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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the quarterly period ended September 30, 2004



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



Commission File No.: 000-33471



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YAK COMMUNICATIONS INC.

(Exact name of small business issuer as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Florida                                                        |  | 98-0203422                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



300 Consilium Place,
Suite 500, Toronto, Ontario, Canada M1H 3G2

(Address of principal executive offices)



(647) 722-2752

(Issuers Telephone Number, Including Area Code)



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Indicate by a check mark whether the issuer: (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.    x  Yes ̈No



Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No ̈



As of September 30, 2004, 12,893,250 shares of the issuers Common Stock, no par value per share, were outstanding.



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YAK COMMUNICATIONS INC. AND SUBSIDIARIES



INDEX TO FORM 10-Q



|                               |  |                                                                                       |  |     
|------------------------------ |  | ------------------------------------------------------------------------------------- |  | ----
|                               |  |                                                                                       |  | Page
|PART I - FINANCIAL INFORMATION |  |                                                                                      
|                               |  |                                                                                      
|Item 1.                        |  | Financial Statements                                                                  |  |     
|                               |  |                                                                                      
|                               |  | Consolidated Balance Sheets                                                           |  | 1   
|                               |  |                                                                                      
|                               |  | Consolidated Statements of Stockholders Equity                                       |  | 1   
|                               |  |                                                                                      
|                               |  | Consolidated Statements of Operations                                                 |  | 1   
|                               |  |                                                                                      
|                               |  | Consolidated Statements of Cash Flows                                                 |  | 1   
|                               |  |                                                                                      
|                               |  | Notes to Consolidated Financial Statements                                            |  | 1   
|                               |  |                                                                                      
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 1   
|                               |  |                                                                                      
|Item 3.                        |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 16  
|                               |  |                                                                                      
|Item 4.                        |  | Controls and Procedures                                                               |  | 16  
|                               | 
|PART II - OTHER INFORMATION    |  |                                                                                      
|                               |  |                                                                                      
|Item 1                         |  | Legal Proceedings                                                                     |  | 18  
|                               |  |                                                                                      
|Item 2                         |  | Changes in Securities and Use of Proceeds                                             |  | 18  
|                               |  |                                                                                      
|Item 3                         |  | Defaults Upon Senior Securities                                                       |  | 18  
|                               |  |                                                                                      
|Item 4                         |  | Submission of Matters to a Vote of Security Holders                                   |  | 18  
|                               |  |                                                                                      
|Item 5                         |  | Other Information                                                                     |  | 18  
|                               |  |                                                                                      
|Item 6                         |  | Exhibits and Reports on Form 8-K                                                      |  | 18  
|                               |  |                                                                                      
|Signatures                     |  |                                                                                       |  | 19  



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PART I

FINANCIAL INFORMATION



Item 1. Financial Statements.



Immediately following THE SIGNATURE PAGE IN THIS FORM 10-Q.



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.



Overview



We are a facilities-based reseller of discount, long-distance telecommunication services in Canada and the U.S. to residential and small business
customers. We primarily concentrate our residential marketing efforts towards consumers that make significant amounts of international calls, directly targeting ethnic markets and communities in major urban centers.



Products



Our primary residential product offering is dial-around services (also known as casual calling) at both variable
and flat rate pricing. Casual calling allows our customers to dial-around their existing long distance carrier on any call by entering a few digits prior to making the call, without permanently switching long distance carriers. We offer 1+
billing which allows our customers to permanently switch all of their calls from their existing long distance carrier to our long distance service. We have continued to experience significant year over year growth in our dial-around business.
Substantially all of our current dial-around business comes from the Canadian market, in which we are the dominant company as it pertains to market share. According to industry sources, the dial-around market in Canada is expected to double in size
to approximately $165 million by 2007. We believe that there still exists an opportunity to further grow the Canadian market, and we continue to increase our focus on this core business in both Canada and the United States in order to provide for
the expansion of other areas of the business.



We initially
launched into the U.S. market with our dial-around product in 2002 in three metropolitan areas: Las Vegas, Miami and Washington, D.C. Since the initial launch into the United States, we have registered with 47 states and have completed the loading
and testing of all of our CIC codes i.e. 10-10-925, 10-15-945 and 10-15-565. We have experienced a small but steady volume of dial-around traffic in the U.S. market without a focused and sustained marketing campaign. As a result of the opportunity
which we believe exists in the U.S. market, we anticipate launching a 1+ product in the fall of 2004 in addition to targeted campaigns for our dial-around product. We have entered into several contracts with both ethnic-focused spokespersons as well
as a targeted internet marketing company in order to further penetrate and expand our U.S. operations. In order to support this expansion, we have opened an office in Aventura, Florida. Although this market is intensely competitive, we believe that
through the implementation of a strategically focused approach, there exists an opportunity to grow this market.



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In November of 2003, we introduced a dial-around service in Peru. Although currently a very small portion
of our total business, we believe this provides us with an opportunity to develop competing long distance services and proactively test the issues relating to the migration to a VoIP platform in international territories.



Our offering to the Canadian SME market consists of competitively priced
voice and data products. In the near future, we will also introduce a broadband offering to the SME market. We also offer telecom management services to the mid-to-large customer base in Canada through our subsidiary Contour Telecom.



In September, 2004 we launched our VoIP service  WorldCity VoIP to residential customers in Canada and the
U.S. For our customers who currently have a broadband connection, WorldCity VoIP combines bundled local and long distance (within North America) calling packages with ultra-competitive international rates, plus great phone features like Caller ID, Three Way Calling and Voicemail for one
flat price. In addition to the basic services to be introduced at launch, we anticipate future releases of the product will make available cutting edge applications to truly differentiate Yak from the competition e.g. unified messaging, virtual
international phone numbers, and free member-to-member international calling. Our plan is to develop the residential offering and then develop an offering to the small and medium business market. Our core business is profitable and growing, and it
is our plan to utilize the success of our core business to launch an exciting array of value-added products throughout the world.



Networks



Over the past three years, we have established and expanded our own private leased line network throughout all major Canadian provinces. In addition, we
have achieved comparable network breadth in the U.S. by interconnecting with a major U.S. carrier. Currently, this coast- to-coast network delivers all of our telephony traffic. In addition to the cost and control advantages of this network, we have
purchased a SanteraOne softswitch and Media Gateway. The port density and significantly reduced foot print of this switch has enabled us to transition our traffic from our legacy Teltronics/Harris switches, resulting in significant cost savings. The
Santera switch currently has 40,000 ports and is expandable to 200,000 ports. Our current level of traffic is using approximately 20,000 ports; as a result, we anticipate having sufficient switching capacity for the foreseeable future.



Costs



In addition to the direct cost savings associated with the transition to and operation of the SanteraOne platform, the
transition has also afforded us the opportunity to bring a greater portion of our traffic onto our own network. There is a savings of approximately $.005 per minute for traffic that is routed over our leased line network as compared to a third party
carriers network. In addition to these savings, we also continually pursue other methods of reducing our variable direct costs including: employing least cost routing of our international traffic; negotiating lower variable costs with multiple
carriers to multiple destinations in order to achieve the lowest available cost per



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minute; and continuing to expand the capacity of our network to accommodate the growing demand in certain areas of the
markets we serve.



VoIP



We believe that broadband voice services represent a significant emerging
market opportunity in the communications industry. The service enables voice communication over broadband IP networks, significantly reducing costs to end users while bundling a broad array of value-added services, e.g., voicemail, call-waiting,
caller-ID, call-forwarding, auto-attendant, find-me/follow-me, etc.



We believe we are uniquely positioned to capture a significant market share as broadband voice gains popularity among traditional phone users. The Company has initiated strong relationships with technology and network providers to
incorporate broadband voice into our current offering. We are planning an aggressive marketing campaign to support our VoIP product launch in January 2005. Leveraging its successful dial around business model and the market reach of current
advertising, our VoIP initiative is expected to have a higher gross margin than our traditional dial-around service as a result of the potential to carry a portion or all of the calls over the Internet.



Foreign Currency



Currently the overwhelming amount of our net revenue (approximately 99%) is derived from sales and operations in Canada. The
functional currency for this revenue is the Canadian dollar. Our reporting currency for our consolidated financial statements is the U.S. dollar. Although we expect to derive less of our total business directly from Canada in the future, exchange
rates have had and may continue to have a significant, and potentially adverse, effect on our results of operations. Any strengthening of the U.S. dollar relative to the Canadian dollar could have an adverse impact on our future results of
operations.



Results of Operations



Comparison of three months ended September 30, 2004 and 2003



The following information for the quarter ended September 30, 2004, and 2003
is provided for informational purposes and should be read in conjunction with the Consolidated Financial Statements and Notes (all amounts in U.S. dollars).



For the Quarter Ended September 30, 2004



|               |  |         |            |           |         |         |             |       |           
|-------------- |  | ------- | ---------- | --------- | ------- | ------- | ----------- | ----- | ----------
|Products       |  | Revenue |            | Customers |         | Minutes |             | Calls
|Dial-Around/1+ |  | $       | 14,775,097 |           | 772,418 |         | 244,282,904 |       | 22,749,977
|LooneyCall     |  | $       | 2,207,046  |           | 84,822  |         | 25,450,583  |       | 1,966,230 
|Yakcell        |  | $       | 75,875     |           | 2,623   |         | 811,396     |       | 102,836   
|               |  |         |            |           |         |         |             |       |           
|TOTAL          |  | $       | 17,058,018 |           | 859,863 |         | 270,545,423 |       | 24,819,043
|               |  |         |            |           |         |         |             |       |           



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For the Quarter Ended September 30, 2003



|               |  |         |            |           |         |         |             |       |           
|-------------- |  | ------- | ---------- | --------- | ------- | ------- | ----------- | ----- | ----------
|Products       |  | Revenue |            | Customers |         | Minutes |             | Calls
|Dial-Around/1+ |  | $       | 12,158,261 |           | 621,348 |         | 178,860,530 |       | 16,474,665
|LooneyCall     |  | $       | 2,006,590  |           | 84,211  |         | 24,565,137  |       | 1,771,785 
|Yakcell        |  | $       | 12,105     |           | 372     |         | 106,470     |       | 14,818    
|               |  |         |            |           |         |         |             |       |           
|TOTAL          |  | $       | 14,176,956 |           | 705,931 |         | 203,532,137 |       | 18,261,268
|               |  |         |            |           |         |         |             |       |           



The Average Rate per
Minute (ARPM) that we derive from our core dial around services was $0.063 for the quarter ended September 30, 2004, as compared to $0.070 for the quarter ended September 30, 2003. Due to the competitive nature of the business and the fact that long
distance services are increasingly a commodity product, we expect gradual, but continuing erosion in our ARPM in the foreseeable future.



Revenue



Net revenue increased $2.4 million, or 12.8%, to $21.2 million for the quarter ended September 30, 2004, from $18.8 million for the quarter ended September 30, 2003. The majority of the growth came from our core
dial-around and LooneyCall products, which increased $2.6 million and $0.2 million respectively on a quarter over quarter basis. Our Yakcell product experienced strong sequential quarterly growth, but this product still represents only an
insignificant amount of our overall revenue. We believe that this product will continue to increase its relative share of total revenue as it becomes more entrenched in the U.S. marketplace.



Our U.S. revenue was largely flat quarter-over-quarter at $0.2 million. We
launched an intense marketing campaign in October 2004 to the Hispanic market in Florida which utilized a variety of media including television and radio commercials, flyers and print media advertising. An intense advertising campaign for the second
fiscal quarter (October, November and December 2004) is expected to significantly increase our presence in the U.S. market. In addition to our marketing to the U.S. Hispanic community, we have embarked on a targeted marketing campaign to other
ethnic communities in the U.S.; this practice that has been very successful in the Canadian marketplace, and we believe these actions will strengthen our brand in the U.S. market.



The balance of our revenue was derived from our Yak for Business subsidiary. This subsidiary contributed revenue of $2.7
million in the first quarter of fiscal year 2005 which represented a decrease of $0.5 million from the quarter ended September 30, 2003. A large portion of the decrease resulted from the reduction of the customer base that occurred after the
acquisition in July, 2003. Due to its overall importance to our long-term strategy, we will focus on growth opportunities in the small and medium business market. Revenue for Contour Telecom was largely flat at $1.4 million for the quarter ended
September 30, 2004.



On September 8, 2004 we launched our
residential WorldCity VoIP product. This product
is a basic VoIP offering to the residential market. Revenue associated with this offering is insignificant at



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the present time; however, in January 2005 we anticipate launching a strategic marketing campaign aimed at capturing a
significant market share of the long distance customer. We have positioned this product as the next generation telecommunication service that will transition the company from its origins of a dial-around company. It is anticipated that an
increasingly significant proportion of total revenues will be derived from this product and the value-add services that will be offered in the future.



Direct Costs



Our cost of revenue increased 12.8% to $13.8 million for the quarter ended September 30, 2004 from $12.2 million for the quarter ended September 30, 2003;
however, as a percentage of sales (64.9%) it was flat when compared to that for the first quarter of fiscal 2004. Despite the decline in ARPM (discussed above), we have been able to maintain our margins as a result of the increased
utilization of our leased line network. We have continued to build out our network, which enables us to bring a greater share of our traffic onto our own network, resulting in a higher utilization of our fixed-cost access lines. As a
result of the continual downward pressure on the price of long distance telephony, our Company is utilizing real-time, least cost routing algorithms and contracting with various carriers in order to manage the direct costs as efficiently and as cost
effectively as possible.



The table below presents a breakdown
of the direct costs of our core dial-around business into its long distance and other components for the first quarter of each of the last three fiscal years (all amounts in U.S. dollars):



Breakdown of Direct Cost for Core Revenue



|                      |  |                |  |       |                |  |        |                |      |   |  |       |  |      |  
|--------------------- |  | -------------- |  | ----- | -------------- |  | ------ | -------------- | ---- | - |  | ----- |  | ---- | -
|                      |  | Sept. 30, 2004 |  |       | Sept. 30, 2003 |  |        | Sept. 30, 2002 |     
|(Thousands)           |  | $              |  | %     |                |  | $      |                | %    |   |  | $     |  | %    |  
|Core Revenue*         |  | 17,058         |  | 100.0 | %              |  | 14,177 |                | 100  | % |  | 8,179 |  | 100  | %
|Long Distance Charges |  | 5,684          |  | 33.3  |                |  | 5,039  |                | 35.5 |   |  | 2,904 |  | 35.5 | %
|Other Fees**          |  | 5,019          |  | 29.5  |                |  | 3,899  |                | 27.5 |   |  | 2,495 |  | 30.5 | %
|Gross Margin          |  | 6,355          |  | 37.3  |                |  | 5,239  |                | 37.0 |   |  | 2,780 |  | 34.0 | %

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|* | Core revenue includes dial-around, LooneyCall and YakCell.
|- | ----------------------------------------------------------

|** | Other fees include line access charges for our leased line network, occupancy, call processing fees, CRTC contribution fees (fees paid to the Canadian government), and costs to
originate and terminate traffic on our leased line network.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Cost of revenue in our dial-around business is comprised primarily of the cost of long distance services, fees for the processing and transporting of our calls and fixed and variable line access costs. The cost of the
pure long distance component of services has increased to $5.7 million or 33.3% for the quarter ended September 30, 2004, from $5.0 million or 35.5% for the quarter ended September 30, 2003. The cost of the Other component of services
has increased to 29.5% for the quarter ended September 30, 2004, from 27.5% for the quarter ended September 30, 2003. This is largely the result of a relative increase in the cost of access lines and billing and collection fees on a
quarter-over-quarter basis.



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Gross Margins



The overall gross margin for the Company remained consistent with the quarter ending September 30, 2003 at 35.1%. The gross margin for the core
dial-around business was 37.3% for the quarter ending September 30, 2004, compared to 37.0% for the quarter ending September 30, 2003. While we do not anticipate that there will be significant erosion in our core margins in the short term as we
continue to optimize our network efficiency and control direct costs through on-going negotiations with various carriers, there can be no assurance that further declines in our gross margins will not occur.



The gross margin in the Yak for Business subsidiary was 24.3% for the quarter
ending September 30, 2004, compared to 30.0% for the quarter ending September 30, 2003. This trend is primarily the result of decreases in the gross margin of our local service and Extended Service area (EAS) offerings. The gross margin for Contour
Telecom was 27.9% for the quarter ending September 30, 2004, compared to 25.1% for the quarter ending September 30, 2003. This increase in gross margin is largely the result of one-time credits booked in the quarter.



General & Administrative Expenses



General and administrative expenses (G&A) increased 37.5% to
$3.1 million for the quarter ending September 30, 2004, from $2.2 million for the quarter ending September 30, 2003. The increase of G&A of $0.9 million can be attributed mainly to increases of salaries ($0.6 million), legal fees ($0.2 million),
and occupancy and office related expenses ($0.1 million).



The
largest component of the increase in G&A was salaries, a result of hiring additional members of our senior management team and customer service representatives to support the growth of the business in fiscal 2005. To facilitate the future growth
of the Company, we added several executives with extensive telecommunications experience to the management team. In addition, as we move aggressively into new markets and introduce new products, we have invested in the front-line customer support
organization. Customer service has always been one of the key differentiators of our Company and we expect it will continue to be in the future. We will continue to closely analyze and control the growth of our headcount, in order to maximize the
return to the organization.



Legal expenses increased $0.2
million or 203.1% to $0.3 million for the quarter ended September 30, 2004. Approximately half of the increase is a result of tax compliance and other legal matters related to the introduction of our products into the U.S. market. The remaining
increase in professional fees included those incurred in connection with regulatory matters and the fees associated with exploring the Companys new acquisition opportunities. As we continue to evaluate potential acquisitions, become more
involved in regulatory proceedings, and launch new products, we do not anticipate a significant reduction in legal expenses on a quarterly basis.



Expenditures for occupancy and office related expenses increased by $0.1 million for the quarter ended September 30, 2004 as a result of the consolidation
to our new offices at 300 Consilium Place in Toronto, Ontario. We would anticipate that our needs for more space in the



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future would increase to match the ultimate growth of the business.



Sales & Marketing



Sales and marketing expenses increased to $1.0 million for the quarter ended September 30, 2004. The cost of advertising in our Canadian territory
decreased $0.2 million to $0.7 million for the quarter ended September 30, 2004; however, those costs increased by $0.3 million in U.S. market. It is managements intention to significantly increase the amount of advertising in the U.S. market
to support the launch of our 1+ service and increase brand recognition through a focused campaign of flyers, TV commercials and internet-based advertising.



Interest on Note Payable



On June 20, 2003, the Company purchased certain next generation telecommunications software from an unrelated third party for $9.5 million.
The consideration paid by the Company was $565,000 in cash, a short-term note of $400,000 and the balance with a long-term note in the amount of $8,535,000. This long-term note bears interest at 7.25% per annum and is payable $174,965 including
interest quarterly and is due in July 2012. The sole recourse by the holder of this long-term note is the acquired software.



Interest expense for the quarter ended September 30, 2004 under this long-term note was $149,998 which was offset against the minimum payment due the
Company pursuant to the joint marketing agreement (discussed below) of $151,108.



Financing



Accounts receivable financing costs
related to the factoring of our trade accounts receivable remained flat for the quarter ended September 30, 2004. The increase in the growth of the business and the amount of the receivables that were being financed, was offset by the decrease in
the interest rate charged. Despite the amount of cash on hand at the present time, we intend to continue our program of factoring certain of our receivables. This decision is based on the relatively favorable terms that we currently receive under
the factoring arrangement, in addition to our desire to use the cash on hand to finance the growth of our VoIP business and for possible future acquisitions.



Organizational & Startup Costs



Organizational and start-up costs for the continued development of our VoIP initiative were $0.5 million for the period ending September 30, 2004. These
costs were composed primarily of employee related expenses ($0.3 million), occupancy and office related expenses ($0.1 million), and legal fees ($0.1 million). The VoIP product was launched September 8, 2004; we do not anticipate further
organizational and startup costs related to this portion of our business.



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Income from Joint Marketing Agreement



On June 24, 2003, the Company entered into a joint marketing agreement with the vendor of the software referred to above for
the exploitation of the software outside of Canada by non-customers of the Company. The Company is entitled to receive 4% of all gross revenue with minimum quarterly payments of $150,000 to June 30, 2006 and thereafter 2.75% of gross revenue with
minimum quarterly payments of $175,000. Income earned under this agreement for the quarter ended September 30, 2004 was $151,108.



Depreciation & Amortization



Depreciation and amortization decreased $0.4 million, or 36%, to $0.5 million for the quarter ended September 30, 2004, as compared to $0.9 million for
the quarter ended September 30, 2003. The decrease was a result of the accelerated write-down on the older Harris switch technology that occurred during fiscal 2004. We anticipate that depreciation will increase in the future as the demand for
further equipment to support our new products materializes. Amortization of customer lists for the period was $101,824.



Liquidity and Capital Resources



Our liquidity requirements arise from cash used in operating activities, purchases of capital assets and interest and principal payments on outstanding
indebtedness. To date, we have financed our growth through the private placement of equity securities, borrowings, accounts receivable financing, vendor financing and capital lease financing.



Net cash provided from operating activities decreased by $2.1 million to $2.2
million for the quarter ended September 30, 2004, as compared to $4.3 million for the quarter ended September 30, 2003. This was principally due to an increase in the net change of assets and liabilities of $1.5 million, a decrease in net income of
$0.1 million, and decrease in depreciation of $0.3 million



Net
cash used in investing activities was $2.0 million for the quarter ended September 30, 2004, as compared to $6.9 million for the quarter ended September 30, 2003. For the quarter ended September 30, 2004, the Company used cash for acquisition of
property and equipment of $2.0 million. It is expected that we will continue to add to our network and network equipment in the coming year to support the growth of the business. In addition, the Company continues to actively pursue potential
acquisitions which we believe will be accretive in nature to our existing business.



Significant commitments that will require the use of cash in future periods include obligations under operating leases, capital leases, advances under contract and other agreements, as shown in the following table (in
millions):



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Payments Due by Period



|                        |  |       |      |                 |   |           |  |           |     |                  |   |     |  |   |  
|----------------------- |  | ----- | ---- | --------------- | - | --------- |  | --------- | --- | ---------------- | - | --- |  | - | -
|Contractual Obligations |  | Total |      | Less Than1 Year |   | 1-3 Years |  | 3-5 Years |     | More Than5 Years
|Operating Leases        |  | $     | 6.2  |                 | $ | 2.5       |  | $         | 3.3 |                  | $ | 0.4 |  | $ | 0
|Capital Leases          |  |       | 2.1  |                 |   | 0.6       |  |           | 1.3 |                  |   | 0.2 |  |   | 0
|Telus Advances          |  |       | 1.4  |                 |   | 1.3       |  |           | 0.1 |                  |   | 0   |  |   | 0
|Carrier Commitments     |  |       | 2.7  |                 |   | 2.7       |  |           | 0   |                  |   | 0   |  |   | 0
|                        |  |       |      |                 |   |           |  |           |     |                  |   |     |  |   |  
|Total                   |  | $     | 12.4 |                 | $ | 7.1       |  | $         | 4.7 |                  | $ | 0.6 |  | $ | 0
|                        |  |       |      |                 |   |           |  |           |     |                  |   |     |  |   |  



Net cash used in
financing activities was $0.3 million for the quarter ended September 30, 2004, as compared to $0.5 million provided by financing activities for the quarter ended September 30, 2003. The decrease largely was a result of a note being issued in the
quarter ending September 30, 2003, with no corresponding indebtedness in the first quarter of fiscal 2005.



We believe we have sufficient fixed capacity to meet our anticipated volume of telephony traffic in both Canada and the U.S. during fiscal 2005. Based on
our current products, we do not anticipate spending additional capital on our switching platform in fiscal 2005. In addition, with the acquisition of the Santera switch, we believe we are capable of providing for future long-term growth, as well as
accommodating anticipated technological changes.



As a result
of the continued convergence of voice and data, we believe the introduction of our VoIP product is significant because it is expected to provide the Company a vehicle for future growth. As broadband services gain a critical level of acceptance in
the marketplace, the ability to bundle other services with this core offering will become the most important distinguishing factor between the many competitors. We plan to continue to review and, where appropriate, augment our core offerings with
value-added services that are priced competitively and address the demands of the market.



United States.During the first fiscal quarter of 2004, we took significant actions to revise and relaunch the development of our dial-around business in the United States; as a result, we lost approximately
$800,000 during that quarter. While we experienced essentially flat revenues in the first quarter, we spent material amounts on marketing, salaries, occupancy costs and legal fees (as described above) in the U.S. Some of these expenses are
non-recurring in nature; however, most of them, along with certain direct costs, are expected to recur and increase in the foreseeable future as we continue to invest in the development of our U. S. operations. As a result, we expect to
experience continuing and increasing losses in the U.S. until we succeed in developing those operations. This activity reflects our decision to acquire U.S. customers through organic growth, while continuing to look for possible synergistic
acquisitions in the U.S. market. We believe that our current operations in Canada will be able to continue to generate sufficient cash to meet our obligations and support the growth of the U.S. business.



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New Accounting Pronouncements



In April 2004, the Emerging Issues Task Force issued Statement No. 03-06 (EITF 03-06), Participating
Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share. EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock
that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings
per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a
security. The Company adopted EITF 03-06 on April 1, 2004, and the adoption did not have a material impact on the Companys consolidated financial statements.



In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003) (FIN46-R), Consolidation of
Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN No. 46-R
replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46), which was issued in January 2003. FIN 46-R requires that if an entity has a controlling financial interest in a variable interest entity,
the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN 46-R are effective immediately to those entities that are considered
to be special-purpose entities. For all other arrangements, the FIN 46-R provisions are required to be adopted at the beginning of the first interim or annual period ending after March 15, 2004. As of June 30, 2004 the Company is not a party to
transactions contemplated under FIN 46-R.



In November 2003,
the Emerging Issues Task Force (EITF) reached an interim consensus on Issue No. 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, to require additional disclosure requirements for
securities classified as available-for-sale or held-to-maturity for fiscal years ending after December 15, 2003. In March 2004, the EITF reached a final consensus on this Issue, to provide additional guidance, which companies must follow in
determining whether investment securities have an impairment which should be considered other-than-temporary. The guidance is applicable for reporting periods after June 15, 2004. The effective date of the guidance in EITF 03-01 has been delayed
until the FASB issues a Staff Interpretation on this matter. The delay does not have a specified date. Until an effective date is determined, existing guidance continues to apply in determining if an impairment is other than temporary. The guidance
in EITF 03-01 that was delayed would require making an evidence-based judgment about a recovery of fair value back up to the cost of the investment, considering the severity and duration of the impairment, and about the investors ability and
intent to hold the investment for a reasonable period of time until the time of the forecasted recovery. The Company does not expect the adoption under the final consensus to have a significant impact on the Companys consolidated financial
statements.



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Special Note Regarding Forward Looking Statements



Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based on current expectations, and are not strictly historical statements. Forward-looking
statements include, without limitation, statements set forth in this document and elsewhere regarding, among other things:



| |  | Expectations of future financial performance;
| | - | ---------------------------------------------



| |  | market acceptance of new product introductions;
| | - | -----------------------------------------------



| |  | plans related to our capital expenditures;
| | - | ------------------------------------------



| |  | assumptions regarding exchange rates; and
| | - | -----------------------------------------



| |  | potential acquisitions
| | - | ----------------------



Our actual results could differ materially from those expressed or implied in the forward-looking statements. Important assumptions and other important
factors that could cause our actual results to differ materially from those in the forward-looking statements, include, but are not limited to:



| |  | Access to sufficient working capital to meet our operating and financial needs;
| | - | -------------------------------------------------------------------------------



| |  | our ability to respond to growing competition in our markets for discount long distance services as well as the extent, timing and success of such competition;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our ability to expand into new markets and to effectively manage our growth;
| | - | ----------------------------------------------------------------------------



| |  | profitability of our expansion into the U.S. market;
| | - | ----------------------------------------------------



| |  | customer acceptance and effectiveness of us as a discount long distance provider and our ability to assimilate new technology and to adapt to technological change in the
telecommunications industry;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our ability to develop and provide voice over internet and web-based communications services;
| | - | ---------------------------------------------------------------------------------------------



| |  | changes in, or failure to comply with, applicable governmental regulation;
| | - | --------------------------------------------------------------------------



| |  | our reliance on our key personnel and the availability of qualified personnel;
| | - | ------------------------------------------------------------------------------



| |  | general economic conditions or material adverse changes in markets we serve;
| | - | ----------------------------------------------------------------------------



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| |  | risk that our analyses of these risks could be incorrect and that the strategies developed to address them could be unsuccessful;
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| |  | changes in our accounting assumptions that regulatory agencies, including the Securities and Exchange Commission, may require or that result from changes in the accounting rules or
their application, which could result in an impact on our earnings;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | integrating the operations of newly acquired businesses;
| | - | --------------------------------------------------------



| |  | successful deployment of new equipment and realization of material savings there from; and
| | - | ------------------------------------------------------------------------------------------



| |  | various other factors discussed in this filing.
| | - | -----------------------------------------------



Industry trends and specific risks may affect our future business and results. The matters discussed below could cause our future results to differ from
past results or those described in forward-looking statements and could have a material adverse effect on our business, financial condition, results of operations and stock price.



Our future growth depends on our ability to attract new customers.Our success will depend on our ability to
effectively anticipate and adapt to customer requirements and offer products and services that meet customer demands. Any failure of our current or prospective customers to purchase products from us for any reason, including a downturn in their
economic fortunes, would seriously harm our ability to grow our business. Increasingly, our growth will depend on our ability to successfully fund and develop and introduce new and enhanced products. The development of new or enhanced products is a
costly, complex and uncertain process that requires us to anticipate accurately future technological and market trends. We cannot be sure whether our new product offerings will be successfully developed and introduced to the market on a timely
basis, or at all. If we do not develop these products in a timely manner, our competitive position and financial condition could be adversely affected.



In addition, as we introduce new or enhanced products, we must also manage the transition from older products to newer products. If we fail to do so, we
may disrupt customer ordering patterns or may not be able to ensure that adequate supplies of new products can be delivered to meet anticipated customer demand. Any failure to effectively manage this transition may cause us to lose current and
prospective customers.



Our business is dependent upon our
ability to keep pace with the latest technological changes.The international telecommunications industry is changing rapidly due to deregulation, technological improvements, and expansion of telecommunications infrastructure, privatization and
the globalization of national economies. There can be no assurance that one or more of these factors will not vary in a manner that could have a material adverse effect on us. In addition, deregulation of any particular market may cause such market
to shift unpredictably. There can be no assurance that we will be able to compete effectively or adjust our contemplated plan of development to meet changing market conditions. The market for our services and the telecommunications industry
generally is in a period of rapid technological evolution, marked by the introduction of new product and service



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offerings and increasing transmission capacity for services similar to those provided by us. Failure to respond in a
timely and cost-effective way to these technological developments could result in serious harm to our business and operating results. We have derived, and we expect to continue to derive, a substantial portion of our revenues from providing
telecommunications services that are based upon current technologies which are capable of adapting to future technologies. As a result, our success will depend, in part, on our ability to afford the cost of acquiring new hardware and software
associated with new technologies, develop and market service offerings that have significant customer demand, respond in a timely manner to the technological advances of our customers, evolving industry standards and changing client preferences. Our
profitability will depend on its ability to offer, on a timely and cost-effective basis, services that meet evolving industry standards. There can be no assurance that we will be able to access or adapt to such technological changes at a competitive
price, maintain competitive services or obtain new technologies on a timely basis or on satisfactory terms.



The increase of services offered by our competitors could adversely impact our business. Recently, telecommunications providers have increased the
range of telecommunication services they offer to customers. This activity and the potential continuing trend towards offering services may lead to a greater ability among our competitors to provide a comprehensive range of telecommunications
services, which could lead to a reduction in demand for our services. Moreover, by offering certain services to end users, competitors could reduce the number of our current or potential customers and increase the bargaining power of our remaining
customers, which may adversely impact our business.



Our
business is susceptible to severe pricing pressures from the larger carriers.The long distance telecommunications industry is significantly impacted by the marketing campaigns and associated pricing decisions of the larger carriers. There has
been downward pressure on prices in the industry in recent years, a trend that we expect to continue. Our competitors within the Canadian market include BCE, Telus, and Allstream, and as we launch our products into the U.S. market, our competitors
will expand dramatically and will likely include AT&T, MCI, Sprint, the RBOCs, and the major wireless carriers. We would also expect that the competition will be intense in certain emerging markets including that associated with our VoIP
product. Many of our competitors are significantly larger than we are and have substantially greater financial, technical and marketing resources, larger networks, a broader portfolio of service offerings, greater control over transmission lines,
stronger name recognition and customer loyalty, and long-standing relationships with our target customers. As a result, our ability to attract and retain customers particularly in the United States may be adversely affected.



The success of our broadband initiative is dependent on growth and public
acceptance of IP telephony as well as our ability to adapt to rapid technological changes in IP telephony. The development of broadband telephony in Canada and the United States is in its nascent stages. It is uncertain as to how competition in
our markets for telephony opportunities provided by broadband applications will develop. The financial models for return on pricing, capital expenditures and return on investment have not been fully developed so it is difficult to gauge what
applications will be



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financially successful. The success of our broadband initiative is dependent upon future demand for IP telephony systems
and services which, in turn, will depend on a number of factors including IP telephony achieving a similar level of reliability that users of the public switched telephone network have come to expect from their telephone service. IP telephony
service providers must offer cost and feature benefits to their customers that are sufficient to cause the customers to switch away from traditional telephony service providers. If any or all of these factors fail to occur, our broadband business
may not grow.



The regulatory environment affecting our
broadband initiative is largely unknown.To date VoIP communication services have been largely unregulated in Canada and the United States. The Canadian Radio-television and Telecommunications Commission, or CRTC, has previously decided not to
regulate the Internet; therefore, it is unclear if this exemption will apply to VoIP telephone service. The incumbent telephony carriers in Canada, including Bell Canada and Telus, have requested the CRTC to regulate VoIP. Although we expect
Canadian regulation of VoIP telephone service to be minimal, such regulations could have an adverse affect on our ability to deploy our broadband initiative effectively. Many regulatory actions are underway or are being contemplated by U.S. federal
and state authorities, including the Federal Communications Commission (FCC), and state regulatory agencies. To date, the FCC has treated Internet service providers as information service providers. Information service providers are
currently exempt from federal and state regulations governing common carriers, including the obligation to pay access charges and contribute to the universal service fund. If the FCC were to determine that internet service providers, or the services
they provide, are subject to FCC regulation, including the payment of access charges and contribution to the universal service funds, it could have a material adverse effect on our broadband initiative. In addition, state regulatory authorities may
determine that IP telephony service should be subject to local regulation, certification and fees. The effect of potential future VoIP telephony laws and regulations on our broadband initiative cannot be determined.



Any future acquisitions could be difficult to integrate, disrupt our
business, dilute stockholder value and adversely affect our operating results. We intend to expand our operations through acquisitions over time. This may require significant management time and financial resources because we may need to
integrate widely dispersed operations with distinct corporate cultures. Our failure to manage future acquisitions successfully could seriously harm our operating results. Also, acquisition costs could cause our quarterly operating results to vary
significantly. Furthermore, our stockholders would be diluted if we financed the acquisitions by incurring convertible debt or issuing securities.



The current expansion of the Company will continue to put pressure on management.Our continued growth and expansion may place a significant strain
on our management, operational and financial resources, and increase demand on our systems and controls. We entered the SME market in July of 2003, and plan to launch our VoIP service and expand into the U.S. 1+ market in the fall of 2004. To manage
our growth effectively, we must continue to implement and improve our operational and financial systems and controls, purchase and utilize other transmission facilities, and expand, train and manage our employee base. If we inaccurately forecast the
movement of traffic



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onto our network, we could have insufficient or excessive transmission facilities and disproportionate fixed expenses. As
we proceed with our development, operational difficulties could arise from additional demand placed on customer support, billing and management information systems, on our support, sales and marketing and administrative resources and on our network
infrastructure.



We have a significant dependence on
Transmission Facilities-Based Carriers. We primarily connect our customers telephone calls through transmission lines that we lease under a variety of arrangements with other facilities-based long distance carriers. Many of these carriers
are, or may become, our competitors. Our ability to maintain and expand our business depends on our ability to maintain favorable relationships with the facilities-based carriers from which we lease transmission lines. If our relationship with one
or more of these carriers were to deteriorate or terminate, it could have a material adverse effect upon our cost structure, service quality, network diversity, results of operations and financial condition.



We are in an industry governed by significant governmental regulation.
The telecommunications industry is subject to constantly changing regulation. There can be no assurance that future regulatory changes will not have a material adverse effect on us, or that regulatory bodies will not raise material issues with
regard to our compliance or noncompliance with applicable regulations, any of which could have a material adverse effect upon us. Although largely unregulated at the current time, VoIP could face material changes with regards to its regulatory
framework that could result in additional fees or price structures that could have a material, adverse effect on our results.



Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.Changing laws, regulations and
standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and other trading market rules, are creating uncertainty for companies such as ours. We are committed to maintaining high
standards of corporate governance and public disclosure. As a result, we intend to invest all appropriate resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of
management time and attention from revenue-generating activities to compliance activities.



Our quarterly results may fluctuate causing our stock price to decline. A number of factors, many of which are outside of our control, are likely to cause these fluctuations.



The factors outside of our control include:



| |  | long distance telecommunications market conditions as well as economic conditions generally;
| | - | --------------------------------------------------------------------------------------------



| |  | fluctuations in demand for our services;
| | - | ----------------------------------------



| |  | reductions in the prices of services offered by our competitors;
| | - | ----------------------------------------------------------------



| |  | costs of integrating technologies or businesses that we add; and
| | - | ----------------------------------------------------------------



| |  | changes in foreign exchange rates.
| | - | ----------------------------------



15



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The factors substantially within our control include:



| |  | the timing of expansion into new markets, both domestically and internationally; and
| | - | ------------------------------------------------------------------------------------



| |  | the timing and payments associated with possible acquisitions.
| | - | --------------------------------------------------------------



Because our operating results may vary significantly from quarter to quarter, our operating results may not meet the expectations of securities analysts
and investors, and our common stock could decline significantly which may expose us to risks of securities litigation, impair our ability to attract and retain qualified individuals using equity incentives and make it more difficult to complete
acquisitions using equity as consideration.



Item 3. Quantitative and Qualitative Disclosures about Market Risk



Our primary market risk exposures relate to changes in foreign currency exchange rates and to changes in interest rates.



Our international operations could subject us to risks due to currency
fluctuations and changes in foreign government regulations, which could harm our business. Our current international (outside of Canada) operations, and any future expansion outside of Canada, are or will be subject to a number of risks, including
changes in foreign governmental regulations and telecommunications standards, import and export license requirements, tariffs, taxes and other trade barriers, fluctuations in currency exchange rates, difficulty in collecting accounts receivable, the
burden of complying with a wide variety of foreign laws, treaties and technical standards, difficulty in staffing and managing foreign operations, and political and economic instability.



The majority of our sales and expenses have been denominated in U.S. dollars. However, the significant majority of our sales
and expenses occur in Canada. As a result, currency fluctuations between the U.S. dollar and the Canadian currency could cause foreign currency translation gains or losses that we would recognize in the period incurred. We cannot predict the effect
of exchange rate fluctuations on our future operating results because of the number of currencies involved, the variability of currency exposure and the potential volatility of currency exchange rates. We do not currently engage in foreign exchange
hedging transactions to manage our foreign currency exposure.



Item 4. Controls and Procedures



Our management has evaluated the effectiveness of our disclosure controls and procedures with the active participation of our Chief Executive Officer and Chief Financial Officer as of the period ending September 30, 2004. The effectiveness
of our or any system of disclosure controls and procedures is subject to certain limitations, including the exercise of judgment in designing, implementing and evaluating the controls and procedures, the assumptions used in identifying the
likelihood of future events, and the inability to eliminate misconduct completely. Based on our



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evaluation, our principal executive officer and principal financial officer have concluded that as of the end of the
period covered by this report, our disclosure controls and procedures were effective.



There were no significant changes during the quarterly period covered by this report in our internal controls or in other factors that could significantly affect internal controls over financial reporting.



17



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##### Table of Contents

PART II

OTHER INFORMATION



Item 1. Legal Proceedings



None.



Item 2. Changes in Securities and Use of Proceeds



None.



Item 3. Defaults Upon Senior Securities



None.



Item 4. Submission of Matters to a Vote of Security Holders



None.



Item 5. Other Information



On
October 18, 2004, our Board of Directors appointed Kevin Crumbo to serve as a director until the next annual meeting of our shareholders. The Company did not have a nominating committee in place on the date of such appointment.



On October 28, 2004, our Board of Directors appointed R. Gregory Breetz, Jr.
to serve as a director until the next annual meeting of our shareholders; our Governance and Nominating Committee of our Board of Directors was established on the same day as Mr. Breetzs election. He was also appointed to the Audit and the
Governance and Nominating Committees of our Board of Directors.



Item 6. Exhibits and Reports on Form 8-K.



| | (a) | Exhibits.
| | --- | ---------



| | 31.1 | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 31.2 | Certification of Principal Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------



| | 32.2 | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Reports on Form 8-K.
| | --- | --------------------



None.



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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.



|                        |  |     |  |                                                            
|----------------------- |  | --- |  | -----------------------------------------------------------
|Date: November 15, 2004 |  | By: |  | /s/ Charles Zwebner                                        
|                        |  |     |  | Charles Zwebner, Chairman of                               
|                        |  |     |  | the Board of Directors & Chief                             
|                        |  |     |  | Executive Officer                                          
|                        |  |    
|                        |  | By: |  | /s/ Gregory Stevens                                        
|                        |  |     |  | Gregory Stevens, Principal Financial and Accounting
Officer



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##### Table of Contents

YAK COMMUNICATIONS, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



(Unaudited)



|                                                                                                           |  |      |  |                   |  |              
|---------------------------------------------------------------------------------------------------------- |  | ---- |  | ----------------- |  | -------------
|                                                                                                           |  | Note |  | September 30,2004 |  | June 30, 2004
|                                                                                                           |  |      |  | $                 |  | $            
|ASSETS                                                                                                     |  |      |  |                   |  |              
|CURRENT                                                                                                    |  |      |  |                   |  |              
|Cash and cash equivalents                                                                                  |  |      |  | 22,087,728        |  | 22,149,387   
|Accounts receivable, net                                                                                   |  | 3    |  | 15,731,671        |  | 15,648,419   
|Income taxes receivable                                                                                    |  |      |  | 881,712           |  | 665,641      
|Prepaid expenses and sundry                                                                                |  |      |  | 1,164,122         |  | 665,031      
|                                                                                                           |  |      |  |                   |  |              
|                                                                                                           |  |      |  | 39,865,233        |  | 39,128,478   
|PROPERTY AND EQUIPMENT, NET                                                                                |  | 4    |  | 12,114,931        |  | 9,243,897    
|                                                                                                           |  |      | 
|LOAN RECEIVABLE                                                                                            |  | 6    |  | 413,944           |  | 445,454      
|                                                                                                           |  |      | 
|CUSTOMER LIST (Net of accumulated amortization of $504,970 - September 30, 2004; $414,614 - June 30, 2004) |  |      |  | 1,598,298         |  | 1,585,386    
|                                                                                                           |  |      | 
|GOODWILL                                                                                                   |  |      |  | 486,584           |  | 457,868      
|                                                                                                           |  |      |  |                   |  |              
|                                                                                                           |  |      |  | 54,478,990        |  | 50,861,083   
|                                                                                                           |  |      |  |                   |  |              



The accompanying notes
are an integral part of these consolidated financial statements.



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YAK COMMUNICATIONS INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



(Unaudited)



|                                                                |  |      |  |                    |  |              
|--------------------------------------------------------------- |  | ---- |  | ------------------ |  | -------------
|                                                                |  | Note |  | September 30, 2004 |  | June 30, 2004
|                                                                |  |      |  | $                  |  | $            
|LIABILITIES                                                     |  |      |  |                    |  |              
|CURRENT                                                         |  |      |  |                    |  |              
|Accounts payable and accrued liabilities                        |  |      |  | 2,744,902          |  | 2,519,591    
|Amounts due for network access and usage                        |  |      |  | 1,854,682          |  | 2,071,091    
|Amounts due to long distance carriers                           |  |      |  | 6,556,184          |  | 6,144,670    
|Amounts due for equipment                                       |  |      |  | 720,725            |  | 773,897      
|Due to Factor                                                   |  | 3    |  | 5,298,017          |  | 5,657,578    
|Current portion of advances from TELUS Communications Inc.      |  | 7    |  | 1,312,440          |  | 1,238,882    
|Current portion of obligations under capital leases             |  | 8    |  | 490,696            |  | 392,538      
|Deferred revenue                                                |  |      |  | 999,793            |  | 950,575      
|                                                                |  |      |  |                    |  |              
|                                                                |  |      |  | 19,977,439         |  | 19,748,822   
|                                                                |  |      |  |                    |  |              
|LONG-TERM DEBT                                                  |  |      |  |                    |  |              
|Advances from TELUS Communications Inc.                         |  | 7    |  | 41,591             |  | 348,980      
|Obligations under capital leases                                |  | 8    |  | 1,297,354          |  | 1,072,986    
|                                                                |  |      |  |                    |  |              
|                                                                |  |      |  | 1,338,945          |  | 1,421,966    
|                                                                |  |      |  |                    |  |              
|DEFERRED INCOME TAXES                                           |  | 9    |  | 2,500,052          |  | 1,662,147    
|                                                                |  |      |  |                    |  |              
|                                                                |  |      |  | 23,816,436         |  | 22,832,935   
|                                                                |  |      |  |                    |  |              
|STOCKHOLDERS EQUITY                                            |  |      |  |                    |  |              
|COMMON STOCK                                                    |  | 10   |  | 225,415            |  | 225,415      
|ADDITIONAL PAID-IN CAPITAL                                      |  |      |  | 16,595,304         |  | 16,582,250   
|COMMON STOCK PURCHASE WARRANTS                                  |  |      |  | 2,432,590          |  | 2,432,590    
|ACCUMULATED OTHER COMPREHENSIVE INCOME - TRANSLATION ADJUSTMENT |  |      |  | 1,285,306          |  | 164,481      
|RETAINED EARNINGS                                               |  |      |  | 10,123,939         |  | 8,623,412    
|                                                                |  |      |  |                    |  |              
|                                                                |  |      |  | 30,662,554         |  | 28,028,148   
|                                                                |  |      |  |                    |  |              
|                                                                |  |      |  | 54,478,990         |  | 50,861,083   
|                                                                |  |      |  |                    |  |              



The accompanying notes
are an integral part of these consolidated financial statements.



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YAK COMMUNICATIONS INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY



|                                           |  |      |        |                |        |                            |  |            |                              |  |                                      |  |           |                           |  |                               |  |            |  
|------------------------------------------ |  | ---- | ------ | -------------- | ------ | -------------------------- |  | ---------- | ---------------------------- |  | ------------------------------------ |  | --------- | ------------------------- |  | ----------------------------- |  | ---------- | -
|                                           |  | Note |        | Common stock |        | Additional paid-in capital |  |            | Common stockpurchasewarrants |  | Accumulatedother comprehensiveincome |  |           | Retainedearnings(deficit) |  | StockholdersEquity (Deficit) | 
|                                           |  |      | Shares |                | Amount |                            |  |            |                              | 
|                                           |  |      |        |                |        | $                          |  | $          |                              |  | $                                    |  | $         |                           |  | $                             |  | $          |  
|Balance, June 30, 2003                     |  |      |        | 9,133,316      |        | 199,266                    |  | 2,050,315  |                              |  |                                     |  | 477,080   |                           |  | 3,001,409                     |  | 5,728,070  |  
|Foreign currency translation adjustment    |  |      |        |               |        |                           |  |           |                              |  |                                     |  | (312,599  | )                         |  |                              |  | (312,599   | )
|Common stock issued to obtain note payable |  |      |        | 20,000         |        | 100                        |  | 89,900     |                              |  |                                     |  |          |                           |  |                              |  | 90,000     |  
|Common stock issued in exchange for        |  |      |        |                |        |                            |  |            |                              |  |                                      |  |           |                           |  |                               |  |            |  
|stock options surrendered                  |  |      |        | 2,260,934      |        | 11,304                     |  | (11,304    | )                            |  |                                     |  |          |                           |  |                              |  |           |  
|Common stock issued for services           |  |      |        | 9,000          |        | 45                         |  | 50,987     |                              |  |                                     |  |          |                           |  |                              |  | 51,032     |  
|Stock compensation expense                 |  | 11   |        |               |        |                           |  | 26,156     |                              |  |                                     |  |          |                           |  |                              |  | 26,156     |  
|Common stock issued for cash               |  |      |        | 1,470,000      |        | 14,700                     |  | 14,376,196 |                              |  | 2,432,590                            |  |          |                           |  |                              |  | 16,823,486 |  
|                                           |  |      |        |                |        |                            |  |            |                              |  |                                      |  |           |                           |  |                               |  |            |  
|Net income                                 |  |      |        |               |        |                           |  |           |                              |  |                                     |  |          |                           |  | 5,622,003                     |  | 5,622,003  |  
|Balance, June 30, 2004                     |  |      |        | 12,893,250     |        | 225,415                    |  | 16,582,250 |                              |  | 2,432,590                            |  | 164,481   |                           |  | 8,623,412                     |  | 28,028,148 |  
|Foreign currency translation adjustment    |  |      |        |               |        |                           |  |           |                              |  |                                     |  | 1,120,825 |                           |  |                              |  | 1,120,825  |  
|Stock compensation expense                 |  | 11   |        |               |        |                           |  | 13,054     |                              |  |                                     |  |          |                           |  |                              |  | 13,054     |  
|Net income                                 |  |      |        |               |        |                           |  |           |                              |  |                                     |  |          |                           |  | 1,500,527                     |  | 1,500,527  |  
|                                           |  |      |        |                |        |                            |  |            |                              |  |                                      |  |           |                           |  |                               |  |            |  
|Balance, September 30, 2004                |  |      |        | 12,893,250     |        | 225,415                    |  | 16,595,304 |                              |  | 2,432,590                            |  | 1,285,306 |                           |  | 10,123,939                    |  | 30,662,554 |  
|                                           |  |      |        |                |        |                            |  |            |                              |  |                                      |  |           |                           |  |                               |  |            |  



The accompanying notes
are an integral part of these consolidated financial statements.



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YAK COMMUNICATIONS INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME



(Unaudited)



|                                                                  |  |      |      |                                         |   |      |            |  
|----------------------------------------------------------------- |  | ---- | ---- | --------------------------------------- | - | ---- | ---------- | -
|                                                                  |  | Note |      | For the three months endedSeptember 30, |  
|                                                                  |  |      | 2004 |                                         |   | 2003 |           
|                                                                  |  |      |      | $                                       |   |      | $          |  
|NET REVENUE                                                       |  |      |      | 21,197,134                              |   |      | 18,791,218 |  
|                                                                  |  |      |     
|COST OF REVENUE                                                   |  |      |      | 13,758,307                              |   |      | 12,196,519 |  
|                                                                  |  |      |      |                                         |   |      |            |  
|GROSS MARGIN                                                      |  |      |      | 7,438,827                               |   |      | 6,594,699  |  
|                                                                  |  |      |      |                                         |   |      |            |  
|EXPENSES                                                          |  |      |      |                                         |   |      |            |  
|General and administration                                        |  |      |      | 3,088,166                               |   |      | 2,245,139  |  
|Sales and marketing                                               |  |      |      | 990,748                                 |   |      | 894,304    |  
|Organizational and start-up costs                                 |  |      |      | 521,775                                 |   |      | 33,024     |  
|Interest on note payable                                          |  |      |      | 149,998                                 |   |      | 153,465    |  
|Accounts receivable financing                                     |  |      |      | 122,094                                 |   |      | 150,203    |  
|Interest on capital lease obligations                             |  |      |      | 32,644                                  |   |      | 1,644      |  
|Writedown of property and equipment and licence fee               |  |      |      | 600                                     |   |      |           |  
|Common stock issued to obtain note payable                        |  |      |      |                                        |   |      | 45,300     |  
|Share of net loss of affiliate                                    |  |      |      |                                        |   |      | 35,423     |  
|Interest earned                                                   |  |      |      | (77,719                                 | ) |      | (19,946    | )
|Income from joint marketing agreement                             |  |      |      | (151,108                                | ) |      | (150,000   | )
|Depreciation and amortization                                     |  |      |      | 544,038                                 |   |      | 852,968    |  
|                                                                  |  |      |      |                                         |   |      |            |  
|                                                                  |  |      |      | 5,221,236                               |   |      | 4,241,524  |  
|                                                                  |  |      |      |                                         |   |      |            |  
|INCOME BEFORE INCOME TAX PROVISION                                |  |      |      | 2,217,591                               |   |      | 2,353,175  |  
|                                                                  |  |      |     
|PROVISION FOR INCOME TAXES                                        |  | 9    |      | 717,064                                 |   |      | 754,417    |  
|                                                                  |  |      |      |                                         |   |      |            |  
|NET INCOME                                                        |  |      |      | 1,500,527                               |   |      | 1,598,758  |  
|                                                                  |  |      |     
|OTHER COMPREHENSIVE INCOMEForeign currency translation adjustment |  |      |      | 1,120,825                               |   |      | (31,930    | )
|                                                                  |  |      |      |                                         |   |      |            |  
|COMPREHENSIVE INCOME                                              |  |      |      | 2,621,352                               |   |      | 1,566,828  |  
|                                                                  |  |      |      |                                         |   |      |            |  
|BASIC EARNINGS PER SHARE                                          |  |      |      | 0.12                                    |   |      | 0.18       |  
|                                                                  |  |      |      |                                         |   |      |            |  
|DILUTED EARNINGS PER SHARE                                        |  |      |      | 0.12                                    |   |      | 0.14       |  
|                                                                  |  |      |      |                                         |   |      |            |  
|WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING              |  |      |      | 12,893,250                              |   |      | 9,149,982  |  
|                                                                  |  |      |      |                                         |   |      |            |  
|WEIGHTED AVERAGE NUMBER OF COMMON SHARES - ASSUMING DILUTION      |  |      |      | 12,984,155                              |   |      | 11,717,982 |  
|                                                                  |  |      |      |                                         |   |      |            |  



The accompanying notes
are an integral part of these consolidated financial statements.



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YAK COMMUNICATIONS INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



(Unaudited)



|                                                                          |  |      |      |                                         |   |      |            |  
|------------------------------------------------------------------------- |  | ---- | ---- | --------------------------------------- | - | ---- | ---------- | -
|                                                                          |  | Note |      | For the three months endedSeptember 30, |  
|                                                                          |  |      | 2004 |                                         |   | 2003 |           
|                                                                          |  |      |      | $                                       |   |      | $          |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                      |  |      |      |                                         |   |      |            |  
|Net income                                                                |  |      |      | 1,500,527                               |   |      | 1,598,758  |  
|Adjustments to reconcile net income to net cash from operating activities |  |      |      |                                         |   |      |            |  
|Depreciation and amortization                                             |  |      |      | 544,038                                 |   |      | 852,968    |  
|Deferred income taxes                                                     |  |      |      | 717,064                                 |   |      | 811,068    |  
|Writedown of property and equipment and licence fee                       |  |      |      | 600                                     |   |      |           |  
|Stock compensation expense                                                |  |      |      | 13,054                                  |   |      |           |  
|Common stock issued to obtain note payable                                |  |      |      |                                        |   |      | 45,300     |  
|Share of net (gain) / loss of affiliate                                   |  |      |      |                                        |   |      | 35,423     |  
|Changes in working capital                                                |  | 13   |      | (536,409                                | ) |      | 954,003    |  
|                                                                          |  |      |      |                                         |   |      |            |  
|Net cash from operating activities                                        |  |      |      | 2,238,873                               |   |      | 4,297,520  |  
|                                                                          |  |      |      |                                         |   |      |            |  
|CASH FLOWS USED IN INVESTING ACTIVITIES                                   |  |      |      |                                         |   |      |            |  
|Purchase of property and equipment                                        |  |      |      | (2,049,589                              | ) |      | (1,579,304 | )
|Proceeds from sale of assets                                              |  |      |      | 9,525                                   |   |      |           |  
|Purchase of shares of Contour Telecom                                     |  |      |      |                                        |   |      | (6,976,891 | )
|Foreign exchange difference on purchase of shares of Contour Telecom      |  |      |      |                                        |   |      | 86,651     |  
|Loan receivable                                                           |  |      |      | 31,510                                  |   |      | (90,565    | )
|Increase in deferred acquisition cost                                     |  |      |      |                                        |   |      | 1,659,458  |  
|                                                                          |  |      |      |                                         |   |      |            |  
|Net cash used in investing activities                                     |  |      |      | (2,008,554                              | ) |      | (6,900,651 | )
|                                                                          |  |      |      |                                         |   |      |            |  
|CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES                            |  |      |      |                                         |   |      |            |  
|Principal payments on capital leases                                      |  |      |      | (32,081                                 | ) |      | (768       | )
|Advances from (to) TELUS Communications Inc.                              |  |      |      | (233,831                                | ) |      | (114,396   | )
|Issuance of note payable                                                  |  |      |      |                                        |   |      | 713,570    |  
|Repayments on short-term note payable                                     |  |      |      |                                        |   |      | (120,000   | )
|Repayments on long-term note payable                                      |  |      |      | (26,067                                 | ) |      | (24,306    | )
|                                                                          |  |      |      |                                         |   |      |            |  
|Net cash from (used in) financing activities                              |  |      |      | (291,979                                | ) |      | 454,100    |  
|                                                                          |  |      |      |                                         |   |      |            |  
|DECREASE IN CASH AND CASH EQUIVALENTS                                     |  |      |      | (61,660                                 | ) |      | (2,149,031 | )
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                            |  |      |      | 22,149,387                              |   |      | 5,442,538  |  
|                                                                          |  |      |      |                                         |   |      |            |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                  |  |      |      | 22,087,727                              |   |      | 3,293,507  |  
|                                                                          |  |      |      |                                         |   |      |            |  
|Supplemental disclosure of cash flow information:                         |  |      |      |                                         |   |      |            |  
|Interest paid                                                             |  |      |      | 182,642                                 |   |      | 155,009    |  
|Taxes paid                                                                |  |      |      | 176,548                                 |   |      | 325,059    |  
|Supplemental disclosure of non-cash investing and financing activities    |  |      |      |                                         |   |      |            |  
|Common stock issued for services                                          |  |      |      |                                        |   |      | 116,000    |  
|Common stock issued to obtain note payable                                |  |      |      |                                        |   |      | 90,000     |  
|Capital leases for acquisition of furniture and equipment                 |  |      |      | 354,607                                 |   |      |           |  



The accompanying notes
are an integral part of these consolidated financial statements.



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YAK COMMUNICATIONS, INC. AND SUBSIDIARIES



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|1. | ORGANIZATION AND BUSINESS
|-- | -------------------------



Yak Communications Inc. is a switch based reseller specializing in offering discounted long-distance services to residential customers and
telecommunication services to small and medium sized businesses. The Company was incorporated in the State of Florida on December 24, 1998 and operates as a holding company of its wholly-owned subsidiaries in the United States and Canada.



The Company began offering its services to consumers in
Canada in July 1999 and in the United States commencing December 2001.



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|-- | ------------------------------------------



The consolidated financial statements are represented in United States dollars and have been prepared in accordance with U.S. generally accepted
accounting principles and reflect the following policies:



Principles of consolidation



These
consolidated financial statements include the accounts of Yak Communications Inc. and its wholly-owned subsidiariesYak Communications (America), Inc. and Yak Communications (Canada) Inc., Yak Broadband Inc., and Contour Telecom Inc.
(collectively referred to as the Company). All intercompany balances and transactions are eliminated upon consolidation.



Use of estimates



The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during
the reported period. Actual results could differ from those estimates. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the period in which they become known.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



Revenue recognition



The Company records revenue using the following recognition policies:



| | (a) | Dial-around services and the resale of long-distance services revenues are recorded at the time of customer usage based upon minutes of use.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Revenue from the resale of voice and data telecommunications services to business enterprises is recorded at the time of customer usage based upon amounts billed by the respective
service providers.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Management fees of Contour Telecom Inc. are recorded on a monthly basis over the term of the management agreement.
| | --- | ------------------------------------------------------------------------------------------------------------------



Cost of revenue



Cost of revenue includes network costs that consist of the cost of
long-distance services, processing costs, line access and usage costs. These costs are recognized when incurred. Contour Telecom Inc.s supplier service costs come directly from the telecommunications carriers and are recorded at the time of
customer usage based upon amounts billed by the respective service providers.



Cash and cash equivalents



Cash and cash equivalents are comprised of cash and term deposits with original maturity dates of less than 90 days. Cash and cash equivalents are stated at cost which approximates market value, and are concentrated in three major financial
institutions.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



Accounts receivable



Accounts receivable is reviewed by Management for doubtful amounts, and allowance is provided for against income as follows:



100% on amounts outstanding over 90 days, in collections, or in bankruptcy



50% on amounts outstanding between 61 and 90 days.



Accounts are written off once management determines the
amount is uncollectable and will no longer actively pursue collection.



A reconciliation of the allowance for doubtful accounts provision during the quarter is presented below:



|                                                  |  |                                          |  |        
|------------------------------------------------- |  | ---------------------------------------- |  | -------
|                                                  |  | For the three months ended September 30,
|                                                  |  | 2004                                     |  | 2003   
|                                                  |  | $                                        |  | $      
|Opening balance                                   |  | 348,470                                  |  | 15,000 
|Additional allowance provision during the quarter |  | 28,467                                   |  | 475,355
|                                                  |  |                                          |  |        
|Ending balance                                    |  | 376,937                                  |  | 490,355
|                                                  |  |                                          |  |        



As at September 30,
2004 and September 30, 2003 there was no interest accrued on overdue amounts.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



Property and equipment



Property and equipment is stated at cost less accumulated depreciation which is provided over the estimated useful lives of the assets as follows:



|                                                     |  |                             
|---------------------------------------------------- |  | ----------------------------
|Next Generation software                           |  | 20% declining balance       
|Telecom switching systems                            |  | 11% to 20% declining balance
|Billing, administration and customer service systems |  | 20% declining balance       
|Installed lines                                      |  | 20% declining balance       
|Office furniture and equipment                       |  | 20% declining balance       
|Broadband equipment                                  |  | 20% declining balance       
|Carrier identification codes loading                 |  | 20% declining balance       
|Computer equipment                                   |  | 20% declining balance       
|Leasehold improvements                               |  | over term of the lease      
|Computer software                                    |  | 20% declining balance       
|Automobile                                           |  | 20% declining balance       



Cost includes major
expenditures for improvements and replacements which extend useful lives or increase capacity of assets as well as expenditures necessary to place assets into readiness for use. Expenditures for maintenance and repairs are expensed as incurred. In
accordance with Statement of Position (SOP) 98-1, Accounting of the Costs of Computer Software Developed or Obtained for Internal Use, costs for internal use software that incurred in the preliminary project stage and in the
post-implementation stage are expensed as incurred. Costs incurred during the application development stage are capitalized and amortized over the estimated useful life of the software.



The Company periodically evaluates the realizability of its property and equipment. In making such evaluations, the Company
compares certain financial indicators such as expected undiscounted future revenues and cash flows to the carrying amount of the assets. If the property is impaired then it is written down to fair value.



Assets under capital leases are amortized using rates consistent with
similar assets.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



Intangibles



In accordance with Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, customer lists are stated at
cost less accumulated amortization which is provided on the straight-line basis over a weighted life of five years.



Goodwill



Goodwill represents the difference between the purchase price, including acquisition costs, of business acquired and the fair value of the identifiable
net assets acquired. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill is not subject to amortization and is tested for impairment annually, or more frequently if events or circumstances indicate that the
asset might be impaired. Impairment is tested by comparing the fair value of the goodwill to its carrying cost. Any excess of carrying value over fair value is charged to income in the period in which the impairment is determined.



Joint Venture



The Companys proportionate share of revenues, expenses, assets and
liabilities in unincorporated joint venture are consolidated in the Companys accounts.



Unearned revenue



Unearned revenue represents billings in advance of services performed and customer deposits for future services.



Cost of Start-up Activities



The Company expenses the cost of start-up activities and organizational costs as incurred in accordance with SOP 98-5 Reporting on the Costs of
Start-up Activities.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



Advertising and promotion expense



The production costs of commercials and programming are charged to operations in the fiscal year during which the production is first aired. The costs of
other advertising, promotion and marketing programs are charged to operations in the fiscal year incurred. The cost of promotional marketing materials are deferred and expensed as used.



Income taxes



The Company accounts for income taxes in accordance with SFAS No. 109 Accounting for Income Taxes which requires an asset and liability
approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or
deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the
amount expected to be realized. The income tax provision is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.



Computation of earnings per common share



Basic earnings per share is computed by dividing the earnings attributable to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted earnings per share is computed giving effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common shares consist of incremental common
shares issuable upon exercise of stock options.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



Foreign currency translation and foreign assets



In accordance with the provisions of Statement of Financial Accounting Standards (SFAS), No. 52, Foreign Currency Translation,
assets and liabilities of the Companys foreign subsidiary were translated into United States dollars at the exchange rates in effect on the reporting date. Income and expenses are translated at an average exchange rate for the respective
period. For the foreign subsidiary which utilizes its local currency as its functional currency, the resulting translation gains and losses are included in other comprehensive income. Gains or losses resulting from foreign exchange transactions are
reflected in earnings.



Stock-based compensation



At September 30, 2004, 230,000 options were outstanding with
an exercise price of $6.50 per share, with a weighted average remaining life of 4.13 years; 50,000 options were outstanding with an exercise price of $6.57 per share, with a weighted average remaining life of 4.61 years; and 50,000 options with an
exercise price of 6.41 with a weighted average remaining life of 4.94 years. None of these options are vested at September 30, 2004.



In addition to this Stock Option Plan, on December 21, 2000, nonqualified options for 2,568,000 common shares were granted to an individual who is a
director and chief executive officer and are exercisable at $0.78 per share on or before December 31, 2003, or upon the sale of the Company. These options were exchanged for 2,260,934 shares of Common Stock on December 30, 2003 (see Note 10).



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



Stock-based compensation (contd)



Compensation expense under stock options is reported using the intrinsic method under the recognition and measurement principles and Accounting Principles
Board (APB) Option No. 25 Accounting for Stock Issued to Employees and related interpretations. Under this method compensation cost is reflected in net income for options granted wit an exercise price less than market price
of the underlying common stock at the date of grant. The Company has adopted only the disclosure provision of SFAS 123, Accounting for Stock-Based Compensation.



If compensation cost for the Companys grants for stock-based compensation had been recorded consistent with the fair
value-based method of accounting per SFAS No. 123, the Companys pro forma net income, and pro forma basic and diluted net income for the three months ending September 30, would be as follows:



|                             |  |                                          |  |          
|---------------------------- |  | ---------------------------------------- |  | ---------
|                             |  | For the three months ended September 30,
|                             |  | 2004                                     |  | 2003     
|                             |  | $                                        |  | $        
|Net income as reported       |  | 1,500,527                                |  | 1,598,758
|Pro forma net income         |  | 1,457,250                                |  | 1,598,758
|Basic net income per share   |  |                                          |  |          
|As reported                  |  | 0.12                                     |  | 0.18     
|Pro forma                    |  | 0.11                                     |  | 0.18     
|                             |  |                                         
|Diluted net income per share |  |                                          |  |          
|As reported                  |  | 0.12                                     |  | 0.14     
|Pro forma                    |  | 0.11                                     |  | 0.14     



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



Financial instruments



SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of the fair value of certain financial instruments for which it
is practicable to estimate fair value. For purposes of the disclosure requirements, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a
forced sale or liquidation. The carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, and other current liabilities are reasonable estimates of their fair value due to the short-term maturity of
the underlying financial instruments. The carrying value of the capital leases is a reasonable estimate of its fair value based on current rates for equipment obligations.



The estimated difference between the carrying value and the fair value of the advances from TELUS Communications Inc. in
which no interest has been charged is not material.



The
Companys financial instruments consist of cash and cash equivalents, accounts receivable, unbilled revenue, accounts payable and accrued liabilities and deferred revenue. Unless otherwise noted, it is managements opinion that the Company
is not exposed to significant interest or currency risks arising from these financial instruments. The Company has in place systems to minimize credit risk and prevent fraudulent use by customers. On occasion, defaults occur on receivables. The
Company makes a provision when deemed necessary. The company places its cash and cash equivalents in high quality financial instruments.



Reclassifications



Certain reclassifications were made to prior year balances to conform to the current period presentation.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



New Accounting Pronouncement



In April 2004, the Emerging Issues Task Force issued Statement No. 03-06 (EITF 03-06), Participating Securities and the Two-Class Method
Under FASB Statement No. 128, Earnings Per Share. EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder
to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes
a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. The Company adopted EITF
03-06 on April 1, 2004, and the adoption did not have a material impact on the Companys consolidated financial statements.



In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003) (FIN46-R), Consolidation of Variable Interest Entities, which
addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN No. 46-R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46), which was issued in January 2003. FIN 46-R requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of
activities of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN 46-R are effective immediately to those entities that are considered to be special-purpose entities. For all
other arrangements, the FIN 46-R provisions are required to be adopted at the beginning of the first interim or annual period ending after March 15, 2004. As of June 30, 2004 the Company is not a party to transactions contemplated under FIN 46-R.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (contd)
|-- | ---------------------------------------------------



New Accounting Pronouncement (contd)



In November 2003, the Emerging Issues Task Force (EITF) reached an interim consensus on Issue No. 03-01, The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments, to require additional disclosure requirements for securities classified as available-for-sale or held-to-maturity for fiscal years ending after December 15, 2003. In March 2004, the EITF reached
a final consensus on this Issue, to provide additional guidance, which companies must follow in determining whether investment securities have an impairment which should be considered other-than-temporary. The guidance is applicable for reporting
periods after June 15, 2004. The effective date of the guidance in EITF 03-01 has been delayed until the FASB issues a Staff Interpretation on this matter. The delay does not have a specified date. Until an effective date is determined, existing
guidance continues to apply in determining if an impairment is other than temporary. The guidance in EITF 03-01 that was delayed would require making an evidence-based judgement about a recovery of fair value back up to the cost of the investment,
considering the severity and duration of the impairment, and about the investors ability and intent to hold the investment for a reasonable period of time until the time of the forecasted recovery. The Company does not expect the adoption
under the final consensus to have a significant impact on the Companys consolidated financial statements.



|3. | DUE TO FACTOR
|-- | -------------



The amounts due to factor are secured by an assignment of the Companys accounts receivable. The Company has an agreement to finance undivided
interest in certain accounts receivable with recourse to the Factor. Payments are received by the Factor from the financed accounts receivable; the collections are reinvested by the Factor in new accounts receivable of the Company, and a yield, as
defined in the agreement is transferred to the Factor. At September 30, 2004, the amounts assigned under the agreement, expiring February 2006, that had not been collected was approximately $7,745,583 (June 30, 2004 - $8,271,312) which will be
forwarded to the Company once collected after repayment of the Factors advances.



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|4. | PROPERTY AND EQUIPMENT
|-- | ----------------------



Property and equipment consist of the following:



|                                                     |  |            |  |                         |  |                |  |          
|---------------------------------------------------- |  | ---------- |  | ----------------------- |  | -------------- |  | ---------
|                                                     |  | Cost       |  | Accumulateddepreciation |  | Net book value
|                                                     |  |            |  | September 30,2004       |  | June 30,2004  
|                                                     |  | $          |  | $                       |  | $              |  | $        
|Next Generation software (Note 5)                  |  | 3,198,126  |  | 136,828                 |  | 3,061,298      |  | 1,771,021
|Telecom switching systems                            |  | 6,473,226  |  | 3,567,225               |  | 2,906,001      |  | 2,862,292
|Billing, administration and customer service systems |  | 1,852,973  |  | 556,225                 |  | 1,296,748      |  | 1,231,851
|Installed lines                                      |  | 1,577,882  |  | 367,946                 |  | 1,209,936      |  | 798,781  
|Office furniture and equipment                       |  | 3,110,780  |  | 2,025,061               |  | 1,085,719      |  | 548,977  
|Broadband Equipment                                  |  | 814,416    |  | 37,868                  |  | 776,548        |  | 591,369  
|Carrier identification codes loading                 |  | 814,412    |  | 140,861                 |  | 673,551        |  | 466,085  
|Computer equipment                                   |  | 1,066,570  |  | 497,521                 |  | 569,049        |  | 505,465  
|Leasehold improvements                               |  | 678,170    |  | 155,150                 |  | 523,020        |  | 454,980  
|Computer software                                    |  | 282,469    |  | 272,374                 |  | 10,095         |  | 10,089   
|Automobile                                           |  | 6,847      |  | 3,881                   |  | 2,966          |  | 2,987    
|                                                     |  |            |  |                         |  |                |  |          
|                                                     |  | 19,875,871 |  | 7,760,940               |  | 12,114,931     |  | 9,243,897
|                                                     |  |            |  |                         |  |                |  |          



Telecom switching
systems include assets under capital leases having a net book value of approximately $1,259,065 as at September 30, 2004 and $1,230,320 as at June 30, 2004. Office furniture and equipment includes assets under capital leases having a net book value
of approximately $348,697 as at September 30, 2004. At June 30, 2004 there were no such assets under capital lease.



Depreciation expense for equipment under capital leases for the three months ended September 30, 2004 and 2003 was approximately $50,215 and $2,000
respectively.



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|5. | NEXT GENERATION SOFTWARE
|-- | ------------------------



On June 20, 2003, the Company purchased certain next generation telecommunications software from an unrelated third party for $9,500,000.
Consideration was $565,000 in cash and short-term note of $400,000 and the balance a long-term note in the amount of $8,535,000. This long-term note bears interest at 7.25% per annum and is payable $174,965 including interest quarterly and is due
July 15, 2012. The sole recourse by the holder of this long-term note is the software.



On June 24, 2003, the Company entered into a joint marketing agreement with the vendor of the software referred to above for the exploitation of the software outside of Canada by non-customers of the Company. The
Company is entitled to receive 4% of all gross revenue with minimum quarterly payments of $150,000 to June 30, 2006 and thereafter 2.75% of gross revenue with minimum quarterly payments of $175,000. The Company is entitled to offset any receivable
under the joint marketing agreement against the note payable.



After a period to further evaluate this software, management has made a decision to reclassify the long-term note payable from June 30, 2003 of $8,510,694 to offset the software previously recorded. This is due to the fact the long-term
note is non-recourse and cash flow for the repayments is earned from our joint marketing agreement with the note holder. Consequently, management will only record its own cash payments under the long-term note as consideration for the software.



Pursuant to an agreement made April 7, 2004, the Company
entered into a contract for further enhancements to the software which amounted to $771,630 at September 30, 2004 and $610,000 at June 30, 2004



|6. | LOAN RECEIVABLE
|-- | ---------------



The Company has entered into a commercial services and marketing agreement with the Companys joint venture participant in Peru to provide financing
to assist in its development of dial-around long-distance service for which the Company will process its international traffic and earn 50% of the profits generated by the business. At September 30, 2004 and June 30, 2004 the Company had made
advances of $956,191 and $956,191 respectively under this agreement, of which $413,944 ($445,454 - June 30, 2004) is a loan receivable (see Note 12).



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|7. | ADVANCES FROM TELUS COMMUNICATIONS INC. (Telus)
|-- | -----------------------------------------------



In fiscal 2003, in return for the Companys commitment to promote its advertising and marketing activities, Telus provided the Company with a
deferral of amounts due to Telus to a total maximum value of $3,250,000. The deferral was calculated as 25% of the value of monthly billed revenue to the Company by Telus in the preceding month to a maximum of $270,000 per month.



Repayment of the deferred amounts commenced September 15, 2003 and is ending
October 15, 2005. Repayments are a minimum of $109,370 per month, plus additional amounts based upon volumes. Up to September 30, 2004, the Companys monthly payments have been the minimum amount. The repayments are non-interest bearing as long
as no payments are in default, and are classified as follows:



|          |  |                    |  |              
|--------- |  | ------------------ |  | -------------
|          |  | September 30, 2004 |  | June 30, 2004
|          |  | $                  |  | $            
|Current   |  | 1,312,440          |  | 1,238,882    
|Long-term |  | 41,591             |  | 348,980      
|          |  |                    |  |              
|          |  | 1,354,031          |  | 1,587,862    
|          |  |                    |  |              



|8. | OBLIGATIONS UNDER CAPITAL LEASES
|-- | --------------------------------



The Companys capital leases are for terms of 24 to 48 months at annual interest rates ranging from 8.9% to 15.00%. In addition to regular lease
payments, the three months ending June 30, 2007 includes a buyout of $235,597.



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|8. | OBLIGATIONS UNDER CAPITAL LEASES (contd)
|-- | -----------------------------------------



The future minimum lease payments required under the capital lease agreements are as follows:



|                              |  |           |  
|----------------------------- |  | --------- | -
|                              |  | $         |  
|Year ending September 30,     |  |           |  
|2005                          |  | 632,623   |  
|2006                          |  | 584,048   |  
|2007                          |  | 689,787   |  
|2008                          |  | 148,436   |  
|2009                          |  | 35,142    |  
|                              |  |           |  
|Total minimum lease payments  |  | 2,090,036 |  
|Amounts representing interest |  | 301,986   |  
|                              |  |           |  
|Principal                     |  | 1,788,050 |  
|Current portion               |  | (490,696  | )
|                              |  |           |  
|                              |  | 1,297,354 |  
|                              |  |           |  



|9. | INCOME TAXES
|-- | ------------



The domestic and international components of income (loss) before income taxes are as follows:



|                           |  |                                          |   |  |           |  
|-------------------------- |  | ---------------------------------------- | - |  | --------- | -
|                           |  | For the three months ended September 30, |  
|                           |  | 2004                                     |   |  | 2003      |  
|                           |  | $                                        |   |  | $         |  
|United States              |  | (626,585                                 | ) |  | (141,225  | )
|Canada                     |  | 2,844,176                                |   |  | 2,494,400 |  
|                           |  |                                          |   |  |           |  
|Income before income taxes |  | 2,217,591                                |   |  | 2,353,175 |  
|                           |  |                                          |   |  |           |  



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|9. | INCOME TAXES (contd)
|-- | ---------------------



The components of the income tax expense are as follows:



|                   |  |                                          |   |  |         |  
|------------------ |  | ---------------------------------------- | - |  | ------- | -
|                   |  | For the three months ended September 30, |  
|                   |  | 2004                                     |   |  | 2003    |  
|                   |  | $                                        |   |  | $       |  
|Current            |  |                                          |   |  |         |  
|United States      |  |                                         |   |  |        |  
|Canada             |  |                                         |   |  | (56,651 | )
|Deferred           |  |                                          |   |  |         |  
|United States      |  | (213,039                                 | ) |  | (48,017 | )
|Canada             |  | 930,103                                  |   |  | 859,085 |  
|                   |  |                                          |   |  |         |  
|Income tax expense |  | 717,064                                  |   |  | 754,417 |  
|                   |  |                                          |   |  |         |  



The tax benefits
associated with employee exercises of non-qualified stock options, disqualifying dispositions of stock acquired with incentive stock options, and disqualifying dispositions of stock acquired under the employee stock purchase plan generally reduce
taxes currently payable. However, no tax benefits were recorded to additional paid-in capital in 2004 and 2003 because their realization was not believed to be more likely than not. Consequently, a valuation allowance was recorded against the entire
benefit.



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|9. | INCOME TAXES (contd)
|-- | ---------------------



Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, as well as the application of the deferred tax asset acquired and have been recognized in the Companys accounts as follows:



|                                                 |  |                   |   |  |               |  
|------------------------------------------------ |  | ----------------- | - |  | ------------- | -
|                                                 |  | September 30,2004 |   |  | June 30, 2004 |  
|                                                 |  | $                 |   |  | $             |  
|Accounting value of assets in excess of tax base |  | 2,705,854         |   |  | 2,549,286     |  
|Unrealized tax loss carryforward                 |  | (205,802          | ) |  | (887,139      | )
|                                                 |  |                   |   |  |               |  
|Net deferred tax liability                       |  | 2,500,052         |   |  | 1,662,147     |  
|                                                 |  |                   |   |  |               |  



The income tax
provision recorded differs from the income tax obtained by applying the statutory income tax rate of 33.12% (2003 - 35.62%) to the Canadian income accounts as follows:



|                                   |  |                                          |   |  |           |  
|---------------------------------- |  | ---------------------------------------- | - |  | --------- | -
|                                   |  | For the three months ended September 30, |  
|                                   |  | 2004                                     |   |  | 2003      |  
|                                   |  | $                                        |   |  | $         |  
|Income (loss) before income taxes: |  |                                          |   |  |           |  
|United States                      |  | (626,585                                 | ) |  | (141,225  | )
|                                   |  |                                          |   |  |           |  
|Canada                             |  | 2,844,176                                |   |  | 2,494,400 |  
|                                   |  |                                          |   |  |           |  
|Calculated income tax expenses     |  | 734,466                                  |   |  | 838,201   |  
|Expenses deductible for tax        |  | (17,402                                  | ) |  | (83,784   | )
|                                   |  |                                          |   |  |           |  
|Provision for income taxes         |  | 717,064                                  |   |  | 754,417   |  
|                                   |  |                                          |   |  |           |  



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|9. | INCOME TAXES (contd)
|-- | ---------------------



The Company has losses of approximately $608,000 available to reduce future taxable income. Such benefits will be recorded as an adjustment to the tax
provision in the year realized. The losses will expire as follows:



|     |  |        
|---- |  | -------
|     |  | $      
|2009 |  | 515,000
|2010 |  | 93,000 
|     |  |        
|     |  | 608,000
|     |  |        



|10. | COMMON STOCK
|--- | ------------



100,000,000 shares authorized, no par value, stated value $0.01 per share.



On July 15, 2003, 20,000 common shares were issued, as consideration for a short-term loan in the amount of $713,570 due
December 31, 2003.



On December 30, 2003, the Company pursuant
to a stock option granted on December 2000, issued 2,260,934 shares of its common stock to its chief executive officer and director. The option provided for the issuance of 2,568,000 shares of common stock less the surrender of 307,066 shares of
common stock which was the number of shares determined by an independent valuator on December 5, 2003, assuming a discounted market price of $5.67 per share as of November 30, 2003. The transaction was accounted for as a cashless exercise of the
option as the option holder held 1,523,800 common shares prior to December 30, 2003.



On December 31, 2003, 9,000 common shares were issued for services rendered of $51,032.



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|10. | COMMON STOCK (contd)
|--- | ---------------------



On January 29, 2004 a two-for-one stock split on the Companys outstanding shares was distributed to shareholders of record at January 15, 2004. For
every one share of the Companys common stock held on the record date, a holder will receive one additional share. All share information has been adjusted retroactively for the stock split.



On March 18, 2004, 1,470,000 common shares were issued for gross proceeds of
$18,007,500 less direct cost associated with the transaction of $1,184,014 for net proceeds of $16,823,486. Attached to these shares were common stock warrants issued to purchase 367,500 shares of the Companys common stock. These warrants have
an exercise price of $17.00 and expire March 18, 2010.



|11. | STOCK OPTION PLAN
|--- | -----------------



Effective June 30, 1999, the Company adopted a Stock Option Plan (the Plan) which permits the issuance of stock options to selected employees
and directors. The Company reserved 640,000 shares of common stock for grant under the Plan. Options granted may be either nonqualified or incentive stock options and will expire no later than 20 years from the date of grant (10 years for incentive
options). No options have been issued under this plan.



On
November 17, 2003, 230,000 options were granted to three officers of the Company, with an exercise price of $6.50. The market price of the stock on that date was $7.25. The holders may exercise 25% of their options on each anniversary date, and the
options expire November 17, 2008. On May 11, 2004, 50,000 options were granted to an officer of the Company, with an exercise price of $6.57. The market price of the stock on that date was $7.30. The holder may exercise 25% of their options on each
anniversary date, and the options expire May 11, 2009. On September 7, 2004 50,000 options were granted to an employee of the Company, with an exercise price of $6.41. The market price of the stock on that date was $7.12. The holder may exercise 25%
of their options on each anniversary date, and the options expire September 7, 2009. The Company has recorded a deferred compensation expense of $13,054 in connection with the grant of these options for the three months ended September 30, 2004.



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|12. | JOINT VENTURE
|--- | -------------



Included in the consolidated financial statements are the Companys proportionate share of revenues, expenses, assets and liabilities of the
unincorporated joint venture as follows:



|                               |  |                   |   |  |              |  
|------------------------------ |  | ----------------- | - |  | ------------ | -
|                               |  | September 30,2004 |   |  | June 30,2004 |  
|                               |  | $                 |   |  | $            |  
|Assets                         |  |                   |   |  |              |  
|Cash                           |  | 12,753            |   |  | 19,935       |  
|Accounts Receivable            |  | 32,461            |   |  | 30,292       |  
|Prepaid expenses               |  | 3,500             |   |  | 3,500        |  
|Property and equipment         |  | 98,486            |   |  | 103,551      |  
|                               |  |                   |   |  |              |  
|                               |  | 147,199           |   |  | 157,278      |  
|                               |  |                   |   |  |              |  
|Liabilities                    |  |                   |   |  |              |  
|Accounts payable               |  | 148,060           |   |  | 90,949       |  
|Due to Yak Communications Inc. |  | 413,944           |   |  | 445,454      |  
|                               |  |                   |   |  |              |  
|                               |  | 562,004           |   |  | 536,403      |  
|Deficit                        |  | (414,805          | ) |  | (379,125     | )
|                               |  |                   |   |  |              |  
|Total liabilities and deficit  |  | 147,199           |   |  | 157,278      |  
|                               |  |                   |   |  |              |  



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|12. | JOINT VENTURE (contd)
|--- | ----------------------



|                                      |  |                                          |   |  |         |  
|------------------------------------- |  | ---------------------------------------- | - |  | ------- | -
|                                      |  | For the three months ended September 30, |  
|                                      |  | 2004                                     |   |  | 2003    |  
|                                      |  | $                                        |   |  | $       |  
|Revenue                               |  | 45,860                                   |   |  |        |  
|Expenses                              |  | 81,538                                   |   |  | 16,635  |  
|                                      |  |                                          |   |  |         |  
|Net loss                              |  | (35,678                                  | ) |  | (16,635 | )
|                                      |  |                                          |   |  |         |  
|Cash used in operating activities     |  | (23,692                                  | ) |  | (54,432 | )
|Cash used in investing activities     |  |                                         |   |  | (21,125 | )
|Cash provided by financing activities |  | 16,510                                   |   |  | 75,557  |  
|                                      |  |                                          |   |  |         |  
|Decrease in cash                      |  | (7,183                                   | ) |  |        |  
|Cash, beginning of period             |  | 19,935                                   |   |  |        |  
|                                      |  |                                          |   |  |         |  
|Cash, end of period                   |  | 12,752                                   |   |  |        |  
|                                      |  |                                          |   |  |         |  



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|13. | STATEMENT OF CASH FLOWS
|--- | -----------------------



The following recap presents the detail of the net change in working capital presented in the statement of cash flows for the following three months
ended:



|                                                   |  |                                          |   |  |            |  
|-------------------------------------------------- |  | ---------------------------------------- | - |  | ---------- | -
|                                                   |  | For the three months ended September 30, |  
|                                                   |  | 2004                                     |   |  | 2003       |  
|                                                   |  | $                                        |   |  | $          |  
|Increase in:                                       |  |                                          |   |  |            |  
|Accounts receivable                                |  | (83,252                                  | ) |  | (4,548,648 | )
|Prepaid expenses and sundry                        |  | (499,091                                 | ) |  | (244,107   | )
|Income taxes receivable                            |  | (216,071                                 | ) |  |           |  
|Increase (decrease) in:                            |  |                                          |   |  |            |  
|Deferred revenue                                   |  | 49,218                                   |   |  | 974,061    |  
|Accounts payable and accrued liabilities           |  | 225,311                                  |   |  | 402,251    |  
|Amounts due for network access and usage           |  | (216,409                                 | ) |  | 1,018,408  |  
|Amounts due to long distance carriers              |  | 411,514                                  |   |  | 2,023,320  |  
|Amount due for equipment                           |  | (53,172                                  | ) |  | 428,929    |  
|Due to Factor                                      |  | (359,561                                 | ) |  | (2,614     | )
|Income taxes payable                               |  |                                         |   |  | (351,706   | )
|Effect of exchange rate changes on working capital |  | 205,104                                  |   |  | (31,930    | )
|Less: Net assets acquired from Contour             |  |                                         |   |  | 1,286,039  |  
|                                                   |  |                                          |   |  |            |  
|                                                   |  | (536,409                                 | ) |  | 954,003    |  
|                                                   |  |                                          |   |  |            |  



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|14. | COMMITMENTS
|--- | -----------



The Company has operating lease commitments for its premises and commitments for leased lines which expire at various dates through July 2009. The future
minimum lease payments (exclusive of operating costs and payments for additional volume) are as follows:



|     |  |          
|---- |  | ---------
|     |  | $        
|2005 |  | 2,540,410
|2006 |  | 1,940,938
|2007 |  | 1,310,114
|2008 |  | 244,228  
|2009 |  | 170,055  



Under the terms of an
agreement with one of their long distance providers, the Company is committed to purchasing a minimum amount of long distance for their customers use. The minimum amount of customer use is $1,722,568 for the year ending September 30, 2005.



The Company has a further agreement to pay a minimum of
$120,000 per month to March 1, 2005 for long distance services terminating in the United States.



|15. | RELATED PARTY TRANSACTIONS
|--- | --------------------------



| | (a) | The Company made advances for the three months ending September 30, 2004 and 2003 of nil and $2,490 respectively to a corporation of which the Companys chairman is a
shareholder and director.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | The Company paid marketing and design fees for the three months ending September 30, 2004 and 2003 of $7,040 and $15,618 respectively to a corporation controlled by a former officer
and minority shareholder.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | The Company paid professional fees for legal services for the three months ending September 30, 2004 and 2003 of $35,436 and $20,442 respectively to a director and minority
shareholder.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



All other related party
transactions have been disclosed on the consolidated financial statements. These transactions have all been accounted for at their exchange amounts.



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|16. | ECONOMIC DEPENDENCE
|--- | -------------------



The Company is dependent in Ontario, Quebec, British Columbia and Alberta upon carriers to provide billing and collection services to its customers under
renewable agreements. The Company is also dependent upon TELUS Communications Inc. to provide billing, transport and handling services under a renewable agreement which expires in June 2007. Management expects that these agreements will
automatically renew.



The Company purchases long-distance
services from a number of carriers and does not feel there is any economic dependence on any one carrier.



|17. | CHANGES IN ESTIMATES
|--- | --------------------



Effective July 1, 2003, the estimated useful life for existing telecom switching systems has been changed to reflect the expected replacement by the new
Switch that was purchased in September, 2003.



This change in
estimate was applied on a prospective basis and the effect of this change increased amortization for the three months ending September 30, 2003 by approximately $290,000 and reduced net income for the period by approximately $290,000. The tax effect
of this change was a deferred tax benefit of approximately $92,840.



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|18. | SEGMENTED AND RELATED INFORMATION
|--- | ---------------------------------



The Company operates in one reportable segment in three geographic regions - Canada, United States and International. Summary information with respect to
the Companys operations by geographic regions are as follows:



|                        |  |                                          |   |  |               |  
|----------------------- |  | ---------------------------------------- | - |  | ------------- | -
|                        |  | For the three months ended September 30, |  
|                        |  | 2004                                     |   |  | 2003          |  
|                        |  | $                                        |   |  | $             |  
|Net revenue             |  |                                          |   |  |               |  
|Canada                  |  | 20,897,155                               |   |  | 18,560,890    |  
|United States           |  | 221,095                                  |   |  | 230,328       |  
|Peru                    |  | 78,884                                   |   |  |              |  
|                        |  |                                          |   |  |               |  
|                        |  | 21,197,134                               |   |  | 18,791,218    |  
|                        |  |                                          |   |  |               |  
|Operating profit (loss) |  |                                          |   |  |               |  
|Canada                  |  | 3,054,448                                |   |  | 2,693,416     |  
|United States           |  | (768,258                                 | ) |  | (301,422      | )
|Peru                    |  | (68,599                                  | ) |  | (38,819       | )
|                        |  |                                          |   |  |               |  
|                        |  | 2,217,591                                |   |  | 2,353,175     |  
|                        |  |                                          |   |  |               |  
|                        |  |                                         
|                        |  | September 30,2004                        |   |  | June 30, 2004 |  
|                        |  | $                                        |   |  | $             |  
|Assets                  |  |                                          |   |  |               |  
|Canada                  |  | 35,001,998                               |   |  | 33,560,131    |  
|United States           |  | 19,192,938                               |   |  | 17,143,674    |  
|Peru                    |  | 284,054                                  |   |  | 157,278       |  
|                        |  |                                          |   |  |               |  
|                        |  | 54,478,990                               |   |  | 50,861,083    |  
|                        |  |                                          |   |  |               |  



The Canadian assets
include goodwill as at September 30, 2004 and June 30, 2004 of $486,584 and $457,868 respectively and customer lists of $1,598,298 and $1,585,386 respectively.



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##### Table of Contents

YAK COMMUNICATIONS, INC. AND SUBSIDIARIES



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



|19. | CONTINGENCIES
|--- | -------------



Various lawsuits and claims are pending against the Company and estimated provisions have been included in current liabilities where appropriate. It is
the opinion of management that the final determination of these claims will not have a material adverse effect on the financial position or the results of the Company.



50



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##### Table of Contents

Exhibit Index



|            |  |                                                                                                                                                                                                        
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                            
|31.1        |  | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.    
|            | 
|31.2        |  | Certification of Principal Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
|            | 
|32.1        |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                     
|            | 
|32.2        |  | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.