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Brilliant Digital Entertainment Inc – ‘10QSB’ for 3/31/02

On:  Wednesday, 5/15/02, at 3:30pm ET   ·   For:  3/31/02   ·   Accession #:  1011438-2-377   ·   File #:  1-14480

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 5/15/02  Brilliant Digital Entertainm… Inc 10QSB       3/31/02    2:101K                                   Akin Gump Str… Office/FA

Quarterly Report — Small Business   —   Form 10-QSB
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10QSB       Quarterly Report -- Small Business                    26    112K 
 2: EX-10       Material Contract                                     12     45K 


10QSB   —   Quarterly Report — Small Business
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
3Part I Financial Information
"Item 1. Financial Statements
10Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
12Revenues
13Sales and marketing
"General and administrative
"Research and development
14Depreciation and amortization
17Cautionary Statements and Risk Factors
25Part Ii Other Information
"Item 2. Changes in Securities and Use of Proceeds
"Item 4. Submission of Matters to a Vote of Security Holders
"Item 6. Exhibits and Reports on Form 8-K
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================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB [X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2002 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________________ to ______________________. Commission file number 0-21637 BRILLIANT DIGITAL ENTERTAINMENT, INC. (Exact Name of Small Business Issuer as Specified in its Charter) DELAWARE 95-4592204 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) TOPANGA CANYON BOULEVARD, SUITE 120 WOODLAND HILLS, CALIFORNIA 91367 (Address of Principal Executive Offices) (818) 615-1500 (Issuer's Telephone Number, Including Area Code) 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[ ] State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: Common Stock, par value $0.001, 24,731,142 shares issued and outstanding as of May 8, 2002. Transitional Small Business Disclosure Format (check one): Yes [ ] No [X] ================================================================================
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BRILLIANT DIGITAL ENTERTAINMENT, INC. INDEX PAGE ---- PART I FINANCIAL INFORMATION...............................................3 Item 1. Financial Statements................................................3 Condensed Consolidated Balance Sheet as of March 31, 2002...........3 Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and March 31, 2001................4 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and March 31, 2001................5 Notes to Consolidated Financial Statements..........................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................................10 PART II OTHER INFORMATION..................................................25 Item 2. Changes in Securities and Use of Proceeds..........................25 Item 4. Submission of Matters to a Vote of Security Holders................25 Item 6. Exhibits and Reports on Form 8-K...................................25 Page 2
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PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS BRILLIANT DIGITAL ENTERTAINMENT, INC. CONDENSED CONSOLIDATED BALANCE SHEET (In thousands) MARCH 31, 2002 ------------ ASSETS (unaudited) Current assets: Cash and cash equivalents............................ $ 771 Accounts receivable, net............................. 71 Other assets, net.................................... 236 ----------- Total current assets.................................... 1,078 Property, plant and equipment, net...................... 127 Other assets, net....................................... 405 ----------- Total assets............................................ $ 1,610 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable..................................... $ 368 Accrued expenses..................................... 1,096 Deferred revenue..................................... 917 Capital financing, net of discount................... 1,123 Current portion of notes payable..................... 137 ----------- Total current liabilities............................... 3,641 Deferred revenue........................................ 2,326 Notes payable, less current portion..................... 20 Other long term liabilities............................. 50 ----------- Total liabilities....................................... 6,037 Commitments and contingencies Stockholders' deficit: Common stock......................................... 22 Additional paid-in capital........................... 51,732 Accumulated deficit.................................. (55,888) Cumulative other comprehensive loss.................. (293) ----------- Total stockholders' deficit............................. (4,427) ----------- Total liabilities and stockholders' deficit............. $ 1,610 =========== See Notes to Consolidated Financial Statements. Page 3
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[Enlarge/Download Table] BRILLIANT DIGITAL ENTERTAINMENT, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) THREE MONTHS ENDED MARCH 31, ------------------------- 2002 2001 ----------- ----------- (unaudited) (unaudited) Revenues.......................................................... $ 293 $ 390 Costs and expenses: Costs of revenues............................................. 52 33 Sales and marketing........................................... 22 297 General and administrative.................................... 557 1,007 Research and development...................................... 90 678 Depreciation and amortization................................. 17 120 ---------- --------- 738 2,135 ---------- --------- Loss from operations.............................................. (445) (1,745) Other income (expense): Export market development grant............................... -- 33 Gain on foreign exchange...................................... -- 23 Interest income (expense), net................................ (866) 14 ---------- --------- Total other income (expense).................................. (866) 70 ---------- --------- Loss from continuing operations................................... (1,311) (1,675) Loss from discontinued operations................................. -- (460) ----------- --------- Net loss before income taxes...................................... (1,311) (2,135) Provision for income taxes........................................ -- -- ---------- --------- Net loss.......................................................... (1,311) (2,135) Foreign currency translation adjustment (net of tax effects)...... (4) (62) --------- --------- Comprehensive loss................................................ $ (1,315) $ (2,197) ========== ========= Basic and diluted continuing operations loss per share............ $ (0.07) $ (0.10) ========== ========= Basic and diluted for discontinued operations per share........... $ (0.00) $ (0.03) ========== ========= Basic and diluted net loss per share.............................. $ (0.07) $ (0.13) ========== ========= Weighted average number of shares used in computing basic and diluted net loss per share.......................... 17,850 16,054 ========== ========= See Notes to Consolidated Financial Statements. Page 4
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[Enlarge/Download Table] BRILLIANT DIGITAL ENTERTAINMENT, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) THREE MONTHS ENDED MARCH 31, ------------------------- 2002 2001 ----------- ----------- (unaudited) (unaudited) OPERATING ACTIVITIES Net loss....................................................... $ (1,311) $ (2,135) Adjustments to reconcile net loss to the net cash used in operating activities: Depreciation and other amortization....................... 936 478 Loss from discontinued operations......................... -- 460 Loss (gain) on foreign exchange........................... -- 25 Effect of warrants granted................................ 21 298 Changes in operating assets and liabilities: Accounts receivable..................................... 1 (138) Other assets............................................ 2 (229) Accounts payable and accruals........................... 46 (219) Deferred revenue........................................ (229) (229) Other long-term liabilities............................. (65) (60) ---------- ---------- Total adjustments.............................................. 712 386 ---------- ---------- Net cash used in continuing activities......................... (599) (1,749) Net cash used in discontinued operations....................... -- (490) ---------- ---------- Net cash used in operating activities.......................... (599) (2,239) INVESTING ACTIVITIES Purchases of equipment......................................... -- (12) ---------- ---------- Net cash used in investing activities.......................... -- (12) FINANCING ACTIVITIES Proceeds from issuance of shares, net of costs................. 800 -- Proceeds from the issuance of capital financing................ 400 -- Repayments of notes............................................ (11) (14) ---------- ---------- Net cash provided by financing activities...................... 1,189 (14) ---------- ---------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........... 590 (2,265) Translation adjustments........................................ (4) (62) Cash and cash equivalents at beginning of period............... 185 3,401 ---------- ---------- Cash and cash equivalents at end of period..................... $ 771 $ 1,074 ========== ========== Supplemental disclosure of cash flow information: Cash paid during the period for: Interest.................................................... $ 4 $ 4 ========== ========== See Notes to Consolidated Financial Statements. Page 5
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SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITY: In May 2001, we issued $2,264,150 in principal amount of Secured Convertible Promissory Notes (the "Original Notes") with warrants to purchase shares of our common stock. A beneficial conversion feature of $1,056,000 was recorded in connection with this transaction, which is being amortized on a straight-line basis over the life of the Original Notes. In December 2001, we issued an additional $350,000 in principal amount of Secured Convertible Promissory Notes as part of an overall financing of $750,000, the balance of which was funded in 2002 (the "New Notes"), with warrants to purchase shares of our common stock. A beneficial conversion feature of $295,000 was recorded in connection with this transaction, which is being amortized on a straight-line basis over the life of the New Notes. Also in December 2001, the conversion feature and warrants issued in connection with the Original Notes were adjusted to the same terms as the New Notes. As such, an additional beneficial conversion feature of $1,632,000 was recorded and will be amortized on a straight-line basis over the remaining life of the Original Notes. In January 2002, we issued the remaining $400,000 in principal amount of Secured Convertible Promissory Notes as part of the overall New Notes financing. A beneficial conversion feature of $337,000 was recorded in connection with this transaction, which is being amortized on a straight-line basis over the life of the New Notes. In connection with these promissory Notes, we amortized $793,000 of debt discount expense and $73,000 interest expense in the first quarter of 2002. Page 6
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BRILLIANT DIGITAL ENTERTAINMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2002 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB and Item 310 of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying unaudited condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are considered necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The accompanying financial statements should be read in conjunction with the audited consolidated financial statements of Brilliant Digital Entertainment, Inc. included in the Company's Form 10-KSB for the fiscal year ended December 31, 2001. The Company has a history of losses, a negative net worth and may never attain profitability. The Company has a limited operating history and has not attained profitability. Since inception, the Company has incurred significant losses and negative cash flow, and as of March 31, 2002 had an accumulated deficit of $55.9 million. These conditions, combined with the Company's historical operating losses, raise substantial doubt about our ability to continue as a going concern. The accompanying condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets and liabilities that may result from the outcome of this uncertainty. The Company is seeking additional funding and believes that the receipt and application of additional funding may result in improved operating results. However, the Company cannot guarantee that it will be able to secure additional funding, or that if such funding is available, the terms or conditions will be acceptable to the Company. 2. STOCKHOLDERS' EQUITY In March 2002, the Company sold an aggregate of 6,051,437 shares of its common stock to Harris Toibb, Markev Services LLC and David Wilson in a private placement at a price per share of $0.1322, for aggregate proceeds to the Company of $800,000. In connection with the offering, the Company also issued to the investors, warrants to purchase up to an aggregate of 10,758,110 shares of common stock at an exercise price of $0.148725 per share. The warrants expire on May 23, 2004. Mark Dyne, the Company's Chairman, and Kevin Bermeister, a director and the Company's Chief Executive Officer and President, are owners of Markev Services and Harris Toibb is a significant stockholder of the Company. Options and warrants representing common shares of 3,384,140 and 58,514,828 were excluded from the average number of common and common equivalent shares outstanding in the diluted EPS calculation for the three months ended March 31, 2001 and 2002, respectively, because they were anti-dilutive. The increase in the warrants is due to warrants issued in connection with capital financing agreements transacted from May 1, 2001 through March 31, 2002. Page 7
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BRILLIANT DIGITAL ENTERTAINMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2002 3. COMMITMENTS AND CONTINGENCIES At March 31, 2002, the Company was obligated under certain licensing agreements to make minimum payments totaling $71,000 for use of certain properties and characters in development of the Company's products. The Company has two fixed asset financing notes with future minimum payments as of March 31, 2002 as follows: YEAR AMOUNT -------------- ----------- 2002 40,000 2003 31,000 ----------- $71,000 =========== The Company leases its facilities under operating lease agreements expiring through 2003. Future minimum payments as of March 31, 2002 under these leases are as follows: YEAR AMOUNT -------------- ----------- 2002 62,000 2003 7,000 ----------- $69,000 =========== Rent expense was $99,000 and $21,000 for the three months ended March 31, 2001 and the three months ended March 31, 2002, respectively. 4. GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS The Company's operations consist of the operations of Brilliant Digital Entertainment Pty. Ltd. in Australia, Brilliant Digital Entertainment in the United States and The Auction Channel was in the United Kingdom. The following schedule sets forth the revenues and long-lived assets, including those of the discontinued operations of The Auction Channel, by geographic area: Page 8
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BRILLIANT DIGITAL ENTERTAINMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2002 [Download Table] UNITED UNITED STATES AUSTRALIA KINGDOM ------------ ------------ ----------- THREE MONTHS ENDED MARCH 31, 2001: Revenues from unaffiliated customers... $151,000 $10,000 $9,000 Revenues from affiliated customers..... 229,000 -- -- ------------ ------------ ----------- Total revenues......................... $380,000 $10,000 $9,000 ============ ============ =========== THREE MONTHS ENDED MARCH 31, 2002: Revenues from unaffiliated customers... $58,000 $6,000 -- Revenues from affiliated customers..... 229,000 -- -- ------------ ------------ ----------- Total revenues......................... $287,000 $6,000 -- ============ ============ =========== LONG-LIVED ASSETS AS OF: March 31, 2002......................... $479,000 $53,000 -- ============ ============ =========== For each of the periods shown above, the movie software costs, a portion of the operating expenses and most of the research and development costs were incurred and paid in Australia. The production costs associated with the web music videos, duplication and packaging, royalties due to third parties, a major portion of the sales and marketing costs, and certain corporate expenses were incurred and paid in the United States. For the three months ended March 31, 2002, e-New Media represented 80% of the revenues with distribution and licensing rights ($229,000). For the three months ended March 31, 2001, e-New Media represented 59% of the revenues with distribution and licensing rights ($229,000). Infogrames contributed 18% ($70,000) of revenues, while Warner Bros. Online contributed advertising revenues of 12% ($46,000). 5. SUBSEQUENT EVENTS In April 2002, the Company sold 2,116,045 shares of its common stock to investors in a private placement at a price per share of $0.1731 for 491,045 shares and a price per share of $0.20 for 1,625,000 shares, for aggregate proceeds to the Company of $410,000. In connection with the offering, the Company also issued to the investors warrants to purchase up to 3,861,476 shares of common stock at exercise prices of $0.19474 per share (for warrants for 491,045 shares) and $0.2175 per share (for warrants for 1,625,000 shares). The warrants expire on May 23, 2004. Page 9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information contained in this Form 10-QSB is intended to update the information contained in our Annual Report on Form 10-KSB for the year ended December 31, 2001 and presumes that readers have access to, and will have read, the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information contained in such Form 10-K. The following discussion and analysis also should be read together with our consolidated financial statements and the notes to the consolidated financial statements included elsewhere in this Form 10-QSB. THIS DISCUSSION SUMMARIZES THE SIGNIFICANT FACTORS AFFECTING THE CONSOLIDATED OPERATING RESULTS, FINANCIAL CONDITION AND LIQUIDITY AND CASH FLOWS OF BRILLIANT DIGITAL ENTERTAINMENT FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND MARCH 31, 2001. EXCEPT FOR HISTORICAL INFORMATION, THE MATTERS DISCUSSED IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ARE FORWARD LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES AND ARE BASED UPON JUDGMENTS CONCERNING VARIOUS FACTORS THAT ARE BEYOND OUR CONTROL. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD LOOKING STATEMENTS AS A RESULT OF, AMONG OTHER THINGS, THE FACTORS DESCRIBED BELOW UNDER THE CAPTION "CAUTIONARY STATEMENTS AND RISK FACTORS." OVERVIEW Brilliant Digital Entertainment, Inc. is a developer of rich media advertising serving technologies, software authoring tools and content for three dimensional, or 3D, animation on the World Wide Web. During the third quarter of 2001, we began marketing and distributing our player, the "Digital Projector" (required for the playback of our rich media content and advertisements) through two large peer-to-peer, or P2P, networks, Sharman Networks, which operates the KaZaA network (formerly operated by Consumer Empowerment B.V.), and StreamCast Networks, which operates the Morpheus network. Previously, our primary method of distribution was through the bundling of the Digital Projector with our animation content which we syndicated to third party web sites. At December 31, 2001, we estimate that our Digital Projector had been distributed to tens of millions of users based on KaZaA's weekly downloads as reported on Download.com, as additional P2P connected computers and other users accessed the KaZaA and Morpheus networks. Sharman Networks continues to distribute our player and StreamCast Networks has discontinued its distribution. We commercialize our technology in two primary ways. We license our rich media advertising server technologies to web sites to enable the selling and serving of our proprietary rich media advertising format, and we license our rich media content authoring tools - "b3d Studio" and "b3d Studio Pro" - to production studios and content developers interested in creating content for the Internet. We launched our rich media 3D advertising banners - Brilliant Banners - into the market to offer advertisers and web sites an alternative to the current Graphics Interchange Format, or GIF, banners that are prevalent on web sites today. With the decline of industry wide banner advertising revenues and click through rates, we believe that our animated 3D banner advertisements perform better than GIF banners and may help reinvigorate certain online advertising campaigns. We license our rich media ad serving technologies, through our wholly-owned subsidiary B3D, Inc., to high traffic web sites, including the P2P network of Sharman Networks, for the serving of Brilliant Banners. We are also introducing our ad format to third party ad serving companies, making our technologies available for them to commence selling and serving this new rich media ad format. In Page 10
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November 2001, we became a Rich Media Silver Vendor of DoubleClick, Inc. This rich media certification was awarded after our technology passed the DoubleClick tests for functionality, impression tracking and click tracking. In February 2002, we formed Brilliant P2P, Inc., later renamed Altnet, Inc., to create a private, peer-to-peer network utilizing existing, proven technology to leverage the processing, storage and distribution power of a peer-to-peer network comprised of tens of millions of users. Altnet intends to license commercially available digital rights management technology to protect against infringement of the proprietary rights of the owners of the content distributed over the Altnet network. Altnet licensed the peer-to-peer technology necessary to operate the network from Blastoise, Ltd. doing business as Joltid. Blastoise is owned and operated by the developers of the FastTrack P2P technology, the underlying technology which operates the KaZaA and Grokster P2P networks. Pursuant to our agreement, Blastoise acquired 49% of the outstanding common stock of Altnet. Peer-to-peer computing is the sharing of computer resources and services by direct exchange between computer systems, and not through a central server. Peer-to-peer computing applications include the exchange of digital files and other information, processing cycles (the cycles by which data is processed in the central processing unit of a computer), cache storage (temporary storage of files in the central processing unit of a computer), and disk storage. Peer-to-peer computing takes advantage of existing desktop computing power and networking connectivity, allowing users to access the collective power of individual computers to benefit the entire enterprise. Millions of computers are logged onto the Internet at any given time, each with excess processing power, excess storage capacity and unused bandwidth. Through Altnet, we intend to create a private peer-to-peer network to enable our clients to access and utilize this excess processing power, storage capacity and unused bandwidth for multiple applications. We intend to commercialize Altnet through licensing agreements for Altnet's three main services: Network Services, Distributed Storage and Distributed Processing. We have licensed some of the world's best known characters for the production and web distribution of episodic animations, called MultipathTM Movies, that include SUPERMAN, XENA: WARRIOR PRINCESS, KISS, and ACE VENTURA, and have produced animated music videos of top selling artists including Ja Rule, Ludacris, DMX and Li'l Romeo. These full-screen productions, developed using our proprietary suite of b3d software tools, have small files for faster download relative to full video files. Currently we distribute our animated content through Internet syndication partners including Warner Bros. Online, Roadrunner and selected sites from the Universal Music Group. In 2001, we substantially reduced our internal production and syndication of 3D animation, which we used primarily to distribute our Digital Projector, in order to reduce our costs and our cash requirements. We have discontinued operations at Digital Hip Hop, the joint venture we formed to produce animated music videos for the World Wide Web, and have discontinued operations at, and placed into liquidation, Brilliant Interactive Ideas Pty. Ltd., our Australian-based production company. The reduction in our content production and syndication activities has allowed us to focus our efforts and allocate our resources to the further development and exploitation of our advertising serving and authoring tools businesses, and to pursue the development of a private, peer-to-peer network business through our Altnet subsidiary. Page 11
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We are a Delaware corporation that was incorporated in July 1996. We were formed through the combination of two businesses: Brilliant Interactive Ideas, Pty. Ltd., an entertainment software developer and producer, and Sega Australia New Developments, a research and development operation for leading edge software tools. Our executive offices are located at 6355 Topanga Canyon Boulevard, Suite 120, Woodland Hills, California 91367, and our telephone number is (818) 615-1500. Information on our web sites, www.brilliantdigital.com and www.b3d.com, does not constitute part of this Form 10-QSB. 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. RESULTS OF OPERATIONS REVENUES. Production fees are paid by customers in exchange for our development of animated content, including banner ads, in accordance with customer specifications. The development agreements generally specify certain "milestones" which must be achieved throughout the production process. As these milestones are achieved, we recognize the portion of the development fee allocated to each milestone. Revenues, which are earned from the sale or licensing of our software tools, are recognized when the sales or licensing agreements are entered into. If the agreement covers a period in excess of one year, the revenue associated with this agreement is recognized on a straight-line basis over the life of the agreement. Advertising revenues, which are earned revenues from the placing of our content on third party web sites, are recognized when the third party accounts to us. Ad server licensing revenues are recognized when we invoice the licensee, which usually occurs after the terms of the advertising campaign insertion order are fulfilled. We enter into distribution contracts under which we are entitled to fixed minimum guaranteed payments. The minimum guaranteed payments are recognized as revenue when the CD-ROM master is delivered to the distributor and the terms of the sale are considered fixed. We have derived our revenues from royalties, development fees and software sales. We license our traditional CD-ROM products to publishers and distributors in exchange for non-refundable advances and royalties based on product sales. Royalties based on product sales are due only to the extent that they exceed any associated non-refundable royalty advance. Royalties related to Page 12
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non-refundable advances are recognized when the CD-ROM master is delivered to the licensees. Royalty revenues in excess of non-refundable advances are recognized upon notification by the distributor that a royalty has been earned. Revenues decreased 25% from $390,000 for the three months ended March 31, 2001 to $293,000 for the three months ended March 31, 2002. The primary source of revenue is our distribution and technology agreements with e-New Media which resulted in revenue of $229,000 in the three months ended March 31, 2001 and the three months ended March 31, 2002 and from advertising revenues. The decrease in revenues is due to a reduction in advertising revenue resulting from the non-recurrence of a one-time advertising sale for $70,000, which occurred during the three months ended March 31, 2001. COST OF REVENUES. Cost of revenues consists primarily of the amortization of licensing royalties to third parties and the direct costs of banner advertising. Cost of revenues increased from $33,000 for the three months ended March 31, 2001 to $52,000 for the three months ended March 31, 2002. This represents an increase of $19,000, or 58%, which is primarily due to the development of banner ads created for Internet advertisers at a cost of $26,000 for the three months ended March 31, 2002. This increase is offset by a reduction in royalty expense, from $26,000 in 2001 to $18,000 in 2002, as two of our licensing agreements were fully amortized during 2001 and the three months ended March 31, 2002. We also incurred initial costs of $5,000 pertaining to the newly formed company, Altnet, Inc. SALES AND MARKETING. Sales and marketing expenses were reduced by 93% from $297,000 for the three months ended March 31, 2001 to $22,000 for the three months ended March 31, 2002. In the first quarter of 2001, we incurred $255,000 in expense for warrants issued in connection with our agreement with Yahoo!, which was fully amortized during 2001. The decrease is also attributable to the reduction in our use of outside sales and marketing consultants. The $22,000 incurred in the three months ended March 31, 2002 is primarily due to fees to sales consultants and our initial marketing efforts for Altnet, Inc. GENERAL AND ADMINISTRATIVE. General and administrative expenses primarily include salaries and benefits of management and administrative personnel, rent, insurance costs and professional fees. General and administrative expenses decreased $450,000 or 45% from $1,007,000 for the three months ended March 31, 2001 to $557,000 for the three months ended March 31, 2002. This decrease is primarily attributable to a decrease in salaries and employee benefits of $359,000 due to a reduction in headcount in the Los Angeles office and a decrease in insurance costs. Additionally, rent expense was reduced by $78,000 due to the closing of production space in Australia and reduction of office space in Los Angeles. The decrease was partially offset by an increase in legal fees relating to our financing transactions in the three months ended March 31, 2002 and costs incurred related to Altnet, Inc. RESEARCH AND DEVELOPMENT. Research and development expenses include salaries and benefits of personnel conducting research and development of software products. Research and development costs also include costs associated with creating our software tools used to develop MultipathTM Movies, 3D animated content for banner ads and Internet web site development costs. These costs decreased 87% from $678,000 for the three months ended March 31, 2001 to $90,000 for the three months ended March 31, 2002 primarily due to a decrease in web site development costs, research and development personnel and overhead costs associated with research and Page 13
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development. We decreased the headcount of our research and development personnel in our Sydney, Australia office during 2001 from 53 employees to 7 employees at March 31, 2002. DEPRECIATION AND AMORTIZATION. Depreciation expense relates to depreciation of fixed assets such as computer equipment and cabling, furniture and fixtures and leasehold improvements. These fixed assets are depreciated over their estimated useful lives (up to five years) using the straight-line method. Depreciation expense decreased 86% from $120,000 for the three months ended March 31, 2001 to $17,000 for the three months ended March 31, 2002. The decrease is attributable to completion of depreciation of certain fixed assets prior to the three months ended March 31, 2002 and the disposal of other fixed assets. OTHER INCOME AND EXPENSE. Other income and expense includes interest income and interest expense and debt discount on capital financing, gains and losses on foreign exchange transactions, and export development grants paid to our subsidiary, Brilliant Interactive Ideas Pty. Ltd., by the Australian Trade Commission for its participation in certain export activities. Other income and expense decreased from income of $70,000 for the three months ended March 31, 2001 to a loss of $866,000 for the three months ended March 31, 2002. The loss is due to a non-cash debt discount expense of $793,000 and accrued interest expense of $73,000 incurred in connection with our sale of $3,014,150 in principal amount of Convertible Promissory Notes in 2001. During the remaining three fiscal quarters of 2002, we will incur an additional $2,082,000 in non-cash debt discount expense in connection with this financing transaction. During the first quarter of 2001, we earned $33,000 for the trade export grant, recognized $23,000 in gain on foreign exchange transactions and earned $14,000 of interest income, net of expense. NET LOSS ON DISCONTINUED OPERATIONS. The Auction Channel has been accounted for as a discontinued operation pursuant to Management's formal adoption on December 31, 2000 of a plan to dissolve the business unit. A net loss of $460,000 was recognized for the three months ended March 31, 2001. The net assets of The Auction Channel were sold in the second quarter of 2001 and the company was subsequently dissolved. LIQUIDITY, CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS As of March 31, 2002, our cash and cash equivalents totaled approximately $771,000. This is an increase of $586,000 as compared to December 31, 2001. The increase is due to debt and equity financing transactions consummated during the quarter in which we raised an aggregate of $1,200,000, partially offset by a net loss of $1,311,00. Cash flows from operating, financing and investing activities for the three months ended March 31, 2002 and 2001 are summarized in the following table: [Download Table] ACTIVITY: 2002 2001 ---------------------------- -------------- -------------- Continuing Operations $ ( 599,000) $ (1,749,000) Discontinuing Operations $ -- $ (490,000) Investing $ -- $ (12,000) Financing $ 1,189,000 $ (14,000) Net cash of $599,000 used in operating activities during the three months ended March 31, 2002 was primarily attributable to a net loss from operations of $1,311,000. This is compared to a Page 14
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net use of cash during the three months ended March 31, 2001 of $1,749,000 attributable to a net loss of $2,135,000 and an additional use of cash of $490,000 attributable to discontinued operations. Net cash used to purchase computer equipment amounted to $12,000 in the three months ended March 31, 2001. We are required as of March 31, 2002 to make minimum payments of $37,000 under various licensing agreements. At March 31, 2002, we had rental commitments for our office facility of $69,000 and two promissory notes for the financing of office furniture and computer equipment in the amount of $36,000 and $35,000 payable over the next 2 years. Our contractual obligations are as follows: [Download Table] CONTRACTUAL LESS THAN 1-3 OBLIGATIONS TOTAL 1 YEAR YEARS ----------------- ---------- ----------- --------- Capital Leases $71,000 $40,000 $31,000 Operating Lease $69,000 $62,000 $ 7,000 In March 2002, we sold an aggregate of 6,051,437 shares of common stock to Harris Toibb, Markev Services LLC and David Wilson in a private placement at a price per share of $0.1322, for aggregate proceeds to us of $800,000. In connection with the offering, we also issued to the investors warrants to purchase up to an aggregate of 10,758,110 shares common stock at an exercise price of $0.148725 per share. The warrants expire in on May 23, 2004. Mark Dyne, our Chairman, and Kevin Bermeister, a director and our Chief Executive Officer and President, are owners of Markev Services and Harris Toibb is a significant stockholder of the company. In April 2002, we sold an additional 2,116,045 shares of common stock to investors in a private placement at a price per share of $0.1731 for 491,045 shares and a price per share of $0.20 for 1,625,000 shares, for aggregate proceeds to the Company of $410,000. In connection with the offering, the Company also issued to the investors warrants to purchase up to 3,861,476 shares common stock at exercise prices of $0.19474 per share (for warrants for 491,045 shares) and $0.2175 per share (for warrants for 1,625,000 shares). The warrants expire on May 23, 2004. Our operations generated negative cash flow during the three months ended March 31, 2001 and 2002, and we expect a significant use of cash during the upcoming 2002 fiscal year as we initiate the business opportunity for Altnet, Inc., as well as continue to develop our software tools and continue our marketing efforts for our tools and 3D rich media banners ads. We anticipate our current cash reserves, plus our expected generation of cash from existing operations, will be sufficient to fund our anticipated expenditures into the third quarter of 2002. Consequently, we will require additional equity or debt financing during 2002, the amount and timing of which will depend in large part on our spending program. Our recent 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 develop or enhance our products and Page 15
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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. The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The carrying amounts of assets and liabilities presented in the financial statements do not purport to represent realizable or settlement values. The report of our Independent Certified Public Accountants for the December 31, 2001 financial statements included an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board finalized FASB Statements No. 141, BUSINESS COMBINATIONS (SFAS 141), and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS (SFAS 142). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that we recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires that, upon adoption of SFAS 142, we reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141. SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that we identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized. SFAS 142 requires us to complete a transitional goodwill impairment test nine months from the date of adoption. We are also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We believe the adoption of this Statement will have no material impact on our financial statements. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFASB 144 requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. Therefore, discontinued operations will no longer be Page 16
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measured at net realizable value or include amounts for operating losses that have not yet occurred. SFASB 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and, generally, are to be applied prospectively. We believe the adoption of this Statement will have no material impact on our financial statements. CAUTIONARY STATEMENTS AND RISK FACTORS Several of the matters discussed in this document contain forward-looking statements that involve risks and uncertainties. Factors associated with the forward-looking statements that could cause actual results to differ materially from those projected or forecast are included in the statements below. In addition to other information contained in this report, readers should carefully consider the following cautionary statements. IF WE ARE UNABLE TO RAISE ADDITIONAL FUNDS, WE MAY BE REQUIRED TO DELAY IMPLEMENTATION OF OUR BUSINESS PLAN, REDUCE OVERHEAD SIGNIFICANTLY OR SUSPEND OPERATIONS. We currently have a number of obligations that we are unable to meet without generating additional revenues or raising additional capital. If we cannot generate additional revenues or raise additional capital in the near future, we may become insolvent. As of March 31, 2002, our cash balance was approximately $771,000 and our outstanding accounts payable, accrued expenses and current debt totaled $2,724,000. Historically, we have funded our capital requirements with debt and equity financing. Our ability to obtain additional equity or debt financing depends on a number of factors including our financial performance and the overall conditions in our industry. If we are not able to raise additional financing or if such financing is not available on acceptable terms, we may liquidate assets, seek or be forced into bankruptcy, and/or continue operations but suffer material harm to our operations and financial condition. These measures could have a material adverse affect on our ability to continue as a going concern. WE HAVE A HISTORY OF LOSSES, A NEGATIVE NET WORTH AND MAY NEVER ATTAIN PROFITABILITY. We have a limited operating history and have not attained profitability. Since inception, we have incurred significant losses and negative cash flow, and as of March 31, 2002 we had an accumulated deficit of $55.9 million. Additionally, as of the date of this report, our current liabilities exceed our current assets. We have not achieved profitability and expect to continue to incur operating losses for the foreseeable future as we fund operating and capital expenditures in the areas of software tools development, brand promotion, sales and marketing, administration, deployment of our Altnet peer-to-peer network and operating infrastructure. Our business model assumes that consumers and advertisers will be attracted to our rich media advertising formats (Brilliant Banners), and that animators and those who produce banner advertisements will use our b3d tools and technology in the development of other b3d-produced content. Our business model also assumes that a significant portion of our future revenues will be derived from our Altnet peer-to-peer business, which is not operational. This business model is not yet proven and we cannot assure you that we will ever achieve or sustain profitability or that our operating losses will not increase in the future or be inconsistent with the expectations of the public market. Primarily as a result of our continued losses, our independent public accountants modified the opinion on our December 31, 2001 financial statements to include an explanatory paragraph wherein they expressed substantial doubt about our ability to continue as a going concern. OUR RECENT CAPITAL RAISING EFFORTS HAVE RESULTED IN SUBSTANTIAL DILUTION TO OUR STOCKHOLDERS AND OUR FUTURE CAPITAL NEEDS WOULD INCREASE THIS DILUTION. During 2001, we Page 17
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raised $3.0 million through the sale of convertible promissory notes and common stock purchase warrants. The promissory notes, which mature on November 10, 2002, and accrued interest may be converted by the holders at any time into a number of shares of our common stock determined by dividing the amount due under the notes, including interest, by a price equal to the lesser of $.20 and the lowest 5 day volume weighted average price of our common stock as reported by the American Stock Exchange at any time during the term of the notes. At May 6, 2002, the principal and interest outstanding under the Notes could be converted by the holders into 26,937,385 shares of common stock, which would represent 52.1% of our outstanding common stock immediately following the conversion. The warrants have an expiration date of May 23, 2004 and entitle the holders to purchase up to an aggregate of 200% of their invested capital in shares of our Common Stock at a per share exercise price equal to 112.5% of the conversion price. The exercise of the warrants would increase the number of shares outstanding and result in further dilution to our other stockholders. Additionally, during the first quarter of 2002, we raised an additional $800,000 through the sale of 6,051,437 shares of common stock and common stock purchase warrants. These warrants have an expiration date of May 23, 2004 and entitle the holders to purchase up to an aggregate of 10,758,110 shares of our Common Stock at a per share exercise price of $0.148725. We anticipate that during remainder of 2002, we will need to raise additional capital, as our current operations do not generate positive cash flow. As such, any additional capital raising efforts would cause further dilution to stockholders. The following table illustrates our capitalization as of May 6, 2002, and identifies the number of shares issued and outstanding as of such date, as well as the number of shares that may be issued in the future upon conversion of outstanding convertible promissory notes and exercise of outstanding options and warrants: [Download Table] SHARES OF PERCENTAGE OF FULLY SECURITY COMMON STOCK DILUTED SHARES -------------------------------------- ------------ ------------------- Outstanding Common Stock 24,731,142 25.6% Convertible Promissory Notes 33,024,575 34.2% Outstanding Warrants(1) 35,885,272 37.2% Outstanding Options 2,944,000 3.0% ------------ ------------------- Fully Diluted Shares of Common Stock(2) 96,584,989 100.0% <FN> ------------------ (1) For purposes of this table, we have only included warrants that are "in-the-money" (the exercise price of the warrants is below the price of our common stock), and the number of shares of common stock underlying the outstanding warrants has been calculated on a "cashless" exercise basis, whereby the holder of each warrant receives upon exercise a number of shares of common stock with a value equal to (i) the total value of the shares underlying the warrants LESS (ii) the aggregate exercise price of the warrants, and is calculated based on the closing sales price of our common stock on the American Stock Exchange on May 6, 2002, which was $0.36. (2) This number excludes 410,375 shares that have been reserved for issuance under our 1996 Stock Option Plan that currently are not the subject of an outstanding stock option or other award. </FN> 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 Page 18
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Notes, in the aggregate principal amount of $3.0 million. If a default occurs, all amounts owed to the holders of the notes would immediately become due and payable. If the debt becomes due before its stated maturity in November 2002, we likely will not have sufficient funds to repay the indebtedness, which will entitle the holders of the notes to exercise all of their rights and remedies, including foreclosure on all of our assets which we pledged as collateral to secure repayment of the debt. ALTNET IS AN UNPROVEN BUSINESS VENTURE AND MAY REQUIRE SIGNIFICANT CAPITAL TO BE SUCCESSFULLY IMPLEMENTED. Our Altnet peer-to-peer business is unproven and we cannot guaranty that it will be successful. The success of the business will depend, in part, on our ability to enter into end user agreements 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, and our underlying peer-to-peer technology. Additionally, we do not have sufficient capital to internally fund Altnet's development and operations. Consequently, the capital necessary to launch and fund Altnet will need to come from outside sources. We cannot make assurances that sufficient capital will be available at all or on terms acceptable to us to fund Altnet's development and operations. OUR BUSINESS MODEL CONTEMPLATES RECEIVING A SIGNIFICANT PORTION OF OUR FUTURE REVENUES FROM RICH MEDIA INTERNET ADVERTISEMENTS DEVELOPED AND SERVED USING OUR SOFTWARE TOOLS AND FROM INTERNET ADVERTISING SERVICES. INTERNET ADVERTISING IS DEPENDENT ON THE ECONOMIC PROSPECTS OF ADVERTISERS AND THE ECONOMY IN GENERAL AND RECENTLY HAS EXPERIENCED A SIGNIFICANT DECLINE. A CONTINUED DECREASE IN EXPENDITURES BY ADVERTISERS OR A PROLONGED DOWNTURN IN THE ECONOMY COULD CAUSE US TO FAIL TO ACHIEVE OUR REVENUE PROJECTIONS. We are increasing our emphasis on generating revenues from the sale of our b3d tools for the creation of rich media Internet advertisements and from the sale of technologies and services to Web publishers, third party advertising representation firms, advertisers and agencies. In recent quarters, the market for Internet advertising has experienced lower demand, lower prices for advertisements and the reduction of marketing and advertising budgets. As a consequence, expenditures for Internet advertisements have decreased. We cannot be certain that future decreases will not occur and that spending on Internet advertisement will return to historical levels. A continued decline in the economic prospects of advertisers or the economy in general could cause us to fail to achieve our advertising-related revenue projections. WE WILL NOT BE ABLE TO GENERATE REVENUES FROM OUR BRILLIANT BANNERS IF THEY DO NOT ACHIEVE MARKET ACCEPTANCE. The success of our Brilliant Banner rich media ad format and our ability to generate revenues through sale and serving of these advertisements will be determined by consumer reaction and acceptance. To generate revenues, we must develop advertisements that appeal to the advertising community and the consumer, which is unpredictable. Additionally, our Brilliant Banner advertisements face competition from other online advertising companies like Unicast and Viewpoint. Other factors that influence our ability to generate revenues from our Brilliant Banners include: o Acceptance of the Brilliant Banner advertising format by web sites; Page 19
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o Performance of the Brilliant Banner versus other rich media advertising formats and traditional 2D advertisements; and o Our ability to broadly disseminate our Digital Projector, which is necessary to view our Brilliant Banners. OUR FAILURE TO MAINTAIN STRATEGIC RELATIONSHIPS WITH DISTRIBUTION PARTNERS COULD REDUCE THE NUMBER OF DIGITAL PROJECTORS WE ARE ABLE TO DISSEMINATE TO CONSUMERS, WHICH WOULD REDUCE THE NUMBER OF USERS THAT ARE ABLE TO VIEW OUR MEDIA CONTENT, DECREASE THE VALUE OF OUR BRILLIANT BANNERS TO ADVERTISERS AND LIMIT THE NUMBER OF USER'S FOR OUR ALTNET PEER-TO-PEER BUSINESS. We distribute our Digital Projector and the software necessary to create and run our Altnet peer-to-peer business primarily by bundling it with Sharman Networks' KaZaA Media Desktop. We rely on computer users' demand for the KaZaA Media Desktop to increase the installed base of our (1) Digital Projector, which is necessary to view b3d-produced content such as our Brilliant Banners, and (2) Altnet software, which is necessary to connect users to our private peer-to-peer network. Our business, results of operations and financial condition could be materially adversely affected if we do not maintain our distribution relationship with Sharman Networks on acceptable terms or if this relationship does not achieve the projected distribution of our Digital Projector and Altnet software. Additionally, a disruption in the distribution of the KaZaA Media Desktop or a decrease in demand for the product by users would necessarily impact the future distribution of our technology. The KaZaA Media Desktop, as well as other peer-to-peer software products, is currently the subject of a lawsuit; METRO-GOLDWYN-MAYER STUDIOS, INC. ET. AL. V. GROKSTER, LTD. ET. AL., filed in the United States District Court for the Central District of California (Western Division) by twenty-eight entertainment companies claiming that, among other things, the KaZaA Media Desktop facilitates, contributes to and encourages copyright infringement. On November 18, 2001, there was an additional complaint filed, LIEBER ET. AL. V. CONSUMER EMPOWERMENT B.V. ET. AL. To the extent that Sharman Networks is precluded from distributing the KaZaA Media Desktop as a result of this litigation, it would prevent the further distribution of the Digital Projector and Altnet peer-to-peer software with the KaZaA product which could have a material adverse affect on our business and financial condition. OUR STOCK PRICE MAY DECLINE SIGNIFICANTLY IF WE ARE DELISTED FROM THE AMERICAN STOCK EXCHANGE. Our common stock currently is quoted on the American Stock Exchange. For continued inclusion on the American Stock Exchange, we must meet certain tests, including maintaining a sales price for our common stock above $1.00 per share, and net tangible assets of at least $4 million. We currently are not in compliance with both the bid price and net tangible assets requirements. If we continue to fail to satisfy the listing standards on a continuous basis, the American Stock Exchange may, at its sole discretion, delist our common stock from the exchange. If this occurs, trading of our common stock may be conducted on (i) the NASDAQ SmallCap Market, if we qualify for listing at that time, which we currently do not, (ii) in the over-the-counter market on the "pink sheets", or (iii) if available, the NASD's "Electronic Bulletin Board." In any of those cases, investors could find it more difficult to buy or sell, or to obtain accurate quotations as to the value of our common stock. The trading price per share of our common stock likely would be reduced as a result. Page 20
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WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY WITH OTHER COMPANIES THAT OFFER SOFTWARE TOOLS AND SERVICES SIMILAR TO OURS. The markets for our software tools are highly competitive and characterized by pressure to incorporate new features and accelerate the release of new and enhanced products. A number of companies currently offer content development products and services that compete directly or indirectly with one or more of our tools sets. These competitors include, among others, Macromedia, Inc., Adobe Systems, Inc. as well as Pulse Entertainment, Inc. and Viewpoint Corporation. As we compete with larger competitors such as Macromedia across a broader range of product lines and different platforms, we may face increasing competition from such companies. WE MAY BE UNABLE TO SUCCESSFULLY COMPETE WITH MICROSOFT, REAL NETWORKS AND OTHER COMPANIES IN THE MEDIA DELIVERY MARKET. The market for software and services for the delivery of media over the Internet is constantly changing and highly competitive. Companies such as Microsoft Corporation and Real Networks, Inc. have substantial penetration in the media delivery market, and significantly greater resources than we do. More companies are entering the market for, and expending increasing resources to develop, media delivery software and services. We expect that competition will continue to intensify. Because our b3d content, such as our Brilliant Banners, can only be viewed using our Digital Projector, if we do not achieve a widespread distribution of our media player, there will not be substantial demand for b3d-produced content or our software tools. IF WE DO NOT IMPROVE OUR SOFTWARE TOOLS TO PRODUCE NEW, MORE ENHANCED 3D ANIMATED CONTENT, OUR REVENUES WILL BE ADVERSELY AFFECTED. The software tools that enable us to create 3D content, such as our Brilliant Banners, have been developed over the past five years. Additional refinement of these tools is necessary to continue to enhance the b3d format. If we cannot develop improvements to these software tools, our Brilliant Banners and all other b3d-produced content may not obtain or maintain market acceptance and our revenues will be adversely affected. ERRORS OR DEFECTS IN OUR SOFTWARE TOOLS AND PRODUCTS MAY CAUSE A LOSS OF MARKET ACCEPTANCE AND RESULT IN FEWER SALES OF OUR PRODUCTS. Our products are complex and may contain undetected errors or defects when first introduced or as new versions are released. In the past, we have discovered software errors in some of our new products and enhancements after their introduction into the market. Because our products are complex, we anticipate that software errors and defects will be present in new products or releases in the future. While to date these errors have not been material, future errors and defects could result in adverse product reviews and a loss of, or delay in, market acceptance of our products. TO DEVELOP PRODUCTS THAT CONSUMERS DESIRE, WE MUST MAKE SUBSTANTIAL INVESTMENTS IN RESEARCH AND DEVELOPMENT TO KEEP UP WITH THE RAPID TECHNOLOGICAL DEVELOPMENTS THAT ARE TYPICAL IN OUR INDUSTRY. The software market and the PC industry are subject to rapid technological developments. To develop products that consumers desire, we must continually improve and enhance our existing products and technologies and develop new products and technologies that incorporate these technological developments. We cannot be certain that we will have the financial and technical resources available to make these improvements. We must make improvements to our technology while remaining competitive in terms of performance and price. This will require us to make investments in research and development, often times well in advance of the widespread release of the products in the market and any revenues these products may generate. Page 21
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OUR STOCK PRICE AND TRADING VOLUME FLUCTUATE WIDELY AND MAY CONTINUE TO DO SO IN THE FUTURE. AS A RESULT, WE MAY EXPERIENCE SIGNIFICANT DECLINES IN OUR STOCK PRICE. The market price and trading volume of our common stock, which trades on the American Stock Exchange, has been subject to substantial volatility, which is likely to continue. This volatility may result in significant declines in the price of our common stock. Factors that may cause these fluctuations include: o variations in quarterly operating results; o the gain or loss of significant contracts; o changes in management; o announcements of technological innovations or new products by us or our competitors; o recommendations by securities industry analysts; o dilution to existing stockholders resulting from the issuance of additional shares of common stock; and o short sales and hedging of our common stock. Additionally, the stock market has experienced extreme price and trading volume fluctuations that have affected the market price of securities of many technology companies. These fluctuations have, at times, been unrelated to the operating performances of the specific companies whose stock is affected. The market price and trading volume of our stock may be subject to these fluctuations. IF OUR STOCK DOES NOT SUSTAIN A SIGNIFICANT TRADING VOLUME, STOCKHOLDERS MAY BE UNABLE TO SELL LARGE POSITIONS IN OUR COMMON STOCK. In the past, our common stock has not experienced significant trading volume on a consistent basis and has not been actively followed by stock market analysts. The average trading volume in our common stock may not increase or sustain its current levels. As a result, we cannot be certain that an adequate trading market will exist to permit stockholders to sell large positions in our common stock. FLUCTUATIONS IN OPERATING RESULTS MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND STOCK PRICE VOLATILITY. We operate in an industry that is subject to significant fluctuations in operating results from quarter to quarter, which may lead to unexpected reductions in revenues and stock price volatility. Factors that may influence our quarterly operating results include: o the introduction or enhancement of software products and technology by us and our competitors; o the use by animators of our toolsets to create b3d-produced content; o the market's acceptance of our 3D Brilliant Banner advertising format; and o our ability to launch and operate our Altnet peer-to-peer business. Page 22
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Additionally, a majority of the unit sales for a product typically occurs in the quarter in which the product is introduced. As a result, our revenues may increase significantly in a quarter in which a major product introduction occurs and may decline in following quarters. DECREASES IN THE PRICE OF OUR COMMON STOCK COULD INCREASE SHORT SALES OF OUR COMMON STOCK BY THIRD PARTIES, WHICH COULD RESULT IN FURTHER REDUCTIONS IN THE PRICE OF OUR COMMON STOCK. Our sales of common stock at a discount to the market price of our common stock, which may be necessary to raise additional capital to fund operations, could result in reductions in the market price of our common stock. Downward pressure on the price of our common stock could encourage short sales of the stock by third parties. Material amounts of short selling could place further downward pressure on the market price of the common stock. A short sale is a sale of stock that is not owned by the seller. The seller borrows the stock for delivery at the time of the short sale, and buys back the stock when it is necessary to return the borrowed shares. If the price of the common stock declines between the time the seller sells the stock and the time the seller subsequently repurchases the common stock, then the seller sold the shares for a higher price than he purchased the shares and may realize a profit. WE WILL NOT BE ABLE TO GENERATE SIGNIFICANT REVENUES FROM OUR TECHNOLOGY BUSINESS IF OUR B3D TOOLSET DOES NOT ACHIEVE MARKET ACCEPTANCE. Our b3d toolset may have programming errors, may be incompatible with other software or hardware products in the market, may face slow adoption in the marketplace and may face competition from other toolmakers. Other factors that influence our ability to generate revenues from our b3d toolset include: o our marketing strategies; o the quality of our products and competing products; o critical reviews; o the availability of alternative forms of entertainment and leisure time activities; o our ability to sell advertising and sponsorships for the content; o our ability to increase the installed base of our Digital Projector, which is necessary to view b3d-produced content; o our b3d toolset may contain features, functionality or workflow conventions that may not be widely accepted by our target audience; o our ability to continue to develop, enhance and deliver the toolset in accordance with established milestones; and o the marketplace's reluctance to adopt a new toolset. OUR PROPRIETARY TECHNOLOGY MAY NOT BE ADEQUATELY PROTECTED FROM UNAUTHORIZED USE BY OTHERS, WHICH COULD INCREASE OUR LITIGATION COSTS AND ADVERSELY AFFECT OUR SALES. Our ability to compete with other entertainment software companies depends in part upon our proprietary technology. Unauthorized use by others of our proprietary technology could result in an increase in competing products and a reduction in our sales. We rely on trademark, patent, trade secret and copyright laws to protect our technology, and require all employees and third-party developers to sign nondisclosure agreements. We cannot be certain, however, that these precautions will provide Page 23
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meaningful protection from unauthorized use by others. We do not copy-protect our software, so it may be possible for unauthorized third parties to copy our products or to reverse engineer or otherwise obtain and use information that we regard as proprietary. Our customers may take inadequate precautions to protect our proprietary information. If we must pursue litigation in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others, we may not prevail and will likely make substantial expenditures and divert valuable resources. In addition, many foreign countries' laws may not protect us from improper use of our proprietary technologies overseas. We may not have adequate remedies if our proprietary rights are breached or our trade secrets are disclosed. IF OUR PRODUCTS INFRINGE ANY PROPRIETARY RIGHTS OF OTHERS, A LAWSUIT MAY BE BROUGHT AGAINST US THAT COULD REQUIRE US TO PAY LARGE LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR DISCONTINUE SELLING OUR PRODUCT. We believe that our products, including our software tools, do not infringe any valid existing proprietary rights of third parties. Any infringement claims, however, whether or not meritorious, could result in costly litigation or require us to enter into royalty or licensing agreements. If we are found to have infringed the proprietary rights of others, we could be required to pay damages, redesign the products or discontinue their sale. Any of these outcomes, individually or collectively, could have a material adverse effect on our business and financial condition. WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF OUR COMMON STOCK. Our 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. Page 24
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PART II OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS In March 2002, we sold an aggregate of 6,051,437 shares of common stock to Harris Toibb, Markev Services LLC and David Wilson in a private placement at a price per share of $0.1322, for aggregate proceeds to us of $800,000. In connection with the offering, we also issued to the investors warrants to purchase up to an aggregate of 10,758,110 shares common stock at an exercise price of $0.148725 per share. The warrants expire in on May 23, 2004. Mark Dyne, our Chairman, and Kevin Bermeister, a director and our Chief Executive Officer and President, are owners of Markev Services and Harris Toibb is a significant stockholder of the company. 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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At a special meeting of our stockholders held on February 20, 2002, our stockholders approved an amendment to our Amended and Restated Certificate of Incorporation to increase the aggregate number of shares of common stock of the company authorized for issuance from 30,000,000 shares to 150,000,000 shares. At the meeting, 10,738,756 shares were voted in favor of, 2,710,277 shares were voted against, and 7,930 shares were withheld from voting on the amendment. There were 0 broker non-votes at the special meeting that were not counted as votes cast for or against the proposal to amend our Amended and Restated Certificate of Incorporation. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - The following exhibits are filed as part of this report: 10.1 Contractor, Confidential Information and Non-Solicitation Agreement, dated as of February 28, 2002, between the Registrant and Abe Sher, an individual. (b) REPORTS ON FORM 8-K The Company filed a Current Report on Form 8-K on March 11, 2002, reporting the consummation of a financing transaction. Page 25
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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BRILLIANT DIGITAL ENTERTAINMENT, INC. Date: May 14, 2002 /S/ ROBERT CHMIEL ------------------------------------- By: Robert Chmiel Its: Chief Operating Officer and Chief Financial Officer (Principal Financial and Accounting Officer) Page 26

Dates Referenced Herein   and   Documents Incorporated by Reference

Referenced-On Page
This ‘10QSB’ Filing    Date First  Last      Other Filings
5/23/04725
11/10/0218
6/15/0216
Filed on:5/15/02
5/14/0226
5/8/021
5/6/0218
For Period End:3/31/0211710QSB/A,  4
3/11/02253,  8-K
2/28/0225
2/20/0225DEF 14A,  PRE 14A
12/31/0171710KSB,  10KSB/A,  4,  5,  5/A
12/15/011617
11/18/0120
7/1/0116
6/30/011610QSB,  10QSB/A
5/1/017
3/31/0121510QSB
12/31/001410KSB,  10KSB/A,  4,  5
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