsidiaries  Altnet  Inc.  and  Brilliant  Digital
Entertainment  Pty.  Limited,  and Kevin  Bermeister and Anthony Rose, our Chief
Executive  Officer and Chief Technology  Officer,  respectively,  were joined as
defendants in the suit by Universal  Music  Australia Pty. Ltd. and other record
labels  against  Sharman  Networks  Limited  and  other   defendants,   alleging
infringement of the copyright in sound recordings  controlled by the plaintiffs.
The plaintiffs  allege that due to our business  dealings with Sharman  Networks
Limited,  we are integrally involved in the operation of the Kazaa Media Desktop
and therefore liable for the alleged  copyright  infringement  occasioned by its
development  and  distribution.  The  plaintiffs  are seeking  damages under the
Australian  Copyright  Act of  1968,  recovery  of  costs  and  interest,  and a
permanent injunction  restraining us from making copies of, communicating to the
public,  or  distributing  their sound  recordings  without a license.  While we
believe these claims are without  merit,  if we are unable to have these charges
dismissed,  defending  against  these  claims  would be  costly,  and an adverse
outcome may result in significant  monetary damages or injunctive relief against
us, all of which would have a material adverse impact on our financial  position
and results of  operations.  A decision  in this  matter is expected  during the
second quarter of 2005.

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


                                       26
<PAGE>


ITEM 7.       FINANCIAL STATEMENTS

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                            PAGE
                                                                            ----

CONSOLIDATED FINANCIAL STATEMENTS OF BRILLIANT DIGITAL ENTERTAINMENT, INC.

Report of Independent Registered Public Accounting Firm..................     28

Report of Independent Registered Public Accounting Firm..................     29

Consolidated Balance Sheet as of December 31, 2004.......................     30

Consolidated Statements of Operations and Comprehensive Loss
    for the years ended December 31, 2003 and 2004.......................     31

Consolidated Statements of Stockholders' Deficit
    for the years ended December 31, 2003 and 2004.......................     32

Consolidated Statements of Cash Flows
    for the years ended December 31, 2003 and 2004.......................     33

Notes to Consolidated Financial Statements...............................     34


                                       27
<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and
Stockholders of Brilliant Digital Entertainment, Inc.
Sherman Oaks, California


         We  have  audited  the  accompanying   consolidated  balance  sheet  of
Brilliant  Digital  Entertainment,  Inc. as of December 31, 2004 and the related
consolidated  statements of operations  and  comprehensive  loss,  stockholders'
deficit,  and cash flows for the year then ended. 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 audit.

         We conducted our audit in  accordance  with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain  reasonable  assurance about whether the
financial  statements  are free of  material  misstatement.  The  Company is not
required  to have,  nor were we engaged  to  perform,  an audit of its  internal
control over financial reporting.  Our audit included  consideration of internal
control over financial  reporting as a basis for designing audit procedures that
are appropriate in the  circumstances,  but not for the purpose of expressing an
opinion on the  effectiveness  of the Company's  internal control over financial
reporting. Accordingly, we express no such opinion. 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 audit provides 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,  2004  and the  results  of its
operations  and its cash  flows  for the year then  ended,  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  shown  in the  financial
statements,  the Company incurred  comprehensive loss of $4,701,000 for the year
ended  December  31, 2004 and at this date,  the  Company had a working  capital
deficiency  of  $5,449,000  (excluding  noncash  prepaid  interest of $2,660,000
related to the issuance of  warrants)and  stockholders'  deficit of  $1,985,000.
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
described in Note 1 to the consolidated  financial statements.  The consolidated
financial  statements do not include any adjustments  that might result from the
outcome of this uncertainty.


/s/ Vasquez & Company LLP
-------------------------

Los Angeles, California
February 18, 2005


                                       28
<PAGE>


         REPORT OF INDEPENDENT  REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and
Stockholders of Brilliant Digital Entertainment, Inc.
Sherman Oaks, California


         We  have  audited  the   consolidated   statements  of  operations  and
comprehensive loss,  stockholders'  deficit, and cash flows of Brilliant Digital
Entertainment,  Inc. (the "Company") for the year ended December 31, 2003. 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 audit.

         We conducted our audit in  accordance  with the standards of the Public
Company Accounting Oversight Board (United States). 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
audit provides a reasonable basis for our opinion.

         In our opinion, the consolidated financial statements referred to above
present  fairly,  in  all  material  respects,  the  results  of  the  Company's
operations  and its  cash  flows  for the  year  ended  December  31,  2003,  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, at
December  31, 2003 to the  consolidated  financial  statements,  the Company has
suffered recurring losses from operations and 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
February 27, 2004


                                       29
<PAGE>


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

                                                                    DECEMBER 31,
                                                                       2004
                                                                   ------------
ASSETS
Current assets:
     Cash and cash equivalents ..............................      $        313
     Restricted cash ........................................                75
     Accounts receivable, net of allowance for doubtful
         accounts of $127 ...................................             1,920
     Prepaid interest .......................................             2,660
     Other assets, net ......................................               122
                                                                   ------------
Total current assets ........................................             5,090
Property and equipment, net .................................               108
License rights ..............................................             1,048
                                                                   ------------
Total assets ................................................      $      6,246
                                                                   ============

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
     Accounts payable .......................................      $        639
     Accrued expenses related parties .......................             2,159
     Accrued expenses .......................................               656
     Guaranteed Minimum Payments, related party .............               360
     Deferred revenue .......................................                32
     Capital financing, including accrued interest ..........             4,033
                                                                   ------------
Total current liabilities ...................................             7,879
Guaranteed Minimum Payments, related party ..................               210
Other long-term liabilities .................................               142
                                                                   ------------
Total liabilities ...........................................             8,231
Commitments and contingencies ...............................              --
Stockholders' deficit:

     Preferred Stock ($0.001 par value; 1,000,000 shares
         authorized; no shares issued or outstanding) .......              --
     Common Stock ($0.001 par value; 350,000,000 shares
         authorized; 41,916,610 shares issued and
         outstanding) .......................................                47
     Additional paid-in capital .............................            73,125
     Accumulated deficit ....................................           (75,228)
     Unrealized gain on marketable securities and
         foreign exchange transactions ......................                71
                                                                   ------------
Total stockholders' deficit .................................            (1,985)
                                                                   ------------
Total liabilities and stockholders' deficit .................      $      6,246
                                                                   ============

                 See Notes to Consolidated Financial Statements


                                       30
<PAGE>


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

                                                               YEAR ENDED
                                                              DECEMBER 31,
                                                          ---------------------
                                                            2003         2004
                                                          --------     --------
Revenues:
   Marketing services ................................    $  2,926     $  6,218
   Licensing and other services ......................       1,758        2,068
   Distribution and technology from related party ....         459         --
   Digital content ...................................         512          489
                                                          --------     --------
       Total revenues ................................       5,655        8,775

Costs and expenses:
   Costs of revenues .................................         755        1,155
   Sales and marketing ...............................       1,211        1,190
   General and administrative ........................       6,085        5,419
   Research and development ..........................         394          473
   Depreciation and amortization .....................         439           38
   Loss on impairment of long lived assets ...........       5,709         --
                                                          --------     --------
       Total operating expenses ......................      14,593        8,275
                                                          --------     --------
Income (loss) from operations ........................      (8,938)         500
Other income (expense):
   Other income ......................................       2,097           (8)
   Interest income ...................................          10            7
   Interest expense ..................................      (2,687)      (5,283)
                                                          --------     --------
       Total other income (expense) ..................        (580)      (5,284)
                                                          --------     --------
Loss from continuing operations ......................      (9,518)      (4,784)

                                                          --------     --------
Net loss .............................................      (9,518)      (4,784)
Other comprehensive income (loss):
    Unrealized gain from marketable securities .......          33         --
    Foreign currency translation adjustment ..........         (32)          83
                                                          --------     --------
Comprehensive loss ...................................    $ (9,517)    $ (4,701)
                                                          ========     ========

Basic and diluted continuing operations ..............    $  (0.26)    $  (0.13)
Basic and diluted net loss per share .................    $  (0.26)    $  (0.13)
                                                          --------     --------

Weighted average number of shares used in
     computing basic and diluted net loss
     per share .......................................      37,218       38,057
                                                          ========     ========

                 See Notes to Consolidated Financial Statements


                                       31
<PAGE>


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

<CAPTION>
                                                                                           UNREALIZED
                                                                                            GAIN ON
                                                                                           MARKETABLE
                                            COMMON STOCK                                   SECURITIES
                                      -----------------------   ADDITIONAL                AND FOREIGN
                                        NO. OF                   PAID-IN     ACCUMULATED    EXCHANGE
                                        SHARES       AMOUNT      CAPITAL       DEFICIT    TRANSACTIONS      TOTAL
                                      ----------   ----------   ----------   ----------    ----------    ----------
<S>                                   <C>          <C>          <C>          <C>           <C>           <C>
BALANCE AT DECEMBER 31, 2002 ......   32,114,978   $       32   $   55,231   $  (60,926)   $      (13)   $   (5,676)
    Issuance of warrants for
    services ......................        1,583         --          1,583
    Exercise of warrants for
    common stock ..................      477,132         --           --           --            --            --
    Issuance of warrants for
       patent right ...............         --           --          5,046         --            --           5,046
    Issuance of common stock for
    investment in subsidiary ......    7,000,000           12        1,470         --            --           1,482
    Issuance of common stock for
    rights to purchase remaining
    shares of subsidiary ..........    1,000,000            2          210         --            --             212
    Warrants issued in conjunction
    with debt .....................         --           --            924         --            --             924
    Conversion of deferred
    compensation ..................         --           --          1,143         --            --           1,143
    Stock option exercise .........    1,218,500            1          208         --            --             209
    Unrealized gain on marketable
    securities ....................         --           --           --           --              33            33
    Foreign exchange translation ..         --           --           --           --             (32)          (32)
    Net loss ......................         --           --           --         (9,518)         --          (9,518)
                                      ----------   ----------   ----------   ----------    ----------    ----------
BALANCE AT DECEMBER 31, 2003 ......   41,810,610           47       65,815      (70,444)          (12)       (4,594)
                                                                                                         ----------
    Warrants issued in
    conjunction with debt .........         --           --          7,291         --            --           7,291
    Stock option exercise .........      106,000         --             19         --            --              19
    Foreign exchange translation ..         --           --           --           --              83            83
     Net loss .....................         --           --           --         (4,784)         --          (4,784)

BALANCE AT DECEMBER 31, 2004 ......   41,916,610   $       47   $   73,125   $  (75,228)   $       71    $   (1,985)
</TABLE>

                 See Notes to Consolidated Financial Statements


                                       32
<PAGE>


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

                                                                 YEAR ENDED
                                                                DECEMBER 31,
                                                             ------------------
                                                               2003       2004
                                                             -------    -------
OPERATING ACTIVITIES
Net loss .................................................   $(9,518)   $(4,784)
Adjustments to reconcile net loss to net cash
    used in operating activities:
      Depreciation and other amortization ................       439         37
      Accrued interest expense on convertible debt
        and capital financing ............................     2,350        251
      Warrant amortization related to agreements .........       864       --
      Warrant amortization related to promissory notes ...       356       --
      Warrant amortization related to purchase of
        license rights ...................................       923        699
      Amortization of prepaid interest ...................      --        4,632
      Impairment loss on long lived assets ...............     5,709       --

      Changes in operating assets and liabilities:
        Accounts receivable ..............................    (1,518)       202
        Other assets .....................................       131        265
        Accounts payable and accruals ....................     3,586     (1,365)
        Deferred revenue .................................    (2,412)      (111)
        Notes receivable .................................      (126)       126
        Other long-term liabilities ......................        36       (330)
                                                             -------    -------
Net cash provided by (used in) continuing activities .....       820       (378)
                                                             -------    -------
Net cash provided by (used in) operating activities ......       820       (378)

INVESTING ACTIVITIES
Purchases of equipment ...................................       (86)       (40)
                                                             -------    -------
Net cash used in investing activities ....................       (86)       (40)

FINANCING ACTIVITIES
Proceeds from issuance of shares .........................        15         18
Restricted cash ..........................................       (75)      --
Proceeds from capital financing ..........................      --         --
Repayments of notes ......................................      --         (250)
                                                             -------    -------
Net cash (used in) financing activities ..................       (60)      (232)
NET INCREASE(DECREASE) IN CASH AND
    CASH EQUIVALENTS .....................................       674       (650)

Translation adjustments ..................................       (30)        83
Cash and cash equivalents at beginning of period .........       236        880
                                                             -------    -------
Cash and cash equivalents at end of period ...............   $   880    $   313
                                                             -------    -------

Supplemental  disclosure of cash flow  information:
    Cash paid during the period for:
      Interest ...........................................   $    10    $    50
                                                             -------    -------

                 See Notes to Consolidated Financial Statements


                                       33
<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2004

         Certain  items in the prior year have been  reclassified  to follow the
Company's current reporting practices.  Additionally,  all intercompany activity
has been eliminated.

1.       DESCRIPTION OF BUSINESS

         Brilliant Digital  Entertainment,  Inc. is a company which, through the
Altnet, Inc.  subsidiary,  operates a  peer-to-peer-based  content  distribution
network  which allows  Altnet to securely and  efficiently  distribute a content
owner's music, video, software and other digital files to computer users via the
Internet.  Using internally developed and licensed  technology,  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, with  authorization  from
the copyright  owner,  directly from one computer user (peer) to another (peer).
The Company's  ability to control which files are  distributed  over its private
network,  as well as its use of widely available  digital rights  management (or
DRM) technologies from Microsoft Corporation, TryMedia Systems, Softwrap Limited
and others prevent the  distribution  of  unauthorized  files over the Company's
network and help to protect against the  unauthorized use of a digital file 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 search for and download  digital files over the Altnet network.
Brilliant also operates a payment processing gateway that enables computer users
to purchase content distributed over the Altnet network.

         The Company owns 75.5% of the  outstanding  capital stock of Altnet and
manages all of its day-to-day  operations,  and the remaining  24.5% is owned by
Joltid,  Ltd., the company from whom Altnet license a substantial portion of the
Company's peer-to-peer technology. The Company increased its ownership of Altnet
from 51% to the present 75.5% in May 2003, when the Company  acquired  1,102,500
shares of Altnet's common stock from Joltid in exchange for 7,000,000  shares of
Brilliant's  common stock. The Company also issued to Joltid 1,000,000 shares of
Brilliant's  common stock as  consideration  for an option to purchase  Joltid's
remaining shares of Altnet. The option,  which expires in May 2005, entitles the
Company to purchase Joltid's  remaining  1,102,500 shares of Altnet common stock
in exchange for 7,000,000  shares of  Brilliant's  common stock.  Prior to these
transactions,  we received 51% of the outstanding capital stock and Joltid, Ltd.
received 49% of the capital stock.  Neither party was required to make a capital
contribution  in  connection  with the  formation of Altnet.  At the time of the
transaction, the only significant asset owned by Altnet was its technology.

         The Company is a Delaware  corporation  that was  incorporated  in July
1996.  The  Company  was  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.

BASIS OF PRESENTATION, RISKS AND GOING CONCERN UNCERTAINTY

         The  discussion and analysis of the Company's  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 of America.  The  preparation  of these  financial
statements  requires the Company to make estimates and judgments that affect the
reported  amounts of assets,  liabilities,  revenues and  expenses,  and related
disclosure of  contingent  assets and  liabilities.  On an on-going  basis,  the
Company  evaluates its  estimates,  including  those related to reserves for bad
debts and those related to the possible  impairment of  long-lived  assets.  The
Company  bases its  estimates  on  historical  experience  and on various  other
assumptions  that are believed to be  reasonable  under the  circumstances,  the
results of which


                                       34
<PAGE>


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

                                DECEMBER 31, 2004

form the basis for  making  judgments  about the  carrying  value of assets  and
liabilities that are not readily apparent from other sources. Actual results may
differ from these  estimates  under  different  assumptions or  conditions.  The
Company's use of estimates,  however, is quite limited, and it has adequate time
to process and record actual results from operations.

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

         The accompanying  consolidated  financial statements have been prepared
assuming that the Company will continue as a going concern,  which  contemplates
the  realization  of assets and the  satisfaction  of  liabilities in the normal
course of business.  The carrying amounts of assets and liabilities presented in
the financial  statements  do not purport to represent  realizable or settlement
values.  However,  the Company has suffered  recurring  operating  losses and at
December 31, 2004,  have negative  working capital of  approximately  $5,449,000
(excluding  noncash  prepaid  interest of $2,660,000  related to the issuance of
warrants)and a stockholders' deficit of approximately $1,985,000.  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.

REVENUE RECOGNITION

         Under SEC Staff  Accounting  Bulletin  No. 104,  generally  the Company
recognizes  revenue when all of the following  criteria are met: (1)  persuasive
evidence of an  arrangement  exists,  (2) delivery has occurred or services have
been rendered, (3) the seller's price to the buyer is fixed or determinable, and
(4) collectibility is reasonably assured. In the case of each of 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 regularly  evaluates the collectibility of its receivables
based on a combination of factors.  When a customer's  account becomes past due,
it initiates a dialogue with the customer to determine the cause. If the Company
determines  that the customer will be unable to meet its financial  obligations,
due to a bankruptcy filing,  deterioration in the operating results or financial
position or other material events impacting its business,  the Company records a
specific reserve for bad debt to reduce the related  receivable to the amount it
expects to recover given all information  presently available.  If circumstances
related  to  specific   customers   change,   the  Company's   estimate  of  the
recoverability of receivables could materially change. The Company does not have
material  exposure to any single customer or group of customers at this time. At
December  31,  2004,  the  Company  had a  reserve  of  $127,000  to cover a few
customers from whom collectibility is uncertain.


                                       35
<PAGE>


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

                                DECEMBER 31, 2004

         The Company's revenues are derived principally from marketing services,
licensing and other services,  digital content revenue,  and the amortization of
non-refundable  advances  related to the  software  licensing  and  distribution
agreement with e-New Media.

         Marketing   services   revenues   are  derived  from  paid  search  and
advertising  agreements.  Under the terms of the  Company's  agreement  with The
Excite Network, the Company is paid a non-refundable bounty for the installation
of an Excite My Search toolbar on an English speaking user's  computer,  and the
Company is paid a percentage of the gross profit earned as a result of clicks on
paid search  results by any end users of the  toolbar.  The  Company  recognizes
revenue as  installations  are  recorded,  and as the gross profit share of paid
searches  is  reported.  The  Company  derives  advertising  revenue  by selling
advertising  inventory on behalf of Sharman  Networks  Limited in exchange for a
percentage of revenue therefrom. Sharman's clients pay a fee based on a cost per
thousand impressions (CPM) or specified conversions delivered (CPA). The Company
recognizes revenue when the impressions are made or conversions are delivered.

         Licensing   and  other   services   revenues   are  derived   from  the
sub-licensing of the TruNames patent, business development services, and payment
processing  services.  Under  the  terms  of  the  Company's  Patent  Sublicense
Agreement,  the Company recognizes  sublicense  payments as revenue on a monthly
basis as earned.  The  Company  generates  fee income  for  performing  business
development  services  for  Sharman  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 solely 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 amortized over the life
of the contract or as earned.  Revenue share fees are recognized as earned.  The
Company charges fees to Sharman  Networks as a percentage of gross sales for the
use of  Altnet's  payment  processing  gateway on the sale of  certain  software
applications.  The Company recognizes this as revenue when the end user pays for
the software application.

         Digital  content  revenues  are  derived  from the Altnet  peer-to-peer
business by processing digital media content (music, PC 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.  The Company may charge
clients a processing fee to prepare content for distribution on the network. The
amount of this fee varies  based on the number of files,  the size of the files,
digital encoding costs, and the preparation of collateral  marketing  materials,
such as artwork.  These fees are recognized as the services are  performed.  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.  These fees are  recognized as the download  delivery  levels are
achieved.  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, or (b) a combination of revenue share and a cost per
specified  number  of  downloaded  files  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.

         In the case of the Company's  software  licensing  agreement with e-New
Media,  e-New Media paid the Company a non-refundable  advance for rights to the
Company's  b3d  toolset to produce  its own  Multipath  Movies and to resell the
toolset within specified  territories.  The Company was recognizing this advance
as revenue on a  straight-line  basis over the five-year  term of the agreement.
During the second quarter of 2003, the Company  determined that it had satisfied
all its obligations under the terms of this agreement, given the fact that 1) by
early 2002 the Company had delivered all of the  entertainment  content to e-New
Media,  as required  under the terms of the  Distribution  Agreement  and 2) the
Company had provided the necessary


                                       36
<PAGE>


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

                                DECEMBER 31, 2004

seat  license  and  alpha-code  version of the  animation  software  tool set as
required under the terms of the Technology  License  Agreement.  As a result the
Company  reflected  the  remaining  unamortized  advance of  $2,097,000 as other
income in the Operating  Statement.  Amortized amounts in the first half of 2003
totaling $459,000 were recognized as Distribution and Technology  Revenue from a
related party.

COST OF REVENUES

         Cost of revenues is primarily related to the costs of services provided
through  our Altnet  subsidiary.  They  include the cost of  providing  internet
bandwidth,  costs  associated with payment  processing  services for the payment
gateway and licensing royalties paid to third parties.

RESEARCH AND DEVELOPMENT COSTS

         Research  and  development  expenses  include  salaries and benefits of
personnel conducting research and development relating to the Company's Internet
web site, payment processing solution and related information database,  and the
development of Altnet's Points Manager software application.

CASH EQUIVALENTS

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

RECEIVABLES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

         The Company  regularly  evaluates  the  collectibility  of its accounts
receivable  balances,  and records  specific  reserve for bad debt to reduce the
related  receivable to the amount they expect to recover  given all  information
currently available.

PROPERTY AND EQUIPMENT

         Property  and   equipment   are  stated  at  cost.   Depreciation   and
amortization  are provided  using the  straight-line  method over the  estimated
useful lives ranging up to five 1/2 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 ($0.7801 at
December 31, 2004),  and revenues and expenses are translated into U.S.  dollars
using an average exchange rate ($0.737) for the year ended December 31, 2004 and
$0.649 for the year ended December 31, 2003).

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


                                       37
<PAGE>


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

                                DECEMBER 31, 2004

Company  recorded a  comprehensive  gain from foreign  currency  translation  of
$83,000 in 2004 and a loss from foreign currency translation of $32,000 in 2003.

         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   transactions  are  included  in  the
statements of operations and comprehensive loss.

NET LOSS PER SHARE

         The Company  computes and presents  loss per share in  accordance  with
FASB  Statement  No.  128,  EARNINGS  PER SHARE.  Basic  earnings  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 138,735,500 and  179,677,900  were excluded from the average number of
common and common equivalent  shares  outstanding in the diluted EPS calculation
for the years ended December 31, 2003 and 2004, 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 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 5 for
supplemental disclosure.

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

                                                      YEAR ENDED     YEAR ENDED
                                                     DECEMBER 31,   DECEMBER 31,
                                                        2003           2004
                                                     -----------    -----------

Net loss, as reported ............................   $(9,518,000)   $(4,784,000)
Employee compensation expense ....................   $  (154,000)   $  (165,000)
Net loss, pro forma ..............................   $(9,672,000)   $(4,949,000)
Basic and diluted loss per share, as reported ....   $     (0.26)   $     (0.13)
Basic and diluted loss per share, pro forma ......   $     (0.26)   $     (0.13)

CONCENTRATION OF REVENUE RISK

         For the twelve months ended  December 31, 2004,  the Company  generated
approximately  100% of its total  revenue  from  activities  dependent  upon the
availability of the Kazaa Media Desktop to computer users.


                                       38
<PAGE>


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

                                DECEMBER 31, 2004

         Financial   instruments  which  potentially   subject  the  Company  to
concentrations  of credit risk  consist  primarily of accounts  receivable.  The
Company  had  $1,912,000  of  accounts   receivable  from  The  Excite  Network,
representing 93% of the Company's  accounts  receivable  balance at December 31,
2004. The Company  performs  credit  evaluations  and generally does not require
collateral.

         The Company  maintains the majority of its cash and cash equivalents in
one bank and with one  brokerage  house.  The bank account is  guaranteed by the
Federal Deposit Insurance  Corporation ("FDIC") up to $100,000.  At December 31,
2004, the Company had  approximately  $313,000 at a bank, which was in excess of
the FDIC insurance limit.

OTHER LONG-TERM INTANGIBLES

         The Company records  intangible  assets in accordance with Statement of
Financial  Accounting  Standards  (or FAS) 141 "Business  Combination",  FAS 142
"Goodwill  and  other  Intangible  Assets"  and  FAS  144  "Accounting  for  the
Impairment or Disposal of Long Lived Assets". FAS 141 requires that the purchase
method of  accounting  be used for all  business  combinations  initiated  after
September  30, 2001,  and also  specifies  the criteria for the  recognition  of
intangible  assets  separately  from goodwill.  FAS 144 requires that intangible
assets with definitive  lives be amortized over their estimated useful lives and
reviewed for impairment  when events or changes in  circumstances  indicate that
the carrying amount of such assets may not be realized. The Company assesses the
recoverability  of  long-lived  assets  whenever  events or changes in  business
circumstances  indicate  that  the  carrying  value  of  an  asset  may  not  be
recoverable.  During the fourth quarter of 2004, in connection with this review,
the Company  obtained  an  independent  valuation  to assist in  evaluating  its
intangible  assets for impairment in accordance with FAS 144. An impairment loss
is recognized  when the sum of the expected  undiscounted  future net cash flows
over the remaining  useful life, is less than the carrying  amount of the asset.
Amortization  expenses  related  to  the  long-lived  asset  were  approximately
$698,000  and  $2,307,000  for the  years  ended  December  31,  2004 and  2003,
respectively. Annual estimated amortization expense for the remaining long-lived
asset for each of the five succeeding years is as follows:

              2005......................      $    698,000
              2006......................           350,000
                                              ------------
              Total.....................      $  1,048,000
                                              ============

LICENSE RIGHTS

         In October 2002, the Company  entered into a patent  license  agreement
with Kinetech, Inc. ("Kinetech"), pursuant to which it acquired a license to the
TruNames patent,  and in consideration  for such license,  the Company issued to
Kinetech a warrant to  purchase  up to  5,000,000  shares of common  stock (the"
Warrant to Purchase  Common Stock") at an exercise price of $0.001 per share. In
July 2003,  the Company  modified  the terms of the  Warrant to Purchase  Common
Stock with Kinetech, Inc., which accelerated the vesting of the then outstanding
warrants.  As a result of the accelerated  vesting and the fact that the Company
now  recognizes  revenue on a monthly  basis  from  sub-licensing  the  TruNames
patent,  the  Company  determined  that the  warrants  granted  to  Kinetech  as
consideration for the patent rights had a determinable  value. The fair value of
the  warrants  was  re-examined  at  the  date  of  modification,   based  on  a
Black-Scholes  model with the following  weighted average  assumptions for 2003:
interest  rates of  4.5%;  dividend  yield  rates of 0;  volatility  factors  of
expected  market  price of the  Company's  common stock of 50%; and the expected
life of the warrants,  or 6 years. The value of these warrants was determined to
be $2,096,000,  which is being  amortized over the remaining  useful life of the
patent license agreement, or 3 years. During 2004, the Company recorded $698,000
of amortization expense related to the patent, leaving an unamortized balance of
$1,048,000  at December  31, 2004,  which is  reflected on the balance  sheet in
License Rights.


                                       39
<PAGE>


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

                                DECEMBER 31, 2004

         RESTRICTED CASH

         At December  31,  2004,  $75,000 of cash was pledged as  collateral  on
outstanding  convertible  promissory notes and was classified as restricted cash
on the balance sheet.

3.       RELATED PARTY TRANSACTIONS

     On  May  28,  2003,   Altnet  entered  into  a  non-exclusive,   perpetual,
irrevocable,  transferable,  worldwide  license to use  rights to Joltid  Ltd.'s
Content  Distribution  Environment   peer-to-peer  computer  program,   commonly
referred to as  PeerEnabler.  In exchange for the license,  Altnet agreed to pay
Joltid a guaranteed  monthly fee of $30,000  based on a  percentage  of revenues
earned  from the  exploitation  of the  licensed  rights,  subject  to a maximum
aggregate  amount.  The  Company  has  reflected  the  current  portion  of  the
guaranteed  payment of $360,000 as a current  liability,  and the balance of the
commitment of $210,000 as a long-term liability.  The Company initially recorded
$1,080,000 related to the value of these license rights under this agreement and
amortized  the  license  rights  on a  straight-line  basis  over  three  years,
recognizing $180,000 as license expense in 2003. In conjunction with our FAS 144
impairment  review, it was determined that the carrying value of the asset would
not be recoverable. As a result the unamortized balance of $900,000, was written
off as impairment  loss in 2003.  The Company paid Joltid  $380,000 and $221,700
for  services  provided  during  the years  ended  December  31,  2004 and 2003,
respectively,  had an  outstanding  trade  payable  to them of  $19,170  and had
guaranteed minimum payments of $570,000 due to Joltid as of December 31, 2004.

         The Company  entered into a Patent  Sublicense  Agreement  with Sharman
Networks  Limited,  the  distributor  of the Kazaa Media  Desktop  file  sharing
software application (or KMD). Pursuant to the Patent Sublicense Agreement,  the
Company  granted  Sharman  Networks a limited,  non-exclusive  sublicense to the
Company's  rights to the  TruNames  patent,  which  the  Company  licenses  from
Kinetech Inc. The TrueNames patent covers a method of identifying  digital files
based on the actual data contents of the file, rather than by its name,  origin,
location,  address,  or  other  information  that  can  easily  be  changed.  As
consideration for the sublicense, the Company will receive from Sharman Networks
a monthly  license  fee.  Additionally,  in June 2003,  the  Company  and Altnet
entered into a Joint Enterprise Agreement with Sharman Networks, to act as their
exclusive   representative   for  the  sale,  license  and/or  other  commercial
exploitation  of index search results  displayed on or otherwise  accessed using
the KMD in response to end user search requests.  The agreement also granted the
Company a  non-exclusive  right to enter into  agreements  with third parties to
provide for the establishment of one or more browse channels within the KMD that
enable  users to find and  download  rights-managed  content  from the  relevant
browse channel in a single click  process,  and to provide for all the terms and
conditions governing the management,  maintenance, operation, and other elements
of each browse  channel.  The Company  shall share in revenues  derived from the
browse channels.  Under the terms of this agreement,  the Company issued Sharman
Networks  warrants to purchase up to 14,000,000  shares of the Company's  common
stock,  par value  $0.001 per share,  at an  exercise  price of $0.61 per share,
expiring  in June 2008.  The fair value of  warrants  as examined at the date of
grant is based on a  Black-Scholes  model  with the  following  weighted-average
assumptions  for  2003:  interest  rates of  4.5%;  dividend  yield  rates of 0;
volatility factors of the expected market price of the Company's common stock of
50.0%;  and the expected  life of the warrants,  or 5 years.  The value of these
warrants was determined to be  $2,951,000.  The Company was reflecting the total
value of these warrants,  net of amortized warrant expense, as License Rights on
the balance  sheet.  The Company  amortized the license rights over three years,
the life of the  agreement,  and recognized  $574,000 of warrant  expense during
2003. In conjunction  with our FAS 144 impairment  review  performed in 2003, it
was determined that the carrying value of the asset would not be recoverable. As
a result the  unamortized  balance of  $2,377,000  was written off as impairment
loss in 2003.  As of December 31, 2004 the Company has an  outstanding  accounts
payable balance to Sharman Networks of $1,300,000.


                                       40
<PAGE>


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

                                DECEMBER 31, 2004

         In June 2003, the Company received additional  financing in the form of
a promissory note,  totaling $100,000,  from Europlay Capital Advisors (ECA), an
entity in which the  Company's  previous  Chairman is an  executive,  bearing an
interest rate of 10% per annum and due August 10, 2003. In conjunction with this
transaction, the Company issued warrants to purchase up to 533,333 shares of the
Company's  common  stock at an  exercise  price  equal to  $0.28125  per  share,
expiring in June 2006.  ECA agreed to extend the maturity  date of the note from
August 10, 2003 to December  31, 2003.  In  consideration  for its  agreement to
extend the maturity date, we issued to the ECA  additional  warrants to purchase
up to an aggregate of 227,272 shares of our common stock at an exercise price of
$0.44 per share.  The fair value of both warrant  grants as examined at the date
of grant is based on a Black-Scholes  model with the following  weighted-average
assumptions  for  2003:  interest  rates of  4.5%;  dividend  yield  rates of 0;
volatility factors of the expected market price of the Company's common stock of
50.0%;  and the  expected  life of the  warrants,  or 3 years.  The value of the
warrants was  determined  to be $187,835.  The note was paid in full in December
2003 and the value of these warrants and related  discount,  were fully expensed
during the current year. In addition,  during 2004 the Company paid ECA $812,000
for  commissions  and  consulting  services,  and as of  December  31,  2004 has
outstanding accrued expenses to ECA of $858,000.

         In 2003,  the Company  issued  warrants to purchase  350,000  shares of
common stock in consideration for consulting  services,  related to a management
initiated  audit of systems and  procedures,  to Scheinrock  Advisory  Group, an
entity owned by Jeff Scheinrock, a previous member of the Board of Directors. In
addition the Company  paid  Scheinrock  Advisory  Group  $43,000 for  consulting
services.

         The Company leased its U.S. offices,  under operating lease agreements,
from Toibb Enterprises  (Toibb), an entity owned by Harris Toibb, a secured debt
holder and the largest  shareholder  in the  Company.  The Company  paid rent to
Toibb of $103,000  and $84,000  during  2004 and 2003  respectively.  In October
2004, the Company  relocated its U.S. office to a facility not controlled by Mr.
Toibb.

         The Company  has paid  Detershan,  an entity  owned by Mark  Miller,  a
member of our Board of Directors,  for technical and hosting services associated
with content placed on our Altnet  network.  The Company paid Detershan  $45,568
and $5,000  during 2004 and 2003,  respectively.  In addition,  the Company paid
Pacific  Interactive  Pty.  Limited $61,950 for consulting  services in the year
ended December 31, 2004.  Mark Miller and his wife are the sole  stockholders of
Pacific Interactive Pty. Limited.

         For the year ended  December  31,  2003,  the Company  paid Abe Sher, a
member of the Board of Directors during 2003, $173,750 for consulting  services.
Mr. Sher  became an  employee  of the Company in December  2003 and for the year
ended December 31, 2004, the Company paid Mr. Sher $172,000.

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


                                       41
<PAGE>


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

                                DECEMBER 31, 2004

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

         Sharman  Networks  Limited  has agreed to  indemnify  the  Company  for
certain  uninsured  legal expenses and related costs incurred in connection with
the ongoing  litigation in Australia in which both Sharman  Networks Limited and
the Company are  defendants.  During 2004, the Company reduced its legal expense
by  approximately  $766,000 and reduced the  corresponding  liability to Sharman
Networks by $766,000.

4.       SIGNIFICANT AGREEMENTS

THE EXCITE NETWORK

         In April  2003,  the  Company  signed a  two-year  Strategic  Alliance,
Marketing and Distribution  Agreement with The Excite Network, Inc. with respect
to its My Search toolbar,  which enables users to access  content,  products and
services.  Pursuant to the agreement,  the parties agreed to develop, market and
distribute  a  customized  version  of the My Search  toolbar  and to operate an
integrated  sweepstakes  and loyalty  program for users of the Company's  Altnet
peer-to-peer  software  application.  The search  toolbar  will be  bundled  and
distributed  with the "Altnet  Loyalty  Points  Manager," the Company's  point's
management  software  program.  The Company received a refundable (under limited
circumstances),   non-recoupable  signing  bonus  in  the  aggregate  amount  of
$500,000,  which was  recognized as revenue in 2003. The agreement also provided
for ongoing payments  between the parties,  based on the success in distributing
the browser plug-ins and their performance.  The Company recognized installation
bounties and search revenues related to this agreement,  totaling $6,076,000 and
$2,466,000 in 2004 and 2003, respectively.

STREAMWAVES

         In  June  2003,  the  Company  entered  into an  Interactive  Marketing
Agreement with  Streamwaves.com,  Inc. to market and promote the streaming music
service of Streamwaves, and to sell Streamwaves' streamed music, video and, when
available,   downloadable   digital  audio  and  video  files  over  the  Altnet
peer-to-peer  network. As consideration for its services,  the Company is paid a
percentage of revenue  Streamwaves  receives from sales of its content to Altnet
users.  The Company also  provides  Streamwaves  and its  customers  with online
payment   processing   services  for  a  transaction  fee.  The  Company  loaned
Streamwaves  $200,000 in connection with this transaction  pursuant to a secured
promissory note,  which note is secured by all of Streamwaves  assets and shares
of Streamwaves stock owned by its founder.  Notes receivable from Streamwaves as
of December 31, 2004 amounted to $53,000.

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.


                                       42
<PAGE>


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

                                DECEMBER 31, 2004

         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 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 was
converted  into common  stock on December 31,  2003,  the  maturity  date of the
Notes,  the Note holders  would have  acquired  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


                                       43
<PAGE>


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

                                DECEMBER 31, 2004

the Company  expensed  $340,000 of debt discount in the fourth  quarter of 2002,
with the remainder expensed in 2003.

         In  December  2003,  the  holders  of the Notes  agreed  to extend  the
maturity  date of the  Notes  from  December  31,  2003 to  March  1,  2004.  In
consideration of their agreement to extend the maturity date, the Company agreed
to pay the  holders  a  $15,000  extension  fee,  plus  legal  fees and costs of
$300,000.

         On March 30,  2004,  in  consideration  of an  agreement  to extend the
maturity date of the secured  indebtedness  to September  26, 2004,  the Company
agreed to the following:

         o        To  amend  the   expiration   date  of  warrants  to  purchase
                  44,542,718  shares of common  stock  held by the note  holders
                  from May 23, 2004 to October 4, 2005;

         o        To issue the note holders  additional  warrants to purchase up
                  to an aggregate of 4,018,867  shares of our common stock at an
                  exercise price of $0.15 per share; and

         o        To apply on a monthly  basis,  50% of our "Excess Cash" toward
                  repayment of the secured indebtedness,  until the indebtedness
                  is paid in full.  Excess Cash is defined to mean,  at any time
                  of  determination,  the amount which is equal to the Company's
                  consolidated revenues minus costs and expenses consisting only
                  of costs of revenues,  sales and marketing costs,  general and
                  administrative  costs, and research and development costs, all
                  of which  are  determined  monthly  in the same  manner  as is
                  reported  in  the   Company's   consolidated   statements   of
                  operations.  Non-cash  expenses are not deducted from revenues
                  in calculating Excess Cash.

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

         o        To extend the  expiration  date of  warrants  to  purchase  an
                  aggregate  of  73,787,613  shares of common  stock held by the
                  note holders from October 2, 2005 to October 4, 2008;

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

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

5.       STOCKHOLDERS' DEFICIT

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


                                       44
<PAGE>


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

                                DECEMBER 31, 2004

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.

         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.

         On May 28, 2003,  the Company  entered into a Share Exchange and Option
Agreement with Joltid, Ltd., the entity which prior to the transaction owned 49%
of Altnet,  Inc. Under the terms of the Agreement,  the Company issued 7,000,000
unregistered  shares of its common stock to acquire  1,102,500  shares of Altnet
common stock (24.5%),  and 1,000,000  unregistered shares of its common stock to
obtain the option to purchase the  remaining  1,102,500  shares of Altnet common
stock (24.5%) at an exercise  price of $0.1575.  The total value assigned to the
8,000,000  shares was  $1,694,000.  The option to purchase the remaining  shares
expires in May 2005.  The  Company  now owns 75.5% of Altnet  and  continues  to
manage all of the day-to-day  operations of Altnet.  Prior to this  transaction,
the Company  received  51% of the  outstanding  capital  stock and Joltid,  Ltd.
received 49% of the capital stock.  Neither party was required to make a capital
contribution  in  connection  with the  formation of Altnet.  At the time of the
transaction, the only significant asset owned by Altnet was its technology.

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, 2004,  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 AND OPTIONS

         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.

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


                                       45
<PAGE>


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

                                DECEMBER 31, 2004

         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.

         Under the terms of the Company's  Deferred  Compensation  Plan ("Plan")
dated January 1, 1997,  the prior  Chairman of the Board of Directors (and prior
employee of the  Company)  and a current  executive,  elected to  exchange  Plan
benefits for stock options on May 30, 2003. In  conjunction  with this election,
the Company issued 10,395,000 options to purchase common stock of the Company to
the two individuals with an exercise price of $0.12 per share,  when the average
market price of the Company's  stock for the five days  preceding the grant date
was equal to $0.23 per share.  The  options  expire in May 2013.  The  intrinsic
value,  which equated to the fair value, of the options of $1,143,450 were equal
to the total amount of deferred compensation,  plus accrued interest owed to the
two  individuals,  as of the date of the grant,  May 30, 2003, and therefore the
Company has not recognized any expense associated with the conversion.

         In June 2003,  the  Company  and its  subsidiary  entered  into a Joint
Enterprise   Agreement   with  Sharman   Networks,   to  act  as  its  exclusive
representative for the sale, license and/or other commercial exploitation of its
search technology. Under the terms of this agreement, the Company issued Sharman
Networks  warrants to purchase up to 14,000,000  shares of the Company's  common
stock,  par value  $0.001 per share,  at an  exercise  price of $0.61 per share,
expiring in June 2008. These warrants were initially vested and exercisable with
respect  to  7,000,000  shares on the  issuance  date and will  vest and  become
exercisable  with respect to the remaining  7,000,000 shares two years following
the issuance  date  provided  that the Joint  Enterprise  Agreement has not been
terminated  prior to such date.  The fair value of  warrants  as examined at the
date  of  grant  is  based  on  a   Black-Scholes   model  with  the   following
weighted-average  assumptions for 2003:  interest rates of 4.5%;  dividend yield
rates of 0;  volatility  factors of the expected  market price of the  Company's
common stock of 50.0%;  and  expected  life of the  warrants.  The fair value of
these warrants was  determined to be $2,951,000.  The Company was reflecting the
total value of these  warrants,  net of amortized  warrant  expense,  as License
Rights on the balance sheet. The Company amortized the license rights over three
years, the life of the agreement, and had recognized $574,000 of warrant expense
during 2003. In conjunction with our FAS 144 impairment  review done in 2003, it
was determined that the carrying value of the asset would not be recoverable. As
a result the  unamortized  balance of  $2,377,000  was written off as impairment
loss in 2003.

         In June 2003, the Company received $200,000 of additional  financing in
the form of promissory notes,  bearing an interest rate of 10% per annum and due
August 10,  2003.  In  conjunction  with this  transaction,  the Company  issued
warrants to purchase up to 1,066,666  shares of the Company's common stock at an
exercise  price equal to $0.28125  per share,  expiring in June 2006.  In August
2003, a holder of one of these notes in the amount of $100,000  agreed to extend
the maturity  date of the notes from August 10, 2003 to December  31,  2003.  In
consideration  for their  agreement  to extend the  maturity  date,  the Company
issued to the Note holder additional  warrants to purchase up to an aggregate of
227,272 shares of common stock at an exercise price of $0.44 per share. The fair
value of all of the  warrants as examined at the date of their  grants was based
on a  Black-Scholes  model with the following  weighted-average  assumptions for
2003:  interest rates of 4.5%;  dividend yield rates of 0; volatility factors of
the  expected  market  price of the  Company's  common  stock of 50.0%;  and the
expected life of the warrants, or 3 years. The value of these


                                       46
<PAGE>


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

                                DECEMBER 31, 2004

warrants was determined to be $414,000 and $48,000  respectively.  These amounts
were fully  amortized and reflected as warrant  expense during 2003.  Both notes
were repaid during the fourth quarter of 2003.

         In October 2002, the Company  entered into a patent  license  agreement
with Kinetech, Inc. ("Kinetech"), pursuant to which it acquired a license to the
TruNames patent,  and in consideration  for such license,  the Company issued to
Kinetech a warrant to  purchase  up to  5,000,000  shares of common  stock (the"
Warrant to Purchase  Common Stock") at an exercise price of $0.001 per share. In
July 2003,  the Company  modified  the terms of the  Warrant to Purchase  Common
Stock with Kinetech, Inc., which accelerated the vesting of the then outstanding
warrants.  As a result of the accelerated  vesting and the fact that the Company
now  recognizes  revenue on a monthly  basis  from  sub-licensing  the  TruNames
patent,  the  Company  determined  that the  warrants  granted  to  Kinetech  as
consideration for the patent rights had a determinable  value. The fair value of
the  warrants  was  re-examined  at the date of  modification  and is based on a
Black-Scholes  model with the following  weighted average  assumptions for 2003:
interest  rates of  4.5%;  dividend  yield  rates of 0;  volatility  factors  of
expected  market  price of the  Company's  common stock of 50%; and the expected
life of the warrants,  or 6 years. The value of these warrants was determined to
be $2,096,000 and will be amortized over the remaining useful life of the patent
license  agreement,  or 3 years. The Company  recorded  $698,000 and $349,000 of
amortization  expense  related to the patent during 2004 and 2003  respectively,
leaving an  unamortized  balance of  $1,048,000  at December 31, 2004,  which is
classified as License Rights on the balance sheet.

         In  August  2003  the  Company  signed a  twelve  month  Representation
Agreement with a legal  consultant,  to assist Altnet in marketing and promoting
its peer-to-peer  technology to major record companies. In conjunction with this
agreement, the Company issued warrants to purchase up to 5,000,000 shares of the
Company's  common stock at an exercise price equal to $0.54 per share,  expiring
on October 15, 2008. The fair value of warrants as examined at the date of grant
is  based  on  a  Black-Scholes   model  with  the  following   weighted-average
assumptions  for  2003:  interest  rates of  4.5%;  dividend  yield  rates of 0;
volatility factors of the expected market price of the Company's common stock of
50.0%;  and the expected  life of the warrants,  or 5 years.  The value of these
warrants was determined to be $1,319,000,  and was to be amortized over the life
of the  agreement,  or 12 months.  In  conjunction  with our FAS 144  impairment
review,  it was  determined  that  the  carrying  value  of the  asset  was  not
recoverable  and as a result the  remaining  unamortized  amount of $770,000 was
written off as an impairment charge in 2003.

         In 2003,  the Company  issued  warrants to  purchase  an  aggregate  of
5,515,000 shares of common stock in consideration for consulting  services.  The
fair  value  of the  warrants  as  examined  at the  date of grant is based on a
Black-Scholes model with the following weighted-average assumptions for 2004 and
2003,  respectively:  interest rates of 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 50.0%;  and  expected  life of the warrants of 3 years
for both  years.  The  Company  expensed  $1,583,000  in  connection  with these
warrants.

         The following table summarizes warrant activity:


                                       47
<PAGE>


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

                                DECEMBER 31, 2004

                                                   NUMBER
                                                  OF SHARES      WARRANT PRICE
                                                 -----------    ----------------
Outstanding at December 31, 2002..........        77,981,000    $0.001 - $6.50
Granted...................................        46,035,000    $0.14  - $0.61
Exercised.................................          (661,000)   $0.19  - $0.28
Forfeited.................................              --             --
                                                 -----------    ----------------
Outstanding at December 31, 2003..........       123,355,000    $0.001 - $6.50
Granted...................................         4,018,865    $0.07
Exercised.................................              --             --
Forfeited.................................        14,637,720    $0.16  - $0.4385
                                                 -----------    ----------------
Outstanding at December 31, 2004..........       112,736,145    $0.07  - $0.75


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 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, 2002..........         6,459,000    $0.001 - $5.94
Granted...................................        10,800,000    $0.12  - $0.41
Exercised.................................        (1,218,500)   $0.15  - $0.16
Forfeited.................................          (660,000)   $0.16  - $5.94
                                                 -----------    ---------------
Outstanding at December 31, 2003..........        15,380,500    $0.001 - $5.94
Granted...................................              --             --
Exercised.................................              --             --
Forfeited.................................       (2,183,267)    $0.16  - $4.81
                                                 -----------    ---------------
Outstanding at December 31, 2004..........        13,197,233    $0.12  - $5.94
Exercisable at December 31, 2004..........        10,015,254    $0.12  - $5.94

         The fair value of the options as examined at the date of grant is based
on a  Black-Scholes  model with the following  weighted-average  assumptions for
2004 and 2003,  respectively:  interest  rates of 4.5% for both years;  dividend
yields of 0% for both years;  volatility factors of the expected market price of
the Company's


                                       48
<PAGE>


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

                                DECEMBER 31, 2004

common stock of 50.0% and 50.0%; and expected life of the options of 3 years for
both years. These assumptions resulted in a weighted average fair value of $0.06
per share for stock options granted in 2003.

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

1997 DEFERRED COMPENSATION PLAN

         The Company  adopted a Deferred  Compensation  Plan (the "1997  Plan"),
which became effective on January 1, 1997. Under the terms of the 1997 Plan, the
participants  (the prior  Chairman of the Board of Directors (and prior employee
of the Company) and a current  executive) are able to elect to defer salary, and
accrue  interest  at 8%. In  accordance  with the terms of the 1997  Plan,  both
elected  to  exchange  Plan  benefits  for stock  options  on May 30,  2003.  In
conjunction  with this  election,  the  Company  issued  10,395,000  options  to
purchase  common  stock of the Company to the two  individuals  with an exercise
price of $0.12 per share,  when the average market price of the Company's  stock
for the five days  preceding  the grant date was equal to $0.23 per  share.  The
options expire in May 2013. The intrinsic value of the options,  which was equal
to the fair  value,  of  $1,143,450  were equal to the total  amount of deferred
compensation,  plus accrued interest owed to the two individuals, as of the date
of the grant,  May 30, 2003,  and therefore the Company has not  recognized  any
expense  associated  with the conversion.  The 10,395,000  options issued in May
2003, are the only options issued and outstanding under the 1997 Plan.

6.       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, 2004 the Company had cumulative tax losses resulting in
a net operating  loss ("NOL") carry forward of  approximately  $11,300,000.  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, 2004 are as follows:

                                                                    DECEMBER 31,
                                                                        2004
                                                                    -----------
Deferred tax assets:

   Net operating losses ..................................          $ 3,861,000
   Temporary differences .................................               13,000
                                                                    -----------
   Total deferred tax assets .............................            3,874,000
   Valuation allowance ...................................           (3,874,000)
                                                                    -----------
Net deferred tax assets (liabilities) ....................          $      --
                                                                    ===========


                                       49
<PAGE>


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

                                DECEMBER 31, 2004

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

                                                                 YEAR ENDED
                                                                DECEMBER 31,
                                                          ----------------------
                                                            2003          2004
                                                          --------      --------
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 %
                                                          ========      ========

7.       PROPERTY AND EQUIPMENT

         Property and equipment consist of the following:

                                                          DECEMBER 31,
                                                             2004
                                                          ----------

         Computers and equipment ..................       $      334

         Furniture and fixtures ...................               51
                                                          ----------
                                                                 385
         Less accumulated depreciation ............             (277)
                                                          ----------
                                                          $      108
                                                          ==========

8.       ACCRUED EXPENSES

         Accrued expenses consist of the following:

                                                          DECEMBER 31,
                                                             2004
                                                          ----------

         Consulting ...............................       $       40
         Legal expenses ...........................              264
         Accrued payroll expenses .................              105
         Other ....................................              247
                                                          ----------
                                                          $      656
                                                          ----------

9.       GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS

         The  Company's  2004  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:


                                       50
<PAGE>


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

                                DECEMBER 31, 2004

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

YEAR ENDED DECEMBER 31, 2004
   Revenues from unaffiliated customers ........      $8,775,000            --
   Revenues from affiliated customers ..........            --              --
                                                      ----------      ----------

   Total revenues ..............................      $8,775,000            --
                                                      ==========      ==========
YEAR ENDED DECEMBER 31, 2003:
   Revenues from unaffiliated customers ........      $5,196,000            --
   Revenues from affiliated customers ..........         459,000            --
                                                      ----------      ----------

   Total revenues ..............................      $5,655,000            --
                                                      ==========      ==========


         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.

         For the year ended December 31, 2004,  The Excite  Network  represented
69% of the  revenues  from  installation  bounty and search  revenues,  based on
active installations of the Excite Activated Installation Toolbar,  bundled with
the Company's  Altnet  Loyalty  Points  Manager  software  application.  Sharman
Networks  contributed  16% of revenues,  with patent  sublicensing  and business
development fees.

10.      COMMITMENTS AND CONTINGENCIES

         The Company  leases its facilities  under  operating  lease  agreements
expiring  through 2006. In October 2004, the Company  relocated its U.S.  office
signing a one-year lease with future minimum  annual  payments of  approximately
$20,000. In Australia, the Company entered into a two year lease, February 2003,
with future minimum annual  payments of  approximately  $42,000.  As of December
2004 the commitment under these lease obligations is as follows:

                  YEAR                       AMOUNT
              ------------                ------------
                  2005                      $  25,000
                                          ------------
                                            $  25,000
                                          ============

         Rent  expense  amounted to  $122,000  and  $157,000  for the year ended
December 31, 2003 and the year ended December 31, 2004, respectively.

         In March  2004,  in the  Federal  Court of  Australia,  New South Wales
District  Registry,  Brilliant  Digital  Entertainment,  Inc., its  subsidiaries
Altnet  Inc.  and  Brilliant  Digital  Entertainment  Pty.  Limited,  and  Kevin
Bermeister and Anthony Rose, the Chief  Executive  Officer and Chief  Technology
Officer, respectively,  were joined as defendants in the suit by Universal Music
Australia Pty. Ltd. and other record labels against Sharman Networks Limited and
other  defendants,  alleging  infringement of the copyright in sound  recordings
controlled by the  plaintiffs.  The plaintiffs  allege that due to the Company's
business  dealings  with Sharman  Networks  Limited,  the Company is  integrally
involved in the operation of the Kazaa Media  Desktop and  therefore  liable for
the  alleged   copyright   infringement   occasioned  by  its   development  and
distribution.  The plaintiffs are seeking damages under the Australian Copyright
Act of  1968,  recovery  of  costs  and  interest,  and a  permanent  injunction
restraining the Company from making copies of,  communicating to the public,  or


                                       51
<PAGE>


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

                                DECEMBER 31, 2004

distributing  the Plaintiff's  sound recordings  without a license.  The Company
believes these  allegations are without merit, and intends to vigorously  defend
against these claims.

         In September 2004,  through its subsidiary  Altnet, the Company filed a
civil lawsuit in the United States District Court Central District of California
against  a number  of  companies  and  organizations,  including  the  Recording
Industry  Association of America,  alleging the breach of the "TrueNames" patent
which the  Company  licenses  from  Kinetech,  Inc.  In that  filing the Company
alleges  that  some  of  the  defendants  infringe  on  the  patent  to  "spoof"
peer-to-peer  users with bogus or  corrupted  media  files,  which  inhibits the
growth of  peer-to-peer  for legitimate file sharing and thereby has injured the
Company's  business.  The Company  believes  that it will  prevail in this civil
lawsuit.

11.      GUARANTEES

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

         Under its bylaws,  the Company has agreed to  indemnify  its  officers,
directors and employees for certain events or occurrences arising as a result of
the  officer,  director,  or  employee  serving in such  capacity.  The  maximum
potential  amount of future payments the Company could be required to make under
these  indemnification  agreements  is  unlimited.  However,  the  Company has a
directors and officer liability insurance policy that mitigates its exposure and
enables  it to  recover a portion of any  future  amounts  paid,  subject to the
applicable  terms of the policy.  As a result of its insurance  policy coverage,
the  Company  believes  the  estimated  fair  value  of  these   indemnification
agreements is minimal and has no liabilities recorded for these agreements as of
December 31, 2004.

         The Company occasionally enters into  indemnification  provisions under
(i) its  agreements  with other  companies in its  ordinary  course of business,
typically with business partners,  contractors,  customers,  and landlords,  and
(ii) its agreements with investors. Under these provisions the Company generally
indemnifies  and holds  harmless the  indemnified  party for losses  suffered or
incurred by the indemnified party as a result of the Company's activities or, in
some  cases,  as a  result  of the  indemnified  party's  activities  under  the
agreement.  These  indemnification  provisions  often  include  indemnifications
relating  to  representations  made by the Company  with regard to  intellectual
property rights. These indemnification  provisions generally survive termination
of the underlying agreement.  In addition, in some cases, the Company has agreed
to reimburse  employees for certain expenses and to provide salary  continuation
during  short-term  disability.  The maximum potential amount of future payments
the Company could be required to make under these indemnification  provisions is
unlimited.  The Company has not incurred  material  costs to defend  lawsuits or
settle claims  related to these  indemnification  agreements.  As a result,  the
Company  believes  the  estimated  fair value of these  agreements  is  minimal.
Accordingly,  the Company has no liabilities recorded for these agreements as of
December 31, 2004.


                                       52
<PAGE>


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

         None.

ITEM 8A.      CONTROLS AND PROCEDURES.

CONTROLS AND PROCEDURES

         Members of the  company's  management,  including  our Chief  Executive
Officer,  President and acting Chief Financial Officer,  Kevin Bermeister,  have
evaluated  the  effectiveness  of our  disclosure  controls and  procedures,  as
defined by paragraph (e) of Exchange Act Rules 13a-15 or 15d-15,  as of December
31,  2004,  the end of the  period  covered  by this  report.  Based  upon  that
evaluation, Mr. Bermeister concluded that our disclosure controls and procedures
are effective.

INTERNAL CONTROL OVER FINANCIAL REPORTING

         There were no changes in our internal control over financial  reporting
or in other factors  identified in connection  with the  evaluation  required by
paragraph  (d) of Exchange Act Rules 13a-15 or 15d-15 that  occurred  during the
fourth quarter ended  December 31, 2004 that have  materially  affected,  or are
reasonably  likely to materially  affect,  our internal  control over  financial
reporting.

ITEM 8B.      OTHER INFORMATION

         None.

                                    PART III

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

         Information  regarding  directors and executive officers will appear in
the  proxy  statement  for the  2005  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 2005  Annual  Meeting of  Stockholders,  and is  incorporated
herein by reference.

ITEM 11.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
              RELATED STOCKHOLDER MATTERS

         Information  regarding  security ownership of certain beneficial owners
and  management  and  related  stockholder  matters  will  appear  in the  proxy
statement  for the 2005  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 2005 Annual Meeting of  Stockholders,
and is incorporated herein by this reference.


                                       53
<PAGE>


ITEM 13.      EXHIBITS.

         See attached Exhibit Index.

ITEM 14.      PRINCIPAL ACCOUNTANT FEES AND SERVICES

         Information  regarding  principal  accountant  fees and  services  will
appear in the proxy statement for the 2005 Annual Meeting of  Stockholders,  and
is incorporated herein by this reference.


                                       54
<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/ KEVIN BERMEISTER
                                         ---------------------------------------
                                         Kevin Bermeister
                                   Its:  President, Chief Executive Officer and
                                         Acting Chief Financial Officer
                                         (Principal Financial and Accounting
                                         Officer)



                                POWER OF ATTORNEY

         The   undersigned   directors   and  officers  of   Brilliant   Digital
Entertainment,  Inc. do hereby constitute and appoint Kevin Bermeister with full
power of substitution and resubstitution,  as their true and lawful attorney and
agent,  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/ KEVIN BERMEISTER         Chairman of the Board of            March 31, 2005
-----------------------          Chief Executive Officer,
    Kevin Bermeister             President and Acting Chief
                                 Financial Officer (Principal
                                 Financial and Accounting
                                 Officer)

    /S/ MARK MILLER           Director                            March 31, 2005
-----------------------
      Mark Miller

  /S/ VINCENT BITETTI         Director                            March 31, 2005
-----------------------
    VINCENT BITETTI

     /S/ RAY MUSCI            Director                            March 31, 2005
-----------------------
       Ray Musci

     /S/ ABE SHER             Director                            March 31, 2005
-----------------------
        Abe Sher


                                       55
<PAGE>

                                  EXHIBIT INDEX


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

3.1            Amended  and  Restated   Certificate  of   Incorporation  of  the
               Registrant, as amended.  Incorporated by reference to Exhibit 3.1
               to  Quarterly  Report  on  Form  10-QSB  for  the  quarter  ended
               September 30, 2004.

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  Fourth Amended and Restated 1996 Stock Option Plan.
               Incorporated by reference to Exhibit 10.1 to Quarterly  Report on
               Form 10-QSB for the quarter ended September 30, 2004.*

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           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.

10.7           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.

10.8           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.

10.9           Amendment to Note and Warrant  Purchase  Agreements,  dated as of
               May  23,   2001,   between   Registrant   and  Harris  Toibb  and
               acknowledged  and consent to by Europlay 1, LLC and Preston Ford,
               Inc.  Incorporated  by  reference  to Exhibit  10.4 to  Quarterly
               Report on Form 10-QSB for the quarter ended June 30, 2001.

10.10          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.


                                       (i)
<PAGE>


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

10.11          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.

10.12          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.

10.13          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.

10.14          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.

10.15          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.

10.16          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.

10.17          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.

10.18          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.

10.19          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.

10.20          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.

10.21          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.

10.22          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.

10.23          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.

10.24          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.


                                      (ii)
<PAGE>


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

10.25          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.

10.26          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.

10.27          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.

10.28          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.

10.29          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.

10.30          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.

10.31          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.

10.32          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.

10.33          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.

10.34          Letter  Agreement  Regarding  Extension  of  Maturity  Date dated
               December 31, 2003 by and among the  Registrant and the holders of
               Secured  Convertible  Promissory Note of the Registrant set forth
               on Schedule 1 thereto. Incorporated by reference to Exhibit 10.34
               to Annual  Report on Form 10-KSB for the year ended  December 31,
               2003, and the amendments thereto.

10.35          Form of Amendment  Number Three to  Convertible  Promissory  Note
               dated  December 31, 2003 between the Registrant and the holder to
               be set forth therein.  Incorporated by reference to Exhibit 10.35
               to Annual  Report on Form 10-KSB for the year ended  December 31,
               2003, and the amendments thereto.

10.36          Form of Amendment  Number Two to Secured  Convertible  Promissory
               Note dated  December  31,  2003  between the  Registrant  and the
               holder to be set forth  therein.  Incorporated  by  reference  to
               Exhibit  10.36 to Annual Report on Form 10-KSB for the year ended
               December 31, 2003, and the amendments thereto.


                                      (iii)
<PAGE>


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

10.37          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.

10.38          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.

10.39          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.

10.40          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.

10.41          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.

10.42          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.

10.43          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.

10.44          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.

10.45          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.

10.46          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.

10.47          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.

10.48          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.

10.49          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.


                                      (iv)
<PAGE>


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

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.

10.51          Strategic  Alliance,  Marketing and Distribution  Agreement dated
               April 14, 2003 between Brilliant Digital Entertainment,  Inc. and
               The Excite  Network,  Inc.  [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 the Exhibit 10.1 to
               Quarterly Report on Form 10-QSB for quarter ended June 30, 2003.

10.52          Digital Content Merchant Agreement, dated November, 2002, between
               Registrant  and  NewGenPay,  Inc.  Incorporated  by  reference to
               Exhibit  10.44  to  Amendment  No.  1 to  Form  S-3  Registration
               Statement as filed July 3, 2003.

10.53          Warrant to Purchase Common Stock, dated February 19, 2003, issued
               in favor of Scheinrock Advisory Group.  Incorporated by reference
               to  Exhibit  10.46 to  Amendment  No. 1 to Form S-3  Registration
               Statement as filed July 3, 2003.

10.54          Share  Exchange and Option  Agreement  dated May 28, 2003 between
               Brilliant   Digital   Entertainment,   Inc.   and  Joltid,   Ltd.
               Incorporated by reference to the Exhibit 10.2 to Quarterly Report
               on Form 10-QSB for quarter ended June 30, 2003.

10.55          Joltid  Software  Licensing  Agreement dated May 28, 2003 between
               Altnet, Inc. and Joltid, Ltd. [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 the Exhibit 10.3 to
               Quarterly Report on Form 10-QSB for quarter ended June 30, 2003.

10.56          Form of Brilliant  Digital  Entertainment,  Inc.  Promissory Note
               dated June 11,  2003.  Incorporated  by  reference to the Exhibit
               10.4 to  Quarterly  Report on Form 10-QSB for quarter  ended June
               30, 2003.

10.57          Form of Warrant to Purchase  Common  Stock of  Brilliant  Digital
               Entertainment,   Inc.  dated  June  11,  2003.   Incorporated  by
               reference to the Exhibit 10.5 to Quarterly  Report on Form 10-QSB
               for quarter ended June 30, 2003.

10.58          Joint  Enterprise  Agreement  dated June 23, 2003 between Altnet,
               Inc. and Sharman Networks Limited. [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  the
               Exhibit 10.6 to Quarterly Report on Form 10-QSB for quarter ended
               June 30, 2003.

10.59          Warrant  to   Purchase   Common   Stock  of   Brilliant   Digital
               Entertainment,  Inc.,  dated  June 23,  2003,  issued to  Sharman
               Networks  Limited.  Incorporated by reference to the Exhibit 10.7
               to  Quarterly  Report on Form 10-QSB for  quarter  ended June 30,
               2003.

10.60          Brilliant Digital Entertainment, Inc. Deferred Compensation Plan.
               Incorporated by reference to the Exhibit 10.8 to Quarterly Report
               on Form 10-QSB for quarter ended June 30, 2003.*

10.61          Form  of   Brilliant   Digital   Entertainment,   Inc.   Deferred
               Compensation  Relinquishment Opportunity Agreement.  Incorporated
               by  reference  to the Exhibit  10.9 to  Quarterly  Report on Form
               10-QSB for quarter ended June 30, 2003.*


                                      (v)
<PAGE>


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

10.62          Standard Form Lease  Agreement  dated  September 21, 2003 between
               the Registrant and Topanga & Victory Partners LP. Incorporated by
               reference to Exhibit 10.1 to Quarterly  Report on Form 10-QSB for
               the quarter ended September 30, 2003.

10.63          Employment  Agreement  dated June 1, 2003 between the  Registrant
               and Tyler Tarr.  Incorporated  by reference  to Exhibit  10.63 to
               Annual  Report on Form  10-KSB  for the year ended  December  31,
               2003, and the amendments thereto.*

10.64          Executive  Employment  Agreement  dated June 1, 2003  between the
               Registrant  and Kevin  Bermeister.  Incorporated  by reference to
               Exhibit  10.64 to Annual Report on Form 10-KSB for the year ended
               December 31, 2003, and the amendments thereto.*

10.65          Letter Agreement Regarding Extension of Maturity Date dated March
               30, 2004 by and among the  Registrant  and the holders of Secured
               Convertible  Promissory  Note  of the  Registrant  set  forth  on
               Schedule 1 thereto.  Incorporated by reference to Exhibit 10.1 to
               Quarterly  Report on Form 10-QSB for the quarter  ended March 31,
               2004.

10.66          Form of  Amendment  Number Four to  Convertible  Promissory  Note
               dated March 30, 2004 between the  Registrant and the holder to be
               set forth therein.  Incorporated  by reference to Exhibit 10.2 to
               Quarterly  Report on Form 10-QSB for the quarter  ended March 31,
               2004.

10.67          Form of Amendment Number Three to Secured Convertible  Promissory
               Note dated March 30, 2004 between the  Registrant  and the holder
               to be set forth  therein.  Incorporated  by  reference to Exhibit
               10.3 to  Quarterly  Report on Form 10-QSB for the  quarter  ended
               March 31, 2004.

10.68          Form of  Amendment  No. 2 to Warrant to  Purchase  Common  Stock,
               dated March 30, 2004, by and between Registrant and the holder to
               be set forth therein.  Incorporated  by reference to Exhibit 10.4
               to  Quarterly  Report on Form 10-QSB for the quarter  ended March
               31, 2004.

10.69          Form of  Amendment  No. 1 to Warrant to  Purchase  Common  Stock,
               dated March 30, 2004, by and between Registrant and the holder to
               be set forth therein.  Incorporated  by reference to Exhibit 10.5
               to  Quarterly  Report on Form 10-QSB for the quarter  ended March
               31, 2004.

10.70          Form of Warrant,  dated March 30. 2004, issued in connection with
               extension  of  maturity  date of Secured  Convertible  Promissory
               Notes.  Incorporated  by  reference  to Exhibit 10.6 to Quarterly
               Report on Form 10-QSB for the quarter ended March 31, 2004.

10.71          Settlement  Agreement  and Mutual  Release,  dated as of June 16,
               2004, by and among the Registrant,  Altnet,  Inc., Detershan Pty.
               Ltd.,   Big  Seven   Entertainment,   LLC,  and  Michael   Toibb.
               Incorporated  by reference to Exhibit 10. to Quarterly  Report on
               Form 10-QSB for the quarter ended June 30, 2004.

10.72          Letter  Agreement  Regarding  Extension  of  Maturity  Date dated
               September 26, 2004, by and among the  Registrant  and the holders
               of Secured  Convertible  Promissory  Notes of the  Registrant set
               forth on Schedule 1 thereto.

10.73          Form of Amendment Number Five to Secured  Convertible  Promissory
               Note  originally  dated May 23, 2001,  dated  September 26, 2004,
               between the Registrant and the holder to be set forth therein.

10.74          Form of Amendment Number Four to Secured  Convertible  Promissory
               Note  originally  dated  December 19, 2001,  dated  September 26,
               2004,  between  the  Registrant  and the  holder  to be set forth
               therein.


                                      (vi)
<PAGE>


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

10.75          Form of Amendment  No. Three to Warrant to Purchase  Common Stock
               originally  dated May 23, 2001,  dated September 26, 2004, by and
               between Registrant and the holder to be set forth therein.

10.76          Form of  Amendment  No. Two to Warrant to Purchase  Common  Stock
               originally  dated December 19, 2001, dated September 26, 2004, by
               and between Registrant and the holder to be set forth therein.

10.77          Form of Amendment No. One to Warrant to Purchase Common Stock
                originally  dated March 30, 2004,  dated  September 26, 2004, by
                and between Registrant and the holder to be set forth therein.

10.78          Form of  Amendment  No. One to Warrant to Purchase  Common  Stock
               originally  dated October 4, 2002,  dated  September 26, 2004, by
               and between Registrant and the holder to be set forth therein.

14.1           Code of Ethics.  Incorporated  by  reference  to Exhibit  14.1 to
               Annual  Report on Form  10-KSB  for the year ended  December  31,
               2003, and the amendments thereto.

21.1           Subsidiaries. Incorporated by reference to Exhibit 21.1 to Annual
               Report on Form 10-KSB for the year ended  December 31, 2003,  and
               the amendments thereto.

23.1           Consent of Vazquez & Company, LLP.

23.2           Consent of BDO Seidman, LLP.

24.1           Power of Attorney (included on signature page).

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

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

32.1           Certificate of Chief Executive Officer and Acting Chief Financial
               Officer  pursuant  to Rule  13a-14(b)  under the  Securities  and
               Exchange Act of 1934, as amended.
----------
* Indicates a management contract or compensatory plan.


                                     (vii)