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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, 2003

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

                         COMMISSION FILE NUMBER 001-14480

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

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

                    6355 TOPANGA CANYON BOULEVARD, SUITE 520
                        WOODLAND HILLS, CALIFORNIA 91367
              (Address of Principal Executive Offices and Zip Code)

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

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

                                                   NAME OF EACH EXCHANGE
               TITLE OF EACH CLASS                  ON WHICH REGISTERED
               -------------------                  -------------------

                                      None

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

                          Common Stock, $.001 par value

         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, 2003 were
$5,655,000.

         At March 10, 2004, the aggregate  market value of the voting stock held
by non-affiliates of the issuer was $4,448,659.

         At March 10, 2004,  the issuer had  41,925,610  shares of Common Stock,
$0.001 par value, issued and outstanding.

         Transitional Small Business Disclosure Format (check one):

                                 Yes [_]   No [X]

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions  of the  issuer's  Proxy  Statement  with  respect to its 2004
Annual Meeting of  Stockholders  are  incorporated by reference into Part III of
this Report.



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                      BRILIANT 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, Related Stockholder Matters
              and Small Business Issuer Purchases of Equity Securities.      10
Item 6.       Management's Discussion and Analysis of Financial
              Condition and Results of Operations......................      13
Item 7.       Financial Statements

              Report of Independent Certified Public Accountants.......      31
              Consolidated Balance Sheet...............................      32
              Consolidated Statements of Operations and Comprehensive
              Loss.....................................................      33
              Consolidated Statements of Stockholders' Deficit.........      34
              Consolidated Statements of Cash Flows....................      35
              Notes to Consolidated Financial Statements...............      37

Item 8.       Changes in and Disagreements with Accountants on
              Accounting and Financial Disclosure......................      58
Item 8A.      Controls and Procedures..................................      58


PART III

Item 9.       Directors and Executive Officers of the Registrant.......      58
Item 10.      Executive Compensation...................................      58
Item 11.      Security Ownership of Certain Beneficial Owners and
              Management and Related Shareholder Matters...............      58
Item 12.      Certain Relationships and Related Transactions...........      58
Item 13.      Principal Accountant Fees and Services...................      59
Item 14.      Exhibits, Financial Statement Schedules and Reports
              on Form 8-K..............................................      59


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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 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.

         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.


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

         Licensing and other  services  revenues are derived from our sublicense
of rights to the TruNames patent,  business  development  services,  and payment
processing  services.  Under the terms of our patent  sublicense  agreement with
Sharman Networks, we recognize sublicense payments as revenue on a monthly basis
as earned. We generate fee income for performing business  development  services
for Sharman  Networks in accordance  with an agreement.  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 on our  efforts.  We also  generate  fees from
processing payments for the purchase of digital content using the Altnet payment
processing gateway.

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

         We are a Delaware  corporation  that was incorporated in July 1996. Our
executive  offices  are located at 6355  Topanga  Canyon  Boulevard,  Suite 520,
Woodland Hills,  California  91367,  and our telephone number is (818) 615-1500.
Information on our web sites,  www.brilliantdigital.com and www.altnet.com, does
not constitute part of this report.

SIGNIFICANT DEVELOPMENTS IN 2003

         In June 2003, we entered into a Joint Enterprise Agreement with Sharman
Networks  Limited  which  memorialized  and  expanded  upon  our  existing  oral
agreement.   Under  this  agreement,  we  act  as  Sharman  Networks'  exclusive
representative  for the sale;  license and/or other  commercial  exploitation of
index search results displayed on or otherwise  accessed using Sharman Networks'
Kazaa Media Desktop (KMD)  software  application  in response to end user search
requests.  We were also granted 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.  We will
share in revenues derived from index search results and the browse channels with
Sharman Networks.

         In April 2003, we 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 our 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 our Altnet  peer-to-peer  based
content distribution network. The search toolbar is bundled and distributed with
the "Altnet Loyalty Points Manager," our point's  management  software  program.
The agreement also provides for ongoing payments  between the parties,  based on
the success in distributing the toolbar and their performance.


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         In May 2003, Altnet entered into a license to use Joltid Ltd.'s Content
Distribution Environment peer-to-peer computer program,  commonly referred to as
PeerEnabler.  In exchange for the license,  we agreed to pay Joltid a guaranteed
monthly fee based on a percentage of revenues  earned from the  exploitation  of
the licensed rights, subject to a maximum aggregate amount.

         In June 2003, we 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 our  services,  we will be paid a  percentage  of revenue
Streamwaves  receives  from sales of its content to Altnet  users.  We will also
provide  Streamwaves and its customers with online payment  processing  services
for a transaction  fee. We 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.

         In September 2003, we entered into a one-year  commercial  distribution
agreement  with  MetaMachine,  Inc.,  developer of Overnet and eDonkey 2000, two
leading  peer-to-peer  networks.  In December 2003, we entered into a commercial
distribution  agreement with Grokster,  Ltd.,  developer of the Grokster leading
file sharing program.  Both of these agreements provide for Altnet to distribute
secure  music,  video,  software  and  games,  on behalf of  artists  and rights
holders,  to users of these file sharing  applications.  These distributors will
integrate our Altnet  TopSearch  technology  with their  software  applications,
which will give  preferential  placement of Altnet  files in the search  results
displayed to users of the  MetaMachine  and Grokster  programs.  MetaMachine and
Grokster  will  also   incorporate   the  Altnet  payment   gateway  into  their
applications,  which will  allows  their users to simply and  securely  purchase
Altnet  files.  We will  receive a  percentage  of revenues  generated  from the
distribution  and sale of  Altnet  files to  users  of  these  popular  software
applications.

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 the Altnet service 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 recently completed  distribution  agreements with Grokster and
MetaMachine  will increase the  distribution of our  peer-to-peer  technology to
users of those file sharing applications.

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


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these users upon request in accordance  with the  parameters  set by the content
owner,  including,  for  instance,  the price at which  they want to sell  their
content  if the  content  owner  desires to offer its media  files for sale.  To
protect the content owner's files against infringement, we "wrap" each file with
DRM  technology  prior to  making  the  file  available  to  Altnet  users.  DRM
technology  controls  how  the end  user  can  access  and  use  the  file  once
downloaded. We charge the content owner a placement or distribution fee based on
one or more of the  following:  (i) a negotiated  fee for each file  downloaded,
(ii) a negotiated  fee for each license issued once the end user tries to "play"
the file the  first  time  (after a file has been  downloaded),  and/or  (iii) a
negotiated  percentage of the sale price of such file, to the extent the file is
paid for by the end user.

         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 Fasttrack  network.  Tens of millions of search requests each day
are being made using the KMD by users  worldwide.  These search  requests can be
accessed  by Altnet,  and  pursuant  to our  agreement  with  Sharman  Networks,
relevant Altnet search results are displayed in the KMD to 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 three positions  within the search results page of the KMD
                  and in every  fourth  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  in
                  multiple  languages 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  all DRM  systems to enable use of our
                  network by a broad base of content owners and their technology
                  partners; and

         o        Leveraging  our  search   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.


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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.  In 2003 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 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;

         o        content  oriented web sites with targeted  traffic  seeking to
                  sell content; and

         o        mobile and  wireless  companies  seeking to provide  customers
                  with content via wireless devices.

         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 via our Altnet
peer-to-peer technology.

SALES AND MARKETING OF ALTNET SERVICES TO CONTENT OWNERS

         We have engaged outside  business  development  professionals to 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 in multiple languages.  We
have had early success with using consultants, and will employ an internal sales
staff when our financial resources permit.

         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. 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, 2003,  we had  contracts,  either  directly or through  third party
aggregators and  distributors,  to provide download services to approximately 35
independent music labels, 12 video and film companies, 50 PC game developers and
publishers,  and 50 software  developers and  publishers,  offering to consumers
approximately  2,700 downloadable media files and approximately  5,000 streaming
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.


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         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 a 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.

         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


                                        6
<PAGE>


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  associated to that user's
computer,  are applied to the transaction.  Within the Altnet Back Office,  file
transactions  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  intend  to  expand  our  payment  gateway  to  offer  users
alternative payment methods, including charging for downloaded files directly to
a  user's   telephone  bill,   pre-paid  phone  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,  Overnet,  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, as evidenced by Sharman Networks' statements that over 300 million copies
of its KMD application  have been downloaded by end users, and that at any given
time during each day,  over 3 million  users are  simultaneously  using the KMD.
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.  We saw a  significant  increase  in the  number of
companies offering music files for sale in 2003, and we expect to see that trend
level off in the near  future.  Some of the more  popular  sites that make music
files  available for sale are iTunes,  Napster,  and Rhapsody.  Other  companies
selling  music  downloads  include  BuyMusic.com, Liquid Audio,  Listen.com  and
MP3.com.  These  businesses  offer a combination  of monthly  subscriptions  and
payments  per  download.  Aside  from the  music  business,  numerous  sites are
available on the Internet to users who wish to download  movies.  These  include
Movies.com  and  CinemaNow.com.  Typically  movie files are sold on an ala-carte
basis at a pre-set price.  Also, many of the large Internet portal sites such as
Yahoo! and


                                       7
<PAGE>


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, FullAudio and
Centerspan Communications  Corporation 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  employ  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.

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 partners 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; and

         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.

RESEARCH AND DEVELOPMENT

         In  fiscal  years  2003 and  2002,  we  spent  $394,000  and  $444,000,
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 services interfaces to media partners,  payment
                  processor  partners  and points  redemption  partners to allow
                  Altnet's servers to communicate with our partner's  servers to
                  provide integrated billing, customer relations management, and
                  reporting services.

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

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


                                        8
<PAGE>



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

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

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

         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, 2003,  we had 16 full-time  employees,  of which 3 were
engaged  in  research  and   development,   2  in   production,   5  in  general
administration and finance and 6 in sales,  marketing and business  development.
None of our  employees  are covered by a  collective  bargaining  agreement.  We
consider our  relationship  with our employees to be good. We currently  utilize
the  services of 7  independent  consultants,  4 in software  development,  2 in
administrative  and  business  development  roles and 1 in sales  and  marketing
pursuant to contractual  relationships.  Twelve  employees,  including the Chief
Financial  Officer and the Senior Vice  President  of Business  Development  are
based in  Woodland  Hills,  California.  Four  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 Woodland Hills, California and are
leased from Toibb  Enterprises  ("Toibb"),  an entity owned by Harris  Toibb,  a
secured debt holder and  shareholder  in the  Company.  In  September  2003,  we
renegotiated  our  lease,  to occupy  new space in the same  building.  This new
five-year  lease  commenced in  September  2003,  with annual lease  payments of
approximately $92,000.

         Our research and  development is conducted in Australia,  and our Chief
Executive Officer resides their. In Australia,  we entered into a two-year lease
in February 2003 with annual lease payments of approximately $42,000.

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 KMD and therefore liable for the alleged copyright infringement
occasioned by its  development  and  distribution.  The  plaintiffs  are seeking
damages  under  the  Australian  Copyright  Act of 1968,  recovery  of costs and
interest,  and a permanent  injunction  restraining  us from  making  copies of,
communicating to the public,  or distributing  their sound recordings  without a
license.  We  believe  these  allegations  are  without  merit,  and  intend  to
vigorously defend against these claims.

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 2003.


                                       9
<PAGE>


                                     PART II

ITEM 5.  MARKET  FOR  COMMON  EQUITY,  RELATED  STOCKHOLDER  MATTERS  AND  SMALL
         BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

COMMON STOCK

         During 2003,  our Common Stock  traded on the American  Stock  Exchange
under the  symbol  "BDE."  The  following  table  sets  forth,  for the  periods
indicated, the high and low sales prices for the Common Stock as reported by the
American Stock Exchange:

                                                            HIGH           LOW
                                                            ----           ---
         YEAR ENDED DECEMBER 31, 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

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

         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 trading on the Over
the Counter Bulletin Board (OTCBB), with a new stock symbol of "BDEI". The OTCBB
is a regulated  quotation  services 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 10,  2004,  the  closing  sales  price of the Common  Stock as
reported on the OTCBB was $0.21 per share. As of March 10, 2004,  there were 236
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.


                                       10
<PAGE>


EQUITY COMPENSATION PLAN INFORMATION

         The following table sets forth certain information regarding our equity
compensation plans as of December 31, 2003.

<TABLE>
<CAPTION>
                         NUMBER OF SECURITIES TO     WEIGHTED-AVERAGE         NUMBER OF SECURITIES
                         BE ISSUED UPON EXERCISE     EXERCISE PRICE OF       REMAINING AVAILABLE FOR
                         OF OUTSTANDING OPTIONS,   OUTSTANDING OPTIONS,   FUTURE ISSUANCE UNDER EQUITY
                           WARRANTS AND RIGHTS      WARRANTS AND RIGHTS        COMPENSATION PLANS
----------------------   -----------------------   --------------------   ----------------------------
<S>                            <C>                         <C>                     <C>
Equity compensation
plans approved by
security holders......          6,359,000                 $ 0.94                   13,395,375
Equity compensation
plans not approved by
security holders......         35,818,804                  $0.36                       --
Total.................         42,177,804                  $0.45                   13,395,375
</TABLE>


MATERIAL  FEATURES  OF  INDIVIDUAL  EQUITY  COMPENSATION  PLANS NOT  APPROVED BY
STOCKHOLDERS

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

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

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

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

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

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

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

         In October 2002, we issued to Kinetech, Inc. warrants to purchase up to
5,000,000 shares of our common stock at an exercise price of $0.001 per share as
consideration  for a patent  license  agreement.  The warrants  have a term of 6
years.


                                       11
<PAGE>


         In June  2003,  we issued  to  Sharman  Networks  Limited  warrants  to
purchase up to  14,000,000  shares of our common  stock at an exercise  price of
$0.6096  per share in  connection  with,  and as partial  consideration  for the
rights  granted to us in, the Joint  Enterprise  Agreement  entered into in June
2003 between Sharman  Networks Limited and our Altnet  subsidiary.  The warrants
have a term of five years.

         In January  2003,  we issued to Lee Jaffe  warrants  to  purchase up to
165,000  shares of our common  stock at an exercise  price of $0.18 per share as
consideration for consulting services rendered to the company. The warrants have
a term of 4 years.

         In February  2003, we issued to Scheinrock  Advisory  Group warrants to
purchase up to 350,000  shares of our common stock at an exercise price of $0.14
per share as consideration for consulting services rendered to the company.  The
warrants have a term of 5 years.

         In August  2003,  we issued to Ziffren,  Brittenham,  Branca,  Fischer,
Gilbert-Lurie  & Stiffelman  warrants to purchase up to 5,000,000  shares of our
common stock at an exercise price of $0.54 per share as consideration  for legal
and consulting  services rendered to the company.  The warrants have a term of 5
years

         In May  2003,  we issued to Mark Dyne  options  to  purchase  8,208,500
shares or our common  stock at an exercise  price of $0.12 per share as deferred
compensation for services rendered to us as chief executive officer.

         In May  2003,  we  issued  to  Kevin  Bermeister  options  to  purchase
2,186,018  shares or our common stock at an exercise price of $0.12 per share as
deferred compensation for services rendered to us as president.

RECENT SALES OF UNREGISTERED SECURITIES

         In  December  2003,  we issued  135,983  shares of our common  stock to
Michael  Toibb.  The shares were issued  pursuant  to the  cashless  exercise of
warrants  held  by Mr.  Toibb  which  he  acquired  in  April  2002.  Mr.  Toibb
represented  to us that he was an  "accredited  investor"  within the meaning of
Rule 501 of  Regulation  D under  the  Securities  Act of 1933,  and that he was
purchasing  the  securities  for  investment  and  not  in  connection   with  a
distribution  thereof. The issuance and sale of these securities was exempt from
the  registration  and prospectus  delivery  requirements  of the Securities Act
pursuant to Section 4(2) of the  Securities  Act as a transaction  not involving
any public offering.


                                       12
<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, 2003
and December 31, 2002.  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.  At the time of this  transaction,  the only  significant  asset owned by
Altnet was its technology.  When we initially formed Altnet,  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.

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

         Licensing and other  services  revenues are derived from our sublicense
of rights to the TruNames patent,  business  development  services,  and payment
processing  services.  Under the terms of our patent  sublicense  agreement with
Sharman Networks,  we recognize sublicense revenue on a monthly basis as earned.
We generate fee income for performing business  development services for Sharman
Networks in accordance  with an agreement.  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


                                       13
<PAGE>

percentage  of  the  gross  revenue   received  by  Sharman  Networks  for  each
transaction  entered  into  based on our  efforts.  We also  generate  fees from
processing payments for the purchase of digital content using the Altnet payment
processing gateway.

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

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, however, we have made significant progress in
2003 towards our goal of proving the viability of the business  model.  The most
significant  developments affecting our financial performance in 2003 related to
our agreement with The Excite Network,  our patent  sublicensing  agreement with
Sharman Networks,  the accelerated  amortization of deferred revenue  associated
with e-New Media,  and our evaluation of long-lived  assets for impairment.  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 200% from $1,885,000 for the year ended December
31, 2002 to  $5,655,000  for the year ended  December 31, 2003.  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
on-going  revenues  for  2004.  We  expect  the  number  of  My  Search  toolbar
installations to continue through 2004. Our patent  sublicensing  agreement with
Sharman  Networks  provides  for a fixed  monthly  fee and  therefore  will  not
fluctuate in 2004. In the case of our software  licensing  agreement  with e-New
Media, e-New Media paid us a non-refundable  advance for rights to our animation
software  toolset to produce  animated  content and to resell the toolset within
specified  territories.  We  were  recognizing  this  advance  as  revenue  on a
straight-line basis over the five-year term of the agreement.  During the second
quarter of 2003, we determined that we had satisfied all our  obligations  under
the  terms of this  agreement  due to the fact  that  (1) we had  delivered  all
content and  technology  required  under the agreement and (2) we were no longer
producing content or updating the relevant technology. As a result, we reflected
the remaining unamortized advance of $2,097,000 as other income in the Operating
Statement.  In 2003,  amortized amounts through June 2003 totaling $459,000 were
recognized as Distribution and technology revenue from a related party.

         Statement of Financial  Accounting Standards (or FAS) 142 "Goodwill and
other Intangible  Assets" and FAS 144 "Accounting for the Impairment or Disposal
of Long-Lived  Assets" require 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.  We assess the  recoverability  of long-lived assets
whenever events or changes in business  circumstances indicate that the carrying
value of an asset may not be recoverable.  During the fourth quarter of 2003, in
connection with this review,  we obtained an independent  valuation to assist us
in evaluating our intangible  assets for impairment in accordance  with FAS 144.
An  impairment  loss is  recognized  when the sum of the  expected  undiscounted
future net cash flows over the remaining  useful life, is less than the carrying
amount of the asset.  Prior to the  impairment  evaluation  we  capitalized  and
reflected on our balance sheet as assets;  Purchased Technology  associated with
our purchase of additional shares of our Altnet subsidiary from Joltid,  License
Rights  associated  with our  PeerEnabler  license  from  Joltid  and our  Joint
Enterprise  Agreement  signed with  Sharman  Networks,  and  Deferred  Marketing
Expense associated with the representation  agreement with Ziffren,  Brittenham,
Branca, Fischer, Gilbert-Lurie & Stiffelman. As a result of the


                                       14
<PAGE>


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)
                                                 ===============

         We expect to devote a  substantial  portion of our resources in 2004 to
further our efforts in the area of content  licensing.  In 2003, 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 2004.
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 2003, we saw a significant increase in the number of active users of
the KMD, and  correspondingly  the number of consumers to whom we can market our
content.  We also  expanded  our  distribution  network  with  the  addition  of
distribution  partners  The Excite  Network,  Inc.,  developer  of the My Search
toolbar,  MetaMachine,  Inc., developer of leading peer-to-peer networks Overnet
and eDonkey 2000, and Grokster,  Ltd., developer of leading peer-to-peer network
Grokster.  We expect these  additions will add a significant  number of users to
the Altnet network 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 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.

         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,
2003,  had  negative   working  capital  of   approximately   $5,763,000  and  a
stockholders'   deficit  of  approximately   $4,594,000.   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 2004, may not be sufficient to fund our anticipated
expenditures.  Consequently,  we may require additional equity or debt financing
during  2004,  the amount  and timing of which will  depend in large part on our
spending program. The report of our Independent Certified Public Accountants for
the December 31, 2003  financial  statements  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:


                                       15
<PAGE>


         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; and

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

         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,  content  oriented web sites with  targeted  traffic  seeking to sell
content,  and mobile and wireless  companies  seeking to provide  customers with
content via wireless devices.

         We intend to  continue  our pursuit of  additional  capital to fund our
expansion  efforts and to pay both our secured debt holders and unsecured  trade
creditors. At December 31, 2003, we were indebted to our secured note holders in
the amount of $4,033,000,  and our trade payables,  including  related  parties,
were  $5,179,000.  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.  104 (SAB  104) and  AICPA
Statement  of Position  97-2 (SOP 97-2),  we  recognize  revenue when all of the
following  criteria are met: (1) persuasive  evidence of an arrangement  exists,
(2) delivery has occurred or services have been rendered, (3) the seller's price
to the buyer is fixed or  determinable,  and (4)  collectibility  is  reasonably
assured.  In the case of each of our product and  service  lines we  establish a
contract or insertion order with our customers with specifics for  requirements,
a


                                       16
<PAGE>


fixed price, a delivery schedule, and terms for payment.  Unless cash is paid in
advance,  our  receivables  are  recorded  as revenue is  earned.  We  regularly
evaluate  the  collectibility  of our  receivables  based  on a  combination  of
factors.  When a customer's  account becomes past due, we initiate dialogue with
the customer to determine the cause.  If we determine  that the customer will be
unable to meet its  financial  obligations  to us, due to a  bankruptcy  filing,
deterioration in the customer's operating results or financial position or other
material events  impacting their business,  we record a specific reserve for bad
debt to reduce the related  receivable  to the amount we expect to recover given
all  information  presently  available.  If  circumstances  related to  specific
customers  change,  our estimates of the  recoverability  of  receivables  could
materially  change.  We do not have material  exposure to any single customer or
group of  customers  at this time.  At December  31,  2003,  we had a reserve of
$73,000 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 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 200% from  $1,885,000 for the year ended
December 31, 2002 to $5,655,000 for the year ended  December 31, 2003.  Revenues
by groups of similar service were as follows:

               REVENUES                 2002         2003      NET CHANGE
     -----------------------------   ----------   ----------   ----------

     Marketing services ..........   $  477,000   $2,926,000         513%
     Licensing and other services    $   74,000   $1,758,000       1,376%
     Distribution and technology .   $  917,000   $  459,000         (50%)
     revenue from related party
     Digital content .............   $  417,000   $  512,000          23%

                                     ----------   ----------   ----------
     Total Revenue ...............   $1,885,000   $5,655,000         200%
                                     ==========   ==========   ==========

         Marketing  services  revenue  increased  in  2003  to  $2,926,000  from
$477,000 in 2002,  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 2003 to  $1,758,000  from $74,000 in
2002, due primarily to increased  patent  sublicense  revenue.  Digital  content
revenue  increased from $417,000 in 2002, to $512,000 in 2003 as a result of the
increase  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 compared to $917,000 in 2002,  as we
fulfilled  all of our  obligations  under our contract  with e-New Media Company
during 2003.

         COST OF REVENUES. Cost of revenues increased from $247,000 for the year
ended December 31, 2002 to $755,000 for the year ended  December 31, 2003.  This
represents an increase of $508,000, or 206%, which is primarily due to increased
bandwidth  costs for  increased  distribution  of digital  files over the Altnet
network, increased costs associated with the implementation and operation of our
payment  gateway   services,   and  increased   royalty  payments  for  licensed
technology.

         SALES AND  MARKETING.  Sales and marketing  expenses  increased by 207%
from $394,000 for the year ended  December 31, 2002 to  $1,211,000  for the year
ended December 31, 2003. The increase of $817,000 in


                                       17
<PAGE>


2003 was primarily attributable to increases of $453,000 of commissions paid for
securing  new business  and  $227,000 to support our  marketing  efforts for the
Altnet network.

         GENERAL  AND  ADMINISTRATIVE.   General  and  administrative   expenses
primarily  include  salaries  and  benefits  of  management  and  administrative
personnel,  rent,  insurance  costs,  professional  fees  and  non-cash  warrant
expense. General and administrative expenses increased $2,829,000,  or 87%, from
$3,256,000 for the year ended December 31, 2002 to $6,085,000 for the year ended
December  31,  2003.  This  increase is largely  attributable  to an increase of
$1,500,000 in non-cash  warrant expense,  related to warrants,  described below,
issued to Sharman Networks, Kinetech and Ziffren,  Brittenham,  Branca, Fischer,
Gilbert-Lurie & Stiffelman.

         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 warrants as  determined 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 initial value of these  warrants
was determined to be $2,951,000,  based on a  Black-Scholes  model. 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.

         Under the terms of our  Patent  License  Agreement  with  Kinetech,  we
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,  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  recognizes  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 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 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 and will be amortized over the remaining useful life
of the patent license agreement,  or 3 years. During the year ended December 31,
2003, we recorded $349,000 of amortization expense related to the patent.

         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 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 our 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
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.

         In addition, during 2003 we increased our efforts to support our Altnet
business, which resulted in increases in payroll expense of $250,000, consulting
expense of $290,000,  legal expense of $150,000, and public relations and travel
expense of $235,000.

         RESEARCH AND  DEVELOPMENT.  Research and development  expenses  include
salaries and benefits of personnel  conducting research and development relating
to our Internet web site, payment gateway and related information database,  and
the development of the Altnet Peer Points Manager  software  application.  These
costs  decreased  from $444,000 for the year ended December 31, 2002 to $394,000
for the year ended December 31, 2003.


                                       18
<PAGE>


         DEPRECIATION  AND   AMORTIZATION.   Depreciation   expense  relates  to
depreciation of fixed assets such as computer  equipment and cabling,  furniture
and fixtures and leasehold improvements. These fixed assets are depreciated over
their estimated useful lives (up to five years) using the straight-line  method.
Amortization  expense is related to the  amortization  of  purchased  technology
associated with our acquisition of an additional  ownership  interest in Altnet,
Inc.  from Joltid,  Ltd. in June 2003,  as well as the  amortization  of license
rights  associated  with  agreements  signed in previous  years.  We  recognized
$402,000  of  amortization  expense  during the year ended  December  31,  2003.
Depreciation  expense  was  $128,000  for the year ended  December  31,  2002 as
compared to $37,000 for the year ended December 31, 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;  Purchased  Technology  associated  with our  purchase of  additional
shares of our Altnet subsidiary from Joltid , License Rights associated with the
PeerEnabler  license from Joltid and 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) was as follows:

                                                   2002               2003
                                              ------------       -------------
         Other income.....................    $     --           $   2,097,000
         Interest income..................          --                  10,000
         Interest expense.................      (3,600,000)         (2,687,000)
                                              ------------       -------------
            Total.........................    $ (3,600,000)      $    (580,000)
                                              ============       =============

         Other income and expense decreased from a net expense of $3,600,000 for
the year ended December 31, 2002 to a net expense of $580,000 for the year ended
December 31, 2003.  The decrease from 2002 to 2003 of  $3,020,000  was primarily
the  result  the  recognition  of  $2,097,000  of  deferred  revenues  under the
agreement  with e-New  Media,  entered  into in February  2000.  As part of this
agreement,  we received advances of $2,500,000 that we were recognizing over six
years, the term of the agreement.  In June 2003, we determined 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 the  agreement as Other
Income. In addition,  there was a $913,000  reduction in interest expense during
2003.  For the year ended  December 31, 2002,  the expense was due to a non-cash
debt discount  expense of $3,237,000  and accrued  interest  expense of $363,000
incurred  in  connection  with our secured  indebtedness.  During the year ended
December 31, 2003, we amortized non-cash warrant expense of $2,170,000,  related
to the extension of this secured indebtedness.

         NET LOSS ON DISCONTINUED  OPERATIONS.  Brilliant Interactive Ideas Pty.
Ltd., our Australian-based  production company, employed a team of animators and
programmers  dedicated to animation  production.  During 2002,  we  discontinued
operations  at  Brilliant  Interactive  Ideas  Pty.  Ltd.  because  of the under
utilization  of animators and  programmers.  Following the closure,  we retained
individual  consultants on a project-by-project  basis in 2002 to complete minor
commitments.  The costs  associated  with the  consultants  were  immaterial and
ceased in 2002. We also discontinued operations at Digital Hip Hop, our majority
owned subsidiary,  in 2002. Digital Hip Hop and Brilliant Interactive Ideas Pty.
Ltd. have been  reported on the 2002  consolidated  statement of operations  and
comprehensive loss as discontinued  operations.  In accordance with FASB 144, we
incurred a net loss of $165,000 related to the closure of these businesses.


                                       19
<PAGE>


LIQUIDITY AND CAPITAL RESOURCES

         As of  December  31,  2003,  our  cash  and  cash  equivalents  totaled
approximately  $880,000. This is an increase of $644,000 as compared to December
31,  2002.  As of  December  31,  2003;  we had a  working  capital  deficit  of
$5,763,000.  Included in this working  capital  deficit are accounts  payable of
$516,000 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 and believe that,  if we are  successful in raising
additional capital, this may result in improved operating results.  There can be
no assurance,  however,  that with any additional  financing,  higher cash flows
will be generated by operations.

         CASH FLOW

         Cash flows from operating,  financing and investing  activities for the
twelve months ended  December 31, 2003 and 2002 are  summarized in the following
table:

               ACTIVITY:                      2002             2003
         --------------------------------------------------------------

         Continuing Operations ......     $(2,660,000)     $   820,000
         Investing ..................            --            (86,000)
         Financing ..................       2,600,000          (60,000)

         During the twelve months ended December 31, 2003, we had a net increase
in cash of $644,000.  The net cash provided by operating  activities of $820,000
during the twelve months ended December 31, 2003 was primarily the net result of
an increase in accounts  payable and accrued expenses of $3,586,000 and non-cash
expenses  of  $10,641,000.  Non-cash  expenses  were  related  to the  effect of
impairment charges on intangible assets,  warrants issued,  warrant amortization
and the effect of  amortization  of debt  discount on capital  financing.  These
amounts  were  offset by the net loss of  $9,518,000,  the  decrease in deferred
revenue of $2,412,000  primarily associated with a change in accounting estimate
related to the e-New Media agreement of $2,097,000, and the increase in accounts
receivable of $1,518,000.

         We expect a  significant  use of cash  during  2004  fiscal  year as we
continue to develop the business  opportunity for Altnet,  Inc. We are currently
generating  sufficient  cash  flow  on a  monthly  basis  to  meet  our  monthly
obligations;  however  we are not  generating  sufficient  cash  flow to pay our
existing current liabilities and secured debt which is due in September 2004. We
are working with our secured debt holders and unsecured creditors to restructure
our obligations, however there can be no guarantee that we will be successful in
our efforts.  Consequently,  we may require  additional equity or debt financing
during  2004,  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 are
secured  debt  holders  as their  debt  matures  or trade  creditors  under  our
contractual terms with them, develop or enhance our products and services,  take
advantage of business opportunities or respond to competitive pressures,  any of
which could have a material adverse effect on our business,  financial condition
and results of  operations,  and would most likely  result in our having to file
for bankruptcy protection under the Bankruptcy Code.

         CONTRACTUAL OBLIGATIONS

         The following  summarizes our  contractual  obligations at December 31,
2003 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:


                                       20
<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 ..   $  900,000   $  360,000   $  540,000   $     --     $     --
Operating lease commitments   $  491,000   $  134,000   $  188,000   $  169,000   $     --
                              ----------   ----------   ----------   ----------   ----------
Total .....................   $5,424,000   $4,527,000   $  728,000   $  169,000   $     --
                              ==========   ==========   ==========   ==========   ==========
</TABLE>

         At December 31, 2003,  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 $0.1203 per share, for a total of 31,141,103 shares of
our common stock at December 31, 2003. In connection  with this  financing,  the
note holders received warrants to purchase up to 44,542,718 shares of our common
stock  at  an  exercise  price  of  $0.1353  per  share.  In  October  2002,  in
consideration  of an  agreement  to  extend  the  maturity  date of the  secured
indebtedness  to December  31, 2003,  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.  In December 2003, in  consideration  of an
agreement to extend the maturity  date of the secured  indebtedness  to March 1,
2004, we paid the holders a $15,000  extension  fee, and increased the principal
amount of the indebtedness by $300,000 in payment of the note holders legal fees
and costs.  Finally,  in March 2004, in  consideration of an agreement to extend
the maturity date of the secured  indebtedness  to September 26, 2004, we 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  our
                  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  our   consolidated   statements  of  operations.
                  Non-cash   expenses   are  not  deducted   from   revenues  in
                  calculating Excess Cash.

RELATED PARTY TRANSACTIONS

         In June 2003, we entered into a Joint Enterprise Agreement with Sharman
Networks, our largest distributor and source of over 90% of our revenues, to act
as their exclusive  representative for the sale, license and/or other commercial
exploitation of its search  technology.  Under the terms of this  agreement,  we
issued  Sharman  Networks  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.  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 provide 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 initial value of
these warrants was determined to be $2,951,000,  based on a Black-Scholes model.
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 the current year. 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


                                       21
<PAGE>


$2,377,000 was written off as an impairment  charge.  As of December 31, 2003 we
have an outstanding accounts payable balance to Sharman Networks of $3,064,000.

         In May 2003,  we entered into a license to use rights to Joltid  Ltd.'s
Content  Distribution  Environment   peer-to-peer  computer  program,   commonly
referred to as PeerEnabler,  the most significant technological component of the
Altnet  network.  In  exchange  for the  license,  we  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.
We reflect  the  current  portion of the  guaranteed  payment of  $360,000  as a
current liability,  and the balance of the commitment of $540,000 as a long-term
liability.  We  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. We
paid Joltid  $221,700 for services  provided  during the year ended December 31,
2003,  have an  outstanding  trade  payable to them of $19,841  in  addition  to
guaranteed minimum payments of $900,000, as of December 31, 2003.

         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, 2003 and 2002, 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.

2003 FINANCING TRANSACTION

         In June 2003, we 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,  we issued warrants to purchase
up to  1,066,666  shares  of our  common  stock at an  exercise  price  equal to
$0.28125  per share,  expiring  in June  2006.  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
our common stock of 50.0%; and expected life of the warrants. The value of these
warrants was  determined to be $414,100.  We attributed 33% of the fair value of
the warrants of $134,900 to debt  discount,  which was fully  amortized over the
two-month  life of the note.  The  remaining  value of $279,200 was reflected as
prepaid  interest expense and was fully amortized over the two-month life of the
note. In August 2003, a holder of one of these notes in the principal  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,  we issued to the Note holder  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  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 3 years. The value of these warrants was determined to
be $48,476 and was expensed. The notes were paid in full during 2003.

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

                                       22
<PAGE>


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.

CAUTIONARY STATEMENTS AND RISK FACTORS

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

         THERE IS DOUBT ABOUT OUR ABILITY TO  CONTINUE  AS A GOING  CONCERN.  We
currently  have a number  of  obligations  that we are  unable  to meet  without
generating  additional  revenues  or raising  additional  capital.  If we cannot
generate  additional revenues or raise additional capital in the near future, we
may  become   insolvent.   As  of  December  31,  2003,  our  cash  balance  was
approximately  $880,000  and we had a working  capital  deficit  of  $5,763,000.
Historically,  we have  funded  our  capital  requirements  with debt and equity
financing.  Our ability to obtain additional equity or debt financing depends on
a  number  of  factors  including  our  financial  performance  and the  overall
conditions in our industry.  If we are not able to raise additional financing or
if such financing is not available on acceptable terms, we may liquidate assets,
seek or be  forced  into  bankruptcy,  and/or  continue  operations  but  suffer
material harm to our  operations and financial  condition.  These measures could
have a material adverse affect on our ability to continue as a going concern.

         WE HAVE A HISTORY OF LOSSES,  A NEGATIVE NET WORTH AND MAY NEVER ATTAIN
PROFITABILITY.  We have a limited operating history and realized a comprehensive
loss of  $9,517,000  for the  twelve  months  ended  December  31,  2003.  Since
inception, we have incurred significant losses and negative cash flow, and as of
December 31, 2003 we had an accumulated  deficit of $70.4 million. We anticipate
that we will continue to generate operating losses for the foreseeable future as
we fund operating and capital expenditures in the areas


                                       23
<PAGE>


of brand  promotion,  sales and  marketing,  administration,  and  research  and
development,  all principally  related to deployment of our Altnet  peer-to-peer
network  and  operating  infrastructure.  Additionally,  as of the  date of this
report, our current liabilities significantly exceed our current assets.

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

         WE HAVE A  SUBSTANTIAL  NUMBER  OF  OUTSTANDING  DERIVATIVE  SECURITIES
WHICH,  IF EXERCISED OR CONVERTED INTO COMMON STOCK,  WILL RESULT IN SUBSTANTIAL
DILUTION TO OUR  STOCKHOLDERS.  During 2001, we raised $3.0 million  through the
sale of convertible  promissory  notes and common stock purchase  warrants.  The
holders may convert the  promissory  notes,  which now mature on  September  26,
2004,  and accrued  interest,  at any time into shares of our common  stock at a
price of $0.1203 per share. The warrants issued with the promissory notes and as
consideration for several  extensions of their maturity date entitle the holders
to purchase up to an  aggregate of  73,787,612  shares of our Common Stock at an
exercise  price of  $0.1353375  per share on 44,542,718  shares,  at an exercise
price of $0.2091 on  25,226,028  shares,  and at an exercise  price of $0.15 per
share on 4,018,867  shares,  all which  warrants  expire on October 4, 2005. The
conversion  of the  promissory  notes and the  exercise  of the  warrants  would
increase  the number of shares  outstanding  and result in dilution to our other
stockholders.

         The conversion  price of the promissory notes and the exercise price of
warrants  to  purchase up to  44,542,718  shares of Common  Stock are subject to
reduction if we issue additional securities at a price below the then applicable
conversion  price or  exercise  price,  with  exceptions  for  certain  types of
securities  issuances.  If we issue  securities at a price below the  conversion
price or exercise price,  then the conversion price will be adjusted downward to
equal the price at which we sold the  additional  securities,  and the  exercise
price will be adjusted downward to equal 112.5% of that price. As a consequence,
if we trigger the adjustment  provision for the promissory notes, the holders of
the promissory  notes could convert them at a lower price,  which would increase
the  number of shares of Common  Stock  they  would  receive.  Similarly,  if we
trigger the adjustment  provision for the warrants,  the holders of the warrants
could  exercise the warrants to purchase a greater number of shares for the same
aggregate purchase price.

         The table  below sets  forth the  number of shares of our Common  Stock
that could be acquired by the holders upon  conversion of the  promissory  notes
and exercise of those  warrants whose exercise price is subject to adjustment if
we issue  additional  securities at a price below the then  applicable  exercise
price,  and the  percentages  of our  outstanding  Common  Stock that the shares
issued  upon  conversion  and  exercise  would  represent.  The  amounts  assume
conversion on the maturity date of the  promissory  notes on September 26, 2004,
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 $0.21 on March 10, 2004,  and on assumed  closing
share prices of $0.16,  $0.11 and $0.05,  which prices  represent a 25%, 50% and
75% decline,  respectively, in our March 10, 2004 closing share price. The table
assumes that we would issue  additional  securities  at these  prices,  and thus
trigger the price  adjustment  provisions of the notes and  warrants.  The table
also assumes that the warrants  would be exercised for cash and that the holders
would pay us the aggregate  exercise price of $6,028,300.  The  percentages  are
also based on  41,925,610  shares of our common stock  outstanding  on March 10,
2004.


                                       24
<PAGE>


Percentage Decline in                                     Percentage of
  November 3, 2003          Assumed        Shares of       Outstanding
    Closing Price        Closing Price    Common Stock    Common Stock
---------------------    -------------    ------------    ------------
         --                  $0.21*        77,562,967        64.9%
         25%                 $0.16*        77,562,967        64.9%
         50%                 $0.11         84,825,681        66.9%
         75%                 $0.05        186,616,498        81.7%

----------
* Based on the terms of the notes and  warrants,  if we sold  securities at this
share closing price the conversion  price of the notes and exercise price of the
warrants would be $0.1203 and $0.1353375 per share, respectively.

         Additionally,  during  2003,  we  issued  warrants  to  purchase  up to
20,808,938  shares of common  stock at  exercise  prices  ranging  from $0.14 to
$0.6096  per  share.  We  anticipate  that  during  2004,  we will 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 10, 2004,  the number of
shares  issued  and  outstanding,  as well as the  number of shares  that may be
issued in the future upon conversion of outstanding convertible promissory notes
and exercise of outstanding options and warrants:

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

Outstanding Common Stock ................      41,925,610           33.4%
Convertible Promissory Notes,
 with accrued interest ..................      31,628,289           25.2%
Outstanding Warrants(1) .................      26,458,210           21.1%
Outstanding Options .....................      25,492,418           20.3%
                                             -------------   -------------------
  Fully Diluted Shares of Common Stock(2)     125,504,527          100.0%

----------
1        For purposes of this table,  we have only  included  warrants  that are
         "in-the-money"  (the exercise  price of the warrants is below the price
         of our  common  stock),  and the  number  of  shares  of  common  stock
         underlying the outstanding warrants has been calculated on a "cashless"
         exercise  basis,  whereby  the  holder of each  warrant  receives  upon
         exercise a number of shares of common  stock with a value  equal to (i)
         the total value of the shares  underlying  the  warrants  LESS (ii) the
         aggregate  exercise price of the warrants,  and is calculated  based on
         the  closing  sales  price of our common  stock on the Over the Counter
         Bulletin Board on March 10, 2004, which was $0.21.
2        This number  excludes (i) 3,433,875  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 10, 2004, and (ii)
         20,670,639 shares underlying warrants that have exercise prices ranging
         from $0.22 to $0.6096 per share, and thus not "in-the-money."

         The following  table  illustrates  as of March 10, 2004,  the number of
shares  issued  and  outstanding,  as well as the  number of shares  that may be
issued in the future upon conversion of outstanding convertible promissory notes
and exercise of outstanding options and warrants. For the purposes of this table
we have included all warrants  whether they are  "in-the-money"  or not, and the
number of shares of common stock  underlying the  outstanding  warrants has been
calculated on a "paid-for"  exercise  basis,  whereby the holder of each warrant
receives upon exercise a number of shares of common stock equal to the number of
warrants held:


                                       25
<PAGE>


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

Outstanding Common Stock ................      41,925,610           19.1%
Convertible Promissory Notes, with
  accrued interest ......................      31,628,289           14.4%
Outstanding Warrants ....................     120,365,799           54.9%
Outstanding Options .....................      25,492,418           11.6%
                                             -------------   -------------------
  Fully Diluted Shares of Common Stock        219,412,116          100.0%

         IF WE  BECOME  INSOLVENT,  WE  WILL BE IN  DEFAULT  UNDER  OUR  SECURED
CONVERTIBLE  PROMISSORY  NOTES,  WHICH  COULD  RESULT IN OUR  OBLIGATION  TO PAY
IMMEDIATELY ALL AMOUNTS THEN OUTSTANDING UNDER THE NOTES. If we generally do not
pay,  or become  unable to pay,  our debts as such  debts  become  due,  we will
default  under  our  outstanding  Secured  Convertible  Promissory  Notes,  with
aggregate  principal and accrued interest and fees of $4,033,000 at December 31,
2003.  If a default  occurs,  all amounts owed to the holders of the notes would
immediately become due and payable.  If the debt becomes due before its maturity
in  September,  2004,  we  likely  will not have  sufficient  funds to repay the
indebtedness,  which will  entitle the  holders of the notes to exercise  all of
their rights and remedies,  including  foreclosure on all of our assets which we
pledged as collateral to secure repayment of the debt.

         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;

         o        changes in management;

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

         o        recommendations by securities industry analysts;

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

         o        short sales and hedging of our common stock.

         Additionally,  the  stock  market  has  experienced  extreme  price and
trading volume fluctuations that have affected the market price of securities of
many technology companies. These fluctuations have, at times,


                                       26
<PAGE>


been unrelated to the operating  performances  of the specific  companies  whose
stock is  affected.  The  market  price and  trading  volume of our stock may be
subject to these fluctuations.

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

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

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

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

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

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

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

RISKS RELATED TO OUR BUSINESS

         ALTNET IS AN UNPROVEN  BUSINESS  VENTURE  AND MAY  REQUIRE  SIGNIFICANT
CAPITAL TO BE  SUCCESSFULLY  implemented.  Our Altnet  peer-to-peer  business is
unproven and we cannot  guaranty  that it will be  financially  successful.  The
success of the business  will depend,  in part, on our ability to enter into end
user


                                       27
<PAGE>


agreements  with a sufficient  number of qualified  personal  computer owners to
allow the network to work efficiently and  effectively,  acceptance by corporate
customers of our services, the technical viability of the commercially available
digital rights management, or DRM, software we employ to protect the proprietary
content  that will  pass  through  the  Altnet  network  and  reside on  network
computers, acceptance of content offered through TopSearch, broad acceptance and
use of our  micro-payment  processing  system,  and our underlying  peer-to-peer
technology.  Additionally,  we do not have sufficient capital to internally fund
Altnet's development and operations. Consequently, the capital necessary to fund
Altnet and expand the  operations  will need to come from  outside  sources.  We
cannot make assurances  that  sufficient  capital will be available at all or on
terms acceptable to us to fund Altnet's development and operations.

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

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

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

         CURRENT LITIGATION AGAINST SHARMAN NETWORKS LIMITED MAY PREVENT FURTHER
DISTRIBUTION  OF OUR ALTNET  PEER-TO-PEER  SOFTWARE,  AND  ADVERSELY  AFFECT OUR
ABILITY TO SERVE BRILLIANT  BANNERS ON, AND DISTRIBUTE AND SELL DIGITAL FILES TO
USERS OF, THE KAZAA MEDIA DESKTOP.  A disruption in the  distribution of the KMD
or its use by  consumers  would  necessarily  adversely  impact  (1) the  future
distribution  of our  Altnet  software,  (2)  revenues  we derive  from  serving
Brilliant Banners on the KMD, and (3) Altnet's sale of authorized  digital files
to users of the KMD. For the twelve months ended December 31, 2003, we generated
approximately  90.9% of our total  revenues from  activities  dependent upon the
availability  of the KMD to  computer  users.  If there is a  disruption  in the
distribution  of the KMD or its use by consumers,  we may not be able to replace
this source of revenue in the short term, or at all. Sharman Networks,  the KMD,
and other peer-


                                       28
<PAGE>


to-peer  software  products,  currently  are the subject of  multiple  lawsuits,
including  METRO-GOLDWYN-MAYER  STUDIOS,  INC. ET. AL. V. GROKSTER LTD. ET. AL.,
filed in the United States District Court for the Central District of California
(Western Division) by twenty-eight  entertainment companies claiming that, among
other things,  the KMD  facilitates,  contributes  to and  encourages  copyright
infringement. To the extent that Sharman Networks is precluded from distributing
the KMD as a result of this  litigation,  our business and  financial  condition
could be materially  and adversely  affected.  While we understand  that Sharman
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 KMD and therefore
liable for the alleged copyright infringement  occasioned by its development and
distribution.  The plaintiffs are seeking damages under the Australian Copyright
Act of  1968,  recovery  of  costs  and  interest,  and a  permanent  injunction
restraining  us  from  making  copies  of,   communicating  to  the  public,  or
distributing  their sound recordings  without a license.  While we believe these
claims are  without  merit,  if we are unable to 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.

         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.


                                       29
<PAGE>


ITEM 7.  FINANCIAL STATEMENTS

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                            PAGE
                                                                            ----
CONSOLIDATED FINANCIAL STATEMENTS OF BRILLIANT DIGITAL ENTERTAINMENT, INC.

Report of Independent Certified Public Accountants.......................     31

Consolidated Balance Sheet as of December 31, 2003.......................     32

Consolidated Statements of Operations and Comprehensive
    Loss for the years ended December 31, 2002 and 2003..................     33

Consolidated Statements of Stockholders' Deficit for the
    years ended December 31, 2002 and 2003...............................     34

Consolidated Statements of Cash Flows for the years ended
    December 31, 2002 and 2003...........................................     35

Notes to Consolidated Financial Statements...............................     37


                                       30
<PAGE>


               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS





To the Board of Directors and
Stockholders of Brilliant Digital Entertainment, Inc.
Woodland Hills, California


         We  have  audited  the  accompanying   consolidated  balance  sheet  of
Brilliant  Digital  Entertainment,  Inc. as of December 31, 2003 and the related
consolidated  statements of operations  and  comprehensive  loss,  stockholders'
deficit,  and cash flows for each of the two years in the period ended  December
31, 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 audits.

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

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material  respects,  the financial  position of Brilliant
Digital  Entertainment,  Inc.  at  December  31,  2003  and the  results  of its
operations  and its cash  flows  for each of the two years in the  period  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


                                       31
<PAGE>


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

                                                                    DECEMBER 31,
                                                                         2003
                                                                       --------
ASSETS
Current assets:
     Cash and cash equivalents .................................       $    880
     Restricted cash ...........................................             75
     Accounts receivable, net of allowance for
        doubtful accounts of $73 ...............................          2,122
     Note receivable ...........................................            126
     Other assets, net .........................................            389
                                                                       --------
Total current assets ...........................................          3,592
Property, plant and equipment, net .............................            105
License rights .................................................          1,746
                                                                       --------
Total assets ...................................................       $  5,443
                                                                       ========

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
     Accounts payable ..........................................       $    683
     Accrued expenses related parties ..........................          3,723
     Accrued expenses ..........................................            413
     Guaranteed minimum payments, related party ................            360
     Deferred revenue ..........................................            143
     Capital financing, including accrued interest .............          4,033
                                                                       --------
Total current liabilities ......................................          9,355
Guaranteed minimum payments, related party .....................            540
Other long-term liabilities ....................................            142
                                                                       --------
Total liabilities ..............................................         10,037
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; 250,000,000
        shares authorized; 41,810,610 shares
        issued and outstanding) ................................             47
     Additional paid-in capital ................................         65,815
     Accumulated deficit .......................................        (70,444)
     Unrealized gain on marketable securities and
        foreign exchange transactions ..........................            (12)
                                                                       --------
Total stockholders' deficit ....................................         (4,594)
                                                                       --------
Total liabilities and stockholders' deficit ....................       $  5,443
                                                                       ========

                 See Notes to Consolidated Financial Statements


                                       32
<PAGE>


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

                                                                 YEAR ENDED
                                                                DECEMBER 31,
                                                           --------------------
                                                              2002       2003
                                                           --------    --------
Revenues:
   Marketing services ..................................   $    477    $  2,926
   Licensing and other services ........................         74       1,758
   Distribution and technology from
      related party ....................................        917         459
   Digital content .....................................        417         512
                                                           --------    --------
       Total Revenues ..................................   $  1,885    $  5,655

Costs and expenses:
   Costs of revenues ...................................        247         755
   Sales and marketing .................................        394       1,211
   General and administrative ..........................      3,256       6,085
   Research and development ............................        444         394
   Depreciation and amortization .......................        128         439
   Loss on impairment of long lived
      assets ...........................................       --         5,709
                                                           --------    --------
       Total operating expenses ........................      4,469      14,593
                                                           --------    --------
Loss from operations ...................................     (2,584)     (8,938)
Other income (expense):
   Other Income ........................................       --         2,097
   Interest income .....................................       --            10
   Interest expense ....................................     (3,600)     (2,687)
                                                           --------    --------
       Total other income (expense) ....................     (3,600)       (580)
                                                           --------    --------
Loss from continuing operations ........................   $ (6,184)   $ (9,518)
Loss from discontinued operations ......................       (165)       --
                                                           --------    --------
Net Loss ...............................................   $ (6,349)   $ (9,518)
Other comprehensive loss:
    Unrealized gain from marketable
       securities ......................................       --            33
    Foreign currency translation
       adjustment ......................................        (13)        (32)
                                                           --------    --------
Comprehensive loss .....................................   $ (6,362)   $ (9,517)
                                                           ========    ========

Basic and diluted continuing operations ................   $  (0.26)   $  (0.26)
Basic and diluted for discontinued
   operations ..........................................   $  (0.01)   $   --
Basic and diluted net loss per share ...................   $  (0.27)   $  (0.26)
                                                           --------    --------

Weighted average number of shares used
  in computing Basic and diluted net loss
  per share ............................................     23,467      37,218
                                                           ========    ========

                See Notes to Consolidated Financial Statements


                                       33
<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, 2001........   16,463,288   $   16   $   50,601   $  (54,577)       $ (289)     $ (4,249)
    Grant of warrants...............                                274                                      274
    Issuance of shares to Investors.   15,441,690       16        2,269                                    2,285
    Issuance of shares for services.      210,000                    21                                       21
    Issuance of warrants for
       patent right.................                                 30                                       30
    Beneficial conversion feature...                              2,036                                    2,036
    Foreign exchange translation....                                                           276           276
    Net loss........................                                          (6,349)                     (6,349)
                                      -----------   ------   ----------   ----------        ------      --------
BALANCE AT DECEMBER 31, 2002........   32,114,978   $   32   $   55,231    $ (60,926)       $  (13)     $ (5,676)
    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 Shares for
       investment in subsidiary.....    7,000,000       12        1,470                                    1,482
    Issuance of shares for rights
       to purchase remaining shares
       of subsidiary................    1,000,000        2          210                                      212
    Warrants issued in conjunction
       with debt conversion of                                      924                                      924
       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)
                                      -----------   ------   ----------   ----------        ------      --------
</TABLE>

                 See Notes to Consolidated Financial Statements


                                       34
<PAGE>


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

                                                                  YEAR ENDED
                                                                 DECEMBER 31,
                                                             ------------------
                                                               2002       2003
                                                             -------    -------
OPERATING ACTIVITIES
Net loss .................................................   $(6,349)   $(9,518)
Adjustments to reconcile net loss to net cash
    used in operating activities:
      Depreciation and other amortization ................       226        439
      Accrued interest expense on convertible debt
         and capital financing ...........................     3,169      2,350
      Warrant amortization related to agreements .........       278        864
      Warrant amortization related to promissory notes ...      --          356
      Warrant amortization related to purchase of
         license rights ..................................      --          923
      Issuance of common stock for services ..............        21       --
      Impairment loss on long lived assets ...............      --        5,709

      Changes in operating assets and liabilities:
        Accounts receivable ..............................      (531)    (1,518)
        Other assets .....................................       573        131
        Accounts payable and accruals ....................       870      3,586
        Deferred revenue .................................      (917)    (2,412)
        Notes receivable .................................      --         (126)
        Other long-term liabilities ......................      --           36
                                                             -------    -------
Net cash (used in) provided by continuing activities .....    (2,660)       820
Net cash (used) provided in discontinued activities ......      (165)      --
                                                             -------    -------
Net cash (used in) provided by operating activities ......    (2,825)       820

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

FINANCING ACTIVITIES
Proceeds from issuance of shares .........................     2,285         15
Restricted cash ..........................................      --          (75)
Proceeds from capital financing ..........................       400       --
Repayments of notes ......................................       (85)      --
                                                             -------    -------
Net cash provided by (used in) financing activities ......     2,600        (60)
NET (DECREASE) INCREASE IN CASH AND
    CASH EQUIVALENTS .....................................      (225)       674

Translation adjustments ..................................       276        (30)
Cash and cash equivalents at beginning of period .........       185        236
                                                             -------    -------
Cash and cash equivalents at end of period ...............   $   236    $   880
                                                             -------    -------

Supplemental disclosure of cash flow information:
   Cash paid during the period for:
      Interest ...........................................   $    14    $    10
                                                             -------    -------

                 See Notes to Consolidated Financial Statements


                                       35
<PAGE>


SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITY:



                                                               2002        2003
                                                             -------     -------

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


                                       36
<PAGE>


                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 2003

         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,  the Company  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 their private  network,  as well as their 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 operate 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.  At the time of
this transaction, the only significant asset owned by Altnet was its technology.
When the Company initially formed Altnet with Joltid, Ltd., 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.

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

         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.  The  preparation of these  financial  statements
requires the Company to make  estimates and  judgments  that affect the reported
amounts of assets, liabilities, revenues


                                       37
<PAGE>


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

                                DECEMBER 31, 2003

and expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, the Company evaluates its estimates,  including those related to
reserves  for  bad  debts  and  those  related  to the  possible  impairment  of
long-lived assets. The Company bases its estimates on historical  experience and
on various  other  assumptions  that are  believed  to be  reasonable  under the
circumstances,  the results of which form the basis for making  judgments  about
the carrying value of assets and liabilities  that are not readily apparent from
other sources.  Actual results may differ from these  estimates  under different
assumptions or  conditions.  The Company's use of estimates,  however,  is quite
limited,  as they have adequate  time to process and record actual  results from
operations.

         The Company is subject to a number of risks similar to 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, 2003, have negative working capital of approximately $5,763,000 and
a  stockholders'  deficit  of  approximately  $4,594,000.  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.

         DISCONTINUED OPERATIONS

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

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


                                       38
<PAGE>


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

                                DECEMBER 31, 2003


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

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

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

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

         REVENUES:
             Brilliant Interactive Ideas.....................          --
             Digital Hip Hop.................................          --
                                                                  -----------
               Total revenues................................          --
                                                                  ===========

         NET LOSS:
             Brilliant Interactive Ideas.....................     $   125,000
             Digital Hip Hop.................................     $    40,000
                                                                  -----------
               Total Net Loss................................     $   165,000
                                                                  ===========

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 also  recognizes  revenue in accordance with the following
with  respect to the  specific  products  and  services.  The Company  regularly
evaluates  the  collectibility  of its  receivables  based on a  combination  of
factors. When a customer's account becomes past due, they initiate dialogue with
the customer to determine the cause. If the Company determines that the customer
will be unable to meet its financial  obligations  to them,  due to a bankruptcy
filing,  deterioration in the customer's operating results or financial position
or other  material  events  impacting  their  business,  they  record a specific
reserve for bad debt to reduce the related  receivable to the amount they expect
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.  They do not have material exposure to any
single  customer or group of customers at this time.  At December 31, 2003,  the
Company  had  a  reserve  of  $73,000  to  cover  a  few  customers   from  whom
collectibility is uncertain.

         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  a  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 there from. Sharman's clients pay a fee


                                       39
<PAGE>


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

                                DECEMBER 31, 2003

based  on a  cost  per  thousand  impressions  (CPM)  or  specified  conversions
delivered (CPA). The Company recognizes revenue when the impressions are made or
conversions 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 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.  Revenue  share fees are  recognized  as earned.  The  Company
charges  Sharman  Networks a fee 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 charges clients
a processing fee to prepare content for distribution on the network.  The amount
of this fee varies based on the number of files, the size of the files,  digital
encoding costs, and the preparation of collateral marketing  materials,  such as
artwork.  These fees are 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,  and (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  distribution  and  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 due
to the fact that (1) the  Company  had  delivered  all  content  and  technology
required under the agreement and (2) the Company was no longer producing content
or updating  the  relevant  technology.  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 our payment processing services for the payment
gateway and licensing royalties paid to third parties.


                                       40
<PAGE>


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

                                DECEMBER 31, 2003

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 and
notes 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, PLANT AND EQUIPMENT

         Property,  plant and  equipment  are stated at cost.  Depreciation  and
amortization are provided using the  straight-line  method over estimated useful
lives or lease life ranging up to five 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 ($0.7459 at
December 31, 2003),  and revenues and expenses are translated into U.S.  dollars
using an average  exchange rate ($0.649 for the year ended December 31, 2003 and
$0.5422 for the year ended December 31, 2002).

         The effects of foreign  currency  translation  adjustments are deferred
and  included  as "other  comprehensive  loss" as a component  of  stockholders'
deficit, on an accumulated basis. The Company recorded comprehensive losses from
foreign currency  translation of $32,000 and $13,000 for the year ended 2003 and
2002, respectively.

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

NET LOSS PER SHARE

         The Company  computes and presents  loss per share in  accordance  with
FASB  Statements  No. 128,  EARNINGS  PER SHARE.  Basic  earnings  per share are
computed based upon the weighted average number of


                                       41
<PAGE>


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

                                DECEMBER 31, 2003

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 84,440,000 and 138,735,500 were
excluded  from the  average  number  of  common  and  common  equivalent  shares
outstanding in the diluted EPS calculation for the years ended December 31, 2002
and 2003, 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 6 for
supplemental disclosure.

         These pro forma amounts may not be representative of future disclosures
since the  estimated  fair value of the options is amortized to expense over the
options' vesting periods.  The pro forma effect on net loss for 2003 and 2002 is
not  representative  of the pro forma effect on net loss in future years because
it reflects expense for only one year's vesting. Pro forma information in future
years  will also  reflect  the  amortization  of any stock  options  granted  in
succeeding years. The Company's pro forma information is as follows:

                                                         YEAR ENDED
                                                            DECEMBER 31,
                                                        2002           2003
                                                     -----------    -----------

Net loss, as reported ............................   $(6,349,000)   $(9,518,000)
Employee compensation expense ....................   $  (118,000)   $  (154,000)
Net loss, pro forma ..............................   $(6,467,000)   $(9,672,000)
Basic and diluted loss per share, as reported ....   $     (0.27)   $     (0.26)
Basic and diluted loss per share, pro forma ......   $     (0.28)   $     (0.26)

CONCENTRATION OF REVENUE RISK

         For the twelve months ended  December 31, 2003,  the Company  generated
approximately  90.9% of its total  revenue from  activities  dependent  upon the
availability of the KMD to computer users.

         Financial  instruments,   which  potentially  subject  the  Company  to
concentrations  of credit risk,  consist primarily of accounts  receivable.  The
Company  had  $2,089,000  of  accounts   receivable  from  The  Excite  Network,
representing 98% of the Company's  accounts  receivable  balance at December 31,
2003. 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,
2003, the Company had  approximately  $880,000 at a bank, which was in excess of
the FDIC insurance limit.


                                       42
<PAGE>


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

                                DECEMBER 31, 2003

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 2003, 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  expense  related to the  long-lived  impaired  assets was
approximately  $2,307,000 for the year ended December 31, 2003. Annual estimated
amortization  expense for the  remaining  long-lived  asset for each of the five
succeeding years is as follows:

                     2004......................      $        698
                     2005......................               698
                     2006......................               350
                                                     ------------
                     Total.....................      $      1,746
                                                     ============

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  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.  During 2003, the Company recorded  $349,000 of
amortization  expense related to the patent,  leaving an unamortized  balance of
$1,746,000  at December  31, 2003,  which is  reflected on the balance  sheet in
License Rights.

         RESTRICTED CASH

         At December  31,  2003,  $75,000 of cash was pledged as  collateral  on
outstanding  convertible  promissory notes and was classified as restricted cash
on the balance sheet.


                                       43
<PAGE>


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

                                DECEMBER 31, 2003

3.       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.

4.       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 $540,000 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  $221,700 for services
provided during the


                                       44
<PAGE>


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

                                DECEMBER 31, 2003

year ended  December  31,  2003,  had an  outstanding  trade  payable to them of
$19,840 and had  guaranteed  minimum  payments  of $900,000  due to Joltid as of
December 31, 2003.

         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 in the
current  year.  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 $2,377,000, was written off as impairment loss
in 2003. As of December 31, 2003 the Company has an outstanding accounts payable
balance to Sharman Networks of $3,064,000.

         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 their  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 2003 the Company paid ECA $610,000
for  commissions  and  consulting  services,  and as of  December  31,  2003 has
outstanding accrued expenses to ECA of $639,000

         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


                                       45
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                      BRILLIANT DIGITAL ENTERTAINMENT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

                                DECEMBER 31, 2003

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 leases it's 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 $84,000 and $41,000 during 2003 and 2002 respectively.

         During 2003,  the Company has paid $5,000,  for  technical  and hosting
services  associated with content placed on our Altnet network,  to Detershan an
entity owned by Mark Miller, a member of our Board of Directors.

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

5.       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
in  2003,  to be  earned  when  they  satisfied  certain  conditions  under  the
agreement.  The Company  satisfied all of these  conditions and has recognized a
total of $500,000 as revenue in 2003.  The  agreement  also provides for ongoing
payments  between the parties,  based on the success in distributing the browser
plug-ins and their performance.

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 their services,  the Company will be
paid a percentage of revenue  Streamwaves  receives from sales of its content to
Altnet users.  The Company will also provide  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. The balance of the note receivable is
$126,000 at December 31, 2003.

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

                                       46
<PAGE>


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

                                DECEMBER 31, 2003

aggregate of 2,850,393  shares of our Common Stock at exercise  prices of $0.793
per share (with respect to 2,792,118  shares) and $0.858 per share (with respect
to 58,275 shares).  We sold these securities for an aggregate  purchase price of
$2,264,150. The Original Notes originally had a term of eighteen months from the
date of issuance and an interest rate of 10% per annum, payable at maturity. The
principal  amount of the  Original  Notes and, at the option of the holder,  all
accrued interest, originally could be converted by the holder into shares of our
Common Stock at a conversion  price of $0.706 per share.  The Original Notes are
secured by all of our assets and the assets of our  subsidiaries,  B3D, Inc. and
Brilliant Studios, Inc., and guaranteed by B3D, Inc. and Brilliant Studios, Inc.

         In December  2001,  pursuant to Note and  Warrant  Purchase  Agreements
dated  December  19,  2001,  we entered  into a financing  transaction  that was
structured similar to the financing we conducted in May 2001 and involved one of
the same  investors.  In the December  2001  financing  transaction,  we sold to
Harris Toibb and Capel Capital Ltd.  secured  convertible  promissory notes (the
"New Notes" and, together with the Original Notes, the "Notes") in the aggregate
principal amount of $750,000.  The principal amount of the New Notes and, at the
option of the holder, all accrued interest,  may be converted by the holder into
shares of our Common Stock at a price equal to the lesser of (i) $0.20,  or (ii)
the volume weighted average price of a share of our Common Stock on the American
Stock  Exchange,  or on any  exchange on which the Common  Stock is then traded,
over any five (5)  consecutive  trading days commencing on December 14, 2001 and
terminating  at 5:00 p.m. on  November  10, 2002 (the  "Conversion  Price").  In
connection  with our sale of the New  Notes,  we issued to the  holders  thereof
warrants (the "New Warrants" and, together with the Original Warrants, the "Debt
Warrants") to purchase up to that number of shares of our Common Stock  obtained
by dividing 200% of the Principal  Amount by the product obtained by multiplying
1.125 by the Conversion  Price,  exercisable at a price per share equal to 1.125
times the Conversion Price. The New Notes mature  simultaneous with the Original
Notes,  which  originally was on November 10, 2002 and bear interest at the 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.


                                       47
<PAGE>


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

                                DECEMBER 31, 2003

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

6.       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
all  assets  remaining  available  for  distribution  to them  after  payment of
liabilities, and after provision is made for each class of stock, if any, having
preference over the Common Stock.

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

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

         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  newly  issued  shares  of the
Company's common stock,  for an aggregate  purchase price of 7,000,000 shares of
the Company's common stock for all such option shares.  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.  At the time of this
transaction,  the only significant asset owned by Alnet was its technology. When
the Company initially formed Altnet with Joltid,  Ltd., the Company received 51%
of the outstanding capital stock and Joltid, Ltd.


                                       48
<PAGE>


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

                                DECEMBER 31, 2003

received 49% of the capital stock.  Neither party was required to make a capital
contribution in connection with the formation of Altnet.

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, 2003,  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 each, the Company  expensed
$176,000 in connection  with the beneficial  conversion  feature.  The remaining
$693,000 was expensed through November 10, 2002.

         In connection  with the December 2001 issuance of warrants from the New
Notes,  a  beneficial  conversion  feature of $295,000 was recorded and is being
amortized on a straight-line  basis over the life of the New Notes.  The Company
incurred a  beneficial  conversion  feature  expense  of $13,400  for the fourth
quarter 2001. The remaining  balance of $282,000 was expensed  through  November
10, 2002.

         Also in December 2001, the  conversion  feature and warrants  issued in
connection  with the Original  Notes were  adjusted to the same terms as the New
Notes. As such, an additional  beneficial  conversion  feature of $1,632,000 was
recorded and $65,000 was  expensed in the 4th Quarter of 2001,  with the balance
of $1,564,000  amortized on a straight-line basis over the remaining life of the
Original Notes in 2002.

         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


                                       49
<PAGE>


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

                                DECEMBER 31, 2003

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  their  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  provide 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 the current year. 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  $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  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.  During 2003, the Company recorded  $349,000 of
amortization  expense related to the patent,  leaving an unamortized  balance of
$1,746,000  at December  31, 2003,  which is  reflected on the balance  sheet in
License Rights.


                                       50
<PAGE>


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

                                DECEMBER 31, 2003

         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.

         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 2003 and  2002,  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.  In 2003, the Company issued  warrants to purchase an
aggregate of 5,515,000  shares of common stock in  consideration  for consulting
services. The Company expensed $1,583,000 in connection with these warrants.

         The following table summarizes warrant activity:

                                                  NUMBER
                                                 OF SHARES       WARRANT PRICE
------------------------------------------     ------------     ---------------
Outstanding at December 31, 2001 .........        3,005,000     $0.75  -- $5.50
Granted ..................................       75,171,000     $0.001 -- $6.50
Exercised ................................         (100,000)    $0.00  -- $0.001
Forfeited ................................          (95,000)    $0.33  -- $6.29
------------------------------------------     ------------     ---------------
Outstanding at December 31, 2002 .........       77,981,000     $0.001 -- $6.50
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 -- $0.61


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


                                       51
<PAGE>


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

                                DECEMBER 31, 2003

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, 2001 ..............     2,969,000    $0.16  -- $5.94
Granted .......................................     3,600,000    $0.001 -- $0.82
Exercised .....................................      (110,000)   $0.001 -- $0.82
Forfeited .....................................          --          $0 -- $0
-----------------------------------------------   -----------    ---------------
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    $0.12  -- $5.94
Exercisable at December 31, 2003 ..............     6,810,654    $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
2003 and 2002, respectively: interest rates of 4.5% and 5.5%; dividend yields of
0% for both  years;  volatility  factors  of the  expected  market  price of the
Company's common stock of 50.0% and 50.0%; and expected life of the options of 3
years for both years.  These  assumptions  resulted in a weighted  average  fair
value of $0.06 and $1.66 per share for stock  options  granted in 2003 and 2002,
respectively.

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

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.


                                       52
<PAGE>


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

                                DECEMBER 31, 2003

7.       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, 2003 the Company had cumulative tax losses resulting in
a net  operating  loss ("NOL") carry forward of  approximately  $4,091,000.  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, 2003 are as follows:

                                                                    DECEMBER 31,
                                                                       2003
                                                                    -----------
Deferred tax assets:

   Net operating losses ..................................            4,091,000
   Temporary differences .................................            2,339,000
                                                                    -----------
   Total deferred tax assets .............................            6,430,000
   Valuation allowance ...................................           (6,430,000)
                                                                    -----------
Net deferred tax assets (liabilities) ....................          $      --
                                                                    ===========

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

                                                               YEAR ENDED
                                                              DECEMBER 31,
                                                           -----------------
                                                            2002       2003
                                                           ------     ------

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%
                                                           ======     ======


                                       53
<PAGE>


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

                                DECEMBER 31, 2003

8.       PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment consist of the following:

                                                      DECEMBER 31, 2003
                                                      -----------------

Computers and equipment............................        $   331
Leasehold improvements.............................             51
Furniture and fixtures.............................             31
                                                           -------
                                                               413
Less accumulated depreciation......................           (308)
                                                           -------
                                                           $   105
                                                           =======

9.       ACCRUED EXPENSES

         Accrued expenses consist of the following:

                                                      DECEMBER 31, 2003
                                                      -----------------


Consulting.........................................        $   138
Legal expenses.....................................             74
Accrued payroll expenses...........................             58
Other .............................................            143
                                                           -------
                                                           $   413
                                                           -------

10.      GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS

         The  Company's  2003  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:


                                       54
<PAGE>


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

                                DECEMBER 31, 2003

                                                     UNITED STATES    AUSTRALIA
                                                      ----------      ----------
YEAR ENDED DECEMBER 31, 2003
   Revenues from unaffiliated customers ........      $5,196,000            --
   Revenues from affiliated customers ..........         459,000            --
                                                      ----------      ----------

   Total revenues ..............................      $5,655,000            --
                                                      ==========      ==========
YEAR ENDED DECEMBER 31, 2002:



   Revenues from unaffiliated customers ........      $  951,000      $   17,000
   Revenues from affiliated customers ..........         917,000            --
                                                      ----------      ----------


   Total revenues ..............................      $1,868,000      $   17,000
                                                      ==========      ==========


         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, 2003,  The Excite  Network  represented
44% 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  25% of revenues,  with patent  sublicensing  and business
development fees. In addition,  the Company earned 8% of the revenues from e-New
Media, for distribution and licensing rights.

         For the year ended December 31, 2002 e-New Media represented 45% of the
revenue,  with distribution and licensing rights.  Internet Fuel contributed 22%
of the revenue,  with media buys and  impressions.  The Company earned 9% of the
revenue through business  development for Sharman  Networks.  Additionally,  the
Company earned 6% of the revenue from Winstar for advertising and media buys.

11.      COMMITMENTS AND CONTINGENCIES

         The Company  leases its facilities  under  operating  lease  agreements
expiring  through  2008.  The  Company  leases  its  U.S.  offices,  from  Toibb
Enterprises;  an  entity  owned by  Harris  Toibb,  a secured  debt  holder  and
shareholder in the Company, and in September 2003,  renegotiated the lease. This
is a  five-year  lease with future  minimum  annual  payments  of  approximately
$92,000. In Australia,  the Company entered into a two year lease future minimum
annual  payments of  approximately  $42,000.  As of December 2003 the commitment
under these lease obligations is as follows:

               YEAR                                 AMOUNT
         -----------------                       -------------
               2004                              $    134,000
               2005                                    96,000
               2006                                    92,000
               2007                                    92,000
               2008                                    77,000
                                                 -------------
                                                 $    491,000
                                                 =============

         Rent expense was $65,000 and  $122,000 for the year ended  December 31,
2002 and the year ended December 31, 2003, respectively.


                                       55
<PAGE>


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

                                DECEMBER 31, 2003

         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
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.

12.  SUBSEQUENT EVENTS

         In  February  2004,  the Company was  informed  by the  American  Stock
Exchange  (AMEX) that the  Company's  appeal to maintain its listing on AMEX had
been  denied  by the  Listing  Qualifications  Panel  of the AMEX  Committee  on
Securities, and as such it did not meet AMEX's standards for continued listing.

         On February  25,  2004,  the Company was  approved for trading over the
Over the Counter Bulletin Board (OTCBB),  with a new stock symbol of "BDEI". The
OTCBB is a regulated  quotation  services 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.

         In March 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 the  Company's  common
                  stock at an exercise price of $0.15 per share; and

         o        To apply on a  monthly  basis,  50% of the  Company's  "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 our
                  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.


                                       56
<PAGE>


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

                                DECEMBER 31, 2003

13.      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, 2003.

         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, 2003.


                                       57
<PAGE>


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

         None.

ITEM 8A. CONTROLS AND PROCEDURES.

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

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

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

                                    PART III

ITEM 9.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Information  regarding  directors and executive officers will appear in
the  proxy  statement  for the  2004  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 2004  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 2004  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 2004 Annual Meeting of  Stockholders,
and is incorporated by this reference.


                                       58
<PAGE>


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

         (a)      Exhibits:

                  See attached Exhibit Index.

         (b)      Reports on Form 8-K.

                  None.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

         Information  regarding  principal  accountant  fees and  services  will
appear in the proxy statement for the 2004 Annual Meeting of  Stockholders,  and
is incorporated by this reference.


                                       59
<PAGE>


                                   SIGNATURES

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

                              BRILLIANT DIGITAL ENTERTAINMENT, INC.

                              By:     /S/ TYLER TARR
                                    --------------------------
                                    Tyler Tarr
                              Its:  Chief Financial Officer (Principal Financial
                                    and Accounting Officer)



                                POWER OF ATTORNEY

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

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

       SIGNATURE                          TITLE                        DATE

 /S/ KEVING BERMEISTER       Acting Chairman of the Board         March 30, 2004
-------------------------    of Directors, Chief Executive
    Kevin Bermeister         Officer and President

  /S/ TYLER TARR             Chief Financial Officer (Principal   March 30, 2004
-------------------------    Financial and Accounting Officer)
       Tyler Tarr

    /S/ MARK MILLER          Director                             March 30, 2004
-------------------------
      Mark Miller

  /S/ RUSSELL SIMMONS        Director                             March 30, 2004
-------------------------
    Russell Simmons

     /S/ RAY MUSCI           Director                             March 30, 2004
-------------------------
       Ray Musci

     /S/ ABE SHER            Director                             March 30, 2004
-------------------------
        Abe Sher


                                       60
<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 June 30,
               2002.

3.2            Amended  and  Restated  Bylaws  of  Registrant.  Incorporated  by
               reference to Exhibit 3.2 to Form S-1 filed on September 17, 1996,
               and the amendments thereto.

4.1            Specimen  Stock   Certificate  of  Common  Stock  of  Registrant.
               Incorporated  by  reference  to Exhibit  4.1 to Form S-1 filed on
               September 17, 1996, and the amendments thereto.

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

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  ad consent to by Europlay 1, LLC and Preston  Ford,
               Inc.  Incorporated  by  reference  to Exhibit  10.4 to  Quarterly
               Report on Form 10-QSB for the quarter ended June 30, 2001.

10.10          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.

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.


                                       (i)
<PAGE>


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

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.

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.


                                      (ii)
<PAGE>


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

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.

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.

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.

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.


                                      (iii)
<PAGE>


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

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.

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.


                                      (iv)
<PAGE>


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

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.

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.

10.64          Executive  Employment  Agreement  dated June 1, 2003  between the
               Registrant and Kevin Bermeister.

14.1           Code of Ethics.

21.1           Subsidiaries.


                                       (v)
<PAGE>


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

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

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


                                      (vi)