<PAGE>
                      SECURITIES AND EXCHANGE COMMISSION

                            WASHINGTON, D.C. 20549

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

                               AMENDMENT NO. 1

                                 FORM 10--Q/A


              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934


                 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998.
                        COMMISSION FILE NUMBER 0-21225


                       U.S. DIGITAL COMMUNICATIONS, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

         NEVADA                                             52-2124492
(STATE OF INCORPORATION)                            (I.R.S. EMPLOYER ID NO.)


          2 Wisconsin Circle, Suite 700, Chevy Chase, Maryland 20815
              (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

                                (301)  961-1540
               (REGISTRANT'S PHONE NUMBER, INCLUDING AREA CODE)

       SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                         COMMON STOCK, $0.01 PAR VALUE
                               (TITLE OF CLASS)

INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 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 THE PAST 90 DAYS.

                            YES              No    X
                                --------        --------

THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUERS CLASSES OF COMMON
STOCK WAS 16,849,200 SHARES OF COMMON STOCK, PAR VALUE $0.01, OUTSTANDING AS
OF JUNE 30, 1998


<PAGE>

PART I:     FINANCIAL INFORMATION

ITEM I:     FINANCIAL STATEMENTS

                       U.S. DIGITAL COMMUNICATIONS, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (UNAUDITED)
<TABLE> 
<CAPTION> 

                                    ASSETS

                                                    June 30,           December 31,
                                                      1998                 1997
                                                   ----------          ------------ 
<S>                                              <C>                 <C> 
Current assets:                              
     Cash and cash equivalents                   $  2,005,515        $    545,790
     Trade accounts receivable, net                   126,220             209,073
     Inventory                                         43,942             107,967
     Note receivable                                  421,000              25,000
     Prepaid expenses                                 111,482              17,436
                                                 ------------        ------------ 
          Total current assets                      2,708,159             905,266
                                             
     Investments                                       29,900               9,750
                                                  
     Property and equipment, net                      112,591             122,500
                                                  
     Intangible assets, net                           876,183             981,327
                                                  
     Other noncurrent assets                           34,010              13,032
                                                 ------------        ------------ 
                                             
     Total assets                                $  3,760,843        $  2,031,875
                                                 ============        ============

                    LIABILITIES AND STOCKHOLDERS' (DEFICIT)

Current liabilities:
     Accounts payable and accrued expenses          1,162,356           1,766,838
     Deferred revenue                                  59,902             107,267
     Dividends payable                                324,610             135,931
     Stockholder loans                              1,462,385             962,385
     Accrued interest on stockholder loans            204,452             147,623
     Notes payable                                    428,278             329,458
     Minimum royalty obligation                       450,000             450,000
     Due to former officers and stockholders          469,522             528,426
                                                 ------------        ------------ 
          Total current liabilities                 4,561,505           4,427,928
                                                 ------------        ------------ 
Notes payable (net of current portion)                      -               1,617
                                                 ------------        ------------ 

          Total liabilities                         4,561,505           4,429,545
                                                 ------------        ------------ 

Commitments and contingencies

Stockholders' (deficit):
     Preferred stock -- $.01 par, 10,000,000 
      shares authorized; 4,164,232 and
      2,882,232 outstanding at June 30,   
      1998 and December 31, 1997                       41,642              28,822
     Common stock -- $0.01 par, 50,000,000 
      shares authorized; 22,751,400 issued
      and 16,849,200 outstanding at June 30,  
      1998; 22,298,000 issued and
      16,395,800 outstanding at December 31, 
      1997                                            227,514             222,980
     Additional paid-in capital                    18,114,855          16,332,314
     Common stock warrants                          4,988,540           1,581,337
     Accumulated other comprehensive loss             (11,050)            (31,200)
     Treasury stock (5,902,200 shares of 
      common stock, at cost)                              (10)                (10)
     Deferred compensation                                  -             (19,648)
     Shares to be issued (including 
      additional paid in capital)                     389,583             389,583
     Stockholders' receivable                        (200,000)           (200,000)
     Accumulated deficit                          (24,351,736)        (20,701,848)
                                                 ------------        ------------ 

          Total stockholders' (deficit)              (800,662)         (2,397,670)
                                                 ------------        ------------ 

          Total liabilities and 
           stockholders' (deficit)               $  3,760,843        $  2,031,875
                                                 ============        ============

</TABLE> 

See accompanying notes to condensed consolidated financial statements

<PAGE>
                       U.S. DIGITAL COMMUNICATIONS, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)

<TABLE> 
<CAPTION> 

                                                       Three Months Ended June 30,           Six Months Ended June 30,
                                                       ---------------------------          ---------------------------
                                                           1998           1997                  1998           1997     
                                                       -----------     -----------          -----------     -----------  
<S>                                                    <C>             <C>                  <C>             <C> 
Sales:
    Equipment                                          $    50,035               -          $   194,356               -
    Services                                               176,675               -              331,801               -
                                                       -----------     -----------          -----------     -----------  
        Total sales                                        226,710               -              526,157               -

Cost of goods sold                                         158,761               -              374,286               -
                                                       -----------     -----------          -----------     -----------  
        Gross margin                                        67,949               -              151,871               -
                                                       -----------     -----------          -----------     -----------  

Operating expenses:
    Sales and marketing                                    198,609               -              389,424               -
    General and administrative                           1,126,909         774,332            1,624,236       1,273,562
    Stock option compensation                              253,787         558,845              369,480         656,741
                                                       -----------     -----------          -----------     -----------  
        Total operating expenses                         1,579,305       1,333,177            2,383,140       1,930,303
                                                       -----------     -----------          -----------     -----------  
Loss from operations                                    (1,511,356)     (1,333,177)          (2,231,269)     (1,930,303)
                                                       -----------     -----------          -----------     -----------  

Other income (expense):
    Interest expense                                       (60,727)        (39,460)             (97,978)        (67,925)
    Interest and other income                               17,575          16,074               17,594          16,074
    Income (loss) on repayment of debt                     167,881               -              167,881               -
    Loss on investments                                          -          (9,050)                   -          (9,050)
                                                       -----------     -----------          -----------     -----------  
        Total other income (expense), net                  124,729         (32,436)              87,497         (60,901)
                                                       -----------     -----------          -----------     -----------  

Net loss                                                (1,386,627)     (1,365,613)          (2,143,772)     (1,991,204)
                                                                        
Dividends on preferred stock                            (1,368,870)       (416,149)          (1,506,115)       (832,298)
                                                       -----------     -----------          -----------     -----------  

Net loss available to common stockholders              $(2,755,497)    $(1,781,762)         $(3,649,887)    $(2,823,502)
                                                       ===========     ===========          ===========     ===========

Net loss per common share:
    Basic                                              $     (0.17)    $     (0.08)         $     (0.22)    $     (0.13)

    Diluted                                            $     (0.17)    $     (0.08)         $     (0.22)    $     (0.13)

    Weighted average shares of common stock 
     outstanding                                        16,576,751      22,128,000           16,511,782      22,128,000

</TABLE> 

     See accompanying notes to condensed consolidated financial statements

<PAGE>

                       U.S. DIGITAL COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
                    FOR THE SIX MONTHS ENDED JUNE 30, 1998
                                  (UNAUDITED)

<TABLE> 
<CAPTION> 

                                                                                          
                                                Preferred Stock        Preferred Stock     
                                                   Series A                Series B        
                                            ---------------------  ----------------------  
                                              Shares     Amount       Shares     Amount    
                                            ----------  ---------   ----------  ---------  
<S>                                         <C>         <C>         <C>         <C>        
BALANCE, DECEMBER 31, 1997                   2,882,232   $28,822        -        $    -        
                                                                                           
Issuance of stock in legal settlement              -         -          -             -        
Sale of stock for cash in option exercise          -         -          -             -     
Sale of Series A Preferred Shares and                                                      
 Warrants for cash                           1,280,000    12,800        -             -   
Sale of Series B Preferred Shares and                                                     
 Warrants for cash                                 -         -         2,000         20     
Put option related to Sale of Series B                                                    
 Preferred Stock                                   -         -          -             -                    
Preferred dividends and beneficial                                                        
 conversion feature                                -         -          -             -   
Deferred compensation related to grant of                                                 
 stock options                                     -         -          -             -   
Amortization of deferred compensation              -         -          -             -
Other comprehensive income                         -         -          -             -     
Stock issuance cost                                -         -          -             -     
Net Loss                                           -         -          -             -     
                                            ----------  ---------   ----------  ---------  
BALANCE, JUNE 30, 1998                       4,162,232   $41,622      $2,000     $   20   
                                            ==========  =========   ==========   ======== 

<CAPTION> 

                                                                                         
                                                Common Stock                               
                                                  Par Value          Additonal       Common      
                                            ---------------------     Paid In        Stock    
                                              Shares     Amount       Capital       Warrants  
                                            ----------  ---------   ------------   ----------- 
<S>                                         <C>         <C>         <C>            <C>       
BALANCE, DECEMBER 31, 1997                  22,298,000   $222,980    $16,332,314    $1,581,337
                                                                                            
Issuance of stock in legal settlement          150,000      1,500         57,405        -      
Sale of stock for cash in option exercise      270,000      2,700        119,175        -   
Sale of Series A Preferred Shares and                                                       
 Warrants for cash                                 -         -           130,000     1,777,200
Sale of Series B Preferred Shares and                                                       
 Warrants for cash                                 -         -           913,311     1,086,669
Put option related to Sale of Series B                                                      
 Preferred Stock                                   -         -             -            -   
Preferred dividends and beneficial                                                          
 conversion feature                                -         -         1,317,438        -   
Deferred compensation related to grant of                                                   
 stock options                                     -         -           349,831        -    
Amortization of deferred compensation              -         -             -            -    
Other comprehensive income                         -         -             -            -    
Stock issuance cost                             33,400       334      (1,104,618)      543,333  
Net Loss                                           -         -             -            -    
                                            ----------  ---------   ------------    ----------  
BALANCE, JUNE 30, 1998                      22,751,400  $227,514     $18,114,856    $4,988,539
                                            ==========  =========   ============    ==========  
 

<CAPTION> 
                                         
                                         Accumulated                                                                     
                                            Other           Treasury Stock                        Shares                 
                                         Comprehensive   -----------------------   Deferred       to be     Stockholders'
                                         Income (Loss)      Shares       Cost     Compensation    Issued     Receivable  
                                         --------------   -----------  ---------  -------------  --------   ------------ 
<S>                                      <C>              <C>          <C>         <C>           <C>        <C>          
BALANCE, DECEMBER 31, 1997                  $(31,200)     (5,902,200)    $ (10)     $ (19,648)   $389,583    $ (200,000) 
                                                                                                                         
Issuance of stock in legal settlement           -              -            -             -          -             -     
Sale of stock for cash in option exercise       -              -            -             -          -             -     
Sale of Series A Preferred Shares and                                                                                    
 Warrants for cash                              -              -            -             -          -             -     
Sale of Series B Preferred Shares and                                                                -                   
 Warrants for cash                              -              -            -             -          -             -     
Put option related to Sale of Series B                                                                                   
 Preferred Stock                                -              -            -             -          -             -     
Preferred dividends and beneficial                                                                                       
 conversion feature                             -              -            -             -          -             -     
Deferred compensation related to grant of                                                                                
 stock options                                  -              -            -         (349,831)      -             -       
Amortization of deferred compensation           -              -            -          369,480       -             -     
Other comprehensive income                    20,150           -            -             -          -             -         
Stock issuance cost                             -              -            -             -          -             -
Net Loss                                        -              -            -             -          -             -
                                         --------------   -----------  ---------  -------------  --------   ------------ 
BALANCE, JUNE 30, 1998                       (11,050)     (5,902,200)    $ (10)     $        1   $389,583    $ (200,000)
                                         ==============   ===========  =========  =============  ========   ============

<CAPTION> 
                                                                  
                                                                    Total
                                           Accumulated           Stockholders'
                                             Deficit               Deficit  
                                          --------------         ------------ 
<S>                                       <C>                    <C>          
BALANCE, DECEMBER 31, 1997                 $(20,701,848)          $(2,397,670)
                                                                              
Issuance of stock in legal settlement             -                    58,905 
Sale of stock for cash in option exercise         -                   121,875 
Sale of Series A Preferred Shares and                                             
 Warrants for cash                                -                 1,920,000
Sale of Series B Preferred Shares and             -                               
 Warrants for cash                                -                 2,000,000
Put option related to Sale of Series B                                     
 Preferred Stock                                  -                     -     
Preferred dividends and beneficial                                            
 conversion feature                          (1,506,115)             (188,677)
Deferred compensation related to grant of                                     
 stock options                                    -                     -      
Amortization of deferred compensation             -                   369,480  
Other comprehensive income                        -                    20,150  
Stock issuance cost                               -                  (560,951) 
Net Loss                                     (2,143,772)           (2,143,772)     
                                          -------------          ------------ 
BALANCE, JUNE 30, 1998                    $ (24,351,735)          $ (800,660)
                                          =============          ============ 

</TABLE> 

See accompanying notes to condensed consolidated financial statements.
<PAGE>

                       U.S. DIGITAL COMMUNICATIONS, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)
<TABLE> 
<CAPTION> 

                                                                         Six Months Ended June 30,
                                                                        --------------------------
                                                                            1998           1997
                                                                        -----------    ----------- 
<S>                                                                     <C>            <C> 
Cash flows from operating activities:
    Net loss                                                            $(2,143,772)   $(1,991,204)

    Adjustments to reconcile net loss to net cash used in
       operating activities --
    Depreciation and amortization                                           123,864         19,861
    Stock option compensation                                               369,480        656,741
    Loss on investment                                                            -          9,050
    Loss on repayment of debt                                                     -              -
    Changes in assets and liabilities:                                      
        Decrease in trade accounts receivable, net                           78,520              -
        Decrease in other receivables                                             -          7,390
        Decrease in inventory                                                64,025              -
        Decrease (increase) in prepaid expenses                            (116,523)       (33,827)
        (Increase) Decrease in other noncurrent assets                        5,832         (3,000)
        (Decrease) increase in accounts payable and accrued expenses       (604,483)      (780,684)
        Decrease in deferred revenue                                        (47,365)             -
        Increase in accrued interest on stockholder loans                    56,829         19,682
        Increase in due to former officers and stockholder                        -        266,000
                                                                        -----------    ----------- 

            Total adjustments                                               (69,821)       161,213
                                                                        -----------    ----------- 

            Net cash used in operating activities                        (2,213,593)    (1,829,991)
                                                                        -----------    ----------- 

Cash flows from investing activities:
    Advances to non-affiliates                                             (396,000)             -
    Purchase of investments                                                       -       (100,000)
    Advances to Skysite prior to acquisition                                      -       (198,481)
    Capital expenditures                                                     (8,810)       (58,394)
                                                                        -----------    ----------- 

            Net cash used in investing activities                          (404,810)      (356,875)
                                                                        -----------    ----------- 

Cash flows from financing activities:
    Borrowings from stockholders                                            600,000         70,000
    Principal payments under notes payable                                   (2,797)        (4,794)
    Proceeds from issuance of preferred stock and warrants                3,920,000      3,069,648
    Proceeds from issuance of common stock                                  121,875              -
    Payment of dividends on preferred stock                                       -       (113,985)
    Payment of stock issuance costs                                        (560,950)      (356,503)
    Repayment of stockholder borrowings                                           -        (50,000)
                                                                        -----------    ----------- 

            Net cash provided by financing activities                     4,078,128      2,614,366
                                                                        -----------    -----------  

Net change in cash and cash equivalents                                   1,459,725        427,500
Cash and cash equivalents, beginning of period                              545,790          8,654
                                                                        -----------    -----------              
            
Cash and cash  equivalents, end of period                               $ 2,005,515    $   436,154
                                                                        ===========    ===========
            
Supplemental disclosures of cash transactions:
    Cash paid for interest                                             $     36,148    $         -
                                                                       ============    ===========

Supplemental disclosures of non-cash transactions:
    Common stock issues in satisfication of stockholder loan           $     58,905   $         -
                                                                       ============   =========== 

    Common stock and warrants issued as consideration for 
     placement fees                                                    $    543,667   $         -
                                                                       ============   =========== 

    Unrealized income on investment                                    $     20,150   $         -
                                                                       ============   =========== 

    Beneficial conversion feature on preferred stock                   $  1,317,438   $   704,808
                                                                       ============   =========== 
</TABLE> 

See accompanying notes to condensed consolidated financial statements

<PAGE>
 
                        US DIGITAL COMMUNICATIONS, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)

(1)      BASIS OF PRESENTATION

  The  condensed   consolidated   balance sheets  of  U.S. Digital
Communications, Inc. (the "Company") as of June 30, 1998 and December 31, 1997
and the related condensed consolidated statements of operations, changes in
stockholders' equity (deficit) and cash  flows for the three and six month
periods  ended June 30, 1998 and 1997 presented in this Form 10-Q are unaudited.
In the opinion of management,  all adjustments necessary for a fair
presentation  of such financial  statements have been included.  Such
adjustments consist only of  normal  recurring  items.  Interim results are not
necessarily indicative of results for a full year.  Certain amounts have been
reclassified to conform to the current year presentation.

Certain notes and other information have been condensed or omitted from these
interim financial statements.


(2)     ACQUISITION

  On June 20, 1997, the Company entered into an Agreement and Plan of
Reorganization (the "Agreement") with Skysite Communications Corporation
("Skysite").  Under the Agreement, the Company was to issue 750,000 shares of
its common stock to the shareholders of Skysite, as well as options to purchase
an additional 500,000 shares of its common stock at an exercise price of $.40
per share.

  The stock of Skysite was transferred to the Company on August 26, 1997.
Subsequent to the acquisition, disputes arose between the Company and the former
President of Skysite related to the value of Skysite at the time of the
acquisition.  As a result of this dispute, the Company withheld its shares.  The
Company has entered into an amended agreement with the shareholders of Skysite,
except for the former President (who was allocated 240,000 shares).  Under the
terms of this amended agreement, the other shareholders' shares and options will
be placed in an escrow account.  The shareholders will have all rights
attributable to these escrowed shares, however, they have agreed that at such
time when they elect to sell these shares, the first $200,000 of related
proceeds will be paid to the Company, and the remaining shares and options will
be released to the shareholders.  The 240,000 shares due to the former President
remain unissued, and the Company does not intend to issue such shares.  The
shares and options for the other shareholders were placed in escrow by the
Company during October 1998.

  The Company has recognized the Skysite acquisition as a purchase for
accounting purposes.  The Company has valued the consideration to be given to
the shareholders of Skysite using the 510,000 shares to be placed in escrow and
the related options, less the $200,000 to be received from escrow when these
shares are sold.  This $200,000 has been recognized by the Company as a
reduction of stockholders' equity.  Since the Company does not intend to issue
the 240,000 shares to Skysite's former President, the value for these shares
($100,980) has not been included in the consideration to be given.  If the
Company is required to distribute such shares in the future, the equity and
related goodwill accounts will be increased.

  Since the Company had not issued the shares or options due to the other
shareholders as of June 30, 1998, the Company has recorded the value of the
consideration to be given as shares to be issued in stockholders' equity.  As
these shares and options have now been placed in the escrow account, the Company
will recognize an increase to its common stock and additional paid in capital
accounts in its financial statements for the year ending December 31, 1998.  The
purchase price is $1,356,536 in excess of the fair value of the net tangible
assets acquired.  The Company has recognized this as intangible assets which is
being amortized straight-line over a period of five years.
<PAGE>
 
  The following unaudited pro forma financial information presents the
consolidated results of operations of the Company and Skysite as if the
acquisition had occurred as of January 1, 1997.  The pro forma financial

information does not necessarily reflect the results of operations that would
have occurred had the Company and Skysite constituted a single entity during
such periods.

<TABLE>
<CAPTION>
                                                         Six Months Ended 
                                                          June 30, 1997
                                                         ---------------- 
<S>                                                      <C>
Proforma sales                                              $   350,061
Proforma net loss available to common stockholders          $(3,382,199)
Proforma net loss per share                                 $     (0.15)
</TABLE>


(3)  RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

  Effective January 1, 1998, the Company adopted Statement of Financial
Standards No. 130, "Reporting Comprehensive Income."  This Statement requires
that all items recognized under accounting standards as components of
comprehensive income (loss) be reported in a financial statement that is
displayed with the same prominence as other financial statements.  Comprehensive
income (loss) as defined includes all changes in equity (net assets) during a
period from non-owner sources.  For the six months ended June 30, 1998,
comprehensive income consisted of unrealized losses on available for sale
securities totaling $20,150.

  Effective January 1, 1998, the Company adopted Statement of Financial
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information."  This Statement establishes standards for reporting financial
information about operating segments in annual financial statements and requires
reporting of selected information about operating segments in interim financial
reports issued to shareholders.  Disclosure in interim financial reports in the
initial year of adoption is not required.  The Statement also establishes
standards for related disclosures about products and services, geographic areas
and major customers.  Operating segments are defined as components of an
enterprise about which separate financial information is available and evaluated
regularly by chief operating decision makers in deciding how to allocate
resources and in assessing performance.  Management is in the process of
evaluating the segment disclosures for purposes of reporting under this
Statement.  The adoption of this Statement will have no impact on the results of
operations or financial condition.
<PAGE>
 
The Company may from time to time make written or oral forward-looking
statements.  Written forward-looking statements may appear in documents filed
with the Securities and Exchange Commission (the "Commission"), in press
releases, and in reports to shareholders.  The Private Securities Litigation
Reform Act of 1995 contains a safe harbor for forward-looking statements on
which the Company relies in making such disclosures.  Forward-looking statements
can be identified by the use of words such as "believes," "anticipates,"
"plans," "expects," "may," "will," "intends," "estimates" and the negatives
thereof and similar expressions.  In connection with this "safe harbor," the
Company has identified in this report and in its report filed December 31 1998
on Form 10-K/A for the fiscal year ending December 31, 1997 important factors
that could cause actual results to differ materially from those contained in any
forward-looking statements made by or on behalf of the Company.  Any such
statement is qualified by reference to these cautionary statements.


ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

General

  This report on Form 10-Q/A for the second quarter of fiscal year 1998 ("June
10-Q"), due on May 15, 1998, is being filed on or about January 13, 1999. The
Company filed a report on Form 10-K for the fiscal year ending December 31, 1997
("1997 10-K"), due on March 30, 1998, on October 7, 1998 and subsequently filed
a report on Form 10-K/A for the fiscal year ending December 31, 1997 ("1997 10-
K/A") on October 20, 1998. Both the 1997 10-K and 1997 10-K/A contained
financial statements and accompanying notes that had not been audited by an
independent accountant. The Company filed a report on Form 10-K/A Amendment No.
2 for the fiscal year ending December 31, 1997 on December 31, 1998 which
contained financial statements and accompanying notes that have been audited by
an independent accountant. The Company filed a report on Form 10-Q for the first
quarter of fiscal year 1998 ("March 10-Q"), due May 15, 1998, on or about
November 19, 1998 and subsequently filed a report on Form 10-Q/A for the first
quarter of fiscal year 1998 on or about January 13, 1999. The Company filed a
report due on Form 10-Q for the second quarter of fiscal year 1998 ("June 10-
Q"), due on August 14, 1998, on or about November 20, 1998. The Company filed a
report on Form 10-Q for the third quarter of fiscal year 1998 on or about
December 7, 1998. This filing should be read in conjunction with the more
extensive information provided in the Company's 10-K/A Amendment No. 2 for
fiscal year 1997 concerning that year and subsequent events in fiscal year 1998.

  The delays and, in the case of the 1997 10-K and 1997 10-K/A, absence of the
required audit were associated with substantial changes in the Company's
management and operations. In the Summer of 1997, the Company discontinued its
principal business activity -- the development of the Universal Internet
Television Interface and Electronic Device technologies -- and acquired Skysite
Communications Corporation, Inc. The Company filed a report on Form 10-K for the
year ended December 31, 1996 on May 15, 1997 that describes the discontinued
development program. The Company filed a report on Form 8-K on July 2, 1997 that
reported these changes in its operations. In July 1998, the Company created U.S.
Digital Satellite, Inc. ("Insat") to oversee its satellite communications
operations and transferred the common stock of Skysite to Insat and incorporated
Project 77 Corp. ("Project 77") as Insat's other wholly-owned subsidiary. As a
result, the Company's business presently consists primarily of the operations of
its wholly owned subsidiary that is engaged in the satellite based
telecommunications business. During the Spring of 1998, the Company relocated
its headquarters from Burbank, California to Chevy Chase, Maryland and replaced
its two principal officers in order to more effectively pursue its new
opportunities. Management believes that it is addressing the effect of these
changes on financial and other operations and intends to achieve compliance with
filing requirements under the Securities Exchange Act of 1934 (the "Exchange
Act") as soon as practically possible. However, as of the date of this report,
the Company is not in compliance with the filing requirements of the Exchange
Act due to amendments required on its 1997 and 1998 reports on Form 10-Q.
 
  The Company's independent accountant in fiscal year 1996, Blackman, Kallick
Bartelstein, LLP, declined to stand for reelection as the Company's auditors,
effecting its decision through a letter dated September 24, 1997. The Company
filed a report on Form 8-K on December 3, 1997 that discloses the declination.
Arthur Andersen LLP was engaged on June 1, 1998 to perform an audit of the
Company's
<PAGE>
 
consolidated balance sheet and related financial statements for the fiscal year
ended December 31, 1997. On September 30, 1998, Arthur Andersen LLP resigned as
the Company's auditors. The Company filed reports on Form 8-K on June 5, 1998
and October 7, 1998 that announced these events. On October 15, 1998, the
Company engaged Reznick Fedder and Silverman P.C. to perform an audit of the
Company's consolidated balance sheet and related financial statements for the
fiscal year ended December 31, 1997. The Company filed a report on Form 8-K on
October 20, 1998 that disclosed the engagement. The audit was completed in
December 1998.


Risk Factors

  The Company has incurred significant operating losses in every fiscal period
since inception.  In August 1997, in connection with the acquisition of Skysite,
the Company terminated its production of the UITI and ED technologies and
concentrated its business on the global satellite communications market.
Skysite was incorporated in August 1995 and has only limited operating history.
The Company is thus subject to the risks inherent in the establishment and
growth of a new business enterprise. The likelihood of success of the Company
must be considered in light of the problems, expenses, difficulties and delays
frequently encountered in connection with a new business, including, but not
limited to, a continually evolving industry subject to rapid technological and
price changes, acceptance of the products that Skysite markets and an increasing
number of market competitors. For the year ended December 31, 1997, the
Company's operating loss was $4,685,185. The Company has incurred substantial
quarterly operating losses through the first three quarters of  1998 and
expects a loss for the full year and possibly longer.  The Company has discussed
risk factors in its report on Form 10-K/A Amendment No. 2 for fiscal year 1997
filed on December 31, 1998.


Results Of Operations

Three Months Ended June 30, 1998 Compared to Three Months Ended June 30, 1997.

  The Company had $226,710 in revenue from sales of satellite equipment and
services in the second quarter of fiscal 1998 compared to no such revenue in the
second quarter of fiscal 1997.  This increase resulted entirely from the
Company's acquisition of Skysite Communications Corporation, Inc. in August,
1997. Skysite is a provider of satellite based telecommunications services and
products which utilize satellite based voice/data fax technology with the
Internet.  The Company's ability to maintain sales volume at current levels or
to increase them is dependent on the uninterrupted supply from its major vendors
of goods and services for resale. This supply could be adversely affected by
trade accounts payable of approximately $1.16 million at the end of the second
quarter of fiscal 1998.

  Costs of goods sold was $158,761 in the second quarter of fiscal 1998 compared
to no cost of goods sold in the second quarter of fiscal 1997.  These costs were
associated with the sales generated by Skysite.

  Sales and marketing expense in the second quarter of fiscal 1998 was $198,609
compared to no such expense in the second quarter of fiscal 1997.  These costs
were due to the operational expense incurred by Skysite.

  General and administrative expenses, including travel and entertainment
expenses, legal fees and consulting fees, as well as certain other expenses,
increased to $1,126,909 in the second quarter of fiscal 1998, compared to
$774,332 in the second quarter of fiscal 1997. This increase of $352,577 was
principally due to increases in general and administrative expenses associated
with operating Skysite that were offset by reductions in staff at the Company's
headquarters.

  The Company granted stock options to various employees and other individuals
during the second quarter of fiscal 1998.  In connection with the granting of
these options, the Company recorded a stock option compensation expense in the
amount of $253,787. The amount recorded represents the difference 
<PAGE>
 
between the exercise price and the fair market value of the Company's Common
Stock, as determined by reference to the publicly traded value of the stock, as
of the date the options were granted.

  Net loss for the second quarter of fiscal 1998 was $1,386,627 as compared to
$1,365,613 in the second quarter of fiscal 1997.  Significant factors
contributing to the increase in the net loss by $21,014 were general and
administrative expenses associated with operating Skysite that were largely
offset by a decrease in stock compensation expense and a one time gain on the
settlement of debt.


Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997.

  The Company had $526,157 in revenue from sales of satellite equipment and
services in the first half of fiscal 1998 compared to no such revenue in the
first half of fiscal 1997.  This increase resulted entirely from the Company's
acquisition of Skysite Communications Corporation, Inc. in August, 1997.
Skysite is a provider of satellite based telecommunications services and
products which utilize satellite based voice/data fax technology with the
Internet.  The Company's ability to maintain sales volume at current levels or
to increase them is dependent on the uninterrupted supply from its major vendors
of goods and services for resale. This supply could be adversely affected by
trade accounts payable of approximately $1.16 million at the end of the first
half of fiscal 1998.

  Costs of goods sold was $374,286 in the first half of fiscal 1998 compared to
no cost of goods sold in the first quarter of fiscal 1997.  These costs were
associated with the sales generated by Skysite.

  Sales and marketing expense in the first half of fiscal 1998 was $389,424
compared to no such expense in the first half of fiscal 1997.  These costs were
due to the operational expense incurred by Skysite.

  General and administrative expenses, including travel and entertainment
expenses, legal fees and consulting fees, as well as certain other expenses,
increased to $1,624,236 in the first half of fiscal 1998, compared to $1,273,562
in the first half of fiscal 1997. This increase of $350,674 was substantially
due to general and administrative expenses associated with operating Skysite
that were offset by reductions in staff at the Company's headquarters.

  The Company granted stock options to various employees and other individuals
during the second half of fiscal 1998.  In connection with the granting of these
options, the Company recorded a stock option compensation expense in the amount
of $369,480. The amount recorded represents the difference between the exercise
price and the fair market value of the Company's Common Stock, as determined by
reference to the publicly traded value of the stock, as of the date the options
were granted.

  Net loss for the first half of fiscal 1998 was $2,143,772 as compared to
$1,991,204 in the first half of fiscal 1997.  Significant factors contributing
to the increase in the net loss by $152,568 were an increase in general and
administrative associated with operating Skysite that were offset by a reduction
in stock compensation expense and a one time gain on the settlement of debt.

Liquidity and Capital Resources

  During the first half of fiscal 1998, cash and short-term investments
increased by approximately $1,459,725. The Company  used approximately
$2,213,593 of cash in operations during the quarter.  This use of cash included
a reduction in accounts payable of approximately $604,483 and an increase in
prepaid expenses of approximately $116,523.  These uses of cash were more than
offset by the sale of  Series A preferred stock for $1,920,000 and Series B
preferred stock for $2,000,000 during the second quarter of fiscal 1998. Cash
stock issuance costs during the quarter were approximately $560,950.

  The Company's operations continue to use cash in excess of the amounts they
produce and are expected to do so at least for the remainder of this fiscal
year.  Additional cash has been required from non-operating sources to support
operational requirements as well as any other cash required, such as for
possible 
<PAGE>
 
acquisitions. The Company has sold additional preferred shares to meet
operational cash requirements and the proceeds of such sales have been
sufficient to allow it to meet its current liquidity requirements.  The Company
expects to make additional offers of stock to support future operations and
acquisitions but there can be no assurance such offerings will be consummated or
that the proceeds thereof will be adequate to meet the Company's requirement.

Series A Preferred Stock:  In December 1996 and again in August 1997, the
Company entered into an agreement with a placement agent to raise equity
financing solely from non-U.S. persons as defined in Regulation S promulgated by
the U.S. Securities and Exchange Commission through private offerings of the
Company's 8 percent cumulative convertible preferred stock ("Series A Preferred
Stock"), $0.01 par value per share. The Series A Preferred Stock is nonvoting.
For each two shares of Series A Preferred Stock, an investor also received a
warrant to purchase one share of the Company's Common Stock.

  The first offering period, according to the December 1996 offering memorandum,
was to expire on June 30, 1997. However, the Company closed that offering in
February of 1997 after selling 2,031,832 shares of Series A Preferred Stock with
1,015,916 warrants for a total consideration of $3,047,748. In August of 1997,
the Company again offered its Series A Preferred Stock and warrants with the
offering period to expire March 31, 1998. The August 1997 memorandum was
subsequently amended and the offering period was extended to July 31, 1998. The
Company raised $3,460,500 through the issuance of 2,307,000 additional shares of
Series A Preferred Stock and 1,153,500 warrants. The Company raised a total of
$6,508,248 through the issuance of 4,338,832 total shares of Series A Preferred
Stock in the two offering.  Of this, $1,920,000 was raised through the issuance
of 1,280,000 shares during the first half of fiscal year 1998.

  For every two Series A preferred shares purchased, the stockholder received
one warrant (which shall expire three years after the date of execution of the
subscription agreement) to purchase one share of common stock at an exercise
price of $3.00 per share (the "Series A Preferred Stock Warrants"). The Series A
Preferred Stock Warrants shall become exercisable in the same increments and on
the same dates that the conversion rights with respect to the shares to which
they are attached become vested, as described below. As of June 30, 1998, a
total of 2,081,116 Series A Preferred Stock Warrants had been issued. No
warrants were exercised through June 30, 1998.

  The Company has allocated the equity raised in the Series A Preferred Stock
Offer between the preferred stock and the warrants. Based on the valuation of
each on the date of issuance, the Company has allocated approximately $2,868,000
to the preferred stock and $3,640,000 to the warrants for the entire proceeds
received under Series A through closing at July 31, 1998.

  Series A preferred stockholders have the right to convert each share into one
share of common stock as follows:  a) 25 percent of the shares 90 days following
the date the shares were issued (the "Series A Initial Conversion Date") and b)
25 percent of the shares at the end of each of the three consecutive 90-day
periods following the Series A Initial Conversion Date.  No conversion of Series
A Preferred Stock to common stock was made through June 30, 1998.

  Six months after the date of issuance of the Series A preferred shares, the
Company shall have the option to require the preferred stockholder to convert
each of such shares into one share of common stock.  Upon such conversion, all
of the Series A Preferred Stock Warrants attached to such shares shall become
fully exercisable.

  Each Series A preferred stockholder is entitled to receive quarterly dividends
on the last day of March, June, September and December in an amount equal to 8
percent per annum of the stated value of the Series A Preferred stock.
Dividends totaling $113,985 were paid in 1997.  Additionally, the Company has
recognized dividends payable totaling $324,610 as of June 30, 1998.

  On the date of issuance of some of the Series A Preferred Stock, the purchase
price of the shares was less than the quoted market price of the Company's
common stock.  Accordingly, the intrinsic value of this 
<PAGE>
 
beneficial conversion feature (approximately $7,650,000) is being accreted to
preferred stock over the conversion rights period. Accretion of the beneficial
conversion feature as of June 30, 1998, totaled $2,649,655 and is reflected as
an increase in the carrying value of the preferred stock and a dividend charge
against retained earnings.

  Upon any voluntary or involuntary liquidation, dissolution or winding up of
the Company, the holders of the Series A Preferred Stock will be entitled to be
paid, before any distribution or payment is made in respect of any Common Stock
as to distribution on liquidation, dissolution or winding up, an amount in cash
equal to the aggregate Stated Value ($1.50 per share) of all shares outstanding
plus all accrued but unpaid dividends.

  Under the terms of the Placement Agent Agreement related to Series A, the
Placement Agent is entitled to (1) a Placement Fee based on a percentage of
capital raised, (2) options to purchase common stock of the Company and (3) five
percent of the proceeds related to exercise of warrants issued with the Series A
preferred shares.  The total fees earned and the value of the options granted
through the closing at July 31, 1998, amounted to $2,037,151.  In accordance
with the Placement Agent Agreement, on March 6, 1997, the placement agent was
granted 2,800,000 options to purchase common stock of the Company at $.3125 per
share.  On December 12, 1997, these options were canceled and the Company
granted the placement agent 2,800,000 new options, for which the placement agent
could exchange each option for .85 share of the Company's stock upon
registration.  On December 12, 1997, the Company valued the new options to be
$1,278,631.  The Company has recognized the value of the new options and the
percentage fee earned by the placement agent and recorded this amount, which
totaled $1,785,888, for the year ended December 31, 1997, as stock issuance
cost, which is reflected as a reduction of additional paid-in capital.  In
addition, if all warrants issued in the Series A offering are exercised, the
placement agent's 5 percent fee would increase by approximately $325,000.

  Series B Preferred Stock:  In April 1998, the Company created a Series B issue
of Preferred Stock, which it offered in a Regulation D Private Placement.  The
Company offered 3,000 shares of the 10,000,000 authorized shares of Preferred
Stock at a purchase price of $1,000 per share.  Each share had a stated value of
$1,000 and a par value of $0.01 per share ("Series B Preferred Stock"). The
offer of Series B Preferred Stock  closed on May 28, 1998.  The Company accepted
subscriptions for all 3,000 shares for $3,000,000, resulting in $2,670,000 net
cash proceeds to the Company.  As of June 30, 1998, the Company had received
payment of  $2,000,000 for 2,000 shares.  The Series B Preferred Stock will not
pay dividends and is nonvoting stock.

  Each share of Series B Preferred Stock shall be convertible into shares of the
Company's common stock based upon a Conversion Formula, as defined in the
Offering Agreement.

  In conjunction with the offering, 500,000 warrants were issued to the Series B
shareholders proportionate to each investor's number of shares purchased to the
total shares offered.  Each warrant entitles the holder to purchase shares of
the Company's common stock at a price 110 percent of the closing bid price as of
the closing of the Series B offering.  The exercise price is $4.34.  The
exercise price and number of shares to be purchased may be adjusted from time to
time based on computations included in the warrant agreement.  Such warrants are
exercisable for three years after closing of the Series B offering.

  The Company has allocated the equity raised in the offering of the Series B
Preferred Stock between the preferred stock and the warrants.  Based on the
valuation of each on the date of issuance, the Company will allocate
approximately.  The equity raised in the Series B Preferred Stock offering
through June 30, 1998 has been allocated $913,331 to the preferred stock and
$1,086,669 to the warrants.

  Each holder of Series B Preferred Stock will have the right to convert their
shares as follows:  a) 50 percent of the shares on the effective date of
registration ("Series B Conversion Date") at the Series B Conversion Price
(lesser of (i) 25 percent off the five-day average Closing Bid Price for the
Company's common stock immediately before conversion or (ii) 100 percent of
Closing Bid Price for the Company's common stock on the date of closing, but not
less than $.50 per share of the Company's common stock) and 
<PAGE>
 
b) 50 percent of the shares on the 45th day after the effective date of
registration at the Conversion Price. The holder shall be entitled to an
additional discount privilege equal to one percent (1%) per month, or fraction
of a month, from the time of closing until the Series B Conversion Date for any
conversion thirty (30) days after the Series B Conversion Date and one-half
percent (.5%) per month or fraction of a month for any conversions thereafter
("Series B Additional Discount"). All shares outstanding on May 1, 2001, will be
automatically converted into common stock in accordance with the Conversion
Formula, at the Conversion Price.

  The Company will have the right, in its sole discretion, to redeem in whole or
in part any shares of Series B Preferred Stock submitted for conversion.  The
redemption price per share of common stock after conversion of the Series B
Preferred Stock shall be calculated as 133 percent of the face value plus any
accrued Series B Additional Discount.

  On the date of issuance of the Series B Preferred Stock, the conversion price
of certain of the Series B Preferred Stock was less than the quoted market price
of the Company's common stock.  Accordingly, had the shares been converted as of
the issuance date, the intrinsic value of this beneficial conversion feature
would have been approximately $1,288,000.  The eventual accretion of the
intrinsic value of the beneficial conversion feature will be recorded as an
increase in the carrying value of the preferred stock and a dividend charge to
retained earnings over the conversion rights period.

  In the event of any liquidation, dissolution or winding-up of the Company,
either voluntary or involuntary (a "Liquidation"), the holders of shares of the
Series B Preferred Stock then issued and outstanding shall be entitled to be
paid out of the assets of the Company available for distribution to its
shareholders, whether from capital, surplus or earnings, before any payment
shall be made to the holders of shares of the Common Stock or upon any other
series of Preferred Stock of the Company with a liquidation preference
subordinate to the liquidation preference of the Series A Preferred Stock.  The
amount of the pay-out will be an amount per share equal to the Stated Value.

  The Series B Preferred Stock subscription agreements contain a "put" provision
for common stock which allows the Company to raise an additional $3,000,000. The
provision specifies that 75 days after the effective date of the registration of
additional common shares to be used under this provision, the Company may sell
common stock (the "Put Stock") to the Series B subscribers. The price of the Put
Stock is determined by taking the lower of (1) 80 percent of the lowest closing
bid price for the previous 20 trading days prior to funding or (2) 80 percent of
the closing bid price on the day of funding.  The minimum draw is $250,000 and
the maximum draw is $750,000.  If the price of the Company's common stock for
the 20 trading days prior to the funding is less than $1.25 and the average
trading volume is less than $300,000 per day for the previous 20 trading days,
the Series B shareholders have the option not to fund the requested draw.  These
minimums increase as the amount of the funds requested by the Company increase
from $250,000 to $750,000.  The Company has valued the Series B Preferred Stock
Put provision at $2,517,000 of which $1,678,000 has been recorded in the second
half of fiscal 1998.  The value has been recorded as an increase in the carrying
value of Preferred stock and an off-setting charge to additional paid in
capital.

  On the date of issuance of the Series B Preferred Stock with the put
provision, the conversion price under the put provision was less than the quoted
market price of the Company's common stock.  Accordingly, had the put provision
been exercised at the date of issuance of the Series B Preferred Stock, the
intrinsic value of the beneficial conversion feature would have been
approximately $483,000.  The put provision will be recorded as an offsetting
charge to shareholders' equity.  The stock put rights will be amortized over the
period of the put provision with an offsetting charge to retained earnings.  The
accretion of the intrinsic value of the beneficial conversion feature will be
recorded ratably over the term of the put contract (two years from execution of
the subscription agreement) based on the earliest dates the Company may put its
shares.

  Under the terms of the Placement Agent Agreement related to the issuance of
Series B Preferred Stock, the Placement Agent was paid fees equal to 11 percent
of the funded amount of $3 million or $330,000 for the placement of the 3,000
shares of Series B Preferred Stock, 50,000 shares of common stock of the
Company, valued at approximately $66,000 as of the closing date, for
establishing the Put Equity Line of 
<PAGE>
 
Credit and warrants to purchase 250,000 shares of common stock at a price and
under the conditions of the Series B Preferred Stock investors' warrants, valued
at approximately $269,000 as of the closing date. As of June 30, 1998, the
Placement Agent had earned $220,000 as well as common stock valued at
approximately $44,000 and warrants valued at approximately $543,333. In
addition, as the Company, at its sole discretion, utilizes the Put Equity Line
of Credit, the Placement Agent will receive a fee of 8 percent of the cash
actually invested at each funding. If the entire Line of Credit is used, the
Placement Agent would earn an additional $240,000.

  Series C Preferred Stock:  In August 1998, the Company created a Series C
issue of Preferred Stock.  The Company offered 4,000 shares of the 10,000,000
authorized shares of Preferred Stock at a purchase price of $1,000 and a par
value of $0.01 per share ("Series C Preferred Stock").  When the offering  ended
on September 1, 1998, the Company had issued 3,000 shares for $3,000,000,
resulting in $2,670,000 net cash proceeds to the Company.   The Series C
Preferred Stock will not pay dividends and is nonvoting stock.

  In conjunction with the offering, 495,000 warrants will be issued to the
Series C shareholders proportionate to each investor's number of shares
purchased to the total shares offered.  Each warrant entitles the holder to
purchase shares of the Company's common stock at a price of $4.34.  The exercise
price and number of shares to be purchased may be adjusted from time to time
based on computations included in the warrant agreement.  Such warrants are
exercisable for three years after closing of the Series C offering.

  The Company has allocated the equity in the offer of the Series C Preferred
Stock raised between the preferred stock and the related warrants.  Based on the
valuation of each on the date of issuance, the Company will allocate $1,802,000
to the preferred stock and $1,198,000 to the warrants.

  Fifty percent of each share of Series C Preferred Stock shall be convertible
on the earlier of the effective date of registration of the Company's common
stock ("Series C Conversion Date") or one-hundred and twenty (120) days from the
closing of the Series C Preferred Stock Offering, the remaining fifty percent
shall be convertible on the earlier of the forty-fifth day after the effective
date of registration or one-hundred and sixty-five (165) from the closing of the
Series C Preferred Stock Offering.  The Series C Conversion Price will be either
the discounted price (twenty-five percent off of the five-day closing bid price)
or $3.94, whichever is less. However, in no event shall the conversion price be
less than $1.875 per share.  In the event the stock is trading below $1.875, the
floor price will be adjusted to the lowest closing bid price for the Company's
common stock during such five-day period from which the holder shall be entitled
to an additional discount.  The holder shall be entitled to an additional
discount privilege equal to one percent (1%) per month, or fraction of a month,
from the time of closing until the Series C Conversion Date for any conversion
thirty (30) days after the Series C Conversion Date and one-half percent (.5%)
per month or fraction of a month for any conversions thereafter ("Series C
Additional Discount").  All shares outstanding on June 1, 2001, will be
automatically converted into Common Stock on such date in accordance with the
Conversion Formula and the Series C Conversion Price then in effect.

  The Company shall have the right in its sole discretion, to redeem, prior to
receipt of the Notice of Conversion, in whole or in part any shares of Series C
Preferred Stock.  The redemption price per share of common stock after
conversion of the Series C Preferred Stock shall be calculated as 133 percent of
the face value plus any unpaid penalty should the Company not effect the date of
registration 150 days from Closing.  The Company shall not have a redemption
privilege if the common stock is trading above $3.50 per share unless the Holder
agrees in writing to allow the Company to redeem such shares.

  On the date of issuance of the Series C Preferred Stock, the conversion price
of certain of the Series C Preferred Stock was less than the quoted market price
of the Company's common stock.  Accordingly, had the shares been converted as of
the issuance date, the intrinsic value of this beneficial conversion feature
would have been approximately $263,000.  The eventual accretion of the intrinsic
value of the beneficial conversion feature will be measured at the date of
conversion and will be recorded as an increase in the 
<PAGE>
 
carrying value of the Series C Preferred Stock and a dividend charge to retained
earnings over the conversion rights period.

  In the event of any liquidation, dissolution or winding-up of the Company,
either voluntary or involuntary (a "Liquidation"), the holders of shares of the
Series C Preferred Stock then issued and outstanding shall be entitled to be
paid out of the assets of the Company available for distribution to its
shareholders, whether from capital, surplus or earnings, before any payment
shall be made to the holders of shares of the Common Stock or upon any other
series of Preferred Stock of the Company with a liquidation preference
subordinate to the liquidation preferences of the Series A and B Preferred
Stock.  The amount of the pay-out will be an amount per share equal to the
Stated Value.

  Under the terms of the placement agent agreement related to the issuance of 
Series C Preferred Stock, the placement agent was paid fees equal to 11% of the 
funded amount of $3,000,000 or $330,000 for the placement of the 3,000 shares of
Series C Preferred Stock, and warrants to purchase 250,000 shares of common 
stock at a price and under the conditions of the Series C Preferred Stock 
investors' warrants, valued at approximately $228,000 as of September 1, 1998, 
the closing date. 

Recent Accounting Pronouncements not yet Adopted

  In April 1998, the AICPA also issued Statement of Position No. 98-5,
"Reporting on the Costs of Start-up Activities" (SOP 98-5).  SOP 98-5 must be
adopted no later than January 1, 1999, and requires that costs of start-up
activities including pre-operating, pre-opening and other organizational costs
be expensed as incurred.  In addition, at the time of adoption the unamortized
balance of any previously deferred start-up costs must be expensed.  Management
does not expect the adoption of SOP 98-5 to have a material effect on results of
operations or financial condition.


PART II  OTHER INFORMATION

     ITEM 1. LEGAL PROCEEDINGS

  William H. Buck v. Viscorp & Visual Information Services Corp.  On or about
  -------------------------------------------------------------              
June 2, 1997, the Company filed a complaint against William H. Buck , the
Company's former Chief Executive Officer and Director, in the United States
District Court, Northern District of Illinois, Eastern Division, Case No. 97 C
3390, entitled Viscorp and Visual Information Services Corp. v. William H. Buck,
               ---------------------------------------------------------------- 
alleging breach of fiduciary duty, breach of employment agreement, accounting as
to severance agreement and conspiracy to defraud arising out of Mr. Buck's
conduct as Chief Executive Officer of the Company.   On June 23 1997, Mr. Buck
filed a complaint against Viscorp, et. al., in the United States District Court,
Northern District of Illinois, Eastern Division, Case No. 97 C 4480.  Mr. Buck
sought a declaratory judgment permitting him to sell 220,000 shares of Common
Stock of the Company.  On September 19, 1997, Mr. Buck filed a counterclaim
against the Company, alleging partial rescission of his severance agreement,
dated January 8, 1997, breach of severance agreement, rescission of lock-up
agreement, breach of lock-up agreement and tortious interference with economic
advantage.  On November 12, 1997, Raquel Velasco filed a complaint against the
Company, in the United States District Court, Northern District of Illinois,
Eastern Division, Case Number 97-C-7897, entitled Raquel Velasco v. Viscorp
                                                  ------------------------- 
seeking $220,000 in damages and expenses from alleged rescission for breach of
written severance agreement, or in the alternative, breach of severance
agreement.  On June 9, 1998, the Company filed a counterclaim against Ms.
Velasco relating to her alleged employment agreement with the Company.  The
aforementioned matters were consolidated for purposes of discovery.  On August
31, 1998, the Company entered into settlement agreements with Mr. Buck and Ms.
Velasco.  Pursuant to the Company's settlement agreement with Mr. Buck, Mr. Buck
is permitted to sell 350,000 shares of the Company's common stock that he
already owns, pursuant to a tradeability schedule.  Mr. Buck returned all other
shares to the Company for cancellation. Mr. Buck's stock options have been
canceled. Pursuant to the Company's settlement agreement with Ms. Velasco, Ms.
Velasco received 350,000 shares of the Company's common stock, formerly held by
Mr. Buck, also subject to a tradeability schedule. Ms. Velasco has also been
granted an option to purchase certain property from the Company, including the
ED and UITI technologies, for $50,000 which she exercised in November 1998.

  Visual Information Service Corp. v. Interactive Video Publishing, Inc.  On
  ---------------------------------------------------------------------     
July 25, 1996, the Company filed a lawsuit in the United States District Court
for the Northern District of California, San Jose Division, case number C 96-
20593 RMW (EAI), against Interactive Video Publishing, Inc., David Serlin, Steve
<PAGE>
 
Owens and Kaori Kuwata ("Defendants") for injunctive relief and damages of
approximately $7 million for misappropriation of trade secrets, conversion and
breach of fiduciary duty.  Defendants filed counterclaims for declaratory
relief, intentional interference with economic advantage, breach of contract and
unfair competition claiming damages yet to be determined.  On November 20, 1996,
David Serlin and Marvin Lerch filed suit against the Company and its former
officer, Jerome Greenberg, in the United States District Court, Northern
District of California, San Jose Division.  The case is captioned  Serlin v.
                                                                   ---------
Visual Information Service Corp., case number C 96-21073. David Serlin and
-------------------------------                                           
Marvin Lerch claimed damages in excess of $6.5 million in connection with the
alleged breach of their employment contracts, alleging breach of employment
contracts, breach of the implied covenant of good faith and fair dealing, fraud,
deceit and negligent misrepresentation among several causes of action. On June
25, 1997, a settlement conference was held in Visual Information Service Corp v.
                                              ----------------------------------
Interactive Video Publishing, Inc. and Serlin v. Visual Information Service
---------------------------------     -------------------------------------
Corp. and a settlement was reached with all parties in both actions. On
September 26, 1997, Messrs. Serlin and Lerch entered into a settlement agreement
with the Company whereby the Company agreed to pay Messrs. Serlin and Lerch
$25,000 each, and granted each 400,000 stock options with an exercise price of
$1.50. The Company is currently unable to comply with terms of the settlement
agreement because the shares underlying the stock options have not yet been
registered. This inability has raised questions about the validity of the
agreement and could result in consequential damages assessed against the
Company. At this time, management is unable to estimate the likelihood or amount
of any such damages.

  Donald Gilbreath v. USDI, Viscorp and Corporate Stock Transfer, Inc.  On
  -------------------------------------------------------------------     
December 19, 1997, Donald Gilbreath, a former director of the Company, filed a
complaint against the Company in the United States District Court, District of
Colorado, Case No. 97-WY-2667-CB, alleging a claim against the Company for
failing to remove restrictive legends on shares owned by Mr. Gilbreath.  Mr.
Gilbreath requested that the Court hold that he was the lawful owner of
1,000,000 unrestricted shares of Common Stock of the Company, and 237,800
unrestricted options to acquire common shares.  On July 2, 1998, the Company
entered into a settlement agreement with Mr. Gilbreath, whereby 500,000 of Mr.
Gilbreath's shares in the Company will be unrestricted, and Mr. Gilbreath will
retain 75,000 options, which must be exercised by January 1, 1999.   As of
December  31, 1998 75,000 of those options have been exercised.  Pursuant to the
settlement agreement, the remaining 500,000 shares have been canceled. Further,
Mr. Gilbreath is permitted to sell his shares pursuant to a tradeability
schedule.

  Roger and Bonnie Remillard v. U.S. Digital Communications, Inc. f/k/a Viscorp
  -----------------------------------------------------------------------------
and Corporate Stock Transfer, Inc.  On or about June 1, 1998, Roger and Bonnie
---------------------------------                                             
Remillard filed a complaint in the United States District Court, District of
Colorado, Case No. 98-WY-1217-CH, alleging that the Company failed to remove
restrictive legends from the Remillards' shares in the Company, in violation of
Nevada Revised Statute 104.8401.  Pursuant to a settlement agreement, dated July
2, 1998, the Remillards retained 820,000 shares of the Company's Common Stock.
Further, the Remillards retained 200,000 out of 288,000 stock options, which
must be exercised before January 1, 1999.  As of December  28, 1998 150,000 of
those options have been exercised.  The Company has placed the remaining 50,000 
options in escrow pending resolution of a dispute over their ownership. These 
options may be exercised in the future. The Remillards are permitted to sell
their shares pursuant to a tradeability schedule.

  James Goodnow v. Viscorp.  On February 9, 1998, James Goodnow filed a
  ------------------------                                             
complaint in the Nevada County Superior Court, State of California, against the
Company, alleging breach of contract, fraud, unfair business practices and money
on open book account, based on the alleged breach of a software consulting
agreement dated July 17, 1997. Mr. Goodnow sought damages in the amount of
$20,219.40.  In June, 1998, the Company and Mr. Goodnow entered into a
settlement agreement whereby the Company agreed to pay Mr. Goodnow $16,000,
which was subsequently paid.

  Cochran Ranch, ITG and Rubin Kitay v. U.S. Digital Communications Inc. and
  --------------------------------------------------------------------------
Larry Siegel.  In January 1998, plaintiffs, former shareholders of Skysite,
------------                                                               
filed a request for mediation and demand for arbitration with the American
Arbitration Association in Los Angeles, California, case number 72 174 00098 98
GS, requesting mediation and arbitration in connection with the Company's
alleged breach of the Agreement and Plan of Reorganization, dated June 20, 1997,
whereby the Company acquired Skysite.   Plaintiffs alleged that the Company
failed to issue shares in consideration of the acquisition.  On May 28, 1998,
plaintiffs and 
<PAGE>
 
the Company settled this dispute pursuant to the amendment to agreement and plan
of reorganization. See "Notes to Condensed Consolidated Financial Statements
(Unaudited) (2) Acquisition."

  Nolan Bushnell v. Viscorp.  On December 13, 1994, Nolan Bushnell filed a
  -------------------------                                               
complaint against the Company, in San Mateo Superior Court, case number 390474,
alleging breach of fiduciary duties, breach of contract, wrongful termination
and other causes of action in connection with Mr. Bushnell's employment with
Company.  On February 3, 1998, the Company and Nolan and Nancy Bushnell entered
into a settlement, the terms of which, by agreement of the parties thereto, are
confidential.  The Company believes that the terms of such settlement agreement
would not have a material adverse effect on the Company.

  David Rosen v. U.S. Digital Communications, Inc.  On July 27, 1998, David
  -----------------------------------------------                          
Rosen, a former employee and consultant of the Company, filed a complaint
against the Company in the California Superior Court, County of San Francisco,
case number 996762, in connection with his alleged employment contract and his
employment termination.  Mr. Rosen alleged breach of contract, breach of the
covenant of good faith and fair dealing, violation of California Labor Code
Sections 201, 226 and 227, and conversion.  Mr. Rosen seeks severance pay and
other damages in excess of $100,000.  Discovery has not yet begun.

  CBS (formerly Westinghouse) v. Skysite.  On April 1, 1998, CBS filed a
  ---------------------------------------                               
complaint, in Los Angeles County Superior Court, case number 188569, alleging
that Skysite breached a distribution agreement with CBS dated December 21, 1996,
and a subsequent settlement agreement between CBS and Skysite, dated March 6,
1997, seeking monies allegedly owed under the distribution agreement. In June
1998, CBS and the Company entered into a settlement agreement whereby Skysite
agreed to pay CBS $430,000, which was paid soon thereafter.

  Witter Publishing v. Skysite.  On February 6, 1997, Witter Publishing filed a
  ----------------------------                                                 
complaint in Los Angeles Municipal Court, case number 97K02741, alleging open
book account and account stated, and seeking money damages. On December 12,
1997, Witter Publishing and Skysite entered a stipulation for entry of judgment
whereby Skysite agreed to pay Witter Publishing $19,038 between December 20,
1997 and November 20, 1998.

  PR Newswire Association, Inc. v. Skysite.  On November 12, 1997, PR Newswire
  ----------------------------------------                                    
filed a complaint against Skysite in New Jersey Superior Court, Hudson County,
docket number DC - 10873 - 97, alleging a breach of contract and seeking damages
of $6,590.  In January 1998, Skysite agreed to pay PR Newswire payments totaling
$5,044, and the case has been dismissed.

  Tom Soumas v. Skysite.  On October 6, 1997, Tom Soumas, a former employee of
  ---------------------                                                       
Skysite, filed a complaint with the Labor Commissioner of the State of
California, seeking damages for vacation pay and wellness days he alleges he was
due upon termination, in the amount of $9,300.  A hearing on Mr. Soumas' claim
was held on June 2, 1998, pursuant to which the Labor Commissioner issued a
decision in favor or Mr. Soumas in the amount of $2,500.

  Penwell Publishing v. Skysite.  On March 5, 1997, plaintiff filed a complaint
  -----------------------------                                                
in the Tulsa County, Oklahoma District Court, Case Number CJ 9701105, alleging
actions for open account and breach of contract resulting from the Company's
alleged obligation to place certain advertisements in Penwell Publications.
Plaintiff seeks damages of $36,217.

  Intelligent Data Systems, Inc.  On August 4, 1998, counsel for Intelligent
  -----------------------------                                             
Date Systems, Inc. ("IDS") made a demand on the Company for (i) rescission of a
technology licensing agreement dated January 1, 1995 and (ii) return of
consideration to IDS, in the amount of $968,750.  No complaint has been filed.

  Tom Soumas.  In a letter dated August 31, 1998, counsel for Tom Soumas made a
  ----------                                                                   
demand on the Company in connection with the Company's acquisition of Skysite.
No lawsuit has been filed and no damages have been alleged. The Company is
unable to express an opinion as to the outcome of this matter as no lawsuit has
been filed and the Company has made no independent investigation of potential
claims, defense and counterclaims.  If a lawsuit is ever filed, it will be
vigorously defended.
<PAGE>
 
ITEM 6  EXHIBITS AND REPORTS ON FORM 8-K

  The Company filed Form 8-K on February 19, 1998 to announce that the Company
had decided in fiscal year 1997 to discontinue the development of  the Universal
Internet Television Interface and Electronic Device technologies described under
the section entitled "Business" in the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.  As a result, the Registrant's business
presently consists solely of the operation of its wholly owned subsidiary
Skysite Communications Corporation.   The filing also reported that the Company
had not yet replaced its prior auditor.

  The Company filed Form 8-K on June 5, 1998 to announce that it had engaged
Arthur Andersen LLP to perform an audit of its consolidated balance sheet for
the fiscal year ended December 31, 1997.

  The Company filed Form 8-K on July 8, 1998 to announce that Jerome Greenberg
resigned from his position as a director of the Company.

  The Company filed Form 8-K on August 20, 1998 to report developments in its
negotiations with EuroTelecomm Communications, Inc. on its possible acquisition
of that company, to disclose sales of Series A Preferred Stock,  to disassociate
itself from unauthorized projections of its earnings and to make further
disclosure of its engagement of Arthur Andersen LLP to perform an audit of its
consolidated balance sheet for the fiscal year ended December 31, 1997.

  The Company filed Form 8-K on October 7, 1998 to announce that Arthur Andersen
LLP had resigned as its auditor.

  The Company filed a Form 8-K on October 20, 1998 to announce that  it had
engaged Reznick Fedder and Silverman P.C. to perform an audit of the its
financial statements for the fiscal year ended December 31, 1997.

  The Company filed a Form 8-K on December 11, 1998 to report the correction to
a press release reporting the Company's financial results for the third quarter
of 1998.
<PAGE>
 
                                   SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                U.S. Digital Communications, Inc.

Date: January 13, 1999          /s/ ROBERT J. WUSSLER
                               ----------------------------------- 
                               Robert J. Wussler
                               (President, Chief Executive Officer
                               and Director (Principal Executive
                               Officer))


Date: January 13, 1999         /s/ EDWARD J. KOPF
                               ----------------------------------- 
                               Edward J. Kopf
                               (Executive Vice President and Chief
                               Operating Officer (Principal Financial and
                               Accounting Officer))