**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-KSB**

 

| **ý**                                                                                                                                                                                                                                                                                                                                                                                |   | **ANNUAL REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                         |
| **For the fiscal year ended September 30, 2003, or**                                                                                                                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                         |
| **o**                                                                                                                                                                                                                                                                                                                                                                                     |   | **TRANSITION REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                         |
| **For the transition period from                                to                             ** |

 

**Commission FileNo. 0-26053**

 

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**MDU COMMUNICATIONS INTERNATIONAL, INC.**

(Name of Small Business Issuerin its charter)

 

| **Delaware**                                                                  |   | **84-1342898**          |
|-------------------------------------------------------------------------------|--------|-------------------------|
| (State  of Incorporation)                                                     |   | (IRS  Employer ID. No.) |
|                                                                          |   |                    |
| **60-D Commerce Way, Totowa, New Jersey 07512**                               |
| (Address  of Principal Executive Offices) (Zip Code)                          |
|                                                                          |
| Issuer’s  telephone number, including area code: **(973) 237-9499** |
|                                                                          |   |                    |
| Securities  registered under Section 12(b) of the Exchange Act:          |

 
| **Title of  Each Class** |   | **Name of  Each Exchange  On Which Registered** |
|--------------------------|--------|-------------------------------------------------|
|                     |   |                                            |

 

Securities registered underSection 12(g) of the Exchange Act:

 

**Common Stock,par value $0.001 per share**(Title of Class)

 

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Check whetherthe issuer: (1) filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes ý No o

 

Check if there is nodisclosure of delinquent filers pursuant to Item 405 of Regulation S-Bcontained herein, and no disclosure will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or anyamendment to this Form 10-KSB. ý

 

The issuer’s revenues forits most recent fiscal year were $4,124,394.

 

The aggregate market valueof the common stock held by non-affiliates, computed by reference to theaverage bid and ask price of our common stock on March 31, 2003 was$4,721,496.  For purposes of thiscalculation only, directors, executive officers and the principal controllingshareholder of the registrant are deemed to be affiliates of the registrant.

 

The aggregate market valueof the common equity held by non-affiliates, computed by reference to the priceat which the issuer’s common stock was sold, based on the average of bid andasked prices on December 11, 2003, was $48,019,336.

 

As of December 11, 2003there were 34,148,261 shares of common stock outstanding and no otheroutstanding classes of a common equity security.

 

Transitional Small BusinessDisclosure Format (check one): Yes o    No ý

 

 

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**TABLE OF CONTENTS**

 
| **PART I**   |                                                                                               | **Page** |
|--------------|----------------------------------------------------------------------------------------------------|----------|
| ITEM 1.      | Description of Business                                                                            | 3        |
| ITEM 2.      | Description of Properties                                                                          | 11       |
| ITEM 3.      | Legal Proceedings                                                                                  | 11       |
| ITEM 4.      | Submission of Matters to a Vote of Security  Holders                                               | 12       |
|         |                                                                                               |     |
| **PART II**  |                                                                                               |     |
| ITEM 5.      | Market for Common Equity and Related  Stockholder Matters                                          | 12       |
| ITEM 6.      | Management’s Discussion and Analysis or  Plan of Operation                                    | 14       |
| ITEM 7.      | Financial Statements                                                                               | 22       |
| ITEM 8.      | Changes In and Disagreements with  Accountants on Accounting and Financial Disclosure              | 47       |
| ITEM 8A.     | Controls and Procedures                                                                            | 47       |
|         |                                                                                               |     |
| **PART III** |                                                                                               |     |
| ITEM  9.     | Directors,  Executive Officers, Promoters and Control Persons; Compliance with  Section 16(a) | 47       |
| ITEM 10.     | Executive Compensation                                                                             | 49       |
| ITEM 11.     | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters    | 50       |
| ITEM 12.     | Certain Relationships and Related  Transactions                                                    | 50       |
| ITEM 13.     | Exhibits and Reports on Form 8-K                                                                   | 51       |
| ITEM 14.     | Principal Accountant Fees and Services                                                             | 51       |

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Reportcontains certain forward looking statements (as such term is defined in thePrivate Securities Litigation Reform Act of 1995) and information relating toMDU Communications International, Inc. that is based on the beliefs of ourmanagement, as well as assumptions made by and information currently availableto our management. When used in this Report, the words “estimate,” “project,”

 

 

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“believe,” “anticipate,”“hope,” “intend,” “expect,” and similar expressions are intended to identifyforward looking statements, although not all forward looking statements containthese identifying words.

Suchstatements reflect our current views with respect to future events and are subjectto unknown risks, uncertainties, and other factors that may cause actualresults to differ materially from those contemplated in such forward lookingstatements. Such factors include the risks described in Item 1. Description ofBusiness; Risk Factors and elsewhere in this Report and, among others, thefollowing: general economic and business conditions, both nationally,internationally, and in the regions in which we operate; catastrophic events,including acts of terrorism; relationships with and events affecting thirdparties like DIRECTV and the possible sale of DIRECTV; demographic changes;existing government regulations, and changes in, or the failure to comply with,government regulations; competition; the loss of any significant numbers of subscribersor viewers; changes in business strategy or development plans; the cost ofpursuing new business initiatives; technological developments and difficulties;the availability and terms of capital to fund the potential expansion of ourbusinesses; and other factors referenced in this Report. Readers are cautionednot to place undue reliance on these forward looking statements, which speakonly as of the date hereof. We do not undertake any obligation to publiclyrelease any revisions to these forward looking statements to reflect events orcircumstances after the date hereof or to reflect the occurrence ofunanticipated events.

 

*The words“MDU Communications,” “the Company,” “we,” “our,” and “us” refer to MDUCommunications International, Inc. together with its subsidiaries, whereappropriate.*

 

**PART I**

 

**Item 1.****          ****Description ofBusiness**

 

**BUSINESS OF THECOMPANY**

 

MDU CommunicationsInternational, Inc. concentrates exclusively on deliveringstate-of-the-art digital satellite television and high-speed Internet solutionsto the United States multi-dwelling unit (“MDU”) residential market—estimatedto include 26 million residences. MDUs include apartment buildings,condominiums, gated communities, universities, nursing homes, hospitals,hotels, motels and other properties having multiple units located within adefined area. We seek to differentiate ourselves from other service providersthrough a unique strategy of balancing the information and communication needsof today’s MDU residents with the technology concerns of property managers andowners and providing the best overall service to both. To accomplish thisobjective, we have partnered with such groups as DIRECTV, Inc. and CiscoSystems, Inc. and have been working with large property owners and realestate investment trusts (REITs) such as AvalonBay Communities, Trammell CrowResidential, Roseland Property Company, KSI Services, as well as many others,to understand and meet the technology needs of these groups.

 

Our Canadian operatingcompany, MDU Communications Inc. (“MDU Canada”), was incorporated inMarch 1998. In November 1998, MDU Canada’s shareholders sold all oftheir MDU Canada stock to Alpha Beta Holdings, Ltd., an inactive U.S.public reporting company, in exchange for Alpha Beta stock, and renamed it “MDUCommunications International, Inc.” Alpha Beta had been incorporated inColorado in July 1995, but never conducted any significant businessactivities and was essentially inactive in November 1998. InApril 1999, we reincorporated MDU Communications International, Inc.in Delaware and MDU Canada became a wholly owned subsidiary that at its peak,had over 15,000 subscribers and seven offices across Canada. InMarch 2000, we formed MDU Communications (USA) Inc., a Washingtoncorporation (“MDU USA”) to conduct business in the U.S.  In early 2001,the Company made a fundamental re-assessment of its business plan anddetermined that the most profitable markets lay in densely populated areas ofthe United States. The Company changed its corporate focus and businessstrategy from serving the entire North American MDU market, to several key U.S.markets, beginning with the Northeast United States. To further this change, in2001, we completed an agreement with Star Choice Television Network, Inc.,one of our Canadian strategic partners, for the sale of certain Canadiansatellite television assets for a total adjusted selling price of approximately$7.0 million. As a result, by May 30,

 

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2001, the Company relocated itsoperations and certain key employees to our New York Metro Area office inTotowa, New Jersey. We now operate essentially as a holding company with MDUCanada and MDU USA as our wholly owned operating subsidiaries, with MDU Canadanow operating on only a limited basis.

 

The Company earns itsrevenue through the sale of digital satellite television programming andhigh-speed Internet services to residents of MDUs. We negotiate long-termaccess agreements with the owners and managers of MDU properties allowing usthe right to provide digital satellite television and high-speed Internetservices, and potentially other services, to their residents.

 

Our common stock tradesunder the symbol “MDTV” on the OTC Bulletin Board. Our principal executiveoffices are located at 60-D Commerce Way, Totowa, New Jersey 07512 and ourtelephone number is (973) 237-9499. Our website is located at *www.mduc.com*.

 

**OUR STRENGTHS**

 

In addition to the highquality of our digital satellite television programming, our high-speed(broadband) Internet solution and the choices that our products offer to MDUresidents, we believe that our access agreements and our strategic alliancesrepresent significant competitive and business strengths.

 

**Access Agreements**

 

Our access agreements withthe owners of MDU properties generally grant us exclusive rights to providedigital satellite television services, and in some cases video servicesaltogether, for terms of seven to ten years, and in many cases a right of firstrefusal for other new telecommunications services. Most access agreementsprovide for marketing services by the owner or manager on our behalf, and inmany cases, these marketing arrangements are exclusive. These access agreementsare in the name of the Company and provide us with revenue streams eitherdirectly from property owners in bulk properties or from individual subscribersin choice or exclusive properties.

 

**Strategic AllianceWith DIRECTV****Ò**

 

In May of2000, we entered into a long-term proprietary System Operator Agreement withDIRECTV. Under this agreement we are able to establish and maintain MDUdistribution systems in non-rural states of the United States (as identified inthe agreement) and act as a commissioned sales agent for the marketing ofDIRECTV programming to residents of MDU properties. We only incur costsassociated with the implementation of our services and do not pay any ofDIRECTV’s programming or broadcasting costs. On September 29, 2003, theCompany entered into a new System Operator Agreement with DIRECTV, whichreplaced the System Operator Agreement previously executed by the Company,which was due to initially expire on May 19, 2005. The Company considersthe following contractual changes as material:

 

•                  The upfrontactivation commission (the “commission”) that the Company receives from DIRECTVfor each new subscriber will now be paid to the Company on “gross” subscriberadditions instead of “net” subscriber additions in a given month and in anaccelerated fashion.

 

•                  The Company mustobtain an annual (twelve month) commitment from a subscriber for DIRECTVprogramming in order to receive the commission.

 

•                  The commissioncan be proportionally “charged back” by DIRECTV only if a subscriberdisconnects within the annual commitment period (i.e., if a subscriberdisconnects after six months, the Company forfeits 50% of the commission).After twelve months, no portion of the commission can be “charged back.”

 

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•                  The monthlyresidual payment paid to the Company by DIRECTV, which is based upon themonthly programming revenue to DIRECTV from a subscriber, has beenconfidentially increased.

 

•                  The newagreement has an initial term of three years with two, two-year automaticrenewal periods upon the Company’s achievement of certain subscriber growthgoals, for a total term of seven years.

 

•                  The agreementhas an automatic extension of the entire agreement to coincide with theexpiration date of the Company’s latest property access agreement.

 

Under the DIRECTV agreement,we may not solicit sales or provide equipment for any other direct-to-homedigital satellite television service in the United States. Consequently, we aretotally dependent on DIRECTV for our digital set-top programming in the UnitedStates. We are not, however, prohibited from contracting with other programproviders in connection with our private cable services. During the fiscal yearended September 30, 2003, revenues from DIRECTV direct-to-home (DTH) were18% of our total revenues. DIRECTV is not required to use us on an exclusivebasis and could either contract with others to install distribution systems andmarket programming in MDUs or undertake such activities directly through retailstores, as it does for single-family television households.

 

DIRECTV offersin excess of 800 entertainment channels of digital quality video and compactdisc quality audio programming. DIRECTV currently transmits via five high powerKu band satellites and has two spare satellites in orbit. We believe thatDIRECTV’s extensive line up of pay per view movies and events and sportspackages, including the exclusive “NFL Sunday Ticket,” have enabled DIRECTV tocapture a majority market share of existing DBS subscribers and will continueto drive strong subscriber growth for DIRECTV programming in the future.  Through our strategic relationshipwith DIRECTV, we expect to capitalize on the significant name recognition thatDIRECTV creates and maintains as well as their immense advertising budget andadvertised programming specials. Additionally, we benefit from the large-scalenational marketing campaigns that are continuously run by DIRECTV.

 

**Strategic AllianceWith Cisco**

 

In June of 2001, weentered into a non-exclusive Master Purchase Sales Agreement with Cisco tobecome part of their preferred network in order to provide broadband Internetproducts, systems and value added services, through our new high-speed Internetservice to our MDUs. Cisco selected us to participate in a direct purchasingprogram as a result of our mutual interest in developing closer workingrelationships with application service providers involved in developingemerging market opportunities. As a result, we signed a preferential agreementwith Cisco Systems Capital for the purchase of high-speed Internet relatedequipment and installation, which includes a half million-dollar leasefinancing line of credit. Our strategic alliance with Cisco also providessignificant name recognition of high quality products and we benefit from thelarge-scale national marketing campaigns that are continuously run by Cisco.

 

**MARKET**

 

The United States MDU marketrepresents a large niche market of potential telecommunications customers.There are over 26 million MDU television households out of a total of100 million U.S. television households with the most densely populated MDUareas in the Northeast. Our short-term goal is to become a significant providerof bundled MDU products and services to the over 8 million MDUs in theNortheastern United States marketplace. Future growth plans include Texas,where we already have operations, and Florida.

 

Historically, the MDU markethas been served by local cable television operators. Generally, these providersused analog technology and MDU residents could not access digital or competitiveservices.

 

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Although many cable companieshave begun the process of upgrading to a digital signal, this transition willrequire significant capital outlays and time to complete. Additionally, the relationshipbetween the property owners and managers that control access to theseproperties and the cable operator have been significantly strained over thepast 15 years due to the monopolistic sentiment of the cable operator.

 

We believe that today’s MDUmarket offers us a very good business opportunity because:

 

•                  Advances in communication and informationtechnology have created demand for new state-of-the-art services such asdigital satellite television and high definition television (HDTV).

 

•                  Regulatory changes in the United Statesauthorizing the provision of digital satellite television services and localchannels has given television viewers the opportunity to choose the provider oftheir television programming based on quality of signal, cost and variety ofprogramming.

 

•                  Our marketing program focuses on the choiceand benefits of using satellite television programming over cable programming,including cost savings.

 

•                  A number of MDUs are underserved by cabletelevision providers or digital satellite television private cable providers.In addition, the market has only been enhanced by the recent pull back by manycompetitors, leaving the residential MDU community with very little choiceamong alternative service providers.

 

•                  To date, DIRECTV and other digital satellitetelevision program providers have focused primarily on the single-familyresidence market because of the lower cost of deployment and fewer technicaldifficulties than those incurred in MDU properties and are now gearing to capitalizeon the MDU market.

 

**COMPETITION**

 

The home entertainment andvideo programming industry is competitive, and we expect competition tointensify in the future. We face our most significant competition from thefranchised cable operators. In addition, our competition includes othersatellite providers, wireless cable and off-air broadcasters:

 

*HardwiredFranchised Cable Systems.*    Cable companies currently dominate the marketin terms of subscriber penetration, the number of programming servicesavailable, audience ratings and expenditures on programming. In the U.S., thetraditional cable companies serve an estimated 69% of U.S. televisionhouseholds. Although many cable operators currently use analog technologies,which produce inferior quality video and sound compared to digitaltechnologies, many cable operators have begun the process of upgrading to adigital signal, however, this transition requires significant capital outlaysand time to deploy. In the meantime, we believe that direct to home (“DTH”)providers like us have a window of opportunity in which to acquire andconsolidate a significant subscriber base by providing a higher quality signalover a vast selection of video and audio channels at a comparable or reducedprice to most cable operators’ current service.

 

*Off-AirBroadcasters.*    Amajority of U.S. households that are not serviced by cable operators areserviced only by broadcast networks and local television stations (“off-airbroadcasters”). Off-air broadcasters send signals through the air, which arereceived by traditional television antennas at the customer’s property. Signalsare accessible to anyone with an antenna and programming is funded byadvertisers. Audio and video quality is limited and service can be adverselyaffected by weather or by buildings blocking a signal.

 

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*WirelessCable Systems (Multi-Channel Multi-Point Distribution Services (“MMDS”)).*    MMDS systems are ahybrid of cable transmission and off-air broadcasting. MMDS was developed as analternative where hard-wired cable systems are unavailable or not possible.MMDS programming is transmitted by local cable operators in a scrambled formthrough the air via microwave frequencies to a small microwave dish at the subscriber’sproperty, which converts the signal to a frequency band used by standard cableservices. However, this system generally requires a direct “line-of-sight” fromthe transmission facility to the subscriber’s receiving dish, which limits itsrange and capability of being received. There are very few MMDS providersoperating in the U.S. and they serve regional markets only.

 

*Other Operators.* Additionally, we compete withother operators who build and operate communications systems such as satellitemaster antenna television systems, commonly known as SMATV, which generallyserve condominiums, apartment and office complexes and residentialdevelopments.  We also compete withother national DBS operators such as Echostar.

 

**GOVERNMENTALREGULATION**

 

*Federal Regulation.* In February 1996, Congresspassed the Telecommunications Act, which substantially amended the FederalCommunications Act of 1934, as amended (“Communications Act”). This legislationhas altered and will continue to alter federal, state, and local laws andregulations affecting the communications industry, including certain of theservices we provide. On November 29, 1999, Congress enacted the SatelliteHome Viewer Improvement Act of 1999 (“SHVIA”), which amended the Satellite HomeViewer Act. SHVIA permits DBS operators to transmit local television signalsinto local markets. In other important statutory amendments of significance tosatellite carriers and television broadcasters, the law generally seeks toplace satellite operators on an equal footing with cable television operatorsin regards to the availability of television broadcast programming.

 

SHVIA amends the Copyright Act and theCommunications Act in order to clarify the terms and conditions under which aDBS operator may retransmit local and distant broadcast television stations tosubscribers. The law was intended to promote the ability of satellite servicesto compete with cable television systems and to resolve disputes that hadarisen between broadcasters and satellite carriers regarding the delivery ofbroadcast television station programming to satellite service subscribers. As aresult of SHVIA, television stations are generally entitled to seek carriage onany DBS operator’s system providing local service in their respective markets.SHVIA creates a statutory copyright license applicable to the retransmission ofbroadcast television stations to DBS subscribers located in their markets.Although there is no royalty payment obligation associated with this license,eligibility for the license is conditioned on the satellite carrier’scompliance with the applicable Communications Act provisions and FCC rulesgoverning the retransmission of such “local” broadcast television stations tosatellite service subscribers. Noncompliance with the Communications Act and/orFCC requirements could subject a satellite carrier to liability for copyrightinfringement. We are subject to certain provisions of SHVIA.

 

We are not directly subjectto rate regulation or certification requirements by the Federal CommunicationsCommission (FCC), the Telecommunications Act of 1996 or state public utilitycommissions because our equipment installation and sales agent activities donot constitute the provision of common carrier or cable television services. Asa resale agent for DIRECTV, we are not subject to regulation as a directbroadcast satellite (DBS) provider, but rely upon DIRECTV to procure allnecessary re-transmission consents and other programming rights under theCommunications Act of 1934 and the Copyright Act. To the extent that we mayalso elect to provide our MDU customers with transmission of signals notcurrently available via satellite, our offering of these services may besubject to compulsory copyright filings with the U.S. Copyright Office,although we do not expect the licensing fees to have a material adverse effecton our business. Our systems do not use or traverse public rights-of-way andthus are exempt from the comprehensive regulation of cable systems under theCommunications Act of 1934. Because we are subject to minimal federalregulation, have fewer programming restrictions, greater pricing freedom andare not required to serve any customer whom we do not choose to serve, we havesignificantly more competitive flexibility than do the franchised cablesystems. We believe that these regulatory advantages help to make our satellitetelevision systems competitive with larger franchised cable systems.

 

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*State andLocal Cable System Regulation.*    We do not anticipate that our deployment ofsatellite television services will be subject to state or local franchise lawsprimarily due to the fact that our facilities do not use or traverse publicrights-of-way. Although we may be required to comply with state and localproperty tax, environmental laws and local zoning laws, we do not anticipatethat compliance with these laws will have any material adverse impact on ourbusiness.

 

*StateMandatory Access Laws.*    Anumber of states have enacted mandatory access laws that generally require, inexchange for just compensation, the owners of rental apartments (and, in someinstances, the owners of condominiums) to allow the local franchise cabletelevision operator to have access to the property to install its equipment andprovide cable service to residents of the MDU. Such state mandatory access lawseffectively eliminate the ability of the property owner to enter into anexclusive right of entry with a provider of cable or other broadcast services.In addition, some states have anti-compensation statutes forbidding an owner ofan MDU from accepting compensation from whomever the owner permits to providecable or other broadcast services to the property. These statutes have been andare being challenged on constitutional grounds in various states. These stateaccess laws may provide both benefits and detriments to our business planshould we expand significantly in any of these states.

 

*PreferentialAccess Rights.*    Wegenerally negotiate exclusive rights to provide satellite services singularly,or in competition with competing cable providers, and also negotiate wherepossible “rights-of-first-refusal” to match price and terms of third-partyoffers to provide other communication services in buildings where we havenegotiated broadcast access rights. We believe that these preferential rightsof entry are generally enforceable under applicable law, however, currenttrends at state and federal level suggest that the future enforceability ofthese provisions may be uncertain. The FCC has recently issued an orderprohibiting telecommunications service providers from negotiating exclusivecontracts with owners of commercial MDU properties, though it deferreddetermination in a pending rulemaking whether to render existing exclusiveaccess agreements unenforceable, or to extend this prohibition to residentialMDUs due to an inadequate administrative record. Although it is open toquestion whether the FCC has statutory and constitutional authority to compel mandatoryaccess, there can be no assurance that it will not attempt to do so. Any suchaction may undermine the exclusivity provisions of our rights of entry on theone hand, but would also open up many other properties to which we couldprovide a competing service. There can be no assurance that future state orfederal laws or regulations will not restrict our ability to offer accesspayments, limit MDU owners’ ability to receive access payments or prohibit MDUowners from entering into exclusive agreements, any of which could have amaterial adverse effect on our business.

 

*Regulationof our High-Speed Internet Business.*    Information service providers (ISPs), includingInternet access providers, are largely unregulated by the FCC or state publicutility commissions at this time (apart from federal, state and local laws andregulations applicable to business in general). However, there can be noassurance that this business will not become subject to regulatory restraints.Also, although the FCC has rejected proposals to impose additional costs andregulations on ISPs to the extent they use local exchange telephone networkfacilities, such change may affect demand for Internet related services. Noassurance can be given that changes in current or future regulations adopted bythe FCC or state regulators or other legislative or judicial initiativesrelating to Internet services would not have a material adverse effect on ourbusiness.

 

**EMPLOYEES**

 

The Company had 38employees, all full-time, as of September 30, 2003. None of the Company’semployees are represented by a labor union. The Company has experienced no workstoppages and believes that its employee relations are good.

 

**RISK FACTORS**

 

The Company faces a numberof risks and uncertainties that could cause actual results or events to differmaterially from those contained in any forward-looking statement. Additionalrisks and uncertainties

 

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not presently known to theCompany or that are currently deemed to be immaterial may also impair theCompany’s business operations. Factors that could cause or contribute to suchdifferences include, but are not limited to, the following:

 

***WeMay Be Unable To Meet Our Future Capital Expansion Requirements.***

 

We may require additionalcapital to finance expansion or growth at levels greater than our currentbusiness plan. Because of the uncertainties in raising additional capital,there can be no assurance that we will be able to obtain the necessary capitalto finance our growth initiatives. Insufficient capital will require us todelay or scale back our proposed development activities.

 

***WeHave Incurred Losses Since Inception And May Incur Future Losses.***

 

To date, we have not shown aprofit in our operations. Through our fiscal year ended September 30,2003, we have incurred net losses of approximately $17,324,000. We do notexpect to have profitable operations until sometime in fiscal year 2004, and wecannot assure that we will ever achieve or attain profitability. If we cannotachieve operating profitability, we may not be able to meet our working capitalrequirements, which could have a material adverse effect on our business andmay impair our ability to continue as a going concern.

 

***WeHave A Limited Operating History.***

 

We commenced operations inAugust 1998. Accordingly, we have a limited operating history and ourbusiness strategy may not be successful. Our failure to implement our businessstrategy or an unsuccessful business strategy could materially adversely affectour business, financial condition and operating losses.

 

***WeDepend Upon Our Relationship With DIRECTV.***

 

In September 2003, weentered into a new System Operator Agreement with DIRECTV to install andmaintain distribution systems in MDU properties. Under our agreement withDIRECTV, we may not maintain MDU distribution systems or market direct-to-homesatellite broadcast services for others. Consequently, we are totally dependentupon DIRECTV for set-top programming. During the fiscal year ended September 30,2003, revenues from DIRECTV were 18% of our total revenues. DIRECTV is notrequired to use us on an exclusive basis for marketing its programming to MDUs.

 

Because we are an intermediary for DIRECTV,events we do not control at DIRECTV could adversely affect us. One of the mostimportant of these is DIRECTV’s ability to provide programming that appeals tomass audiences. DIRECTV generally does not produce its own programming; itpurchases programming from third parties. DIRECTV’s success - and accordinglyours - depends in large part on its ability to select popular programmingsources and acquire access to this programming on favorable terms. We have nocontrol or influence over this. If DIRECTV is unable to retain access to itscurrent programming, we cannot assure you that DIRECTV would be able to obtainsubstitute programming, or that such substitute programming would be comparablein quality or cost to its existing programming. If DIRECTV is unable tocontinue to provide desirable programming, we would be placed at a competitivedisadvantage and may lose subscribers and revenues.  Additionally, any potential sale of DIRECTV, as a company, mayhave a material affect on our business.

 

***WeFace Competition.***

 

We face competition fromothers who are competing for a share of the MDU subscriber base including othersatellite companies, other DIRECTV system operators, cable companies andoff-air broadcasters. Also, DIRECTV itself could corporately focus on MDUs.Other companies with substantially greater assets and operating histories couldenter this market. Our competitors may be able to respond more quickly to newor emerging technologies and changes in customer requirements and devotegreater resources to

 

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develop, promote and sell theirproducts or services. In addition, increased competition could result inreduced subscriber fees, reduced margins and loss of market share, any of whichcould harm our business.

 

Cable television operators have a large,established subscriber base, and many cable operators have significantinvestments in, and access to, programming. One of the competitive advantagesof DBS systems is their ability to provide subscribers with more channels and abetter quality digital signal than traditional analog cable television systems.Many cable television operators have made significant investments to upgradetheir systems from analog to digital, significantly increasing the number andvariety of channels and the quality of the transmission they can provide totheir subscribers. As a result of these upgrades, cable television operatorshave become better able to compete with DBS providers. If competition fromcable television operators should increase in the future, we could experience adecrease in our number of subscribers or increased difficulty in obtaining newsubscriptions.

 

***WeNeed To Manage Our Growth.***

 

We have experienced growth,but to manage potential future growth effectively, we must improve ouroperational, financial and management information systems and must hire, trainand manage our employees and commissioned salespersons. Our future success willalso depend on the ability to increase our customer base and to attract andretain qualified technical, sales, marketing and management personnel, for whomcompetition is intense. We may not be able to effectively manage such growth,and failure to do so could have a material adverse effect on our business,financial condition and results of operations.

 

***WeDepend On Key Personnel To Maintain Our Success.***

 

Our success dependssubstantially on the continued services of our executive officers and keyemployees, in particular Sheldon Nelson and certain other executive officers.The loss of the services of any of our key executive officers or key employeescould harm our business. None of our key executive officers or key employeescurrently has a contract that guarantees their continued employment by us.There can be no assurance that any of these persons will remain employed by usor that these persons will not participate in businesses that compete with usin the future.

 

***TechnologicalChange.***

 

The market for digitalsatellite television and high-speed Internet products and services ischaracterized by rapid change, evolving industry standards and frequentintroductions of new technological developments. These new standards anddevelopments could make our existing or future products or services obsolete.Our keeping pace with the introduction of new standards and technologicaldevelopments could result in additional costs or prove difficult or impossible.The failure to keep pace with these changes and to continue to enhance andimprove the responsiveness, functionality and features of our services couldharm our ability to attract and retain users.

 

***SystemDisruptions.***

 

Our ability to attract andretain subscribers depends on the performance, reliability and availability ofour services and infrastructure. We may experience periodic serviceinterruptions caused by temporary problems in our own systems or in the systemsof third parties upon whom we rely to provide service or support. Fire, floods,earthquakes, power loss, telecommunications failures, break-ins and similarevents could damage these systems and interrupt our services. Servicedisruptions could adversely affect our revenue and, if they were prolonged,would seriously harm our business and reputation. We do not carry businessinterruption insurance to compensate for losses that may occur as a result ofthese interruptions. Any of these problems could adversely affect our business.If any of the DIRECTV satellites are damaged or stop working partiallyor completely, DIRECTV may not be able to continue to provide its subscriberswith programming services. We would in turn likely lose subscribers, whichcould materially and adversely

 

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affect our operations andfinancial performance. DBS technology is highly complex and is still evolving.As with any high technology product or system, it may not function as expected.

 

***UnitedStates Participation in a War or Military or Other Actions; Terrorism.***

 

Involvement in a war or other military actionor acts of terrorism may cause significant disruption to commerce throughoutthe world. To the extent that such disruptions result in 1) delays orcancellations of customer orders, 2) a general decrease in consumer spending onsatellite broadcast and information technology, 3) our inability to effectivelymarket and distribute our products, or 4) our inability to access capitalmarkets, our business and results of operations could be materially andadversely affected. We are unable to predict whether the involvement in a waror other military action will result in any long term commercial disruptions orif such involvement or responses will have any long term material adverseeffect on our business, results of operations, or financial condition.

 

***WeMay Issue Preferred Stock.***

 

Our Board of Directors hasthe authority to issue up to 5,000,000 shares of convertible preferred stockand to determine the price, rights, preferences, privileges and restrictions,including voting rights, of those shares without any vote or action by ourcommon stockholders. The rights of the holders of the common stock will besubject to, and could be materially adversely affected by, the rights of theholders of any preferred stock that may be issued in the future. The issuanceof preferred stock, while providing flexibility in connection with corporatepurposes, could have the effect of delaying, deferring or preventing a changein control, discouraging tender offers for the common stock, and materiallyadversely affecting the voting rights and market price of the common stock.

 

***WeMay Issue Shares Of Common Stock In The Future.***

 

Our certificate ofincorporation authorizes the issuance of 50,000,000 shares of common stock. Thefuture issuance of all or part of the remaining authorized common stock mayresult in substantial dilution in the percentage of our common stock held byour existing stockholders. Also, any stock we sell in the future may be valuedon an arbitrary basis by us and the issuance of shares of common stock forfuture services, acquisitions or other corporate actions may have the effect ofdiluting the value of the shares held by existing shareholders.

 

**Item 2.****          ****Description ofProperty**

 

Our headquarters are inTotowa, New Jersey, where we centralize our corporate administrative functions.The office houses our senior management, accounting and billing functions, callcenter and subscription management system. We currently hold a lease in Totowa,New Jersey of 6,983 square feet at a current monthly cost of $8,147, expiringJuly 31, 2004, with a two year extension, which we intend to exercise. Webelieve that this space is adequate to suit our needs for the foreseeablefuture. In addition, we carry short term warehouse lease space in Connecticut,Massachusetts and Maryland.

 

**Item 3.****          ****LegalProceedings**

 

From time to time, we may besubject to legal proceedings, which could have a material adverse effect on ourbusiness. At year end there is only one currently pending legal proceedings. *Whistler Cable Television Ltd.*commenced a lawsuit against us in The Supreme Court of British Columbia onJuly 14, 1999. Other defendants are Whistler Resort Management Ltd.and The Owners, Strata Plan No. LMS3230. Plaintiff alleges that its personalproperty was taken and seeks return of its personal property or damages in thealternative, damages resulting from breach of the Broadcasting Act, R.S.C.1991, C.11, an injunction against use of its personal property, interest andcosts. This case is in the discovery phase. Given the preliminary stage of theproceedings, it is not presently possible to estimate or determine whetherthere will be any loss to the Company resulting from this claim.

 

11

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

 

None.

 

**PART II**

 

**Item 5.  Market forCommon Equity and Related Stockholder Matters**

 

**A.****           ****Market for Common Stock**

 

The Company’s common stockis not traded on a national securities exchange or the NASDAQ Stock Market. Thecommon stock has been quoted on the OTC Bulletin Board under the symbol “MDTV”since December 2, 1998. The range of high and low bid prices on the OTCBulletin Board during each fiscal quarter, as reported by Bloomberg L.P., is asfollows:

 

| **Quarter  Ended**      |   | **High** |   | **Low** |   |
|-------------------------|--------|----------|--------|---------|--------|
|                    |   |     |   |    |   |
| September 30, 2000 |   | $        | 2.50   |    | $      | 0.81 |   |
| December 31, 2000  |   | $        | 1.50   |    | $      | 0.25 |   |
| March 31, 2001     |   | $        | 0.71   |    | $      | 0.23 |   |
| June 30, 2001      |   | $        | 0.74   |    | $      | 0.37 |   |
| September 30, 2001 |   | $        | 0.48   |    | $      | 0.26 |   |
| December 31, 2001  |   | $        | 0.50   |    | $      | 0.25 |   |
| March 31, 2002     |   | $        | 0.77   |    | $      | 0.33 |   |
| June 30, 2002      |   | $        | 0.63   |    | $      | 0.35 |   |
| September 30, 2002 |   | $        | 0.50   |    | $      | 0.25 |   |
| December 31, 2002  |   | $        | 0.34   |    | $      | 0.15 |   |
| March 31, 2003     |   | $        | 0.31   |    | $      | 0.17 |   |
| June 30, 2003      |   | $        | 0.55   |    | $      | 0.22 |   |
| September 30, 2003 |   | $        | 0.84   |    | $      | 0.41 |   |

 

Thesequotations reflect inter-dealer prices, without retail mark-up, mark-down orcommission, and may not represent actual transactions.

 

**“Penny Stock” Rules**

 

The Company’s common stockis a “penny stock” which is subject to Rule 15g-9 under the SecuritiesExchange Act of 1934. It is considered penny stock because it is not listed ona national exchange or NASDAQ, its bid price is below $5.00 per share, has nettangible assets of less than $5,000,000, and average annual revenue has notexceeded $6,000,000 in the past three years.

 

As a result, broker-dealersmust comply with additional sales practices requirements. Broker-dealers mustdetermine that the investment is suitable for the buyer and receive the buyer’swritten agreement to the transaction before they can sell the Company’s commonstock to buyers who are not the broker-dealer’s established customers orinstitutional accredited investors. In addition, broker-dealers must deliver tothe buyer before the transaction a disclosure schedule which explains thepenny stock market and its risks, discloses the commissions to be paid to thebroker-dealer, discloses the stock’s bid and offer quotations, and discloses ifthe broker-dealer is the sole market maker in the stock.

 

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**B.****           ****Holders ofRecord**

 

As of December 11,2003, the Company had 99 holders of record of its shares of common stock,excluding shares held by broker-dealers, with an approximate total of 3,000shareholders.

 

**C.****           ****Dividends**

 

We have notpaid any cash dividends and we do not anticipate that we will pay cashdividends on our common stock in the foreseeable future.  Payment of cash dividends is within thediscretion of our Board of Directors and will depend, among other factors, uponour earnings, financial condition and capital requirements.  There are no restrictions on the payment ofdividends.

 

**D.****            Securities Authorizedfor Issuance under Equity Compensation Plans**

 

**EQUITY COMPENSATION PLAN INFORMATION**

**(September 30, 2003)**

 
| **Plan  category**                                          |   | **Number of securities to be  issued upon exercise of  outstanding options,  warrants and rights** |   | **Weighted-average exercise  price of outstanding options,  warrants and rights** |   | **Number of securities  remaining available for  future issuance under equity  compensation plans** |      |
|-------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|-----------|
| Equity compensation plans approved by  security holders     |   | 2,565,000 shares                                                                                   | (1)    | $                                                                                 | 0.41   |                                                                                                | 1,174,375 |   |
| Equity compensation plans not approved by  security holders |   | 250,000 shares                                                                                     | (2)    | $                                                                                 | 1.23   |                                                                                                | 0         |   |

 

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(1)          2001 Stock Option Plan, approved by theshareholders on May 10, 2001, see Note 4(a), contained herein.

 

(2)          Supplier Stock Option Plan, see Note 4(a),contained herein.

 

**E.****             ****Unregistered Securities Sales (Not Previously Disclosed)**

 

**Preferred Stock**

 

There were no sales orissuances of these securities during the fiscal year ended September 30,2003.

 

**Common Stock**

 

OnJune 10, 2003 the Company began offering unregistered securities pursuantto a private placement Confidential Offering Memorandum.  The offering consisted of up to 11 units ata purchase price of $75,000 per unit. Each unit consisted of: (i) 300,000common shares, par value $.001, and (ii) five-year warrants to purchase anaggregate of 300,000 common shares of the Company at an exercise price of  $0.33 per share, subject to adjustment, fora total issuance of 3,300,00 shares and 3,900,000 warrants. The units wereoffered by the Company through Casimir Capital L.P. on a “best efforts - nominimum basis.”  The units were offeredand sold only to “accredited investors,” as that term is defined in Rule 501(a)of Regulation D promulgated under the Securities Act of 1933, and were offeredpursuant to exemptions provided by Section 4(2) of the Securities Act andRule 506 of Regulation D and certain state securities laws.  The offering was fully closed onJune 30, 2003 with the Company receiving net proceeds of $664,000. Casimirreceived a fee of $75,000 and 600,000 warrants as described above. The sharesand warrants were subsequently registered on August 28, 2003 on Form SB-2,which was declared effective by the Securities and Exchange Commission onOctober 1, 2003.

 

On July 23, 2003, theCompany converted a promissory term note of $100,000 and $1,644 ininterest held by an investor into 254,110 restricted common shares at a priceof $0.40 per share. The shares are unregistered.

 

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On July 23, 2003, theCompany converted a promissory term note of  $75,000 and $2,301 in interest held by an investor into 193,253restricted common shares at a price of $0.40 per share.  The shares are unregistered.

 

OnNovember 14, 2003 the Company began offering unregistered securitiespursuant to a private placement Confidential Offering Memorandum.  The offering consisted of up to 22 units ata purchase price of $150,000 per unit. Each unit consisted of: (i) 100,000common shares, par value $.001, and (ii) three-year warrants to purchase anaggregate of 50,000 common shares of the Company at an exercise price of  $1.75 per share, subject to adjustment, fora total issuance of 2,200,00 shares and 1,100,000 warrants. The units wereoffered by the Company on a “best efforts - no minimum basis.”  The units were offered and sold only to“accredited investors,” as that term is defined in Rule 501(a) of Regulation Dpromulgated under the Securities Act of 1933, and were offered pursuant toexemptions provided by Section 4(2) of the Securities Act and Rule 506 ofRegulation D and certain state securities laws.  The offering was fully closed on November 25, 2003 with theCompany receiving net proceeds of $3,300,000. The shares and warrants are to besubsequently registered on Form SB-2 within 120 days of closing.

 

All other unregisteredcommon stock issuances for this fiscal year have been previously disclosed inthe Company’s disclosures on Forms 10-QSB.

 

**Warrants**

 

See above for warrants associated withthe June 30, 2003 and November 25, 2003 private placements.

 

On July 23, 2003, the Companyissued to an investor a five year warrant to purchase 254,110 common shares ata price of $0.40 per share. The shares underlying the warrant are unregistered.

 

On July 23, 2003, the Companyissued to an investor a five year warrant to purchase 193,253 common shares ata price of $0.40 per share. The shares underlying the warrant are unregistered.

 

All other warrants for thepurchase of unregistered stock for this fiscal year have been previouslydisclosed in the Company’s disclosures on Forms 10-QSB.

 

**Options**

 

Therewere no issuances of options to purchase unregistered common stock during thefiscal year ended September 30, 2003.

 

**Item 6.  Management’sDiscussion and Analysis or Plan of Operation**

 

The following discussion ofthe financial condition and results of operations of the Company should be readin conjunction with the consolidated financial statements and related notes,which are included herein. This report contains forward-looking statements thatinvolve risks and uncertainties. The Company’s actual results could differmaterially from those indicated in the forward-looking statements.

 

**OVERVIEW**

 

MDU CommunicationsInternational, Inc. concentrates exclusively on deliveringstate-of-the-art digital satellite television and high-speed Internet solutionsto the United States multi-dwelling unit (“MDU”) residential market, estimatedto include 26 million residences. MDUs include apartment buildings,condominiums, gated communities, universities, nursing homes, hospitals,hotels, motels and other properties having multiple units located within adefined area. We seek to differentiate ourselves from other service providersthrough a unique strategy of balancing the information and communication needsof today’s MDU residents with the technology concerns of property managers andowners and providing the

 

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best overall service to both.To accomplish this objective, we have partnered with such groups asDIRECTV, Inc. and Cisco Systems, Inc. and have been working withlarge U.S. property owners and real estate investment trusts (REITs) such asAvalonBay Communities, Trammell Crow Residential, Roseland Property Company,KSI Services, The Related Companies, as well as many others, to understand andmeet the technology needs of these groups.

 

The Company earns its revenue throughthe sale of digital satellite television programming and high-speed Internetservices to residents of MDUs. We negotiate long-term access agreements withthe owners and managers of MDU properties allowing us the right to providedigital satellite television and high-speed Internet services, and potentiallyother services, to their residents, resulting in monthly annuity-like revenuestreams. We offer two types of digital satellite television service. First, weoffer Digital Broadcast Service (“DBS”), which uses an in-suite set-top digitalreceiver for residents to receive state-of-the-art digital satellite and localchannel programming. For DBS, we exclusively offer DIRECTV programmingpackages.  From our DBS offerings we receive the following revenue; (i) asubstantial upfront subscriber commission from DIRECTV for each new subscriber,(ii) a percentage of the fees charged by DIRECTV to the subscriber each monthfor programming, (iii) a per subscriber monthly digital access fee we billsubscribers for rental of the set-top box and connection to the propertysatellite network system, and (iv) occasional other marketing incentives fromDIRECTV. Second, we offer Private Cable Service, where digital satellitetelevision programming can be tailored to the needs of an individual propertyand received through normal cable-ready televisions. Our revenues from PrivateCable result from the difference between the wholesale price charged to us bytelevision program providers and the price we charge subscribers for theprivate cable programming package. We provide the DBS and Private Cableservices on an individual subscriber basis, but in many properties we providethese services in bulk, directly to the property owner, resulting in oneinvoice and thus minimizing churn, collection and bad debt exposure. Onoccasion, we derive revenue from installation services to building owners andmanagers for property wiring and the installation of equipment to allow fortelecommunications services. Most of our services can be installed to receivehigh definition television (HDTV).

 

We began offering high-speed(broadband) Internet access services in July of 2000. In July of2001, we entered into a Master Lease Agreement to Purchase Equipment with CiscoSystems, Inc. (“Cisco”). Under this agreement, we receive preferredpricing and discounts for equipment purchased to support our high-speedInternet services. As part of this agreement, Cisco has extended $500,000 oflease financing to the Company to purchase Internet related equipment and tofinance a portion of installation costs. At September 30, 2003 the Companyhas $272,000 available under the agreement with Cisco. From subscribers to ourInternet service, we earn a monthly Internet access service fee.  Again,in many properties we provide this service in bulk.

 

Industry-wide, demand for digitalsatellite television is outpacing traditional cable. The Television Bureau ofAdvertising recently reported that franchised cable penetration rates are at asix-year low.  Nielson Media Research has reported that wired cable hasfallen from 69.2% of American homes to 68.9% in the past year (2002). Duringthe same period, digital satellite television increased its penetration from12.3% of American homes to 14.4%.  For the period September 2002 toSeptember 2003, CNNMoney reports that the cable industry lost another 1%of subscribers, while the satellite industry increased its subscriber base by12%. The trend is expected to continue. The Carmel Group is forecasting a 0.6%annual decline in subscribers to wired cable, whereas satellite television isexpected to grow at a rate of 8.2% per year, through 2008.

 

During thefour fiscal quarters of 2003, the Company reached and maintained an importantmilestone; positive earnings before interest, taxes, depreciation, amortizationand non-cash stock option charges (“EBITDA”), cumulatively of $108,669,$462,637, $557,458 and $923,791, respectively. The Company uses the commonperformance gauge of EBITDA (inclusive of non-cash stock option charges) toevidence earnings exclusive of mainly non-cash events, as is common in thetechnology, and particularly the cable and telecommunications industries. Webelieve that EBITDA is important because people who follow our industryfrequently use it as a measure of financial performance and ability to pay debtservice, if any.  The most directlycomparable GAAP reference is simply the removal of - in the Company’s case -interest, depreciation, amortization and non-cash charges related to its stockoptions. EBITDA is not, and should not

 

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be considered,an alternative to income from operations, net income, net cash provided byoperating activities, or any other measure for determining our operatingperformance or liquidity, as determined under generally accepted accountingprinciples. EBITDA also does not necessarily indicate whether our cash flowwill be sufficient to fund working capital, capital expenditures or to react tochanges in our industry or the economy generally.

 

Recurring revenue as a percentage oftotal revenue has been substantially increasing.  During the period endedSeptember 30, 2003, recurring revenue was 96% of total revenues, whereason average for fiscal year 2002, it was only 54%.  As for subscribergrowth, the Company had to again maintain slow growth during the fourth quarterdue to financial constraints, and in addition, 1,273 non-core subscribers weresold by the Joint Venture during the fourth quarter. At September 30, 2003 theCompany had a total of 12,589 subscribers. However, with the proceeds from theJune 30, 2003 and November 24, 2003 equity financings, mentionedbelow, the Company believes that it will be able to again significantlyincrease subscribers in the upcoming quarters.

 

One of the mainchallenges facing the Company over the past year has been its available cash.To that end, on June 30, 2003, the Company, with the assistance of CasimirCapital as placement agent, closed an equity private placement pursuant to aConfidential Offering Memorandum for 11 equity units at $75,000 per unit, eachconsisting of 300,000 Company common shares at a price of $0.25 per share and300,000 five-year warrants to purchase Company common shares at an exerciseprice of $0.33 per share.  Net proceeds to the Company were $663,937,which were used partially to retire high interest debt and partially forsubscriber growth.  On November 14,2003, the Company began offering up to 22 units in a second private placementpursuant to a Confidential Offering Memorandum, with each unit consisting of100,000 common shares and 50,000 warrants to purchase common shares.  The price of the common shares and theexercise price of the warrants to purchase common shares were set as of theoffering date at $1.50 and $1.75 per share, respectively.   On November 24, 2003, the Companyclosed on all 22 units for $3.3 million in net proceeds.  In addition, the Company has receivedapproximately $1.7 million in net proceeds from the early exercise of warrantsheld by various Company shareholders. The proceeds from these financing events will be used for subscribergrowth in upcoming quarters.

 

On July 28, 2003, the Companypurchased AvalonBay Cable I, Inc.’s fifty percent interest in the AvalonDigital Joint Venture for approximately $320,000. As of that date, the AvalonDigital Joint Venture provided services to approximately 2,084 subscribers ineleven properties.  On July 30, 2003, the Avalon Digital JointVenture sold 1,273 digital satellite television subscribers in five propertiesto CSC Holdings, Inc. for $1,200 per subscriber. The total sales price,including an amount applicable to certain equipment, was $1,557,600.

 

Although we have incurred operatinglosses since inception, since focusing on operations in the most profitableU.S. markets, our recurring revenues have steadily increased. As such, weshould be able to maintain positive EBIDTA on a going forward basis and reachprofitable operations with existing resources.

 

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**Critical AccountingPolicies and Estimates**

 

Our consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America. The preparation of theseconsolidated financial statements requires us to make estimates and judgmentsthat affect the reported amounts of assets, liabilities, revenues and expenses,and related disclosure of contingent assets and liabilities. On an on-goingbasis, we evaluate our estimates. We base our estimates on historicalexperience and on other assumptions that are believed to be reasonable underthe circumstances. Accordingly, actual results could differ from theseestimates under different assumptions or conditions. Thissection summarizes the critical accounting policies and the relatedjudgments involved in their application.

 

*(a)**      **Revenue recognition withrespect to initial service or connection:*

 

New subscriber activation subsidiesfrom the satellite programming provider are recognized as revenue on astraight-line basis over the estimated average period that a customer willremain a subscriber to a maximum of four years. The expected customerrelationship is estimated based on the historical relationship with similartype customers. Any significant variations to these historical relationshipswould cause an increase or decrease in the expected term of the customerrelationship, which would have a converse effect on the amount of revenuerecognized.

 

*(b)**      **Allowance for doubtfulaccounts:*

 

We provide an allowance fordoubtful accounts equal to the estimated collection losses based on ourhistorical experience coupled with a review of the current status of existingreceivables. Any significant variations in our historical experience or statusof our existing accounts receivable could have a material impact on ourstatement of operations.

 

*(c)*        *Fair value of equity instruments:*

 

We estimate the fair valueof options issued to employees for pro-forma disclosure purposes using anoption-pricing model (generally, the Black Scholes model) that meets thecriteria set forth in Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation” (“SFAS 123”) and common stockusing the market value of our stock. In accordance with SFAS 123, allother issuances of common stock, stock options, warrants or other equityinstruments to employees and nonemployees as consideration for goods orservices received by us are accounted for based on the fair value of theconsideration received or the fair value of the equity instrument, whichever ismore readily measurable. Such fair value is measured at an appropriate datepursuant to the guidance in the consensus reached for EITF Issue No. 96-18(generally, the earlier of the date the other party becomes committed toprovide goods or services or the date the performance by the other party iscomplete) and capitalized or expensed as if we had paid cash for the goods orservices. For purposes of determining the fair value of options and warrantsusing the Black-Scholes option pricing model, we have used the followingassumptions in the years ended September 30, 2003 and 2002: ExpectedVolatility 127%; Risk Free Interest Rate 4.75%; Expected Years of Option Life 1to 5 years; and Expected Dividends 0%.

 

Given an active tradingmarket for our common stock, we estimate the volatility of our stock based onweek ending closing prices over a historical period of not less than one year.As a result, depending on how the market perceives any news regarding us or ourearnings, as well as market conditions in general, it could have a materialimpact on the volatility we use in computing the value we place on these equityinstruments.

 

*(d)*       *Valuation of deferred tax assets:*

 

We regularly evaluate our ability torecover the reported amount of our deferred income taxes and other deferred taxassets considering several factors, including our estimate of the likelihoodthat we will

 

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generate sufficient taxableincome in future years in which temporary differences reverse. Due to theuncertainties related to, among other things, the extent and timing of futuretaxable income, we offset our net deferred tax assets by an equivalentvaluation allowance as of September 30, 2003.

 

*(e)*        *Valuation of long-lived assets:*

 

We assess the recoverability oflong-lived tangible and intangible assets whenever we determine that events orchanges in circumstances indicate that their carrying amount may not berecoverable. Our assessment is primarily based upon our estimate of future cashflows associated with these assets. Although there has been a sustainedweakness in our operating results through September 30, 2003, we continueto project income in the future. Accordingly, we have determined that there hasnot been an impairment of any of our long-lived assets. However, should ouroperating results deteriorate, we may determine that some portions of ourlong-lived tangible or intangible assets are impaired. Such determination couldresult in non-cash charges to income that could materially affect ourconsolidated financial position or results of operations for that period.

 

**RESULTS OF OPERATIONSFOR THE YEARS ENDED SEPTEMBER 30, 2003 AND 2002**

 

***Net Loss.***    We reported a netloss of $2,117,707 for the year ended September 30, 2003 compared to a netloss of $2,988,036 for the year ended September 30, 2002. The reduction inactual net loss from 2002 to 2003 is due mainly to the gain on sale ofcustomers of $869,259 and an increase in revenues from a larger subscriber baseover a full year period.

 

***Revenues.***    Revenue for the yearended September 30, 2003 of $4,124,394 increased 37% fromSeptember 30, 2002 revenue of $3,015,709. Revenue for the twelve monthsended September 30, 2003 was comprised of 32% private cable revenue, 54%net programming revenue, 10% Internet access fees and 4% from wiring, equipmentand other sales. Increased revenue for the current period is due to an increasein the average number of subscribers during 2003 that provided higher revenueand the combining of the Joint Venture revenue ($545,579) with our revenues,due to the purchase (see Note 8). We also recorded interest income of $4,746and $4,344 for the twelve months ended September 30, 2003 and 2002. Weanticipate that revenues will increase in 2004 proportionally with achieved andanticipated growth.

 

***Direct Costs.***    Direct costs areprimarily comprised of private cable programming, monthly recurring InternetT-1 line connections, system maintenance costs and equipment costs and are 26%of revenue for the year ended September 30, 2003 compared to 38% for thesame period in the prior year. Direct costs decreased slightly to $1,060,198 asof September 30, 2003 from $1,145,761 in the year ended September 30,2002. This slight decrease was due to a reduction in deployment of propertiesand overall cost reductions during the year. We anticipate direct costs willincrease proportionally with planned growth during 2004.

 

***Sales Expenses.***    Sales expensesconsist mainly of salaries, commissions, marketing materials, trade shows,advertising and promotion. Sales expenses decreased to $353,980 as ofSeptember 30, 2003 from $446,732 in the year ended September 30,2002. This decrease in sales expenses was mainly due to a decrease in salesfunctions during the year and overall cost reductions during the year. Weanticipate sales expenses will increase proportionally with planned growthduring 2004.

 

***Customer Service Expenses.***    Customer serviceexpenses consist mainly of call center and customer technical services.Customer service expenses were $1,075,255 for the year ended September 30,2003 compared to $571,236 for the year ended September 30, 2002. This increaseis primarily the result of (i) serving a significantly larger subscriber basethroughout the course of the full year as opposed to the year endingSeptember 30, 2002, and (ii) increasing our levels of customer service andsatisfaction, and (iii) upgrades and maintenance to our Dataman SubscriberManagement System (SMS), which is our internally developed software system usedto manage, deploy, track and bill our customers. We anticipate customer serviceexpenses will increase proportionally with achieved growth during 2004.

 

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***General and Administrative Expenses.***    General andadministrative expenses increased slightly to $2,278,818 in 2003 from$2,133,700 in the year ending September 30, 2002. Stock optioncompensation including the effects of variable accounting for options and othernon-cash charges (excluding amortization) of $778,047 and $103,108 arerespectively included in general and administrative expenses in the years endedSeptember 30, 2003 and 2002. The balance of general and administrativeexpenses for the years ended September 30, 2003 and 2002 is mainlycomprised of the following:

 
|              |   | **Year ended  September 30, 2003** |    | **%****of  G&A** |   | **Year ended  September 30, 2002** |   | **%****of  G&A** |   |
|-------------------|--------|-----------------------------------------|---------|----------------------|--------|-----------------------------------------|--------|----------------------|--------|
| Wages             |   | $                                       | 445,244 |                 | 20     | %                                       | $      | 742,825              |   | 34 | % |
| Professional fees |   | 76,423                                  |    | 3                    | %      | 118,912                                 |   | 5                    | %      |
| Office            |   | 16,753                                  |    | 1                    | %      | 22,886                                  |   | 1                    | %      |
| Travel            |   | 20,716                                  |    | 1                    | %      | 60,704                                  |   | 3                    | %      |
|                   |        |                                         |         |                      |        |                                         |        |                      |        |  |  |

 

***OtherNon-Cash Charges.***    Interestexpense in the twelve months ended September 30, 2003 was $998,659compared to interest expense at September 30, 2002 of $865,743. Of theseamounts, $914,779 and $730,667 were respectively non-cash interest expenseitems related to amortization of the fair value of warrants and the beneficialconversion feature related to the issuance of convertible notes issued duringthe twelve months ended September 30, 2003 and 2002, respectively.

 

***Settlementof Liabilities***.    During theyear ended September 30, 2003, we settled certain outstanding tradepayables for a gain of $175,011, with no settlement of trade payables occurringin the year ending September 30, 2002. During the year endedSeptember 30, 2003, we incurred noncash charges in the amount of $174,472relating to the conversions of promissory notes into common stock, with no similarcharges being incurred during the year ended September 30, 2002.

 

**OUTLOOK**

 

Although the Company hasincurred operating losses since inception, with consolidated operations in themost profitable U.S. markets, a significant reduction in monthly expenses,increasing revenues, and achievement of positive EBITDA for all of fiscal 2003;the Company expects to achieve profitability in fiscal year 2004. Although theCompany can reach profitability with existing financial resources, toaggressively reach or exceed business plan forecasts, the Company may bedependent upon its ability to obtain additional financing.

 

**LIQUIDITY AND CAPITALRESOURCES**

 

Our consolidated financialstatements have been prepared on the going concern basis of accounting, whichcontemplates realization of assets and liquidation of liabilities in theordinary course of business. During the years ended September 30, 2003 and2002, we recorded a net loss of $2,117,707 and $2,988,036, respectively.Although we had negative cash flows from operating activities of $282,417during the year ended September 30, 2002, we had positive cash flows fromoperating activities of $663,123 during the year ended September 30, 2003.At September 30, 2003, we had an accumulated deficit of $17,323,726.

 

As the result of thecontinued execution of our business strategy, we expect that cash fromoperating activities and available credit will be sufficient to fund ouroperating needs, contractual obligations, and capital expenditures for fiscal2004.  However, if (i) a disproportionatenumber of subscribers churn relative to the number of quality subscribers weenroll; (ii) we are not able to enroll a sufficient number of qualitysubscribers, or (iii) we do not realize desirable aggregate margins from oursubscriber base, our

 

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results of operations may notbe able to provide sufficient cash flows from operating activities to sustainour business strategy.

 

Subsequent to September 30, 2003,we received net proceeds of $3,300,000 relating to the sale of units in aprivate placement as of November 24, 2003 and net proceeds from theexercise of warrants and options in the amount of $1,763,505 for totaladditional liquidity of $5,063,505.

 

The following table displays paymentsfor our contractual obligations outstanding at September 30, 2003:

 

|                        |   | **Total** |    | **Less than one year** |   |
|-----------------------------|--------|-----------|---------|------------------------|--------|
| Debt Obligations            |   | $         | 86,653  |                   | $      | 86,653 |   |
| Capital Lease Obligations   |   | 94,721    |    | 94,721                 |   |
| Operating Lease Obligations |   | 81,470    |    | 81,470                 |   |
| Total                       |   | $         | 262,844 |                   | $      | 262,844 |   |

 

***Cash Position.***    At September 30,2003, we had cash and cash equivalents of $507,775 compared to $99,277 atSeptember 30, 2002. The increase in our cash position is due mainly toproceeds from financing activities.

 

***Operating Activities.***    Despite our net lossduring the year ended September 30, 2003 of $2,117,707, our operatingactivities provided us with cash flows of $663,123 as compared with a net lossof $2,988,036 and a use of cash of $282,417 during the year endedSeptember 30, 2002.  The principalreasons for the improved cash flows from operating activities were, (i) anincreased level of sustained revenues and improved collections, (ii) ourefforts to better contain costs at levels more appropriate for our operations,and (iii) during the year ended September 30, 2003, we incurred net noncash charges of approximately $2,230,000 as compared to approximately$1,757,000 during the year ended September 30, 2002.

 

***Investing and Financing Activities.***    During the twelvemonths ended September 30, 2003, we purchased $1,465,853 of equipment. InJuly 2001, Cisco Systems Capital Corp. extended lease financing to us inorder to purchase Internet related equipment with monthly repayment terms overthree years from the date that the goods were accepted. The total creditavailable under the agreement is $500,000, 30% of which can be installationcosts capitalized under the lease. As of September 30, 2003, we hadavailable $272,000 under the agreement.

 

During the year endedSeptember 30, 2003, we used $793,045 for the repayment of certain notespayable.  In addition, we (i) issued 3,447,506 shares of common stock inconnection with conversion of notes payable and accrued interest thereon in theamount of $1,168,992, (ii) issued 944,559 shares of common stock for accruedsalaries of $198,841, (iii) issued 140,000 shares of common stock with a fairvalue of $26,600 as partial settlement of a trade accounts payable, and  (iv) converted five trade accountspayable in the total amount of $186,594 into five short term note payables.

 

On February 28, 2003 we enteredinto two short-term 90 day notes with two investors for $125,000 each at aninterest rate of 16%. Upon maturity, these notes were extended for anadditional 90 days with principal and interest being paid in full onAugust 27, 2003.

 

On June 10, 2003 we began offeringa private placement of equity securities pursuant to a confidential offeringmemorandum of 11 units comprised of 300,000 common shares and 300,000 warrantsto purchase common shares for gross aggregate proceeds of $825,000.  On June 30, 2003, the private placementwas closed resulting in net cash proceeds to the Company of $663,937.

 

***Settlementof Accounts Payable***.    During theyear ended September 30, 2003, we settled certain outstanding tradepayables for a gain of $175,011.

 

20

----

 

***Gainon Sale of Customers. ***OnDecember 6, 2002, we entered into an agreement to sell certain equipmentand customer lists associated with a particular multi-dwelling unitproperty.  The sales price was fixed at$1,150 cash per active subscriber, plus a specified amount for certainequipment for a total sales price of $185,150. On January 16, 2003, we entered into an agreement to sell certainequipment and customer lists associated with a particular multi-dwelling unitproperty.  The sales price was fixed at$67,000 cash.  On July 30, 2003, weentered into an agreement to sell certain equipment and customer listsassociated with five multi-dwelling unit properties.  The sales price was fixed at $1,200 cash per active subscriber,plus certain equipment for a total of $1,557,600, as adjusted.  As a result of the aforementioned sale, werecognized total gains from sales of customers of $869,259 for the year endedSeptember 30, 2003.

 

***Capital Commitments and Contingencies.***    We have accessagreements with the owners of multiple dwelling unit properties to supply oursatellite television viewing systems and services to the residents of thoseproperties. However, we have no obligation to build out those properties and nopenalties will accrue if we elect not to do so.

 

***Future Capital Requirements.***    We have sufficientcurrent asset resources to cover current levels of operating expenses.

 

21

----

 

**Item7—Financial Statements**

 

**REPORT OFINDEPENDENT PUBLIC ACCOUNTANTS**

 

Boardof Directors and StockholdersMDU Communications International, Inc.

 

We have audited the accompanyingconsolidated balance sheets of MDU Communications International, Inc. andSubsidiaries as of September 30, 2003, and 2002, and the relatedconsolidated statements of operations, stockholders’ equity and cash flows forthe years then ended. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordancewith auditing standards generally accepted in the United States of America.Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the consolidated financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the consolidated financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidatedfinancial statements referred to above present fairly, in all materialrespects, the financial position of MDU Communications International, Inc.and Subsidiaries as of September 30, 2003 and 2002, and their results ofoperations and cash flows for the years then ended, in conformity withaccounting principles generally accepted in the United States of America.

 
| /s/ J. H. Cohn LLP                           |   |
|----------------------------------------------|--------|
| Roseland, New Jersey  December 10, 2003 |

 

22

----

 

**MDU COMMUNICATIONSINTERNATIONAL, INC.Consolidated Balance Sheets****September 30, 2003 and 2002**
| ** **                                                                                                                   |   | **September  30,**

**2003** |       | **September  30,**

**2002** |       |
|------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|------------------------------|------------|
|                                                                                                                         |   |                         |       |                         |       |
| **ASSETS**                                                                                                                   |   |                         | ** ** |                         | ** ** |
|                                                                                                                         |   |                         | ** ** |                         | ** ** |
| CURRENT                                                                                                                      |   |                         | ** ** |                         | ** ** |
| Cash and cash equivalents                                                                                                    |   | $                            | 507,775    |                         | $          | 99,277 |   |
| Accounts receivable—  trade, net of an allowance of $72,605 and $80,000                                                 |   | 348,332                      |       | 755,056                      |       |
| Prepaid expenses and deposits                                                                                                |   | 463,314                      |       | 100,370                      |       |
| TOTAL CURRENT ASSETS                                                                                                         |   | 1,319,421                    |       | 954,703                      |       |
|                                                                                                                         |   |                         |       |                         |       |
| Telecommunications equipment inventory                                                                                       |   | 255,878                      |       | 266,595                      |       |
| Property and equipment, net                                                                                                  |   | 3,736,680                    |       | 3,320,375                    |       |
| Investment in joint venture                                                                                                  |   | —                       |       | 311,466                      |       |
| Intangible assets, net                                                                                                       |   | 1,081,982                    |       | 1,505,229                    |       |
|                                                                                                                         |   |                         |       |                         |       |
| Deferred finance costs, net                                                                                                  |   | —                       |       | 88,859                       |       |
| TOTAL ASSETS                                                                                                                 |   | $                            | 6,393,961  |                         | $          | 6,447,227 |   |
|                                                                                                                         |   |                         |       |                         |       |
| **LIABILITIES and STOCKHOLDERS’ EQUITY**                                                                                |   |                         |       |                         |       |
|                                                                                                                         |   |                         |       |                         |       |
| CURRENT                                                                                                                      |   |                         |       |                         |       |
| Accounts payable                                                                                                             |   | $                            | 489,275    |                         | $          | 611,239 |   |
| Other accrued liabilities                                                                                                    |   | 700,171                      |       | 666,111                      |       |
| Current portion of notes payable,net of debt discount of $14,645 and $713,969                                                |   | 86,653                       |       | 828,197                      |       |
| Current portion of capital lease obligation                                                                                  |   | 94,721                       |       | 135,650                      |       |
| TOTAL CURRENT LIABILITIES                                                                                                    |   | 1,370,820                    |       | 2,241,197                    |       |
|                                                                                                                         |   |                         |       |                         |       |
| Deferred revenue                                                                                                             |   | 579,941                      |       | 781,099                      |       |
| Notes payable, net of current  portion and debt discount of $21,963                                                          |   |                         |       | 18,120                       |       |
| Capital lease obligation, net of current  portion                                                                            |   |                         |       | 87,000                       |       |
| TOTAL LIABILITIES                                                                                                            |   | 1,950,761                    |       | 3,127,416                    |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                |   |                         | ** ** |                         | ** ** |
|                                                                                                                         |   |                         | ** ** |                         | ** ** |
| **STOCKHOLDERS’ EQUITY**                                                                                                |   |                         |       |                         |       |
| Preferred stock, par value $0.001;  5,000,000 shares authorized                                                              |   | —                       |       | —                       |       |
| Common stock, par value $0.001;  50,000,000 shares  authorized, 27,751,479 and 19,539,136 shares issued and outstanding |   | 27,750                       |       | 19,539                       |       |
| Additional paid-in capital                                                                                                   |   | 21,822,509                   |       | 18,506,291                   |       |
| Unearned compensation                                                                                                        |   | (83,333                      | )          |                         |       |
| Accumulated deficit                                                                                                          |   | (17,323,726                  | )          | (15,206,019                  | )          |
| TOTAL STOCKHOLDERS’ EQUITY                                                                                              |   | 4,443,200                    |       | 3,319,811                    |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’  EQUITY                                                                             |   | $                            | 6,393,961  |                         | $          | 6,447,227 |   |

 

See accompanying notes to the condensed consolidated financialstatements

 

23

----

 

**MDU COMMUNICATIONSINTERNATIONAL, INC.Consolidated Statements of Operations****For the Years EndedSeptember 30, 2003 and 2002**
|                                                                     |   | **For the  year**

**ended**

**September  30,**

**2003** |       | **For the year**

**ended**

**September 30,**

**2002** |   |
|--------------------------------------------------------------------------|--------|------------------------------------------------------------|------------|----------------------------------------------------------|--------|
|                                                                     |   |                                                       |       |                                                     |   |
| REVENUE                                                                  |   | $                                                          | 4,124,394  |                                                     | $      | 3,015,709 |   |
|                                                                     |   |                                                       |       |                                                     |   |
| OPERATING EXPENSES                                                       |   |                                                       |       |                                                     |   |
| Direct costs                                                             |   | 1,060,198                                                  |       | 1,145,761                                                |   |
| Sales expenses                                                           |   | 353,980                                                    |       | 466,732                                                  |   |
| Customer service expenses                                                |   | 1,075,255                                                  |       | 571,236                                                  |   |
| General and administrative expenses                                      |   | 2,278,818                                                  |       | 2,133,700                                                |   |
| Depreciation and amortization                                            |   | 1,264,792                                                  |       | 856,927                                                  |   |
| TOTALS                                                                   |   | 6,033,043                                                  |       | 5,174,356                                                |   |
|                                                                     |   |                                                       |       |                                                     |   |
| OPERATING LOSS                                                           |   | (1,908,649                                                 | )          | (2,158,647                                               | )      |
|                                                                     |   |                                                       |       |                                                     |   |
| Other income (expenses)                                                  |   |                                                       |       |                                                     |   |
| Gain on sale of customers                                                |   | 869,259                                                    |       | —                                                   |   |
| Gain on settlement of accounts payable                                   |   | 175,011                                                    |       |                                                     |   |
| Loss on extinguishment of notes payable                                  |   | (174,472                                                   | )          |                                                     |   |
| Interest income                                                          |   | 4,746                                                      |       | 4,344                                                    |   |
| Interest expense (including non cash interest of $914,779 and  $730,667) |   | (998,659                                                   | )          | (865,743                                                 | )      |
| Minority interest                                                        |   | (84,943                                                    | )          |                                                     |   |
| Equity in earnings of joint venture                                      |   | —                                                     |       | 32,010                                                   |   |
| Totals                                                                   |   | (209,058                                                   | )          | (829,389                                                 | )      |
|                                                                     |   |                                                       |       |                                                     |   |
| NET LOSS                                                                 |   | $                                                          | (2,117,707 | )                                                        | $      | (2,988,036 | ) |
|                                                                     |   |                                                       |       |                                                     |   |
| BASIC AND DILUTED LOSS PER COMMON SHARE                                  |   | $                                                          | (0.09      | )                                                        | $      | (0.16 | ) |
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING                               |   | 22,788,924                                                 |       | 18,384,874                                               |   |

 

Seeaccompanying notes to the condensed consolidated financial statements

 

24

----

 

**MDU COMMUNICATIONSINTERNATIONAL, INC.Consolidated Statements of Stockholders’ Equity****For the Years EndedSeptember 30, 2003 and 2002**
|                                                                             |   | **Common stock** |   | **Convertible preferred stock** |   | **Additional********paid-in  capital** |       |       |   |       |       |                       |       |
|----------------------------------------------------------------------------------|--------|------------------|--------|---------------------------------|--------|----------------------------------------|------------|------------|--------|------------|------------|----------------------------|------------|
|                                                                             |   | **Shares**       |   | **Amount**                      |   | **Shares**                             | ** ** | **Amount** |   | **Amount** |       | **Unearned  Compensation** |       | **Accumulated********deficit** |   | **Total** |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| **Balance, October 1, 2001**                                                     |   | 18,046,320       |   | $                               | 18,047 |                                   | 7,200      |       | $      | 7          |       | $                          | 16,483,476 |   |   |   | $ | (12,217,983 | )  | $ | 4,283,547 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of warrants in exchange for services                                    |   |             |   |                            |   |                                   |       |       |   | 83,108     |       |                       |       |   |   | 83,108 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of warrants in connection with issuance of notes payable                |   |             |   |                            |   |                                   |       |       |   | 1,367,625  |       |                       |       |   |   | 1,367,625 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Beneficial conversion feature related to issuance of notes payable  and warrants |   |             |   |                            |   |                                   |       |       |   | 19,500     |       |                       |       |   |   | 19,500 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of warrants in connection with extension of due dates of  notes payable |   |             |   |                            |   |                                   |       |       |   | 55,500     |       |                       |       |   |   | 55,500 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of common stock in connection with issuance of notes payable            |   | 150,000          |   | 150                             |   |                                   |       |       |   | 74,850     |       |                       |       |   |   | 75,000 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Conversion of notes payable                                                      |   | 861,077          |   | 861                             |   |                                   |       |       |   | 283,293    |       |                       |       |   |   | 284,154 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of options to consultants                                               |   |             |   |                            |   |                                   |       |       |   | 20,000     |       |                       |       |   |   | 20,000 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of common stock under employee stock purchase plan                      |   | 473,459          |   | 473                             |   |                                   |       |       |   | 118,940    |       |                       |       |   |   | 119,413 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Conversion of preferred shares                                                   |   | 8,280            |   | 8                               |   | (7,200                                 | )          | (7         | )      | (1         | )          |                       |       |   |   | — |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Net loss                                                                         |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       | (2,988,036 | ) | (2,988,036 | ) |
| **Balance, September 30, 2002**                                                  |   | 19,539,136       |   | 19,539                          |   | —                                 |       | —     |   | 18,506,291 |       | —                     |       | (15,206,019 | )  | 3,319,811 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Conversion of notes payable and accrued interest                                 |   | 3,447,506        |   | 3,447                           |   |                                   |       |       |   | 1,165,545  |       |                       |       |   |   | 1,168,992 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of common stock for accrued compensation                                |   | 944,559          |   | 945                             |   |                                   |       |       |   | 197,896    |       |                       |       |   |   | 198,841 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of shares as partial settlement of accounts payable                     |   | 140,000          |   | 140                             |   |                                   |       |       |   | 26,460     |       |                       |       |   |   | 26,600 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of warrants in connection with issuances of notes payable               |   |             |   |                            |   |                                   |       |       |   | 89,550     |       |                       |       |   |   | 89,550 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of warrants in connection extinguishment of notes payable               |   |             |   |                            |   |                                   |       |       |   | 174,472    |       |                       |       |   |   | 174,472 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of options and warrants in exchange for services                        |   |             |   |                            |   |                                   |       |       |   | 147,250    |       | $                          | (147,250   | ) |   |   | — |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Amortization of unearned compensation                                            |   |             |   |                            |   |                                   |       |       |   |       |       | $                          | 63,917     |   |   |   | 63,917 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of common stock through private placement                               |   | 3,300,000        |   | 3,300                           |   |                                   |       |       |   | 660,637    |       |                       |       |   |   | 663,937 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Effect of variable accounting for options                                        |   |             |   |                            |   |                                   |       |       |   | 714,130    |       |                       |       |   |   | 714,130 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of common stock for warrants exercised                                  |   | 94,653           |   | 93                              |   |                                   |       |       |   | 8,507      |       |                       |       |   |   | 8,600 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Issuance of common stock for options exercised                                   |   | 285,625          |   | 286                             |   |                                   |       |       |   | 131,771    |       |                       |       |   |   | 132,057 |   |
|                                                                             |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       |   |   |   |   |
| Net loss                                                                         |   |             |   |                            |   |                                   |       |       |   |       |       |                       |       | $ | (2,117,707 | ) | $ |  (2,117,707 | ) |
| **Balance, September 30, 2003**                                                  |   | 27,751,479       |   | 27,750                          |   | —                                 |       | —     |   | $          | 21,822,509 |                       | $          | (83,333 | ) | $ | (17,323,726 | ) | $ |  4,443,200 |   |
|                                                                                  |        |                  |        |                                 |        |                                        |            |            |        |            |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes tothe condensed consolidated financial statements

 

25

----

 

**MDU COMMUNICATIONSINTERNATIONAL, INC.Consolidated Statements of Cash Flows****Years ended September 30, 2003 and 2002**
|                                                                                       |   | **For the  year**

**ended**

**September  30,**

**2003** |             | **For the year**

**ended**

**September 30,  2002** |    |
|--------------------------------------------------------------------------------------------|--------|------------------------------------------------------------|------------------|------------------------------------------------------|---------|
|                                                                                       |   |                                                       |             |                                                 |    |
| OPERATING ACTIVITIES                                                                       |   |                                                       |             |                                                 |    |
| Net loss                                                                                   |   | $                                                          |  (2,117,707 | )                                                    | $       | (2,988,036 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in)  operating activities: |   |                                                       |             |                                                 |    |
| Provision for doubtful accounts                                                            |   | 57,121                                                     |             | 98,584                                               |    |
| Depreciation and amortization                                                              |   | 1,264,792                                                  |             | 856,927                                              |    |
| Issuance of options and warrants in exchange for services                                  |   |                                                       |             | 103,108                                              |    |
| Amortization of unearned compensation                                                      |   | 63,917                                                     |             |                                                 |    |
| Effect of variable accounting for options                                                  |   | 714,130                                                    |             |                                                 |    |
| Charge to interest expense for amortization of deferred finance costs  and debt discount   |   | 914,779                                                    |             | 730,667                                              |    |
| Minority Interest                                                                          |   | 84,943                                                     |             |                                                 |    |
| Equity in earnings of joint venture                                                        |   | —                                                     |             | (32,010                                              | )       |
| Gain on sale of customers                                                                  |   | (869,259                                                   | )                |                                                 |    |
| Gain on settlement of accounts payable                                                     |   | (175,011                                                   | )                |                                                 |    |
| Loss on extinguishment of notes payable                                                    |   | 174,472                                                    |             |                                                 |    |
| Changes in operating assets and liabilities:                                               |   |                                                       |             |                                                 |    |
| Accounts receivable                                                                        |   | 635,240                                                    |             | (503,890                                             | )       |
| Prepaid expenses and deposits                                                              |   | 18,336                                                     |             | (48,632                                              | )       |
| Accounts payable                                                                           |   | (15,943                                                    | )                | 359,006                                              |    |
| Other accrued liabilities                                                                  |   | 242,067                                                    |             | 616,685                                              |    |
| Deferred revenue                                                                           |   | (328,754                                                   | )                | 525,174                                              |    |
| Net cash provided by (used in) operating activities                                        |   | 663,123                                                    |             | (282,417                                             | )       |
| INVESTING ACTIVITIES                                                                       |   |                                                       |             |                                                 |    |
| Purchase of property and equipment                                                         |   | (1,465,853                                                 | )                | (1,365,513                                           | )       |
| Acquisition of Verizon assets                                                              |   |                                                       |             | (763,210                                             | )       |
| Proceeds from sale of customers and property and equipment                                 |   | 1,443,522                                                  |             |                                                 |    |
| Contributions to joint venture                                                             |   | (73,589                                                    |             | (207,622                                             | )       |
| Distributions from joint venture                                                           |   | 27,300                                                     |             | 127,387                                              |    |
| Purchase of remaining interest in joint venture                                            |   | (319,625                                                   | )                |                                                 |    |
| Net cash used in investing activities                                                      |   | (388,245                                                   | )                | (2,208,958                                           | )       |
| FINANCING ACTIVITIES                                                                       |   |                                                       |             |                                                 |    |
| Proceeds from issuance of convertible notes payable                                        |   |                                                       |             | 2,005,166                                            |    |
| Proceeds from issuance of other notes payable                                              |   | 250,000                                                    |             |                                                 |    |
| Payments of notes payable                                                                  |   | (793,045                                                   | )                | (156,250                                             | )       |
| Payments of finance costs                                                                  |   |                                                       |             | (37,833                                              | )       |
| Payments of capital lease obligation                                                       |   | (127,929                                                   | )                | (5,883                                               | )       |
| Proceeds from private placement of common stock and warrants                               |   | 663,937                                                    |             |                                                 |    |
| Proceeds from warrants exercised                                                           |   | 8,600                                                      |             |                                                 |    |
| Proceeds from options exercised                                                            |   | 132,057                                                    |             |                                                 |    |
| Net cash provided by financing activities                                                  |   | 133,620                                                    |             | 1,805,200                                            |    |
| NET INCREASE (DECREASE)  IN  CASH AND CASH  EQUIVALENTS                               |   | 408,498                                                    |             | (686,175                                             | )  |
| CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                                               |   | 99,277                                                     |             | 785,452                                              |    |
| CASH AND CASH EQUIVALENTS, END OF YEAR                                                     |   | $                                                          |  507,775    |                                                 | $       | 99,277 |   |

 

See accompanying notes tothe condensed consolidated financial statements

 

 

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**MDUCOMMUNICATIONS INTERNATIONAL, INC.Notes to Consolidated Financial Statements**

 

**1.****             ****BUSINESS AND BASIS OF PRESENTATION**

 

MDUCommunications International, Inc. and its subsidiaries (the “Company”)provide delivery of digital satellite television programming and high-speed(broadband) Internet service to residents of multi-dwelling unit properties(“MDUs”) such as apartment buildings, condominiums, gated communities, hotelsand universities.

 

Theconsolidated financial statements have been prepared on the going concern basisof accounting, which contemplates realization of assets and liquidation ofliabilities in the ordinary course of business. During the years endedSeptember 30, 2003 and 2002, the Company recorded a net loss of $2,117,707and $2,988,036, respectively. Although the Company had negative cash flow fromoperating activities during the year ended September 30, 2002 of $282,417,it had positive cash flows from operating activities during the year endedSeptember 30, 2003 of $663,123. At September 30, 2003, the Companyhad an accumulated deficit of $17,323,726. Management believes that the Company will have sufficient resources tomeet its obligations and continue as a going concern through at leastSeptember 30, 2004.

 

The Company has unusedborrowing capacity as of September 30, 2003, for the purchase of equipmentfrom Cisco Systems, Inc. in the amount of approximately $272,000  (See Note 6).  In addition, during the period fromOctober 1, 2003 through December 10, 2003, the Company received netproceeds of approximately $3,300,000 from a private placement of units ofcommon stock and warrants and net proceeds of $1,700,000 from the exercise ofpreviously issued options and warrants (See Note 14).

 

**2.****             ****SIGNIFICANT ACCOUNTING POLICIES**

 

These consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States and reflect the significant accountingpolices described below:

 

*(a)**Principles of Consolidation*

 

Theconsolidated financial statements include the accounts of the Company and itssubsidiaries, MDU Communications Inc., MDU Communications (USA) Inc.and, effective October 1, 2002, Avalon Digital Joint Venture (the “JointVenture”).  All inter-company balancesand transactions are eliminated.

 

*(b)**Use of Estimates*

 

Thepreparation of the consolidated financial statements in conformity withaccounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Significant estimates are used for,but not limited to, revenue recognition with respect to a new subscriberactivation subsidy, allowance for doubtful accounts, fair value of equityinstruments and valuation of deferred tax assets and long lived assets. Actualresults could differ from those estimates.

 

*(c)**Property and Equipment*

 

Telecommunicationsequipment inventory consists of receivers and other supplies that will eitherbe sold or installed by the Company under subscription agreements and,accordingly, is not depreciated. Such inventory is stated at the lower of costor market. The cost of inventory sold or

 

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transferredto telecommunications equipment upon installation in connection withsubscription agreements is determined on a first-in, first-out basis.

 

Propertyand equipment are recorded at cost less accumulated depreciation andamortization. Direct costs of placing telecommunications equipment into serviceand major improvements are capitalized. Costs of connecting and disconnectingservice are expensed. Depreciation and amortization of property and equipmentis provided using the straight-line method over the estimated useful lives asfollows:

 

| Telecommunications equipment, installed |   | 7  years |   |
|-----------------------------------------|--------|----------|--------|
| Computer equipment                      |   | 5  years |   |
| Furniture and fixtures                  |   | 5  years |   |
| Vehicles                                |   | 5  years |   |

 

*(d)**Investment in Joint Venture*

 

Priorto October 1, 2002, the Company’s investment in the Joint Venture was recordedon the equity basis whereby the Company recorded its proportionate share ofincome or loss from the joint venture. Dividends received were recorded asreductions in the net investment.

 

*(e)**Intangible Assets*

 

Intangibleassets consist of building access agreements and subscriber lists, which wereacquired in the purchase of Digital Solutions, LLC and the acquisition of videoassets from Verizon and are being amortized on the straight-line basis overfour to five years.

 

*(f)**Long-lived Assets*

 

TheCompany performs a review for the impairment of long-lived assets withdefinitive lives whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. Under Statement ofFinancial Accounting Standards (“SFAS”) 144 “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to be Disposed of,” an impairmentloss is recognized when estimates of future undiscounted cash flows expected toresult from the use of an asset and its eventual disposition are less than itscarrying amount. No impairment losses were identified by the Company for theyears ended September 30, 2003 and 2002.

 

*(g)**Revenue Recognition*

 

TheCompany recognizes revenue for satellite programming and other services tocustomers in the period the related services are provided when the amount ofrevenue is determinable and collection is reasonably assured.

 

TheCompany offers installation services to building owners and managers for theconstruction of wiring and installation of equipment to allow fortelecommunications services, including the sale of related equipment. Revenuefrom the sale of equipment is recognized when title transfers and installationrevenue is recognized in the period that the services are performed when the amountof revenue is determinable and collection is reasonably assured.

 

Incertain arrangements with suppliers of satellite programming or other services,the Company does not bear inventory or credit risk in connection with theservice provided to the customer. Such revenue is recorded on the net basiswhere the amount of revenue is equivalent to the contractual commission earnedby the Company. Revenues from providing services under contracts where theCompany acts as a principal in the transaction, exercises pricing control and

 

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bearsthe risk of collection are recorded based on the gross amount billed to thecustomer when the amount is determinable.

 

TheCompany may also receive a new subscriber activation subsidy from the satelliteprogramming provider at the time it signs up a new customer. However, thissubsidy is a “net” subsidy, meaning that if the subscriber terminates service,the subsidy is recouped by the programming provider through an offset againstthe subsidy earned on another new customer. These subsidies are recognized asrevenue on a straight-line basis over the estimated average period that acustomer will remain a subscriber of four years.

 

Revenuesfrom contracts involving multiple elements are allocated to each element basedon the relative fair value of each element.

 

TheCompany provides an allowance for doubtful accounts equal to the estimatedcollection losses based on historical experience coupled with a review of thecurrent status of existing receivables.

 

*(h)**Loss Per Common Share*

 

TheCompany presents “basic” earnings (loss) per share and, if applicable,“diluted” earnings per share pursuant to the provisions of Statement ofFinancial Accounting Standards No. 128, “Earnings per Share.” Basic earnings(loss) per share is calculated by dividing net income or loss by the weightedaverage number of common shares outstanding during each period. The calculationof diluted earnings per share is similar to that of basic earnings per share,except that the denominator is increased to include the number of additionalcommon shares that would have been outstanding if all potentially dilutivecommon shares, such as those issuable upon the exercise of stock options andwarrants, and the conversion of promissory notes, were issued during the periodand other related adjustments were made.

 

Therewere 12,360,677 potentially dilutive common shares (9,467,363 from warrants;2,815,000 from options; 78,314 from convertible notes) as of September 30,2003 and 10,380,047 potentially dilutive common shares (4,577,500 fromwarrants; 2,822,750 from options; 2,979,797 from convertible notes), as ofSeptember 30, 2002. However, diluted per share amounts have not beenpresented in the accompanying consolidated statements of operations because theCompany had a net loss in 2003 and 2002 and the assumed effects of the exerciseof all of the Company’s stock options and warrants and the conversion ofpromissory notes that were outstanding during all or part of those years wouldhave been anti-dilutive.

 

*(i)**Foreign Exchange*

 

EffectiveSeptember 30, 2001, the Company adopted the United States dollar as itsfunctional and reporting currency since a majority of the Company’s revenues,expenses, assets and liabilities are in the United States and the focus of theCompany’s operations is in that country. Previously, the Company’s functionaland reporting currency was Canadian dollars. Assets and liabilities in foreigncurrencies (primarily Canadian dollars) are translated using the exchange rateat the balance sheet date. Revenues and expenses are translated at averagerates of exchange during the year. Gains and losses from foreign currencytransactions and translation for the years ended September 30, 2003 and 2002and cumulative translation gains and losses as of September 30, 2003 and2002 were not material.

 

*(j)**Stock-Based Compensation*

 

Aspermitted under SFAS 123, “Accounting for Stock-BasedCompensation,”(“SFAS 123”) the Company has accounted for employee anddirector stock options using the intrinsic value method in accordance withAccounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued toEmployees,” (“APB 25”) and has made the pro forma disclosures required bySFAS 123

 

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inNote 4. Under APB 25, compensation charges arise from those situationswhere options are granted to employees and directors at an exercise price lowerthan the fair value of the underlying common shares. These amounts are amortizedas a charge to operations over the vesting periods of the related stockoptions.

 

Forvariable stock option plans, the Company recognizes a compensation expense orcredit for the increase or decrease in the intrinsic value of the option. Theintrinsic value is represented by the excess of the market price of theCompany’s stock over the exercise price of the option.

Stock-basedcompensation charges to other than employees are recorded over the period thatthe related stock option or warrant is earned. The amount of the compensationis based on the fair value of the option or warrant at the applicablemeasurement date.

 

*(k)**Cash and Cash Equivalents*

 

Cashand cash equivalents consist of bank deposits and short-term notes withoriginal maturities at the date of acquisition of 90 days or less thathave insignificant interest rate risk.

 

*(l)**Fair Value of Financial Instruments*

 

Thefair value of the Company’s cash and cash equivalents, accounts receivable,accounts payable, other accrued liabilities, notes payable and capital leaseobligations at September 30, 2003 and 2002 are estimated to approximatetheir carrying values due to the relative liquidity or short-term nature ofthese instruments.

 

*(m)**Credit Concentration*

 

Financialinstruments that potentially subject the Company to a concentration of creditrisk consist principally of cash and cash equivalents and accounts receivable.

 

TheCompany places its cash and cash equivalents with high credit qualityinstitutions.  At September 30,2003, the Company has cash balances that exceed Federally insured limits in theamount of approximately $290,000**.**Accountsreceivable from DIRECTV (see Note 6) at September 30, 2003 and 2002,respectively, represented 25% and 42% of total trade accounts receivable. Revenuesrealized from DIRECTV represented 18% and 12% of total revenues in the yearsended September 30, 2003 and 2002, respectively.

 

TheCompany provides an allowance for bad debts based on historical experience andspecifically identified risk.

 

*(n)**Debt Issuance Costs and Debt Discount*

 

Loanfees and other debt issuance costs are deferred and amortized to interestexpense over the term of the related loan on a straight-line basis. Debtdiscount is offset against the principal balance and amortized using theinterest method over the term of the related loan.

 

*(o)**Income Taxes*

 

TheCompany accounts for income taxes pursuant to the asset and liability methodwhich requires deferred income tax assets and liabilities to be computedannually for temporary differences between the financial statement and taxbases of assets and liabilities that will result in taxable or deductibleamounts in the future based on enacted tax laws and rates applicable to theperiods in which the differences are expected to affect taxable income.Valuation allowances are established when necessary to reduce deferred taxassets to the amount expected to be realized. The income

 

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taxprovision or credit is the tax payable or refundable for the period plus orminus the change during the period in deferred tax assets and liabilities.

 

*(p)**Impact of Recently Issued Accounting Standards*

 

TheFinancial Accounting Standards Board, the Emerging Issues Task Force (the“EITF”) and the Accounting Standards Executive Committee of the AmericanInstitute of Certified Public Accountants have issued certain accountingpronouncements as of September 30, 2003 that will become effective insubsequent periods; however, management of the Company does not believe thatany of those pronouncements would have significantly affected the Company’sfinancial accounting measurements or disclosures had they been in effect during2003 and 2002, and it does not believe that any of those pronouncements willhave a significant impact on the Company’s consolidated financial statements atthe time they become effective.

 

*(q)**Reclassifications*

 

Certainprior year amounts have been reclassified to conform to the presentations inthe consolidated financial statements as of and for the year endedSeptember 30, 2003.

 

**3.****             ****NOTES PAYABLE**

 

Notespayable under term loans and convertible promissory notes payable outstandingas of September 30, 2003 consisted of the following:

 
| 6.5%  note under term loan due in installments through March 3, 2004(a)                                             |   | $      | 9,239  |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| 11%  note under term loan due in installments through February 15, 2004(b)                                          |   | 8,521  |   |
| 9%  note under term loan due in installments through October 10, 2003(c)                                            |   | 2,322  |   |
| 12%  note under term loan due in installments through May 15, 2004(d)                                               |   | 39,541 |   |
| 9%  note under term loan due in installments through September 30, 2004(e)                                          |   | 15,085 |   |
| 9%  convertible notes due in installments through January 24, 2004, net of  unamortized debt discount of $14,645(f) |   | 10,355 |   |
| 9%  note under term loan due in installments through October 1, 2003(g)                                             |   | 1,590  |   |
| Total,  net of unamortized debt discount of  $14,645                                                                |   | $      | 86,653 |   |

 

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(a)          On February 24, 2003, theCompany entered into a Term Loan and Promissory Note Agreement with a supplier,North Supply Company, for $22,174. The note has a term of one year with twelveequal monthly payments of principal and earned interest at a stated rate of6.5%.

 

(b)         On February 20, 2003, theCompany entered into a Term Loan and Promissory Note Agreement with a supplier,TLA Associates, for $21,724. The note has a term of one year with twelve equalmonthly payments of principal and earned interest at a stated rate of 11%.

 

(c)          On January 10, 2003, theCompany entered into a Term Loan and Promissory Note Agreement with a supplier,Distinctive Communications, Inc., for $23,215. The note has a term of tenmonths with ten equal monthly payments of principal and earned interest at astated rate of 9%.

 

(d)         On May 15, 2003, theCompany entered into a Term Loan and Promissory Note Agreement with a supplier,PDI Communications, Inc., for $59,311. The note has a

 

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termof twelve months with twelve equal monthly payments of principal and earnedinterest at a stated rate of 12%.

 

(e)          On September 30, 2002, theCompany entered into a Term Loan and Promissory Note Agreement with a supplier,Blonder Tongue Laboratories, Inc., for $30,165. The note has a term of twoyears with eight equal quarterly payments of principal and earned interest at astated rate of 9%. The note is secured by certain assets and equipment.

 

(f)            OnJanuary 24, 2002, the Company entered into a Convertible Promissory Noteand Loan Agreement with Roselink Investors, LLC (“Roselink”) for $100,000. ThePromissory Note is for two years at a stated interest rate of 9%, withquarterly repayment of principal and earned interest. If the Company does notmake the quarterly payment of principal and earned interest, it automaticallyconverts to common stock at a conversion price of $0.33 per share. Asadditional consideration in connection with the issuance of the PromissoryNote, the Company issued 300,000 warrants to Roselink at an exercise price of$0.43 per share for a two-year exercise period with an estimated fair value of$111,000, as calculated using a Black-Scholes option pricing model inaccordance with SFAS 123. In addition, the fair value of the Company’scommon stock on January 24, 2002 was $0.37 per share, which exceeded theeffective conversion price for the Promissory Note resulting in a BeneficialConversion Feature of $130,303. As a result, the aggregate fair value of thewarrants and the Beneficial Conversion Feature associated with the PromissoryNote was $241,303. Since the amount of the debt discount cannot exceed theprincipal balance of the Promissory Note, the Company initially increasedadditional paid-in capital by $100,000 and reduced the carrying value of thePromissory Note by a corresponding amount. Because payments were not made, they automatically converted. A total of166,825 and 88,542 common shares were issued for this obligation during theyears ended September 30, 2003 and 2002, respectively.

 

(g)         On August 8, 2003, theCompany entered into a Term Loan and Promissory Note Agreement with aconsultant, Tim Lucy, for $4,770. The note has a term of three months withthree equal monthly payments of principal and earned interest at a stated rateof 9%.

 

OnDecember 30, 2002, the Company entered into a Term Loan and PromissoryNote Agreement with a supplier, Direct Focus, for $55,000 on an outstandinginvoice of $95,000. As additional consideration, the Company issued 140,000shares of common stock with a fair value of $26,600 to Direct Focus. As ofSeptember 30, 2003, all payments of principal and interest had been madeand the Company had no further obligation under the terms of the note.

 

On February 28, 2003, the Company enteredinto a Term Loan and Promissory Note Agreement with David Lyall for $125,000.The note had an original term of 90 days with interest at a stated rate of16%.  On May 28, 2003, the Company renegotiated and extended the termto 180 days and as additional compensation, issued Mr. Lyall warrants topurchase 40,000 shares of common stock at $.33 per share through May 28,2006. Such warrants had a fair value of $10,800 using a Black-Scholes optionpricing model  which was initiallyrecorded as a debt discount with an offsetting increase to additional paid-incapital. As of September 30, 2003, all payments of principal and interesthad been made and the Company had no further obligation under the terms of thenote.

 

On February 28, 2003, the Company enteredinto a Term Loan and Promissory Note Agreement with Steve Mazur for $125,000.The note had an original term of 90 days with interest at a stated rate of 16%.In connection therewith, warrants to purchase 25,000 shares of common stock atan exercise price of $.33 per share through February 28, 2006 were issued.Such warrants had a fair value of $5,500 using a Black-Scholes option pricingmodel which was initially recorded as a debt discount with an offsettingincrease to additional paid-in capital.  On May 28, 2003, the Companyrenegotiated and extended the term to 180 days

 

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and as additional compensation, issued Mr.Mazur warrants to purchase 25,000 shares of common stock at $0.33 per sharethrough May 28, 2006. Such warrants had a fair value of $6,750 using aBlack-Scholes option pricing model which was initially recorded as a debtdiscount with an offsetting increase to additional paid-in capital. As ofSeptember 30, 2003, all payments of principal and interest had been madeand the Company had no further obligation under the terms of the note.

 

On August 28, 2002, the Company entered into aTerm Loan and Promissory Note Agreement with an investment group consisting ofProtea Ventures, Ltd., Domino International, Ltd., Jon Gruber and Lloyd Berhofffor $250,000. The notes had a term of one year with, originally, four equalquarterly payments of principal and earned interest at a stated rate of 20%. Asfurther consideration for the Term Loan and Promissory Note Agreement, ProteaVentures, Ltd. was issued 12,500 two-year warrants, DominoInternational, Ltd. was issued 25,000 two-year warrants, Jon Gruber wasissued 50,000 two-year warrants, and Lloyd Berhoff was issued 37,500 two-yearwarrants, each to purchase common stock at an exercise price of $0.43. The fairvalue of the warrants, as calculated using a Black-Scholes option pricingmodel, was $26,250. Accordingly, the Company initially increased additionalpaid-in capital by $26,250 representing the fair value of the warrants andreduced the carrying value of the notes for the debt discount attributable tothe fair value of the warrants. The debt discount was amortized to interestexpense over the lives of the notes. On November 26, 2002, Lloyd Berhoff,who held a note in the principal amount of $75,000, agreed to defer all of thequarterly principal payments until November 28, 2003. As further considerationfor the extension, the Company issued warrants to purchase 150,000 shares ofcommon stock at an exercise price of $.25 per share through November 26,2005 to Berhoff. Such warrants had a fair value of $28,500 calculated using aBlack-Scholes option pricing model. Accordingly, the Company initiallyincreased debt discount and additional paid-in capital by the fair value of thewarrants. On July 23, 2003, Lloyd Berhoff, agreed to convert the principalbalance of the note and accrued interest thereon which aggregated $77,301 into193,253 shares of common stock.  Inaddition, the Company issued warrants to Berhoff to purchase 193,523 shares ofcommon stock at an exercise price of $.40 per share through July 23, 2008.  The fair value of the warrants of $75,369,as calculated using a Black-Scholes option pricing model, was charged to otherexpense with an offsetting credit to additional paid-in capital in accordancewith SFAS 84, “Induced Conversions of Convertible Debt” (“SFAS 84”).   As of September 30, 2003, all paymentsof principal and interest had been made and the Company had no furtherobligation under the terms of the notes.

 

On June 24, 2002, the Company enteredinto a Term Loan and Promissory Note Agreement with an investment groupconsisting of Protea Ventures, Ltd., William Begley and the Warren K. andPatricia A. Kourt Trust for $175,000. The notes had a term of one year with,originally, four equal quarterly payments of principal and earned interest at astated rate of 20%. As further consideration for the Term Loan and PromissoryNote Agreement, Protea Ventures, Ltd. was issued 25,000 two-year warrants,William Begley was issued 50,000 two-year warrants and the Warren K. andPatricia A. Kourt Trust were issued 12,500 two-year warrants each to purchasecommon stock at an exercise price of $0.43. The fair value of the warrants, ascalculated using a Black-Scholes option pricing model, was $25,375.Accordingly, the Company initially increased additional paid-in capital by$25,375 representing the fair value of the warrants and reduced the carryingvalue of the notes for the debt discount attributable to the fair value of thewarrants. In addition, the Company paid approximately $5,000 of legal and otherprofessional fees in connection with the sale of the notes and, accordingly,recorded deferred finance costs of an equivalent amount. The debt discount anddeferred finance costs were amortized to interest expense over the lives of thenotes. On November 26, 2002, William Begley, who held a note in the principalamount of $100,000, agreed to defer all principal payments untilSeptember 24, 2003. As further consideration for the extension, theCompany issued warrants to purchase 200,000 shares of common stock at anexercise price of $.25 per share through November 26, 2005 to Begley. Suchwarrants had a fair value of $38,000 calculated using a Black-Scholes optionpricing model. Accordingly, the Company initially increased debt discount andadditional paid-in capital by the fair value of the warrants. On July 23,2003, William Begley, agreed to convert the principal balance of the note andaccrued interest thereon which aggregated $101,644 into 254,110 shares ofcommon stock.  In addition, the Companyissued warrants to Begley to purchase 254,110 shares of common stock at anexercise price of $.40 per share through July 23, 2008.  The fair value of the warrants of $99,103,as calculated using a Black-Scholes option pricing model, was charged to otherexpense with an offsetting credit to additional paid-in capital in accordancewith SFAS 84. As of

 

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September 30, 2003, all payments ofprincipal and interest had been made and the Company had no further obligationunder the terms of the notes.

 

On March 6, 2002, the Company enteredinto a Term Loan and Promissory Note Agreement with an investment groupconsisting of Protea Ventures, Ltd., Vancadia Capital Corp., AspenInternational, Ltd. and Jon Gruber for $300,000. The notes had a term ofone year with four equal quarterly payments of principal and earned interest ata stated rate of 20%. As further consideration for the Term Loan and PromissoryNote Agreement, Protea Ventures, Ltd. and Vancadia Capital Corp. wereissued 25,000 two-year warrants and Aspen International, Ltd. and JonGruber were issued 50,000 two-year warrants, each to purchase common stock atan exercise price of $0.43. The fair value of the warrants, as calculated usinga Black-Scholes option pricing model, was $85,500. Accordingly, the Company initiallyincreased additional paid-in capital by $85,500 representing the fair value ofthe warrants and reduced the carrying value of the notes for the debt discountattributable to the fair value of the warrants. In addition, the Company paid$33,000 of legal and other professional fees in connection with the sale of thenotes and, accordingly, recorded deferred finance costs of an equivalentamount. The debt discount and deferred finance costs were amortized to interestexpense over the lives of the notes. As of September 30, 2003, all payments of principal and interesthad been made and the Company had no further obligation under the terms of thenotes.

 

On January 24, 2002, the Company enteredinto a Convertible Promissory Note and Loan Agreement with Trinity PacificInvestments, Ltd. (“Trinity”) for $1,000,000. The Promissory Note was payablethrough July 1, 2003 at a stated interest rate of 3%, with monthlyrepayment of principal and earned interest. The monthly payments of principaland earned interest automatically converted into common stock at an exerciseprice of $.33 per share. As additional consideration in connection with theissuance of the Promissory Note, the Company issued 3,000,000 warrants toTrinity at an exercise price of $0.43 per share for a two-year exercise periodwith an estimated fair value of $1,110,000, as calculated using a Black-Scholesoption pricing model. In addition, the fair value of the Company’s common stockon January 24, 2002 was $0.37 per share, which exceeded the effectiveconversion price for the Promissory Note resulting in a beneficial conversionfeature (“Beneficial Conversion Feature”) or right for which the value ismeasured by the difference between the aggregate effective conversion price andthe fair value of the common stock into which the securities are converted. TheBeneficial Conversion Feature associated with these notes aggregated of$1,303,030. As a result, the aggregate fair value of the warrants and theBeneficial Conversion Feature associated with the Promissory Note was$2,413,030. Since the amount of the debt discount cannot exceed the principalbalance of the Promissory Note, the Company initially increased additionalpaid-in capital by $1,000,000 and reduced the carrying value of the Promissory Noteby a corresponding amount. In addition, the placement agent, HaywoodSecurities Inc., received 150,000 shares of Company stock with a fairvalue of $75,000 and warrants to purchase 150,000 shares of the Company’scommon stock at an exercise price of $0.43 for a two-year period with a fairvalue of $55,500, as calculated using a Black-Scholes option pricing model.Accordingly, the Company increased common stock and additional paid-in capitaland deferred finance costs for the fair value of the common stock and warrantsissued. A total of2,598,374 and 527,365 common shares were issued for this obligation during theyears ended September 30, 2003 and 2002, respectively. As ofSeptember 30, 2003, all payments of principal and interest had been madeand the Company had no further obligation under the terms of the note.

 

On January 18, 2002, the Company enteredinto two Convertible Promissory Note and Loan Agreements, one with DanielFitzgerald and the other with William Begley, each for $75,000. The PromissoryNotes, which matured on January 18, 2003 and bore interest at 9%, providedfor quarterly repayment of principal and interest. In addition, each ofFitzgerald and Begley was able to request quarterly conversion of principal andinterest at a conversion rate of $.33 per share. As additional consideration in connectionwith the issuance of the Promissory Notes, the Company issued 225,000 warrantseach to Fitzgerald and Begley at an exercise price of $0.43 per share for atwo-year exercise period. Accordingly, the Company initially increasedadditional paid-in capital by $65,250 each for the fair value of the warrantsas calculated using a Black-Scholes option pricing model, and reduced thecarrying value of the Promissory Notes for the debt discount attributable tothe fair value of the warrants issued to the investors. The fair value of theCompany’s stock at January 18, 2002 was $0.36 per share, which exceededthe effective conversion price

 

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for the Promissory Notes. The BeneficialConversion Feature associated with these notes aggregated $175,955. Since theamount of debt discount cannot exceed the principal balance of the PromissoryNotes, the Company initially increased additional paid-in capital by $19,500and reduced the carrying value of the Promissory Notes by a correspondingamount. A total of 234,944and 245,170 common shares were issued for this obligation during the yearsended September 30, 2003 and 2002, respectively. As of September 30,2003, all payments of principal and interest had been made and the Company hadno further obligation under the terms of the note.

 

The issuances of shares ofcommon stock as payments of principal and interest on certain notes werenoncash transactions that are not reflected in the accompanying condensedconsolidated statements of cash flows.

 

**4.****             ****SHARE CAPITAL**

 

***Preferred Shares:***

 

OnJanuary 28, 2000, the Company issued 3,630,000 shares of Series AConvertible Preferred Stock (the “Preferred Shares”), at an issue price of$2.50 per share, in exchange for cash and services in connection with a privateplacement. A total of 3,637,200 Preferred Shares were converted in the yearended September 30, 2001 and the remaining 7,200 Preferred Shares wereeffectively converted in the year ended September 30, 2002 at theconversion ratio that was in effect during those years of 1.15 common sharesfor each Preferred Share.

 

Asof September 30, 2003, the Company was still authorized to issue up to5,000,000 shares of preferred stock with a par value of $.001 per share. Thepreferred stock may be issued in one or more series with dividend rates,conversion rights, voting rights and other terms and preferences to bedetermined by the Company’s Board of Directors, subject to certain limitationsset forth in the Company’s Articles of Incorporation. However, there were noshares of preferred stock outstanding as of September 30, 2003.

 

***Stock Option Plans:***

 

**(a)**          **Suppliers’ Stock Option Plan (“Suppliers’ Plan”):**

 

OnDecember 31, 1998, the Company established a stock option plan pursuant towhich certain key suppliers of the Company will be granted options oncompletion of specified activities. Under the terms of the Suppliers’ Plan,eligible suppliers can earn options to purchase an aggregate of 250,000 commonshares of the Company. As of September 30, 2003, all 250,000 options hadbeen granted.  During the year endedSeptember 30, 2003, the Board repriced 75,000 of the supplier options from$1.50 per share to $0.33 per share. As a result of such repricing, the Companyis subject to variable accounting for such options and, accordingly hasrecognized a non-cash credit of $500 during the year ended September 30,2003 based on changes in the fair value of the options subsequent to the date ofrepricing.

 

**(b)**          **Employees’ Stock Option Plans (“Employee Plans”):**

 

OnNovember 24, 1998, the Company established Employee Plans whereby certainemployees, officers and directors were granted options to purchase up to anaggregate of 600,000 common shares of the Company. On February 5, 2000,the Company approved the 2000 Incentive Stock Option Plan (“2000 Option Plan”).Under the 2000 Option Plan, the Company was authorized to grant certainemployees, consultants, officers and directors of the Company and its affiliatesoptions to purchase up to 4,000,000 common shares of the Company at $5.00 pershare. The options have vesting periods ranging from immediate to three yearsafter the grant date. Of the options originally authorized as part of the

 

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November 24,1998 Employee Plans, 90,276 were redesignated to be included in the 2000 OptionPlan.

 

OnApril 11, 2001, the Board of Directors approved the 2001 Stock Option Plan(“2001 Option Plan”) to replace the 2000 Option Plan. The 2001 Option Plan isin all respects identical to the 2000 Option Plan, which had not been approvedby a vote of the stockholders within one year of its adoption by the Board andtherefore became ineffective. The 2001 Option Plan was approved by a vote ofthe stockholders at the Annual General Meeting on May 10, 2001.  In October 2000, the Board of Directorsof the Company approved the re-pricing, at $2.00 per share, of the exerciseprice of all options previously granted at $5.00 per share under the 2000Option Plan. On March 9, 2001, the Board of Directors approved there-pricing, at $0.60 per share, of these same options. On April 11, 2001,the Board of Directors of the Company approved the re-pricing, at $0.60 pershare, of all options previously granted to directors at $2.50 per share underthe 2000 Option Plan.  During the yearended September 30, 2003, the Board of Directors approved the repricing ofcertain options previously granted to directors, officers, employees andconsultants from $0.60 per share to $0.33 per share.  As of September 30, 2003, a total of 1,925,624 of the2,565,000 shares subject to outstanding options under the 2001 Stock OptionPlan had been repriced to $0.33 per share. As a result of such repricing, the Company is subject to variable-planaccounting for such options and, accordingly, it recognized non-cash chargesfor compensation expense of $714,630 during the year ended September 30,2003 based on the net increases in the market value of the options subsequentto the respective dates of repricing. The Company did not recognize any charges for compensation expenseduring the year ended September 30, 2002 related to variable-planaccounting since the changes in the market value of the options wereimmaterial.

 

OnMay 9, 2002, the Board of Directors of the Company granted a total of230,000 options pursuant to the 2001 Option Plan to employees. These optionshave a five-year term and an exercise price of $0.60 per share.

 

OnSeptember 12, 2002, the Board of Directors of the Company granted eachindependent Board member additional options as compensation for sitting on theBoard for the current and upcoming year. Douglas Hooper, J.E. “Ted” Boyle andRobert Dyck each received 50,000 fully vested options at an exercise price of$0.60 per share, exercisable for five years.

 

OnJuly 29, 2003 the Board of Directors granted a total of 215,000 optionspursuant to the 2001 Option Plan to employees. These options have a five-year term and an exercise price of $0.33 pershare.

 

TheCompany accounts for its stock-based employee compensation plans under theintrinsic value method per APB 25 whereby compensation cost is recorded for theexcess, if any, of the quoted market price of the common shares over theexercise price at the date of grant for all employee stock options issued. Forthe years ended September 30, 2003 and 2002, there was no excess and,accordingly, no compensation cost was required to be recorded in connectionwith options issued to directors, officers and employees.

 

Sincethe Company has elected to continue to use the provisions of APB 25 inaccounting for stock options granted to employees, it is required bySFAS 123 and SFAS 148, “Accounting for Stock-Based Compensation —Transition and Disclosure,” to present additional pro forma information showingeffects on its historical results of operations of the use of a method thatestimates the fair value of the options at the grant date and then amortizesthe fair value to expense over the options’ vesting period. Had the Companyelected to recognize compensation expense based upon the fair value at thegrant dates for awards under these plans, net loss and loss per common sharewould have been increased to the pro forma amounts shown in the table below.  The fair value of each grant was estimatedon the

 

36

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dateof grant using the Black-Scholes option pricing model and the assumptions setforth in Note 4(d).

 
|                                                                                                     |   | **Years ended September 30,** |       |
|----------------------------------------------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                                                                     |   | **2003**                           |       | **2002** |   |
| Net loss as reported                                                                                     |   | $                                  | (2,117,707 | ) | $ | (2,988,036 | ) |
| Deduct: Total stock based employee compensation determined under fair  value based method for all awards |   | 135,892                            |       | 1,653,309 |   |
| Pro forma net loss                                                                                       |   | $                                  | (2,253,599 | ) | $ | ((4,641,345 | ) |
| Pro forma loss per common share                                                                          |   | $                                  | (0.10      | ) | $ | (0.25 | ) |

 

Theunamortized fair value of all remaining outstanding employee stock options asof September 30, 2003 is $78,413, which will be charged to pro forma netearnings in future years according to the vesting terms of the options.

 

**(c)****Issuance of Options to Consultants:**

 

OnFebruary 28, 2003, the Company granted five-year options to purchase atotal of 25,000 shares of common stock under the 2001 Option Plan to aconsultant in exchange for services. The options were originally granted at an exerciseprice of $0.60 per share but were repriced on July 23, 2003 at $0.33 pershare. The fair value of the options, as calculated using a Black-Scholesoption pricing model in accordance with SFAS 123 (See Note 4(d)), was$3,750, which was charged to general and administrative expenses in the yearended September 30, 2003.

 

OnJanuary 17, 2003, the Company granted options to purchase a total of150,000 shares of common stock under the 2001 Option Plan to a consultant inexchange for services. Options to purchase 75,000 shares became vestedimmediately and exercisable at $0.60 per share and options to purchase theremaining 75,000 shares vest over one year and are exercisable at $1.00 pershare.  All of these options expire intwo years from the date of grant. The fair value of the options, as calculatedusing a Black-Scholes option pricing model in accordance with SFAS 123(See Note 4(d)) was $18,750, which was charged to general and administrativeexpenses in the year ended September 30, 2003.

 

OnMay 9, 2002, the Company granted options to purchase a total of 50,000shares of common stock under the 2001 Option Plan to a consultant in exchangefor services. The options are exercisable at $0.60 per share, vestedimmediately and are exercisable for a period of five years. The fair value ofthe options, as calculated using a Black-Scholes option pricing model inaccordance with SFAS 123 (see Note 4(d)) was $20,000, which wascharged to general and administrative expenses in the year ended September 30,2002.

 

**(d)****         ****Stock Option Activity:**

 

TheEmployees’ Plans were initially authorized to issue a total of 4,000,000 sharesand the Suppliers’ Plan was authorized to issue a total of 250,000 shares. Thefollowing table summarizes all of the Company’s stock option activity duringthe years ended September 30, 2003 and 2002:

 

37

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|                                                     |   | **Options  Available  For Issuance** |   | **Number of Options  Outstanding** |   | **Options  Exercised** |   | **Weighted Avg.  Exercise  Price Per Share** |   |
|----------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|------------------------|--------|----------------------------------------------|--------|
| Outstanding at Sept. 30, 2001                            |   | 836,404                              |   | 3,288,596                          |   | 125,000                |   | $                                            | 0.75   |   |
| Granted (weighted average fair value of $0.41 per share) |   | (430,000                             | )      | 430,000                            |   | —                 |   | $                                            | 0.60   |   |
| Expired                                                  |   | 895,846                              |   | (895,846                           | )      |                   |   | 0.60                                         |   |
| Exercised                                                |   | —                               |   | —                             |   | —                 |   | $                                            | — |   |
| Outstanding at Sept. 30, 2002                            |   | 1,302,250                            |   | 2,822,750                          |   | 125,000                |   | $                                            | 0.68   |   |
| Cancelled (A)                                            |   | 2,000,624                            |   | (2,000,624                         | )      |                   |   | $                                            | 0.83   |   |
| Granted (A)                                              |   | (2,000,624                           | )      | 2,000,624                          |   |                   |   | $                                            | 0.36   |   |
| Granted (weighted average fair value of $0.34 per share) |   | (390,000                             | )      | 390,000                            |   | —                 |   | $                                            | 0.33   |   |
| Expired                                                  |   | 112,125                              |   | (112,125                           | )      |                   |   | 0.60                                         |   |
| Exercised                                                |   | —                               |   | (285,625                           | )      | 285,625                |   | $                                            | 0.46   |   |
| Outstanding at Sept. 30, 2003                            |   | 1,024,375                            |   | 2,815,000                          |   | 410,625                |   | $                                            | 0.44   |   |

 

----

(A)– Includes options to purchase 1,769,624 shares of common stock that werere-priced from an exercise price of $0.60 per share to an exercise price of$0.33 per share; options to purchase 206,000 shares that were re-priced from anexercise price of $2.50 to an exercise price of $0.60 per share; and options topurchase 25,000 shares of common stock that were re-priced from an exerciseprice of $1.50 per share to an exercise price of $0.33 per share.

 

Asat September 30, 2003, the following stock options were outstanding:

 

| **Exercise  Prices** |   | **Number  Outstanding** |      | **Weighted-  Average  Remaining  Contractual  Life (years)** |   | **Number  Exercisable** |      |
|----------------------|--------|-------------------------|-----------|--------------------------------------------------------------|--------|-------------------------|-----------|
| $                    | 0.33   |                    | 2,135,000 |                                                         | 2.50   |                    | 1,698,168 |   |
| 0.60                 |   | 505,000                 |      | 1.30                                                         |   | 505,000                 |      |
| 1.00                 |   | 75,000                  |      | .54                                                          |   | 75,000                  |      |
| 1.50                 |   | 73,885                  |      | .45                                                          |   | 73,885                  |      |
| 1.75                 |   | 12,375                  |      | 1.46                                                         |   | 12,375                  |      |
| 2.00                 |   | 13,740                  |      | 1.46                                                         |   | 13,740                  |      |
|                 |   |                    |      |                                                         |   |                    |      |
| Total                |   | 2,815,000               |      |                                                         |   | 2,378,168               |      |
|                      |        |                         |           |                                                              |        |                         |           |  |

 

The436,832 unvested options outstanding at September 30, 2003 vest over athree-year period.

 

***Warrants Issued:***

 

Duringthe year ended September 30, 2003 the Company issued warrants to purchase5,287,363 shares of common stock at an average weighted exercise price of $0.33per share.  Such warrants had an estimated fair value of $264,022 at thedate of grant calculated using a Black-

 

38

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Scholesoption pricing model. Accordingly, the Company initially increased unearnedcompensation and additional paid-in capital by the fair value of the warrants.

 

Thefollowing table summarizes all of the Company’s warrant activity during theyears ended September 30, 2003 and 2002:

 
|                          |   | **Number of  Warrants  Outstanding** |   | **Weighted Avg. Exercise  Price Per Share****($)** |   |
|-------------------------------|--------|--------------------------------------|--------|----------------------------------------------------|--------|
| Outstanding at Sept.30, 2001  |   | 3,532,749                            |   | 1.22                                               |   |
| Granted                       |   | 4,412,500                            |   | .43                                                |   |
| Expired                       |   | (3,367,749                           | )      | 1.22                                               |   |
| Outstanding at Sept. 30, 2002 |   | 4,577,500                            |   |                                               | 0.42   |   |
| Granted (2)                   |   | 5,287,363                            |   |                                               | 0.33   |   |
| Expired                       |   | (165,000                             | )      |                                               | 1.00   |   |
| Cancelled (1)                 |   | (137,847                             | )      |                                               | .43    |   |
| Exercised (1)                 |   | (94,653                              | )      |                                               | 0.43   |   |
| Outstanding at Sept. 30, 2003 |   | 9,467,363                            |   |                                               | 0.37   |   |

 

----

(1)   Certainof the warrants issued to investors contain cashless exercise provisions.During the year ended September 30, 2003, certain investors exercisedwarrants to purchase 232,500 shares of common stock pursuant to the cashlessprovision, therefore warrants to purchase 137,847 shares were canceled aspayment for the exercise price of the 94,653 shares issued.  As the fair value of the warrants at thedate of grant exceeded the fair value of the shares issued upon exercise, noadditional compensation was recorded in the accompanying consolidated financialstatements.

 

(2)          The Company granted the following options during the year endedSeptember 30, 2003:

 
| **Warrant  Holder**                                         |   | **Number of  Warrants** |   | **Exercise  Price ($)** |   | **Expiry Date** |   |
|-------------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|-----------------|--------|
|                                                        |   |                    |   |                    |   |            |   |
| William  Begley (A)                                         |   | 200,000                 |   | 0.25                    |   | 11/26/05        |   |
| Lloyd  Berhoff (A)                                          |   | 150,000                 |   | 0.25                    |   | 11/26/05        |   |
| Steve Mazur (A)                                             |   | 25,000                  |   | 0.33                    |   | 2/28/06         |   |
| David Lyall (A)                                             |   | 40,000                  |   | 0.33                    |   | 5/28/06         |   |
| Steve Mazur (A)                                             |   | 25,000                  |   | 0.33                    |   | 5/28/06         |   |
| Steve Mazur (B)                                             |   | 250,000                 |   | 0.33                    |   | 6/10/08         |   |
| MH Holdings (B)                                             |   | 250,000                 |   | 0.33                    |   | 6/10/08         |   |
| June 30,  2003  Private Placement  Warrant Holders (C) |   | 3,900,000               |   | 0.33                    |   | 6/24/08         |   |
| William  Begley (A)                                         |   | 254,110                 |   | 0.40                    |   | 7/23/08         |   |
| Lloyd  Berhoff(A)                                           |   | 193,253                 |   | 0.40                    |   | 7/23/08         |   |

 

                           

(A)These warrants were issued in connection with notes payable (See Note 3).

 

(B)These warrants were issued pursuant to consulting agreements.  The fair value of such warrants of $125,000as determined using a Black-Scholes option pricing model was initially chargedto unearned compensation with an offsetting credit to additional paid-incapital.  The unearned compensation,which is reflected as a reduction of stockholders’ equity, is being amortizedto the appropriate expense over the benefit period of the consulting agreement.

 

(C)See description of private placement below.

 

39

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***Assumptions Used inDetermining Fair Value of Stock Options and Warrants:***

 

Thefair value of the warrants issued in connection with the issuances of notespayable, the fair value of the options issued to employees used in connectionwith the computation of pro forma net loss and loss per common share and thefair value of the options and warrants issued to non-employees in exchange forconsulting, marketing and financial services were estimated using aBlack-Scholes option-pricing model with the following weighted-average assumptionsused for 2003 and 2002:

** **

| Expected volatility           |   | 127     | %      |
|-------------------------------|--------|---------|--------|
| Risk-free interest rate       |   | 4.75    | %      |
| Expected years of option life |   | 1  to 5 |   |
| Expected dividends            |   | 0       | %      |

 

***Stock Purchase Plan:***

 

OnOctober 23, 2001, the Company established, and the Board of Director’sapproved, the 2001 Employee Stock Purchase Plan (“Purchase Plan”) wherebycertain employees (i) whose customary employment is greater than20 hours per week, (ii) are employed for at least six consecutivemonths, and (iii) do not own five percent or more of any class of Companystock can participate in the Purchase Plan and invest from one percent to fiftypercent of their net pay, through payroll deduction, in Company common stock.In addition, participating employees can invest from one percent to one hundredpercent of any Company bonus in Company common stock. Employees are limited toa maximum investment per calendar year of $25,000.

 

Thereare a maximum number of shares of Company common stock reserved under thePurchase Plan of 2,000,000 shares. The Purchase Plan shall terminate in fiveyears or (i) upon the maximum number of shares being issued, or(ii) sooner terminated per the discretion of the administrator. Thepurchase price per share under the Purchase Plan is equal to 85% of the fairmarket value of a share of Company common stock at the beginning of thepurchase period or on the exercise date (the last day in a purchase period)whichever is lower.

 

Duringthe years ended September 30, 2003 and 2002, the Company issued 424,875and 473,459 shares respectively, to employees under the Purchase Plan. Theaggregate purchase price for those shares of $83,976 and $119,413,respectively, was paid by the employees through the offset of the amount theyowed for the shares against an equivalent amount the Company owed them foraccrued salaries or severance. Funds derived from the employee purchase ofCompany common stock under the Purchase Plan can be used for general corporatepurposes.

 

***Shares Issued in Lieu of Salary ofExecutive Officer:***

 

OnJanuary 29, 2003, the Company issued 169,533 shares to an executiveofficer to pay $50,250 of salary accrued as of September 30, 2002.

 

OnAugust 5, 2003, the Company issued 207,843 shares to an executive officerto pay $36,000 of salary accrued during the year ending September 30,2003.

 

40

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OnSeptember 30, 2003, Board of Directors authorized the issuance of 50,000shares of common stock with a fair value of $12,000 to an executive officer asadditional salary.

 

***Shares Issued Pursuant to SeveranceAgreement:***

 

Duringthe year ended September 30, 2003, the Company issued 92,308 shares ofcommon stock to a former employee to pay accrued compensation of $16,615pursuant to a severance agreement. The Company had no further obligation to theemployee as of September 30, 2003.

 

***Shares Issued for Settlement of AccountsPayable:***

 

Pursuantto a settlement agreement with Direct Focus, a supplier, the Company issued140,000 shares of common stock during the year ended September 30, 2003 witha fair value of $26,600 as partial settlement of an outstanding trade payableand recognized a gain of approximately $36,000, which is included in the gainon settlement of accounts payable of $175,011 in the accompanying consolidatedstatement of operations.

 

***Shares Issued Pursuant to PrivatePlacement:***

 

OnJune 10, 2003, the Company began offering 11 units of common stock andwarrants at $75,000 per unit to raise up to $825,000 through a ConfidentialOffering Memorandum with Casimir Capital L.P. as placement agent.  Eachunit consisted of 300,000 common shares and warrants to purchase 300,000 commonshares at an exercise price of $0.33 per share through June 2008. TheCompany closed the sale of all 11 units on June 30, 2003 and receivedproceeds of approximately $664,000, net of fees and expenses of approximately$161,000. The Company also issued 600,000 warrants to the placement agent forservices in connection with the offering of the equity securities.  The Company issued 3,300,000 common sharesfor this obligation on June 30, 2003.

 

**5.****             ****COMMITMENTS AND CONTINGENCIES**

 

***(a)******        ******Litigation***

 

TheCompany has been named as a defendant in a lawsuit by Whistler CableTelevision Ltd. claiming damages for conversion, the return of personalproperty, an injunction and costs. The Company has filed a defense disputingthat the plaintiff has any legal right to bring the action, and alleging thatin any event the amount of damages suffered, if any, is minimal. As ofSeptember 30, 2003, this case was still in the pre-discovery phase. Giventhe preliminary stage of the proceedings, it was not possible for management toestimate or determine whether there will be any loss to the Company. Theamount, if any, of such loss will be recorded in the period in which it becomesdeterminable.

 

***(b)******        ******Contracts***

 

TheCompany has previously entered into a management agreement with a seniorexecutive that provides for annual compensation, excluding bonuses, of$180,000. The Company can terminate this agreement at any time upon reasonablenotice and the payment of an amount equal to 24 months of salary. In theevent of a change in control of the Company, either party may, during a periodof 12 months from the change of control, terminate the agreement uponreasonable notice and the payment by the Company of an amount equal to36 months of salary.

 

41

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***(c)******         ******DisputedAccounts Payable***

 

Asof September 30, 2003, the Company was in a dispute with WorldCom overcharges of $58,367 based on their pricing of two T-1 lines for Internetservice. It is the Company’s position that the pricing should be consistentwith written quotes received by the Company from WorldCom. WorldCom has beencharging a substantially more significant price. WorldCom has been unresponsiveto requests to negotiate. Management believes that the Company has madeappropriate accruals as of September 30, 2003 and the amount, if any, ofcharges to be recorded in subsequent periods in connection with these disputeswill not be material.

 

***(d)******        ******OperatingLeases***

 

TheCompany is required to make future minimum rental payments of $81,470 duringthe year ended September 30, 2004 under a non-cancelable lease for itsfacilities. Rent expense under all operating leases amounted to $129,888 and$127,873, respectively, for the years ended September 2003 and 2002.

 

**6.    STRATEGICALLIANCES**

 

***(a)******        ******DIRECTV***

 

InMay 2000, the Company entered into a long-term System Operator Agreementwith DirecTV, Inc. (“DIRECTV”), a California company. On September 29, 2003, theCompany entered into a new System Operator Agreement with DIRECTV, whichreplaced the System Operator Agreement previously executed by the Company andwas due to initially expire on May 19, 2005.  The Company’s contract with DIRECTV gives the Company ashare of monthly net subscriber receipts, depending upon the number of activesubscribers, from the sale of DIRECTV programming services, plus a commissionfor each new subscriber addition. The Company incurs only the costs associatedwith the implementation of its services and will not share any of DIRECTV’sprogramming or broadcasting costs.

 

***(b)******        ******CiscoSystems***

 

InJuly 2001, the Company entered into a Master Lease Agreement to PurchaseEquipment with Cisco Systems, Inc. (“Cisco”). Under this agreement, theCompany will receive preferred pricing and discounts for equipment purchased tosupport the Company’s high-speed Internet services. As part of this agreement,Cisco Systems Capital Corp. has extended lease financing to the Company for thepurchase of Internet related equipment with monthly repayment terms over threeyears from the date that the goods were accepted. The total credit availableunder the agreement is $500,000, 30% of which can be installation costscapitalized under the lease. As of September 30, 2003, the Company had atotal remaining obligation under this agreement of $102,861, which wasaccounted for as a capital lease. Such purchases are non-cash transactions.

 

Futureminimum lease payments under capital lease obligations in each of the yearssubsequent to September 30, 2003 are as follows:

 

| **Year Ending  September 30,**         |   | **Amount** |    |
|---------------------------------------------|--------|------------|---------|
| 2004                                        |   | $          | 102,861 |   |
| Less amount representing interest           |   | $          | 8,140   |   |
|                                        |   |       |    |   |
| Present value of net minimum lease payments |   | $          | 94,721  |   |

 

Thenet book value of equipment under capital leases as of September 30, 2003was $115,409 and is included in property and equipment.

 

42

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**7.****             ****ACQUISITION OF SUBSCRIBERS AND EQUIPMENT**

 

In February 2002, the Companyexecuted an agreement with Verizon Media Ventures and Verizon EntertainmentServices (“Verizon”) to purchase certain assets of its digital satellite videodivision. A majority of the funds raised through the series of privatelyoffered convertible promissory notes in January 2002 were for thepurchase, integration, maintenance and growth of the portfolio of subscribersand properties being acquired by the Company from Verizon (see Note 3).The assets acquired consisted of digital satellite video subscribers and theequipment and systems to service these subscribers in MDU properties locatedmainly in the Northeast U.S. The total acquisition price of $763,210 wasattributable to building access agreements and customer lists and, accordingly,included in intangible assets. Intangible assets acquired are being amortizedover four years.

 

**8.****             ****INVESTMENT IN AND TRANSACTIONS WITH AVALONBAY JOINT VENTURE**

 

As part of an acquisition onApril 30, 2001, the Company acquired a 50% interest in a joint ventureagreement with AvalonBay Cable I, Inc. (the “Joint Venture”), an affiliate ofAvalonBay Communities, Inc., for the purpose of managing, owning andotherwise operating systems and equipment to provide digital satellitetelevision services to certain of AvalonBay’s residential communities. The Company’s50% investment in the Joint Venture had been accounted for pursuant to theequity method and, accordingly, the Company’s proportionate interest in the netearnings of the Joint Venture has been reflected separately in the Company’sconsolidated statement of operations for the year ended September 30,2002. During the yearended September 30, 2002, the Company made additional contributions of$207,622, received distributions of $127,387 and recorded $32,010 as its 50%share of the Joint Venture’s net income, and its investment in the JointVenture was $311,466 at September 30, 2002.

 

During the year endedSeptember 30, 2003, the percentage of the Company’s ownership interest inthe Joint Venture increased from 50% to 100%. The increase in the Company’s interest resulted from the purchase by theCompany on July 28, 2003 of the 50% interest held by AvalonBay Cable I,Inc. for approximately $320,000.  As ofthat date, the Joint Venture provided services to approximately 2,084subscribers in 11 properties.  The acquisition of the controlling interestwas accounted for pursuant to the purchase method and the purchase price wasallocated to the fair value of the net assets acquired, which approximatedtheir carrying values.  Accordingly, theJoint Venture became a consolidated subsidiary of the Company effectiveOctober 1, 2002 and increased/(decreased) the consolidated balance sheetas follows:

 

| Cash  and cash equivalents   |   | $        | 15,672  |   |
|------------------------------|--------|----------|---------|--------|
| Accounts  receivable, net    |   | 285,637  |    |
| Property  and equipment, net |   | 751,762  |    |
| Investment  in joint venture |   | (311,466 | )       |
| Total                        |   | $        | 741,605 |   |
|                         |   |     |    |
| Accounts  payable            |   | $        | 282,184 |   |
| Other  accrued liabilities   |   | 20,243   |    |
| Deferred  revenue            |   | 127,596  |    |
| Minority  interest           |   | 311,582  |    |
| Total                        |   | $        | 741,605 |   |

 

Had the Joint Venture been consolidatedin the statement of operations for the year ended September 30, 2002,revenues would have increased by $496,697, expenses would have increased by$432,675 and minority interest expense would have increased by $32,011.  However, such consolidation would have hadno effect on the net loss.

 

On July 30, 2003, the JointVenture sold 1,273 digital satellite television subscribers in five propertiesto CSC Holdings, Inc. (“CSC Holdings”) for $1,200 per subscriber. The totalsales price, including amounts applicable to the sale of certain relatedequipment, was $1,557,600.  Approximately $381,000 of

 

43

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the sales price was held inescrow for 80 days to confirm the number of subscribers and after September 30,2003, $32,400 was returned to CSC Holdings from escrow due to subscriberfluctuations. After certain transactional deductions, including a negotiatedrecoupment by the Company of approximately $150,000 of the $320,000 purchaseprice for the Company’s additional 50% interest in the Joint Venture describedabove, the net proceeds from the sale will flow 50% to the Company with theother 50% apportioned to each of the other owner entities of the fiveproperties involved in the CSC Holdings sale. At September 30, 2003, the Company has accrued approximately$550,000 representing 50% of the net proceeds due its former partners.  Accordingly, the accompanying consolidatedstatement of operations for the year ended September 30, 2003 includes again on sale of customers to CSC Holdings of approximately $703,000, which isnet of the write-off of the remaining net book value of tangible and intangibleassets the Company will no longer use.

 

The Company’s revenue for the yearended September 30, 2002 includes $280,818 from sales of receivers to theJoint Venture and charges primarily for installation and management fees. TheCompany also receives certain payments from DIRECTV on behalf of the JointVenture. The Company did not have any material net receivables from or payablesto the Joint Venture at September 30, 2002.

 

**9.****             ****PROPERTY AND EQUIPMENT**

 

The components of property andequipment are set forth below:

 

|                                    |   | **September 30,** |      |
|-----------------------------------------|--------|------------------------|-----------|
|                                    |   | **2003**               |      | **2002** |   |
| Telecommunications equipment, installed |   | $                      | 4,875,749 |   | $ | 3,587,397 |   |
| Computer equipment                      |   | 339,732                |      | 341,732 |   |
| Furniture and fixtures                  |   | 105,412                |      | 105,640 |   |
| Vehicles                                |   | 24,954                 |      | 24,954 |   |
|                                    |   | 5,345,847              |      | 4,059,723 |   |
| Less: Accumulated depreciation          |   | (1,609,167             | )         | (739,348 | ) |
|                                    |   | $                      | 3,736,680 |   | $ | 3,320,375 |   |

 

Depreciation expense amounted to$845,656 and  $487,391 for the yearsended September 30, 2003 and 2002, respectively.

 

**10.****      ****INTANGIBLE ASSETS**

 

The components of intangible assets areset forth below:

 

|                                            |   | **September 30,** |      |
|-------------------------------------------------|--------|------------------------|-----------|
|                                            |   | **2003**               |      | **2002** |   |
| Building access agreements and subscriber lists |   | $                      | 2,007,516 |   | $ | 2,011,627 |   |
| Less: Accumulated amortization                  |   | (925,534               | )         | (506,398 | ) |
|                                            |   | $                      | 1,081,982 |   | $ | 1,505,229 |   |

 

44

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Amortization expense amounted to$419,136 and $335,076 for the years ended September 30, 2003 and 2002, respectively.Amortization of intangibles in years subsequent to September 30, 2003 isas follows:

 

| **Year** |   | **Amortization  Amount** |    |
|----------|--------|--------------------------|---------|
| 2004     |   | $                        | 419,136 |   |
| 2005     |   | 419,136                  |    |
| 2006     |   | 243,710                  |    |
|          |        |                          |         |  |

 

**11.****      ****INCOME TAXES**

 

The Company had pre-tax losses but didnot record any credits for Federal or other income taxes for the years endedSeptember 30, 2003 and 2002. The Company did not record Federal income taxbenefits at the statutory rate of 34% and state income tax credits because(a) it has incurred losses in each period since its inception and cannotcarry back any of its losses against previously recorded income tax expense and(b) although such losses, among other things, have generated futurepotential income tax benefits, there is significant uncertainty as to whetherthe Company will be able to generate income in the future to enable it torealize any of those benefits and, accordingly, it has had to take valuationreserves against those potential benefits as shown below.

 

As of September 30, 2003 and 2002,the Company had net deferred tax assets, which generate potential future incometax benefits that consisted of the effects of temporary differencesattributable to the following:

 

|                                                                 |   | **2003**   |      | **2002**   |   |
|----------------------------------------------------------------------|--------|------------|-----------|------------|--------|
| Deferred tax assets:                                                 |   |       |      |       |   |
| Benefits from net operating loss carryforwards:                      |   |       |      |       |   |
| United States                                                        |   | $          | 3,866,000 |       | $      | 2,802,000 |   |
| Canada                                                               |   | 3,199,000  |      | 3,135,000  |   |
| Depreciation of property and equipment                               |   |       |      |       |   |
| Amortization of intangible assets                                    |   | 274,000    |      | 135,000    |   |
| Other                                                                |   | 63,000     |      | 40,000     |   |
| Totals                                                               |   | 7,402,000  |      | 6,112,000  |   |
| Deferred tax liabilities—depreciation of property and equipment |   | (450,000   | )         | (281,000   | )      |
| Net deferred tax assets                                              |   | 6,952,000  |      | 5,831,000  |   |
| Less valuation allowance                                             |   | (6,952,000 | )         | (5,831,000 | )      |
| Total                                                                |   | $          | —    |       | $      | — |   |

 

45

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At September 30, 2003 and 2002,the Company had net operating loss carry forwards of approximately $9,666,000and $7,005,000, respectively, available to reduce future Federal taxable incomeand net operating loss carryforwards of approximately $7,030,000 and$6,890,000, respectively, available to reduce future Canadian taxable income.As of September 30, 2003, the Federal tax loss carry forwards will expirefrom 2004 through 2023 and the Canadian tax loss carryforwards will expire from2005 through 2009. However, the Company terminated substantially all of itsCanadian operations in the year ended September 30, 2002.

 

The deferred tax valuation allowanceincreased by $1,121,000 and $1,945,000 in the years ended September 30,2003 and 2002, respectively.

 

**12.****      ****SEGMENT AND RELATED INFORMATION**

 

The Company operates in one industrysegment. The Company’s operations are comprised of providing delivery of homeentertainment and information technology to multi-unit dwellings.

 

**13.****      ****GAIN ON SALE OF CUSTOMERS**

 

Thegain on sale of customers during the year ended September 30, 2003consisted of the following:

 

| **Transaction**  |   | **Gain** |    |
|------------------|--------|----------|---------|
| Joint Venture(A) |   | $        | 703,309 |   |
| CSC Holdings(B)  |   | $        | 152,150 |   |
| Other(C)         |   | $        | 13,800  |   |
| Total            |   | $        | 869,259 |   |

 

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(A)      See Note 8 above.

(B)        On December 6, 2002, theCompany entered into an agreement to sell certain equipment and customer listsassociated with a particular multi-dwelling unit property.  The sales price was fixed at $1,150 cash peractive subscriber, plus certain equipment for a total sales price of $185,150.

(C)        On January 16, 2003, theCompany entered into an agreement to sell certain equipment and customer listsassociated with a particular multi-dwelling unit property.  The purchase price was fixed at $67,000payable in cash.

 

**14.****      ****SUBSEQUENT EVENTS**

 

From October 1, 2003 throughDecember 10, 2003, options for 373,334 common shares were exercisedpursuant to the 2001 Stock Option Plan for net proceeds to the Company of$218,750.

 

From October 1, 2003 throughDecember 10, 2003, warrants for 3,592,500 common shares were exercised fornet proceeds to the Company of $1,544,755.

 

From October 1, 2003 throughDecember 10, 2003, warrants for 199,645 common shares were exercisedpursuant to cashless provisions, and 62,855 additional warrants were cancelledin exchange for the exercise price.

 

On January 24, 2002, the Companyentered into a Convertible Promissory Note and Loan Agreement with Roselink for$100,000 (see Note 3). The seventh quarterly payment was due onOctober 24, 2003. Because the payment was not made, the amount due wasautomatically converted into a total of 39,583 common shares, which were issuedon November 16, 2003.

 

On November 24, 2003, the Company closeda private placement of its securities pursuant to a Confidential Offering Memorandum.  The placement was made up of 22 units witheach unit consisting of 100,000 common shares and 50,000 warrants to purchasecommon shares.  The price of the commonshares

 

46

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and the exercise price of thewarrants to purchase common shares were set at $1.50 and $1.75 per share,respectively.   The Company received netproceeds in the amount of $3,300,000.

 

**Item 8.  Changes inand Disagreements with Accountants on Accounting and Financial Disclosure**

 

None.

 

**Item 8A.  Controls andProcedures**

 

It is the Chief Executive Officer’sresponsibility to ensure the Company maintains disclosure controls andprocedures designed to provide reasonable assurance that material information,both financial and non-financial, and other information required to bedisclosed under the securities laws, is identified and communicated to seniormanagement on a timely basis. Our disclosure controls and procedures includemandatory communication of material events, management review of monthly andquarterly results and an established system of internal controls.

 

As of the date of this report on Form10-KSB, management, including the Chief Executive Officer, conducted anevaluation of disclosure controls and procedures pursuant to Exchange ActRule 13a-14. Based on that evaluation, the Chief Executive Officerconcluded that the Company’s disclosure controls and procedures then in place,are adequate for a company its size, to ensure material information and otherinformation requiring disclosure are identified and communicated in a timelyfashion. There have been no significant changes in internal controls overfinancial reporting, or in factors that could significantly affect suchinternal controls, subsequent to the date the Chief Executive Officer completedhis evaluation.

 

**PART III**

 

**Item 9. ****Directors, Executive Officers, Promoters and Control Persons;Compliance with Section 16(a) of the Exchange Act**

 

The following are the directors andexecutive officers of the Company:

 

Sheldon B. Nelson, 42, has served asPresident, Chief Executive Officer and Chairman of the Board of the Companysince November 1998. From 1983 to 1998, he was President of 4-12Electronics Corporation, a provider of products and services to the Canadiansatellite, cable, broadcasting and SMATV industries. In addition to hisday-to-day responsibilities during his tenure at 4-12 Electronics,Mr. Nelson developed the Company into one of Canada’s largest privatecable system operators. Mr. Nelson is a graduate of Gonzaga University, inSpokane, WA. He graduated from the School of Business Administration in 1983,Magna cum Laude, and was the recipient of the School of BusinessAdministrations’ Award of Excellence.

 

Robert Dyck, 45, joined the Board ofDirectors in May 2000. He has been president of WRE Development Ltd.since 1978. WRE Development Ltd. owns, develops and manages residentialrental properties throughout the U.S. and Canada. Mr. Dyck is alsoco-owner of Norquay Management, a residential property management venture. Hehas overseen the expansion of a property and development portfolio now valuedat more that C$100 million. Mr. Dyck has substantial experience inthe supervision of new apartment construction, analysis of acquisitionopportunities for development and investment purposes and review of newtechnologies to increase the efficiency of the property portfolio. Mr. Dyck’sseat on the Board expired on May 20, 2002 and he retired from the Board onJanuary 31, 2003.

 

Douglas G. Hooper, 43, joined the Boardof Directors in May 2000. He is currently an acquisitions and financeconsultant, who has extensive experience as a venture capitalist and mergersand acquisition specialist in the mineral exploration, industrial processingand software industries. He was President and CEO of Sand RiverResources Ltd. from 1995 to 1997. Mr. Hooper was a founder andPresident of TelSoft Mobile Data Inc. from 1992 to 1995, now Mobile DataSolutions, Inc., a wireless communications software company. In thatposition, he developed and implemented corporate strategy and was responsiblefor raising capital, strategic alliances and mergers and acquisitions.

 

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John Edward Boyle, 59, joined the Boardof Directors in May 2000. From 1998 to 2001 he was President and CEO ofMultivision (Pvt.) Ltd., a cable television company. From 1996 to 1997,Mr. Boyle was President and CEO of PowerTel TV Inc., a digitalwireless cable company. As founding President and CEO of ExpressVu Inc.(1995-1996), Mr. Boyle was responsible for taking one of Canada’s firstnational direct-to-home satellite services from conception to launch readinesswhile raising public awareness of DTH. Prior to 1995, Mr. Boyle has alsoheld executive positions with Tee-Comm Electronics, Regional Cablesystems andCanadian Satellite Communications Inc. (Cancom). As Vice-President ofRegional Companies at Cancom, and later as Vice President of Market Developmentat Regional Cablesystems, he led the licensing or acquisition of over 1,000Canadian and American cable systems.

 

Edward L. Huguez, 45, joined the Board in October of 2003. He iscurrently President and CEO of MidStream Technologies, a privately held companyconcentrating on Video on Demand and Network Digital Video Recording.  Prior to joining Midstream, he served assenior vice president at Akamai Technologies, the leading provider of global,high performance services for the delivery of interactive Internet content,streaming media and Internet applications. He joined Akamai upon its $2.8 billion acquisition of INTERVU inApril 2000.  As chief operatingofficer at INTERVU, Mr. Huguez helped drive the evolution of the company from astart up with about 30 employees and no revenue, to the market leader with 400employees and more than 900 customers. Before INTERVU, Mr. Huguez spent almost six years at DIRECTV, thenation’s leading digital satellite television service.  He joined DIRECTV in 1992 and was part ofthe senior executive team that launched the service in 1994.  He had two primary responsibilities while atDIRECTV; first, vice president of programming acquisition, then, after DIRECTVsuccessfully launched its service and became the leading television satelliteservice, he was asked to lead DIRECTV’s newly formed New Media &Interactive Programming and Platforms Group, where he assumed the role of vicepresident and general manager. He also initiated and negotiated successfultechnology, distribution and interactive and multimedia content agreements withthird parties, and formed or initiated strategic partnerships with TiVo, WebTVand Direct PC, to name a few, to deploy DIRECTV’s interactive and new mediastrategies.  Mr. Huguez earned his MBAat UCLA and holds a bachelor’s degree in political science from Arizona State.

 

Patrick Cunningham, 35, hasbeen Vice President of the Company since March 2000.  He has over twelve years of managementexperience focused on the telecommunications industry. Mr. Cunningham wasformerly the Vice President of Distribution and Sales for SkyView World Media,LLC. At SkyView, he was responsible for the distribution, sales, marketing andtechnical service of the SkyView products. SkyView was one of the leadingprivate providers of television services to the MDU and ethnic communities withover 100,000 subscribers nationwide. SkyView was the largest Master SystemsOperator for DIRECTV and a leading producer and distributor of foreign languagetelevision programming. Prior to SkyView, and after some time as a maintenancemanager with Schnieder National, Inc., Mr. Cunningham was an Officer in theU.S. Army where he served as a Battalion Communications Officer and an M1A1Tank Platoon Leader. Mr. Cunningham has a Bachelor of Science from UnionCollege in Schenectady, NY where he majored in Industrial Economics.

 

**SECTION 16(a)BENEFICIAL OWNERSHIP REPORTING COMPLIANCE**

 

Section 16(a) of the SecuritiesExchange Act of 1934 requires the Company’s directors, executive officers andpersons who own beneficially more than 10% of the Company’s common stock tofile with the Securities and Exchange Commission (“SEC”) initial reports ofownership and reports of changes in ownership of common stock and other equitysecurities of the Company. Officers, directors and greater than 10%stockholders are required by SEC regulation to furnish the Company with copiesof all Section 16(a) reports they file. To the Company’s knowledge, basedsolely on review of the copies of such reports furnished to the Company oradvice that no filings were required, during fiscal year 2003 all officers,directors and greater than 10% beneficial owners complied with theSection 16(a) filing requirements.

 

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**Item 10.  ExecutiveCompensation**

 

**COMPENSATION OFEXECUTIVE OFFICERS**

 

The following table sets forth certaininformation regarding compensation paid during each of the Company’s last threefiscal years to our chief executive officer and other executive officers whosetotal annual salary and bonuses exceeded $100,000 (the “named executiveofficers”).

 

**SUMMARYCOMPENSATION TABLE**

 
|                            |   |             |       |                         |       | **Long Term  Compensation  Awards******                       |       |              |       |                               |       |
|---------------------------------|--------|------------------|------------|------------------------------|------------|---------------------------------------------------------------|------------|-------------------|------------|------------------------------------|------------|
| **Name and Principal Position** |   | **Fiscal  Year** | ** ** | **Annual  Compensation****** | ** ** | **Securities  Underlying  Options  (in shares,  cumulative)** | ** ** | **Bonus ($****)** | ** ** | **All Other  Compensation(2****)** | ** ** |
| **Salary ($)**                  |
|                            |   |             |       |                         | ** ** |                                                          | ** ** |              | ** ** |                               | ** ** |
| Sheldon B. Nelson,(1)           |   | 2003             |       | $                            | 192,000    |                                                          | 800,000    |              | $          | 50,000                             |       | $ | -0- |   |
| President and CEO               |   | 2002             |       | $                            | 181,723    |                                                          | 800,000    |              | $          | -0-                                |       | $ | -0- |   |
|                            |   | 2001             |       | $                            | 143,395    |                                                          | 800,000    |              | $          | 29,656                             |       | $ | -0- |   |
|                            |   |             |       |                         |       |                                                          |       |              |       |                               |       |
| Patrick Cunningham,(3)          |   | 2003             |       | $                            | 160,000    |                                                          | 300,000    |              | $          | -0-                                |       | $ | 6,000 |   |
| Vice President of Marketing     |   | 2002             |       | $                            | 160,000    |                                                          | 300,000    |              | $          | -0-                                |       | $ | 6,000 |   |
|                            |   | 2001             |       | $                            | 160,000    |                                                          | 300,000    |              | $          | 23,333                             |       | 6,000 |   |

 

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(1)Mr. Nelson became the President and Chief Executive Officer of theCompany in November 1998. Mr. Nelson’s salary of $192,000 for fiscalyear 2003 consists of $144,000 in salary (cash) and common shares in the amountof 257,843 in lieu of $48,000 of salary (cash). Mr. Nelson’s bonus consisted of$50,000, had not been paid as of September 30, 2003, and can be taken incommon shares at his discretion.

 

(2)Auto allowance.

 

(3)Mr. Cunningham joined the Company in March 2000 as VicePresident.

 

**OPTIONS GRANTEDIN FISCAL YEAR 2002**

 

The Company granted no options to anynamed executive officer and director during fiscal year endingSeptember 30, 2003. However, options previously issued to the above namedexecutive officers and the directors were repriced from $0.60 per share to$0.33 per share.

 

**COMPENSATION OFDIRECTORS**

 

Each director who is not an employee orfull time consultant of the Company is paid $1,000 (cdn) per month and anattendance fee of $1,000 (cdn), plus out-of-pocket expenses, for each Board orcommittee meeting attended. During fiscal year ended September 30, 2000,Messrs. Boyle, Dyck and Hooper each received a five-year, fully-vestedoption to purchase 50,000 shares of common stock as additional compensation fortwo years of Board service.  During thefiscal year ended September 30, 2002, Messrs. Boyle, Dyck and Hoopereach received an additional five-year, fully-vested option to purchase 50,000shares of common stock as additional compensation for two additional years ofBoard Service. These options are currently priced at $0.33 per share. Mr.Huguez, who joined the Board in October 2003, is paid $1,000 (us) permonth and an attendance fee of $1,000 (us), plus out-of-pocket expenses, foreach Board or committee meeting attended. On November 14, 2003, Mr. Huguezreceived a five-year option to purchase 100,000 shares of common stock asadditional compensation for two years of Board service, one

 

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halfvested immediately and the remainder at one year.  These options are currently priced at $0.65 per share.

 

**Item 11.  SecurityOwnership of Certain Beneficial Owners and Management**

 

The following table sets forthinformation with respect to beneficial ownership of our outstanding stock as ofSeptember 30, 2003 by (i) each person known to the Company to be thebeneficial owner of more than 5% of the Company’s common stock; (ii) eachof the Company’s directors; (iii) each executive officer named in theSummary Compensation Table; and (iv) all of the Company’s executiveofficers and directors as a group.

 
|                                                                            |   | **Shares Beneficially  Owned(1)** |       |
|---------------------------------------------------------------------------------|--------|-----------------------------------|------------|
| **Name of Beneficial Owner**                                                    |   | **Number(2)**                     |       | **Percent** |   |
|                                                                            |   |                              | ** ** |   | ** ** |
| Sheldon B. Nelson(3)                                                            |   | 1,801,016                         |       | 5.3 | % |
| Patrick Cunningham(4)                                                           |   | 476,117                           |       | 1.4 | % |
| J.E. (Ted) Boyle                                                                |   | 100,000                           |       | 0.3 | % |
| Robert Dyck                                                                     |   | 100,000                           |       | 0.3 | % |
| Douglas G. Hooper                                                               |   | 100,000                           |       | 0.3 | % |
| Edward Huguez                                                                   |   | 100,000                           |       | 0.3 | % |
| Amajac Capital Mgmt.; Jeffrey Priest(5)                                         |   | 2,353,000                         |       | 6.9 | % |
| All executive officers, directors, beneficial owners as a group (7  persons)(6) |   | 5,045,633                         |       | 14.8 | % |

 

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(1)Unless otherwise indicated below, eachstockholder had sole voting and sole investment power with respect to allshares beneficially owned.

 

(2)Includes common stock and currentlyexercisable options to purchase shares of common stock.

 

(3) Includes 946,016 shares held of record by 567780BC Ltd., a British Columbia corporation wholly owned by the Sheldon NelsonFamily Trust whose trustees are Sheldon Nelson and his sister, Nicole Nelson,55,000 held personally and 800,000 shares subject to options exercisable within60 days.

 

(4) Includes234,450 shares and 241,667 shares subject to options exercisable within 60days.

 

(5) Pursuantto 13G filing on June 30, 2003.

 

(6)Includes 3,603,966 shares of common stock andoptions to purchase 1,441,667 shares of common stock exercisable within60 days.

 

**Item 12.  CertainRelationships and Related Transactions**

 

There have been no such transactionsduring the past two fiscal years, other than transactions with the JointVenture prior to October 1, 2002 when it becomes a 100% owned entity (seeNote 8). Revenue for the year ended September 30, 2002 includes $280,818from sales of receivers to Joint Venture and charges primarily for installationand management fees. The Company also receives certain payments from DIRECTV onbehalf of the Joint Venture. The Company did not have any material net receivablesfrom or payables to the Joint Venture at September 30, 2002.

 

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**Item 13.  Exhibits andReports On Form 8-K**

 

On October 2, 2003 we filed an 8-Kdisclosing the appointment of a new member to our Board of Directors.

 

On August 18, 2003 we filed an 8-Kdisclosing the transaction with Avalon Digital Joint Venture and the sale ofcertain of its subscribers.

 

On June 9, 2003, we filed an 8-Kdisclosing the repricing of certain options in the 2001 Stock Option Plan.

 

The Company files herewith the followingExhibits:

 

Exhibit 4.15 - Form of Warrant toPurchase Common Stock, dated November 14, 2003, to various purchasers inthe Company’s November 2003 private placement of units.

 

Exhibit 4.16 - Form of SubscriptionAgreement, dated November 14, 2003, to various purchasers in the Company’sNovember 2003 private placement of units.

 

Exhibit 10.22 – DIRECTV MDU System OperatorAgreement dated September 29, 2003 (redacted).

 

Exhibit 31.1 – Certification pursuant toSection 302.

 

Exhibit 32.1 – Certification pursuant toSection 906.

 

**Item 14.  PrincipalAccountant Fees and Services**

 

JH Cohn, LLP has served as the Company’sPrincipal Accountant since January 1, 2002. Their fees billed to theCompany for the past two fiscal years are set forth below:

 
|               |   | **Fiscal  year endingSeptember 30, 2003** |   | **Fiscal year ending  September 30, 2002** |   |
|--------------------|--------|------------------------------------------------|--------|-------------------------------------------------|--------|
| Audit Fees         |   | $                                              | 71,591 |                                            | $      | 80,265 |   |
| Audit Related Fees |   | —                                         |   | —                                          |   |
| Tax Fees           |   | $                                              | 10,855 |                                            | — |   |
| All Other Fees     |   | $                                              | 14,650 |                                            | $      | 12,695 |   |

 

As of September 30,2003, the Company’s Audit Committee did not have a pre-approval policy for thefees of the principal accountant.  It isin the process of adopting such a policy.

 

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**SIGNATURES**

 

Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 

 
|   | MDU COMMUNICATIONS  INTERNATIONAL, INC. |
|--------|----------------------------------------------|
|   |                                         |
|   | By:                                          | /s/  SHELDON NELSON |
|   |                                         | Sheldon Nelson*Chief Financial Officer*December 23, 2003 |

 

 

Pursuant to the requirement of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

 
| **Signature**                     |   | **Title**                                 |   | **Date**               |
|-----------------------------------|--------|-------------------------------------------|--------|------------------------|
|                              |   |                                      |   |                   |
| /s/  SHELDON  B. NELSON |   |                                      |   |                   |
| Sheldon  B. Nelson                |   | Principal Executive  Officer and Director |   | December 23, 2003 |
|                              |   |                                      |   |                   |
| /s/  DOUGLAS  G. HOOPER |   |                                      |   |                   |
| Douglas  G. Hooper                |   | Director                                  |   | December 23, 2003 |
|                              |   |                                      |   |                   |
| /s/  JOHN  EDWARD BOYLE |   |                                      |   |                   |
| John  Edward Boyle                |   | Director                                  |   | December 23, 2003 |
|                              |   |                                      |   |                   |
| /s/  EDWARD  HUGUEZ     |   |                                      |   |                   |
| Edward Huguez                     |   | Director                                  |   | December 23, 2003 |

 

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