**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-KSB/A**

 

| **ý**                                                                                                                                                                                                                                                                                                                                                                                |   | **ANNUAL REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
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|                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                         |
| **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 File No. 0-26053**

 

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**MDUCOMMUNICATIONS INTERNATIONAL, INC.**

(Name of Small Business Issuer in 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 under Section 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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**TABLEOF 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-LOOKING STATEMENTS**

 

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 identify forwardlooking statements, although not all forward looking statements contain theseidentifying words.

Suchstatements reflect our current views with respect to future events and aresubject to unknown risks, uncertainties, and other factors that may causeactual results to differ materially from those contemplated in such forwardlooking statements. Such factors include the risks described in Item 1.Description of Business; Risk Factors and elsewhere in this Report and, amongothers, the following: general economic and business conditions, bothnationally, internationally, and in the regions in which we operate;catastrophic events, including acts of terrorism; relationships with and eventsaffecting third parties like DIRECTV and the possible sale of DIRECTV;demographic changes; existing government regulations, and changes in, or thefailure to comply with, government regulations; competition; the loss of anysignificant numbers of subscribers or viewers; changes in business strategy ordevelopment plans; the cost of pursuing new business initiatives; technologicaldevelopments and difficulties; the availability and terms of capital to fundthe potential expansion of our businesses; and other factors referenced in thisReport. Readers are cautioned not to place undue reliance on these forwardlooking statements, which speak only as of the date hereof. We do not undertakeany obligation to publicly release any revisions to these forward lookingstatements to reflect events or circumstances after the date hereof or toreflect the occurrence of unanticipated 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 of Business**

 

**BUSINESS OF THE COMPANY**

 

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 executive officesare located at 60-D Commerce Way, Totowa, New Jersey 07512 and our telephonenumber 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 Alliance With 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 Alliance With 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, therelationship between the property owners and managers that control access tothese properties and the cable operator have been significantly strained overthe past 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 services available,audience ratings and expenditures on programming. In the U.S., the traditionalcable companies serve an estimated 69% of U.S. television households. Althoughmany cable operators currently use analog technologies, which produce inferiorquality video and sound compared to digital technologies, many cable operatorshave begun the process of upgrading to a digital signal, however, thistransition requires significant capital outlays and time to deploy. In themeantime, we believe that direct to home (“DTH”) providers like us have awindow of opportunity in which to acquire and consolidate a significantsubscriber base by providing a higher quality signal over a vast selection ofvideo and audio channels at a comparable or reduced price 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 with other operators who build and operatecommunications systems such as satellite master antenna television systems,commonly known as SMATV, which generally serve condominiums, apartment andoffice complexes and residential developments. We also compete with other national DBS operators such as Echostar.

 

**GOVERNMENTAL REGULATION**

 

*Federal Regulation.*In February 1996, Congress passed the Telecommunications Act, whichsubstantially amended the Federal Communications Act of 1934, as amended(“Communications Act”). This legislation has altered and will continue to alterfederal, state, and local laws and regulations affecting the communicationsindustry, including certain of the services we provide. On November 29,1999, Congress enacted the Satellite Home Viewer Improvement Act of 1999(“SHVIA”), which amended the Satellite Home Viewer Act. SHVIA permits DBSoperators to transmit local television signals into local markets. In otherimportant statutory amendments of significance to satellite carriers andtelevision broadcasters, the law generally seeks to place satellite operatorson an equal footing with cable television operators in regards to theavailability of television broadcast programming.

 

SHVIA amends the Copyright Act and the Communications Act in order toclarify the terms and conditions under which a DBS operator may retransmitlocal and distant broadcast television stations to subscribers. The law wasintended to promote the ability of satellite services to compete with cabletelevision systems and to resolve disputes that had arisen between broadcastersand satellite carriers regarding the delivery of broadcast television stationprogramming to satellite service subscribers. As a result of SHVIA, televisionstations are generally entitled to seek carriage on any DBS operator’s systemproviding local service in their respective markets. SHVIA creates a statutorycopyright license applicable to the retransmission of broadcast televisionstations to DBS subscribers located in their markets. Although there is noroyalty payment obligation associated with this license, eligibility for thelicense is conditioned on the satellite carrier’s compliance with theapplicable Communications Act provisions and FCC rules governing theretransmission of such “local” broadcast television stations to satelliteservice subscribers. Noncompliance with the Communications Act and/or FCCrequirements 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 compelmandatory access, there can be no assurance that it will not attempt to do so.Any such action may undermine the exclusivity provisions of our rights of entryon the one 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:

 

***We May Be Unable To Meet Our FutureCapital 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.

 

***We Have Incurred Losses Since Inception AndMay 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.

 

***We Have 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.

 

***We Depend Upon Our Relationship WithDIRECTV.***

 

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 atDIRECTV could adversely affect us. One of the most important of these isDIRECTV’s ability to provide programming that appeals to mass audiences.DIRECTV generally does not produce its own programming; it purchasesprogramming from third parties. DIRECTV’s success - and accordingly ours -depends in large part on its ability to select popular programming sources andacquire access to this programming on favorable terms. We have no control orinfluence over this. If DIRECTV is unable to retain access to its currentprogramming, 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.

 

***We Face 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 significant investments in, and access to,programming. One of the competitive advantages of DBS systems is their abilityto provide subscribers with more channels and a better quality digital signal thantraditional analog cable television systems. Many cable television operatorshave made significant investments to upgrade their systems from analog todigital, significantly increasing the number and variety of channels and thequality of the transmission they can provide to their subscribers. As a resultof these upgrades, cable television operators have become better able tocompete with DBS providers. If competition from cable television operatorsshould increase in the future, we could experience a decrease in our number ofsubscribers or increased difficulty in obtaining new subscriptions.

 

***We Need 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.

 

***We Depend On Key Personnel To Maintain OurSuccess.***

 

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.

 

***Technological Change.***

 

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.

 

***System Disruptions.***

 

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.

 

***United StatesParticipation in a War or Military or Other Actions; Terrorism.***

 

Involvement in a war or other military action or acts of terrorism maycause significant disruption to commerce throughout the world. To the extentthat such disruptions result in 1) delays or cancellations of customer orders,2) a general decrease in consumer spending on satellite broadcast andinformation technology, 3) our inability to effectively market and distributeour products, or 4) our inability to access capital markets, our business andresults of operations could be materially and adversely affected. We are unableto predict whether the involvement in a war or other military action willresult in any long term commercial disruptions or if such involvement orresponses will have any long term material adverse effect on our business,results of operations, or financial condition.

 

***We May 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.

 

***We May Issue Shares Of Common Stock InThe 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 of Property**

 

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.****          ****Legal Proceedings**

 

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 aVote of Security Holders**

 

None.

 

**PART II**

 

**Item5.  Market for Common Equity and RelatedStockholder 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 |   |

 

These quotations reflectinter-dealer prices, without retail mark-up, mark-down or commission, and maynot 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 of Record**

 

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

 

**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 SecuritiesSales (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**

 

Seeabove for warrants associated with the June 30, 2003 and November 25,2003 private placements.

 

OnJuly 23, 2003, the Company issued to an investor a five year warrant topurchase 254,110 common shares at a price of $0.40 per share. The sharesunderlying the warrant are unregistered.

 

OnJuly 23, 2003, the Company issued to an investor a five year warrant to purchase193,253 common shares at a price of $0.40 per share. The shares underlying thewarrant 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.

 

**Item6.  Management’s Discussion and Analysisor 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**

 

MDUCommunications International, 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.

 

TheCompany earns its revenue through the sale of digital satellite televisionprogramming and high-speed Internet services to residents of MDUs. We negotiatelong-term access agreements with the owners and managers of MDU propertiesallowing us the right to provide digital satellite television and high-speedInternet services, and potentially other services, to their residents,resulting in monthly annuity-like revenue streams. We offer two types ofdigital satellite television service. First, we offer Digital Broadcast Service(“DBS”), which uses an in-suite set-top digital receiver for residents toreceive state-of-the-art digital satellite and local channel programming. ForDBS, we exclusively offer DIRECTV programming packages.  From our DBSofferings we receive the following revenue; (i) a substantial upfrontsubscriber commission from DIRECTV for each new subscriber, (ii) a percentageof the fees charged by DIRECTV to the subscriber each month for programming,(iii) a per subscriber monthly digital access fee we bill subscribers forrental of the set-top box and connection to the property satellite networksystem, and (iv) occasional other marketing incentives from DIRECTV. Second, weoffer Private Cable Service, where digital satellite television programming canbe tailored to the needs of an individual property and received through normalcable-ready televisions. Our revenues from Private Cable result from thedifference between the wholesale price charged to us by television programproviders and the price we charge subscribers for the private cable programmingpackage. We provide the DBS and Private Cable services on an individualsubscriber basis, but in many properties we provide these services in bulk,directly to the property owner, resulting in one invoice and thus minimizingchurn, collection and bad debt exposure. On occasion, we derive revenue frominstallation services to building owners and managers for property wiring andthe installation of equipment to allow for telecommunications services. Most ofour services can be installed to receive high definition television (HDTV).

 

Webegan offering high-speed (broadband) Internet access services in July of2000. In July of 2001, we entered into a Master Lease Agreement toPurchase Equipment with Cisco Systems, Inc. (“Cisco”). Under thisagreement, we receive preferred pricing and discounts for equipment purchasedto support our high-speed Internet services. As part of this agreement, Ciscohas extended $500,000 of lease financing to the Company to purchase Internetrelated equipment and to finance a portion of installation costs. AtSeptember 30, 2003 the Company has $272,000 available under the agreementwith Cisco. From subscribers to our Internet service, we earn a monthlyInternet access service fee.  Again, in many properties we provide thisservice in bulk.

 

Industry-wide,demand for digital satellite television is outpacing traditional cable. TheTelevision Bureau of Advertising recently reported that franchised cablepenetration rates are at a six-year low.  Nielson Media Research hasreported that wired cable has fallen from 69.2% of American homes to 68.9% inthe past year (2002). During the same period, digital satellite television increasedits penetration from 12.3% of American homes to 14.4%.  For the periodSeptember 2002 to September 2003, CNNMoney reports that the cableindustry lost another 1% of subscribers, while the satellite industry increasedits subscriber base by 12%. The trend is expected to continue. The Carmel Groupis forecasting a 0.6% annual decline in subscribers to wired cable, whereassatellite television is expected to grow at a rate of 8.2% per year, through2008.

 

During 2003,the Company reached and maintained an important milestone; positive earningsbefore interest, taxes, depreciation, amortization and non-cash stock optioncharges (“EBITDA”) of $923,791.  TheCompany uses the common performance gauge of EBITDA (inclusive of non-cashstock option charges) to evidence earnings exclusive of mainly non-cash events,as is common in the technology, and particularly the cable andtelecommunications industries. We believe that EBITDA is important becausepeople who follow our industry frequently use it as a measure of financialperformance and ability to pay debt service, if any.  The most directly comparable GAAP reference is simply the removalof - in the Company’s case - interest, depreciation, amortization and non-cashcharges related to its stock options. 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.

 

The following table reconcilesthe comparative EBITDA of the Company to our consolidated net loss as computedunder accounting principles generally accepted in the United States of America:

 
|                                             |   | **2003**   |       | **2004** |   |
|--------------------------------------------------|--------|------------|------------|----------|--------|
| EBITDA                                           |   | $          | 923,791    |     | $      | (1,265,366 | ) |
| Interest Expense                                 |   | (998,659   | )          | (865,743 | )      |
| Depreciation and Amortization                    |   | (1,264,792 | )          | (856,927 | )      |
| Effect of Variable Accounting for Options  Plans |   | (714,130   | )          | —   |   |
| Amortization of Unearned Compensation            |   | (63,917    | )          | —   |   |
| Net Loss                                         |   | $          | (2,117,707 | )        | $      | (2,988,036 | ) |

 

Recurringrevenue as a percentage of total revenue has been substantially increasing.Recurring revenue consists of monthly access fee charges to subscribers, theDIRECTV monthly residual and commissions, the monthly programming revenue fromprivate cable subscriptions and the monthly Internet access fee.  As our subscriber base increases, ourrecurring revenue increases.  Inaddition, our non-recurring revenue is decreasing due to the emphasis away fromproviding property wiring services and satellite system sales.  During the period ended September 30,2003, recurring revenue was 96% of total revenues, whereas on average forfiscal year 2002, it was only 54%.  As for subscriber growth, the Companyhad to again maintain slow growth during the fourth quarter due to financialconstraints, and in addition, 1,273 non-core subscribers were sold by the JointVenture during the fourth quarter. At September 30, 2003 the Company had atotal of 12,589 subscribers. However, with the proceeds from the June 30,2003 and November 24, 2003 equity financings, mentioned below, the Companybelieves that it will be able to again significantly increase subscribers inthe 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 subscriber growthin upcoming quarters.

 

OnJuly 28, 2003, the Company purchased AvalonBay Cable I, Inc.’s fiftypercent interest in the Avalon Digital Joint Venture for approximately$320,000. As of that date, the Avalon Digital Joint Venture provided servicesto approximately 2,084 subscribers in eleven properties.  On July 30,2003, the Avalon Digital Joint Venture sold 1,273 digital satellite televisionsubscribers in five properties to CSC Holdings, Inc. for $1,200 per subscriber.The total sales price, including an amount applicable to certain equipment, was$1,557,600.

 

Althoughwe have incurred operating losses since inception, since focusing on operationsin the most profitable U.S. markets, our recurring revenues have steadilyincreased. As such, we should be able to maintain positive EBIDTA on agoing forward basis and reach profitable operations with existing resources.

 

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**Critical Accounting Policies 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 under thecircumstances. Accordingly, actual results could differ from these estimatesunder different assumptions or conditions. This section summarizes thecritical accounting policies and the related judgments involved in theirapplication.

 

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

 

New subscriber activationsubsidies from the satellite programming provider are recognized as revenue ona straight-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 equity instrumentsto employees and nonemployees as consideration for goods or services receivedby us are accounted for based on the fair value of the consideration receivedor the fair value of the equity instrument, whichever is more readilymeasurable. Such fair value is measured at an appropriate date pursuant to theguidance in the consensus reached for EITF Issue No. 96-18 (generally, theearlier of the date the other party becomes committed to provide goods orservices or the date the performance by the other party is complete) andcapitalized or expensed as if we had paid cash for the goods or services. Forpurposes of determining the fair value of options and warrants using theBlack-Scholes option pricing model, we have used the following assumptions inthe years ended September 30, 2003 and 2002: Expected Volatility 127%;Risk Free Interest Rate 4.75%; Expected Years of Option Life 1 to 5 years;and Expected Dividends 0%.

 

Given an active tradingmarket for our common stock, we estimate the volatility of our stock based on weekending closing prices over a historical period of not less than one year. As aresult, 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:*

 

Weregularly evaluate our ability to recover the reported amount of our deferredincome taxes and other deferred tax assets considering several factors,including our estimate of the likelihood that 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:*

 

Weassess the recoverability of long-lived tangible and intangible assets wheneverwe determine that events or changes in circumstances indicate that theircarrying amount may not be recoverable. Our assessment is primarily based uponour estimate of future cash flows associated with these assets. Although therehas been a sustained weakness in our operating results throughSeptember 30, 2003, we continue to project income in the future.Accordingly, we have determined that there has not been an impairment of any ofour long-lived assets. However, should our operating results deteriorate, wemay determine that some portions of our long-lived tangible or intangibleassets are impaired. Such determination could result in non-cash charges toincome that could materially affect our consolidated financial position or resultsof operations for that period.

 

**RESULTS OF OPERATIONS FOR 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. Thisincrease is primarily the result of (i) serving a significantly largersubscriber base throughout the course of the full year as opposed to the yearending September 30, 2002, and (ii) increasing our levels of customerservice and satisfaction, and (iii) upgrades and maintenance to our DatamanSubscriber Management System (SMS), which is our internally developed softwaresystem used to manage, deploy, track and bill our customers. We anticipatecustomer service expenses will increase proportionally with achieved growthduring 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                    | %      |
|                   |        |                                         |         |                      |        |                                         |        |                      |        |  |  |

 

***Other Non-Cash Charges.***    Interest expense inthe twelve months ended September 30, 2003 was $998,659 compared tointerest expense at September 30, 2002 of $865,743. Of these amounts,$914,779 and $730,667 were respectively non-cash interest expense items relatedto amortization of the fair value of warrants and the beneficial conversionfeature related to the issuance of convertible notes issued during the twelvemonths ended September 30, 2003 and 2002, respectively.

 

***Settlement of Liabilities***.    During the yearended September 30, 2003, we settled certain outstanding trade payablesfor a gain of $175,011, with no settlement of trade payables occurring in theyear ending September 30, 2002. During the year ended September 30,2003, we incurred noncash charges in the amount of $174,472 relating to theconversions of promissory notes into common stock, with no similar chargesbeing 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 CAPITAL RESOURCES**

 

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) adisproportionate number of subscribers churn relative to the number of qualitysubscribers we enroll; (ii) we are not able to enroll a sufficient number ofquality subscribers, or (iii) we do not realize desirable aggregate marginsfrom our subscriber base, our

 

19

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

 

Subsequentto September 30, 2003, we received net proceeds of $3,300,000 relating tothe sale of units in a private placement as of November 24, 2003 and netproceeds from the exercise of warrants and options in the amount of $1,763,505for total additional liquidity of $5,063,505.

 

Thefollowing table displays payments for our contractual obligations outstandingat 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 had available$272,000 under the agreement.

 

Duringthe year ended September 30, 2003, we used $793,045 for the repayment ofcertain notes payable.  In addition, we (i) issued 3,447,506 shares ofcommon stock in connection with conversion of notes payable and accrued interestthereon in the amount of $1,168,992, (ii) issued 944,559 shares of common stockfor accrued salaries of $198,841, (iii) issued 140,000 shares of common stockwith a fair value of $26,600 as partial settlement of a trade accounts payable,and  (iv) converted five tradeaccounts payable in the total amount of $186,594 into five short term notepayables.

 

OnFebruary 28, 2003 we entered into two short-term 90 day notes with twoinvestors for $125,000 each at an interest rate of 16%. Upon maturity, thesenotes were extended for an additional 90 days with principal and interest beingpaid in full on August 27, 2003.

 

OnJune 10, 2003 we began offering a private placement of equity securitiespursuant to a confidential offering memorandum of 11 units comprised of 300,000common shares and 300,000 warrants to purchase common shares for grossaggregate proceeds of $825,000.  OnJune 30, 2003, the private placement was closed resulting in net cashproceeds to the Company of $663,937.

 

***Settlement of Accounts Payable***.    During the yearended September 30, 2003, we settled certain outstanding trade payablesfor a gain of $175,011.

 

20

----

 

***Gain on Sale of Customers. ***On December 6, 2002, we entered into anagreement to sell certain equipment and customer lists associated with aparticular multi-dwelling unit property. The sales price was fixed at $1,150 cash per active subscriber, plus aspecified amount for certain equipment for a total sales price of$185,150.  On January 16, 2003, weentered into an agreement to sell certain equipment and customer listsassociated with a particular multi-dwelling unit property.  The sales price was fixed at $67,000 cash.  On July 30, 2003, we entered into anagreement to sell certain equipment and customer lists associated with fivemulti-dwelling unit properties.  Thesales price was fixed at $1,200 cash per active subscriber, plus certainequipment for a total of $1,557,600, as adjusted.  As a result of the aforementioned sale, we recognized total gainsfrom sales of customers of $869,259 for the year ended September 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

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**Item7—Financial Statements**

 

**REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS**

 

Board of Directors andStockholdersMDU Communications International, Inc.

 

Wehave audited the accompanying consolidated balance sheets of MDU CommunicationsInternational, Inc. and Subsidiaries as of September 30, 2003, and2002, and the related consolidated statements of operations, stockholders’equity and cash flows for the years then ended. These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

Weconducted our audits in accordance with auditing standards generally acceptedin the United States of America. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe consolidated financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of MDU CommunicationsInternational, Inc. and Subsidiaries as of September 30, 2003 and2002, and their results of operations and cash flows for the years then ended,in conformity with accounting principles generally accepted in the United Statesof 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

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**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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**MDU COMMUNICATIONS 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*

 

The consolidated financialstatements include the accounts of the Company and its subsidiaries, MDUCommunications Inc., MDU Communications (USA) Inc. and, effectiveOctober 1, 2002, Avalon Digital Joint Venture (the “Joint Venture”).  All inter-company balances and transactionsare eliminated.

 

*(b)**Use of Estimates*

 

The preparation of the consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Significant estimates are used for, but not limited to,revenue recognition with respect to a new subscriber activation subsidy,allowance for doubtful accounts, fair value of equity instruments and valuationof deferred tax assets and long lived assets. Actual results could differ fromthose estimates.

 

*(c)**Property and Equipment*

 

Telecommunications equipmentinventory consists of receivers and other supplies that will either be sold orinstalled by the Company under subscription agreements and, accordingly, is notdepreciated. Such inventory is stated at the lower of cost or market. The costof inventory sold or

 

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transferred totelecommunications equipment upon installation in connection with subscriptionagreements is determined on a first-in, first-out basis.

 

Property and equipment arerecorded at cost less accumulated depreciation and amortization. Direct costsof placing telecommunications equipment into service and major improvements arecapitalized. Costs of connecting and disconnecting service are expensed.Depreciation and amortization of property and equipment is provided using thestraight-line method over the estimated useful lives as follows:

 

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

 

*(d)**Investment in Joint Venture*

 

Prior to October 1,2002, the Company’s investment in the Joint Venture was recorded on the equitybasis whereby the Company recorded its proportionate share of income or lossfrom the joint venture. Dividends received were recorded as reductions in thenet investment.

 

*(e)**Intangible Assets*

 

Intangible assets consist ofbuilding access agreements and subscriber lists, which were acquired in thepurchase of Digital Solutions, LLC and the acquisition of video assets fromVerizon and are being amortized on the straight-line basis over four to fiveyears.

 

*(f)**Long-lived Assets*

 

The Company performs areview for the impairment of long-lived assets with definitive lives wheneverevents or changes in circumstances indicate that the carrying amount of an assetmay not be recoverable. Under Statement of Financial Accounting Standards(“SFAS”) 144 “Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to be Disposed of,” an impairment loss is recognized whenestimates of future undiscounted cash flows expected to result from the use ofan asset and its eventual disposition are less than its carrying amount. Noimpairment losses were identified by the Company for the years endedSeptember 30, 2003 and 2002.

 

*(g)**Revenue Recognition*

 

The Company recognizesrevenue for satellite programming and other services to customers in the periodthe related services are provided when the amount of revenue is determinableand collection is reasonably assured.

 

The Company offersinstallation services to building owners and managers for the construction ofwiring and installation of equipment to allow for telecommunications services,including the sale of related equipment. Revenue from the sale of equipment isrecognized when title transfers and installation revenue is recognized in theperiod that the services are performed when the amount of revenue isdeterminable and collection is reasonably assured.

 

In certain arrangements withsuppliers of satellite programming or other services, the Company does not bearinventory or credit risk in connection with the service provided to thecustomer.  For those arrangements wherethe Company does not act as a principal in the transaction, such revenue isrecorded on the net basis and, accordingly, the amount of revenue is equivalentto the contractual commission earned by the Company. Revenues from providingservices under contracts where the Company acts as a principal in thetransaction, exercises pricing control and

 

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bears the risk of collectionare recorded based on the gross amount billed to the customer when the amountis determinable.

 

The Company may also receivea new subscriber activation subsidy from the satellite programming provider atthe time it signs up a new customer. However, this subsidy is a “net” subsidy,meaning that if the subscriber terminates service, the subsidy is recouped bythe programming provider through an offset against the subsidy earned onanother new customer. These subsidies are recognized as revenue on astraight-line basis over the estimated average period that a customer willremain a subscriber of four years.

 

Revenues from contractsinvolving multiple elements are allocated to each element based on the relativefair value of each element.

 

The Company provides anallowance for doubtful accounts equal to the estimated collection losses basedon historical experience coupled with a review of the current status ofexisting receivables.

 

*(h)**Loss Per Common Share*

 

The Company presents “basic”earnings (loss) per share and, if applicable, “diluted” earnings per sharepursuant to the provisions of Statement of Financial Accounting Standards No.128, “Earnings per Share.” Basic earnings (loss) per share is calculated bydividing net income or loss by the weighted average number of common sharesoutstanding during each period. The calculation of diluted earnings per shareis similar to that of basic earnings per share, except that the denominator isincreased to include the number of additional common shares that would havebeen outstanding if all potentially dilutive common shares, such as thoseissuable upon the exercise of stock options and warrants, and the conversion ofpromissory notes, were issued during the period and other related adjustmentswere made.

 

There were 12,360,677potentially dilutive common shares (9,467,363 from warrants; 2,815,000 fromoptions; 78,314 from convertible notes) as of September 30, 2003 and10,380,047 potentially dilutive common shares (4,577,500 from warrants;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*

 

Effective September 30,2001, the Company adopted the United States dollar as its functional andreporting currency since a majority of the Company’s revenues, expenses, assetsand liabilities are in the United States and the focus of the Company’soperations is in that country. Previously, the Company’s functional andreporting 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 and2002 and cumulative translation gains and losses as of September 30, 2003and 2002 were not material.

 

*(j)**Stock-Based Compensation*

 

As permitted underSFAS 123, “Accounting for Stock-Based Compensation,”(“SFAS 123”) theCompany has accounted for employee and director stock options using theintrinsic value method in accordance with Accounting Principles Board (“APB”)Opinion 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and has madethe pro forma disclosures required by SFAS 123

 

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in Note 4. Under APB25, compensation charges arise from those situations where options are grantedto employees and directors at an exercise price lower than the fair value ofthe underlying common shares. These amounts are amortized as a charge tooperations over the vesting periods of the related stock options.

 

For variable stock optionplans, the Company recognizes a compensation expense or credit for the increaseor decrease in the intrinsic value of the option. The intrinsic value isrepresented by the excess of the market price of the Company’s stock over theexercise price of the option.

Stock-based compensationcharges to other than employees are recorded over the period that the relatedstock option or warrant is earned. The amount of the compensation is based onthe fair value of the option or warrant at the applicable measurement date.

 

*(k)**Cash and Cash Equivalents*

 

Cash and cash equivalentsconsist of bank deposits and short-term notes with original maturities at thedate of acquisition of 90 days or less that have insignificant interestrate risk.

 

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

 

The fair value of theCompany’s cash and cash equivalents, accounts receivable, accounts payable,other accrued liabilities, notes payable and capital lease obligations atSeptember 30, 2003 and 2002 are estimated to approximate their carryingvalues due to the relative liquidity or short-term nature of these instruments.

 

*(m)**Credit Concentration*

 

Financial instruments thatpotentially subject the Company to a concentration of credit risk consist principallyof cash and cash equivalents and accounts receivable.

 

The Company places its cashand cash equivalents with high credit quality institutions.  At September 30, 2003, the Company hascash balances that exceed Federally insured limits in the amount ofapproximately $290,000**.**Accountsreceivable from DIRECTV (see Note 6) at September 30, 2003 and 2002,respectively, represented 25% and 42% of total trade accounts receivable.Revenues realized from DIRECTV represented 18% and 12% of total revenues in theyears ended September 30, 2003 and 2002, respectively.

 

The Company provides anallowance for bad debts based on historical experience and specificallyidentified risk.

 

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

 

Loan fees and other debtissuance costs are deferred and amortized to interest expense over the term ofthe related loan on a straight-line basis. Debt discount is offset against theprincipal balance and amortized using the interest method over the term of therelated loan.

 

*(o)**Income Taxes*

 

The Company accounts forincome taxes pursuant to the asset and liability method which requires deferredincome tax assets and liabilities to be computed annually for temporarydifferences between the financial statement and tax bases of assets and liabilitiesthat will result in taxable or deductible amounts in the future based onenacted tax laws and rates applicable to the periods in which the differencesare expected to affect taxable income. Valuation allowances are establishedwhen necessary to reduce deferred tax assets to the amount expected to berealized. The income

 

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tax provision or credit isthe tax payable or refundable for the period plus or minus the change duringthe period in deferred tax assets and liabilities.

 

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

 

The Financial AccountingStandards Board, the Emerging Issues Task Force (the “EITF”) and the AccountingStandards Executive Committee of the American Institute of Certified PublicAccountants have issued certain accounting pronouncements as ofSeptember 30, 2003 that will become effective in subsequent periods;however, management of the Company does not believe that any of thosepronouncements would have significantly affected the Company’s financialaccounting measurements or disclosures had they been in effect during 2003 and2002, and it does not believe that any of those pronouncements will have asignificant impact on the Company’s consolidated financial statements at the timethey become effective.

 

*(q)**Reclassifications*

 

Certain prior year amountshave been reclassified to conform to the presentations in the consolidatedfinancial statements as of and for the year ended September 30, 2003.

 

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

 

Notes payable under termloans and convertible promissory notes payable outstanding as ofSeptember 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, the Company entered into a Term Loan andPromissory Note Agreement with a supplier, North Supply Company, for $22,174.The note has a term of one year with twelve equal monthly payments of principaland earned interest at a stated rate of 6.5%.

 

(b)         On February 20, 2003, the Company entered into a Term Loan andPromissory Note Agreement with a supplier, TLA Associates, for $21,724. Thenote has a term of one year with twelve equal monthly payments of principal andearned interest at a stated rate of 11%.

 

(c)          On January 10, 2003, the Company entered into a Term Loan andPromissory Note Agreement with a supplier, Distinctive Communications, Inc.,for $23,215. The note has a term of ten months with ten equal monthly paymentsof principal and earned interest at a stated rate of 9%.

 

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

 

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term of twelve months withtwelve equal monthly payments of principal and earned interest at a stated rateof 12%.

 

(e)          On September 30, 2002, the Company entered into a Term Loan andPromissory Note Agreement with a supplier, Blonder Tongue Laboratories, Inc.,for $30,165. The note has a term of two years with eight equal quarterlypayments of principal and earned interest at a stated rate of 9%. The note issecured by certain assets and equipment.

 

(f)            On January 24, 2002, the Company enteredinto a Convertible Promissory Note and Loan Agreement with Roselink Investors,LLC (“Roselink”) for $100,000. The Promissory Note is for two years at a statedinterest rate of 9%, with quarterly repayment of principal and earned interest.If the Company does not make the quarterly payment of principal and earnedinterest, it automatically converts to common stock at a conversion price of$0.33 per share. As additional consideration in connection with the issuance ofthe Promissory Note, the Company issued 300,000 warrants to Roselink at anexercise price of $0.43 per share for a two-year exercise period with anestimated fair value of $111,000, as calculated using a Black-Scholes optionpricing model in accordance with SFAS 123. In addition, the fair value ofthe Company’s common stock on January 24, 2002 was $0.37 per share, whichexceeded the effective conversion price for the Promissory Note resulting in aBeneficial Conversion Feature of $130,303. As a result, the aggregate fairvalue of the warrants and the Beneficial Conversion Feature associated with thePromissory Note was $241,303. Since the amount of the debt discount cannotexceed the principal balance of the Promissory Note, the Company initiallyincreased additional paid-in capital by $100,000 and reduced the carrying valueof the Promissory Note by a corresponding amount.  Because payments were not made, they automatically converted. Atotal of 166,825 and 88,542 common shares were issued for this obligation duringthe years ended September 30, 2003 and 2002, respectively.

 

(g)         On August 8, 2003, the Company entered into a Term Loan andPromissory Note Agreement with a consultant, Tim Lucy, for $4,770. The note hasa term of three months with three equal monthly payments of principal andearned interest at a stated rate of 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 offsetting increaseto 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 furtherconsideration for the extension, the Company issued warrants to purchase150,000 shares of common stock at an exercise price of $.25 per share throughNovember 26, 2005 to Berhoff. Such warrants had a fair value of $28,500calculated using a Black-Scholes option pricing model. Accordingly, the Companyinitially increased debt discount and additional paid-in capital by the fairvalue of the warrants. On July 23, 2003, Lloyd Berhoff, agreed to convertthe principal balance of the note and accrued interest thereon which aggregated$77,301 into 193,253 shares of common stock. In addition, the Company issued warrants to Berhoff to purchase 193,523shares of common stock at an exercise price of $.40 per share throughJuly 23, 2008.  The fair value ofthe warrants of $75,369, as calculated using a Black-Scholes option pricingmodel, was charged to other expense with an offsetting credit to additionalpaid-in capital in accordance with SFAS 84, “Induced Conversions of ConvertibleDebt” (“SFAS 84”).   As ofSeptember 30, 2003, all payments of principal and interest had been madeand the Company had no further obligation 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 theprincipal amount 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 Companyinitially increased additional paid-in capital by $85,500 representing the fairvalue of the warrants and reduced the carrying value of the notes for the debtdiscount attributable to the fair value of the warrants. In addition, theCompany paid $33,000 of legal and other professional fees in connection withthe sale of the notes and, accordingly, recorded deferred finance costs of anequivalent amount. The debt discount and deferred finance costs were amortizedto interest expense over the lives of the notes. As of September 30, 2003, all payments ofprincipal and interest had been made and the Company had no further obligationunder the terms of the notes.

 

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 PromissoryNote by a corresponding amount. In addition, the placement agent, Haywood Securities Inc.,received 150,000 shares of Company stock with a fair value of $75,000 andwarrants to purchase 150,000 shares of the Company’s common stock at anexercise price of $0.43 for a two-year period with a fair value of $55,500, ascalculated using a Black-Scholes option pricing model. Accordingly, the Companyincreased common stock and additional paid-in capital and deferred financecosts for the fair value of the common stock and warrants issued. A total of 2,598,374 and 527,365 common shareswere issued for this obligation during the years ended September 30, 2003and 2002, respectively. As of September 30, 2003, all payments ofprincipal and interest had been made and the Company had no further obligationunder 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:***

 

On January 28, 2000,the Company issued 3,630,000 shares of Series A Convertible PreferredStock (the “Preferred Shares”), at an issue price of $2.50 per share, inexchange for cash and services in connection with a private placement. A totalof 3,637,200 Preferred Shares were converted in the year endedSeptember 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.

 

As of September 30,2003, the Company was still authorized to issue up to 5,000,000 shares ofpreferred stock with a par value of $.001 per share. The preferred stock may beissued in one or more series with dividend rates, conversion rights, votingrights and other terms and preferences to be determined by the Company’s Boardof Directors, subject to certain limitations set forth in the Company’sArticles of Incorporation. However, there were no shares of preferred stockoutstanding as of September 30, 2003.

 

***Stock Option Plans:***

 

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

 

On December 31, 1998,the Company established a stock option plan pursuant to which certain key suppliersof the Company will be granted options on completion of specified activities.Under the terms of the Suppliers’ Plan, eligible suppliers can earn options topurchase an aggregate of 250,000 common shares of the Company. As ofSeptember 30, 2003, all 250,000 options had been granted.  During the year ended September 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 Company is subject tovariable accounting for such options and, accordingly has recognized a non-cashcredit of $500 during the year ended September 30, 2003 based on changesin the fair value of the options subsequent to the date of repricing.

 

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

 

On November 24, 1998,the Company established Employee Plans whereby certain employees, officers anddirectors were granted options to purchase up to an aggregate of 600,000 commonshares of the Company. On February 5, 2000, the Company approved the 2000Incentive Stock Option Plan (“2000 Option Plan”). Under the 2000 Option Plan,the Company was authorized to grant certain employees, consultants, officersand directors of the Company and its affiliates options to purchase up to4,000,000 common shares of the Company at $5.00 per share. The options havevesting periods ranging from immediate to three years after the grant date. Ofthe options originally authorized as part of the

 

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

 

On April 11, 2001, theBoard of Directors approved the 2001 Stock Option Plan (“2001 Option Plan”) toreplace the 2000 Option Plan. The 2001 Option Plan is in all respects identicalto the 2000 Option Plan, which had not been approved by a vote of thestockholders within one year of its adoption by the Board and therefore becameineffective. The 2001 Option Plan was approved by a vote of the stockholders atthe Annual General Meeting on May 10, 2001.  In October 2000, the Board of Directors of the Companyapproved the re-pricing, at $2.00 per share, of the exercise price of alloptions previously granted at $5.00 per share under the 2000 Option Plan. OnMarch 9, 2001, the Board of Directors approved the re-pricing, at $0.60per share, of these same options. On April 11, 2001, the Board ofDirectors of the Company approved the re-pricing, at $0.60 per share, of alloptions previously granted to directors at $2.50 per share under the 2000 OptionPlan.  During the year endedSeptember 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.

 

On May 9, 2002, theBoard of Directors of the Company granted a total of 230,000 options pursuantto the 2001 Option Plan to employees. These options have a five-year term andan exercise price of $0.60 per share.

 

On September 12, 2002,the Board of Directors of the Company granted each independent Board memberadditional options as compensation for sitting on the Board for the current andupcoming year. Douglas Hooper, J.E. “Ted” Boyle and Robert Dyck each received50,000 fully vested options at an exercise price of $0.60 per share,exercisable for five years.

 

On July 29, 2003 theBoard of Directors granted a total of 215,000 options pursuant to the 2001Option Plan to employees.  These optionshave a five-year term and an exercise price of $0.33 per share.

 

The Company accounts for itsstock-based employee compensation plans under the intrinsic value method perAPB 25 whereby compensation cost is recorded for the excess, if any, of thequoted market price of the common shares over the exercise price at the date ofgrant for all employee stock options issued. For the years endedSeptember 30, 2003 and 2002, there was no excess and, accordingly, nocompensation cost was required to be recorded in connection with options issuedto directors, officers and employees.

 

Since the Company haselected to continue to use the provisions of APB 25 in accounting for stockoptions granted to employees, it is required by SFAS 123 and SFAS 148,“Accounting for Stock-Based Compensation — Transition and Disclosure,” topresent additional pro forma information showing effects on its historical resultsof operations of the use of a method that estimates the fair value of theoptions at the grant date and then amortizes the fair value to expense over theoptions’ vesting period. Had the Company elected to recognize compensationexpense based upon the fair value at the grant dates for awards under theseplans, net loss and loss per common share would have been increased to the proforma amounts shown in the table below. The fair value of each grant was estimated on the

 

36

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date of grant using theBlack-Scholes option pricing model and the assumptions set forth inNote 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 | ) |

 

The unamortized fair valueof all remaining outstanding employee stock options as of September 30,2003 is $78,413, which will be charged to pro forma net earnings in futureyears according to the vesting terms of the options.

 

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

 

On February 28, 2003,the Company granted five-year options to purchase a total of 25,000 shares ofcommon stock under the 2001 Option Plan to a consultant in exchange forservices. The options were originally granted at an exercise price of $0.60 pershare but were repriced on July 23, 2003 at $0.33 per share. The fairvalue of the options, as calculated using a Black-Scholes option pricing modelin accordance with SFAS 123 (See Note 4(d)), was $3,750, which was chargedto general and administrative expenses in the year ended September 30,2003.

 

On January 17, 2003,the Company granted options to purchase a total of 150,000 shares of commonstock under the 2001 Option Plan to a consultant in exchange for services.Options to purchase 75,000 shares became vested immediately and exercisable at$0.60 per share and options to purchase the remaining 75,000 shares vest overone year and are exercisable at $1.00 per share.  All of these options expire in two years from the date of grant.The fair value of the options, as calculated using a Black-Scholes optionpricing model in accordance with SFAS 123 (See Note 4(d)) was $18,750,which was charged to general and administrative expenses in the year endedSeptember 30, 2003.

 

On May 9, 2002, theCompany granted options to purchase a total of 50,000 shares of common stockunder the 2001 Option Plan to a consultant in exchange for services. Theoptions are exercisable at $0.60 per share, vested immediately and areexercisable for a period of five years. The fair value of the options, ascalculated using a Black-Scholes option pricing model in accordance withSFAS 123 (see Note 4(d)) was $20,000, which was charged to generaland administrative expenses in the year ended September 30, 2002.

 

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

 

The Employees’ Plans wereinitially authorized to issue a total of 4,000,000 shares and the Suppliers’Plan was authorized to issue a total of 250,000 shares. The following tablesummarizes all of the Company’s stock option activity during the years endedSeptember 30, 2003 and 2002:

 

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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   |   |

 

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

 

As at 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               |      |
|                      |        |                         |           |                                                              |        |                         |           |  |

 

The 436,832 unvested optionsoutstanding at September 30, 2003 vest over a three-year period.

 

***Warrants Issued:***

 

During the year endedSeptember 30, 2003 the Company issued warrants to purchase 5,287,363shares of common stock at an average weighted exercise price of $0.33 pershare.  Such warrants had an estimated fair value of $264,022 at the dateof grant calculated using a Black-

 

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Scholes option pricingmodel. Accordingly, the Company initially increased unearned compensation andadditional paid-in capital by the fair value of the warrants.

 

The following tablesummarizes all of the Company’s warrant activity during the years endedSeptember 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)   Certain of the warrants issued to investorscontain cashless exercise provisions. During the year ended September 30,2003, certain investors exercised warrants to purchase 232,500 shares of commonstock pursuant to the cashless provision, therefore warrants to purchase137,847 shares were canceled as payment for the exercise price of the 94,653shares issued.  As the fair value of thewarrants at the date of grant exceeded the fair value of the shares issued uponexercise, no additional compensation was recorded in the accompanyingconsolidated financial statements.

 

(2)          TheCompany granted the following options during the year ended September 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 wereissued in connection with notes payable (See Note 3).

 

(B) These warrants wereissued pursuant to consulting agreements. The fair value of such warrants of $125,000 as determined using aBlack-Scholes option pricing model was initially charged to unearnedcompensation with an offsetting credit to additional paid-in capital.  The unearned compensation, which isreflected as a reduction of stockholders’ equity, is being amortized to theappropriate expense over the benefit period of the consulting agreement.

 

(C) See description ofprivate placement below.

 

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

 

The fair value of the warrantsissued in connection with the issuances of notes payable, the fair value of theoptions issued to employees used in connection with the computation of proforma net loss and loss per common share and the fair value of the options andwarrants issued to non-employees in exchange for consulting, marketing andfinancial services were estimated using a Black-Scholes option-pricingmodel with the following weighted-average assumptions used 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:***

 

On October 23, 2001,the Company established, and the Board of Director’s approved, the 2001Employee Stock Purchase Plan (“Purchase Plan”) whereby certain employees(i) whose customary employment is greater than 20 hours per week,(ii) are employed for at least six consecutive months, and (iii) donot own five percent or more of any class of Company stock can participate inthe Purchase Plan and invest from one percent to fifty percent of their netpay, through payroll deduction, in Company common stock. In addition,participating employees can invest from one percent to one hundred percent ofany Company bonus in Company common stock. Employees are limited to a maximuminvestment per calendar year of $25,000.

 

There are a maximum numberof shares of Company common stock reserved under the Purchase Plan of 2,000,000shares. The Purchase Plan shall terminate in five years or (i) upon themaximum number of shares being issued, or (ii) sooner terminated per thediscretion of the administrator. The purchase price per share under thePurchase Plan is equal to 85% of the fair market value of a share of Companycommon stock at the beginning of the purchase period or on the exercise date(the last day in a purchase period) whichever is lower.

 

During the years endedSeptember 30, 2003 and 2002, the Company issued 424,875 and 473,459 sharesrespectively, to employees under the Purchase Plan. The aggregate purchase pricefor those shares of $83,976 and $119,413, respectively, was paid by theemployees through the offset of the amount they owed for the shares against anequivalent amount the Company owed them for accrued salaries or severance.Funds derived from the employee purchase of Company common stock under thePurchase Plan can be used for general corporate purposes.

 

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

 

On January 29, 2003,the Company issued 169,533 shares to an executive officer to pay $50,250 ofsalary accrued as of September 30, 2002.

 

On August 5, 2003, theCompany issued 207,843 shares to an executive officer to pay $36,000 of salaryaccrued during the year ending September 30, 2003.

 

40

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On September 30, 2003,Board of Directors authorized the issuance of 50,000 shares of common stockwith a fair value of $12,000 to an executive officer as additional salary.

 

***Shares Issued Pursuant to Severance Agreement:***

 

During the year endedSeptember 30, 2003, the Company issued 92,308 shares of common stock to aformer employee to pay accrued compensation of $16,615 pursuant to a severanceagreement. The Company had no further obligation to the employee as ofSeptember 30, 2003.

 

***Shares Issued for Settlement of Accounts Payable:***

 

Pursuant to a settlementagreement with Direct Focus, a supplier, the Company issued 140,000 shares ofcommon stock during the year ended September 30, 2003 with a fair value of$26,600 as partial settlement of an outstanding trade payable and recognized again of approximately $36,000, which is included in the gain on settlement ofaccounts payable of $175,011 in the accompanying consolidated statement ofoperations.

 

***Shares Issued Pursuant to Private Placement:***

 

On June 10, 2003, theCompany began offering 11 units of common stock and warrants at $75,000 perunit to raise up to $825,000 through a Confidential Offering Memorandum withCasimir Capital L.P. as placement agent.  Each unit consisted of 300,000common shares and warrants to purchase 300,000 common shares at an exerciseprice of $0.33 per share through June 2008. The Company closed the sale ofall 11 units on June 30, 2003 and received proceeds of approximately$664,000, net of fees and expenses of approximately $161,000. The Company alsoissued 600,000 warrants to the placement agent for services in connection withthe offering of the equity securities. The Company issued 3,300,000 common shares for this obligation onJune 30, 2003.

 

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

 

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

 

The Company has been namedas a defendant in a lawsuit by Whistler Cable Television Ltd. claimingdamages for conversion, the return of personal property, an injunction andcosts. The Company has filed a defense disputing that the plaintiff has anylegal right to bring the action, and alleging that in any event the amount ofdamages suffered, if any, is minimal. As of September 30, 2003, this casewas still in the pre-discovery phase. Given the preliminary stage of theproceedings, it was not possible for management to estimate or determinewhether there will be any loss to the Company. The amount, if any, of such losswill be recorded in the period in which it becomes determinable.

 

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

 

The Company has previouslyentered into a management agreement with a senior executive that provides forannual compensation, excluding bonuses, of $180,000. The Company can terminatethis agreement at any time upon reasonable notice and the payment of an amountequal to 24 months of salary. In the event of a change in control of theCompany, either party may, during a period of 12 months from the change ofcontrol, terminate the agreement upon reasonable notice and the payment by theCompany of an amount equal to 36 months of salary.

 

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

 

As of September 30,2003, the Company was in a dispute with WorldCom over charges of $58,367 basedon their pricing of two T-1 lines for Internet service. It is the Company’sposition that the pricing should be consistent with written quotes received bythe Company from WorldCom. WorldCom has been charging a substantially moresignificant price. WorldCom has been unresponsive to requests to negotiate.Management believes that the Company has made appropriate accruals as ofSeptember 30, 2003 and the amount, if any, of charges to be recorded insubsequent periods in connection with these disputes will not be material.

 

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

 

The Company is required tomake future minimum rental payments of $81,470 during the year endedSeptember 30, 2004 under a non-cancelable lease for its facilities. Rentexpense under all operating leases amounted to $129,888 and $127,873,respectively, for the years ended September 2003 and 2002.

 

**6.    STRATEGIC ALLIANCES**

 

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

 

In May 2000, theCompany entered into a long-term System Operator Agreement withDirecTV, Inc. (“DIRECTV”), a California company. OnSeptember 29, 2003, the Company entered into a new System OperatorAgreement with DIRECTV, which replaced the System Operator Agreement previouslyexecuted by the Company and was due to initially expire on May 19,2005.  The Company’s contract with DIRECTV gives the Company a share ofmonthly 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***

 

In July 2001, theCompany entered into a Master Lease Agreement to Purchase Equipment with CiscoSystems, Inc. (“Cisco”). Under this agreement, the Company will receivepreferred pricing and discounts for equipment purchased to support theCompany’s high-speed Internet services. As part of this agreement, CiscoSystems 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.

 

Future minimum leasepayments under capital lease obligations in each of the years subsequent toSeptember 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  |   |

 

The net book value ofequipment under capital leases as of September 30, 2003 was $115,409 andis included in property and equipment.

 

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

 

InFebruary 2002, the Company executed an agreement with Verizon MediaVentures and Verizon Entertainment Services (“Verizon”) to purchase certainassets of its digital satellite video division. A majority of the funds raisedthrough the series of privately offered convertible promissory notes inJanuary 2002 were for the purchase, integration, maintenance and growth ofthe portfolio of subscribers and properties being acquired by the Company fromVerizon (see Note 3). The assets acquired consisted of digital satellitevideo subscribers and the equipment and systems to service these subscribers inMDU properties located mainly in the Northeast U.S. The total acquisition priceof $763,210 was attributable to building access agreements and customer listsand, accordingly, included in intangible assets. Intangible assets acquired arebeing amortized over four years.

 

**8.****             ****INVESTMENT IN AND TRANSACTIONS WITH AVALONBAY JOINTVENTURE**

 

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. TheCompany’s 50% investment in the Joint Venture had been accounted for pursuantto the equity method and, accordingly, the Company’s proportionate interest inthe net earnings of the Joint Venture has been reflected separately in theCompany’s consolidated statement of operations for the year endedSeptember 30, 2002. Duringthe year ended September 30, 2002, the Company made additionalcontributions 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 investmentin the Joint Venture was $311,466 at September 30, 2002.

 

Duringthe year ended September 30, 2003, the percentage of the Company’sownership interest in the Joint Venture increased from 50% to 100%.  The increase in the Company’s interestresulted from the purchase by the Company on July 28, 2003 of the 50%interest held by AvalonBay Cable I, Inc. for approximately $320,000.  As of that date, the Joint Venture providedservices to approximately 2,084 subscribers in 11 properties.  Theacquisition of the controlling interest was accounted for pursuant to thepurchase method and the purchase price was allocated to the fair value of thenet assets acquired, which approximated their carrying values.  Accordingly, the Joint Venture became aconsolidated subsidiary of the Company effective October 1, 2002 andincreased/(decreased) the consolidated balance sheet as 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 |   |

 

Hadthe Joint Venture been consolidated in the statement of operations for the yearended September 30, 2002, revenues would have increased by $496,697,expenses would have increased by $432,675 and minority interest expense wouldhave increased by $32,011.  However,such consolidation would have had no effect on the net loss.

 

OnJuly 30, 2003, the Joint Venture sold 1,273 digital satellite televisionsubscribers in five properties to CSC Holdings, Inc. (“CSC Holdings”) for$1,200 per subscriber. The total sales price, including amounts applicable tothe sale of certain related equipment, was $1,557,600.  Approximately$381,000 of

 

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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 subscriber fluctuations.After certain transactional deductions, including a negotiated recoupment bythe Company of approximately $150,000 of the $320,000 purchase price for theCompany’s additional 50% interest in the Joint Venture described above, the netproceeds from the sale will flow 50% to the Company with the other 50%apportioned to each of the other owner entities of the five properties involvedin the CSC Holdings sale.  AtSeptember 30, 2003, the Company has accrued approximately $550,000representing 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.

 

TheCompany’s revenue for the year ended September 30, 2002 includes $280,818from sales of receivers to the 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 netreceivables from or payables to the Joint Venture at September 30, 2002.

 

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

 

Thecomponents of property and equipment 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 |   |

 

Depreciationexpense amounted to $845,656 and $487,391 for the years ended September 30, 2003 and 2002,respectively.

 

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

 

Thecomponents of intangible assets are set 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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Amortizationexpense amounted to $419,136 and $335,076 for the years endedSeptember 30, 2003 and 2002, respectively. Amortization of intangibles inyears subsequent to September 30, 2003 is as follows:

 

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

 

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

 

TheCompany had pre-tax losses but did not record any credits for Federal or otherincome taxes for the years ended September 30, 2003 and 2002. The Companydid not record Federal income tax benefits at the statutory rate of 34% andstate income tax credits because (a) it has incurred losses in each periodsince its inception and cannot carry back any of its losses against previouslyrecorded income tax expense and (b) although such losses, among otherthings, have generated future potential income tax benefits, there issignificant uncertainty as to whether the Company will be able to generateincome in the future to enable it to realize any of those benefits and,accordingly, it has had to take valuation reserves against those potentialbenefits as shown below.

 

Asof September 30, 2003 and 2002, the Company had net deferred tax assets,which generate potential future income tax benefits that consisted of theeffects of temporary differences attributable 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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AtSeptember 30, 2003 and 2002, the Company had net operating loss carryforwards of approximately $9,666,000 and $7,005,000, respectively, available toreduce future Federal taxable income and net operating loss carryforwards ofapproximately $7,030,000 and $6,890,000, respectively, available to reducefuture Canadian taxable income. As of September 30, 2003, the Federal taxloss carry forwards will expire from 2004 through 2023 and the Canadian taxloss carryforwards will expire from 2005 through 2009. However, the Companyterminated substantially all of its Canadian operations in the year endedSeptember 30, 2002.

 

Thedeferred tax valuation allowance increased by $1,121,000 and $1,945,000 in theyears ended September 30, 2003 and 2002, respectively.

 

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

 

TheCompany operates in one industry segment. The Company’s operations arecomprised of providing delivery of home entertainment and informationtechnology to multi-unit dwellings.

 

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

 

The gain on sale ofcustomers during the year ended September 30, 2003 consisted of thefollowing:

 

| **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, the Company entered into an agreement to sellcertain equipment and customer lists associated with a particularmulti-dwelling unit property.  The salesprice was fixed at $1,150 cash per active subscriber, plus certain equipmentfor a total sales price of $185,150.

(C)        On January 16, 2003, the Company entered into an agreement to sellcertain equipment and customer lists associated with a particularmulti-dwelling unit property.  Thepurchase price was fixed at $67,000 payable in cash.

 

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

 

FromOctober 1, 2003 through December 10, 2003, options for 373,334 commonshares were exercised pursuant to the 2001 Stock Option Plan for net proceedsto the Company of $218,750.

 

FromOctober 1, 2003 through December 10, 2003, warrants for 3,592,500common shares were exercised for net proceeds to the Company of $1,544,755.

 

FromOctober 1, 2003 through December 10, 2003, warrants for 199,645common shares were exercised pursuant to cashless provisions, and 62,855additional warrants were cancelled in exchange for the exercise price.

 

OnJanuary 24, 2002, the Company entered into a Convertible Promissory Noteand Loan Agreement with Roselink for $100,000 (see Note 3). The seventhquarterly payment was due on October 24, 2003. Because the payment was notmade, the amount due was automatically converted into a total of 39,583 commonshares, which were issued on November 16, 2003.

 

On November 24, 2003, the Company closed a private placement ofits 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.

 

**Item8.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

 

None.

 

**Item8A.  Controls and Procedures**

 

**(a)Evaluation of Disclosure Controls and Procedures**

 

The Company, under the supervision and with the participation of itsmanagement, including the Chief Executive Officer, who is also the ChiefFinancial Officer, evaluated the effectiveness of the design and operation ofthe Company’s “disclosure controls and procedures” (as defined in Rule13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the ExchangeAct) as of the end of the period covered by this report.  Based on that evaluation, the ChiefExecutive Officer, who is also the Chief Financial Officer, concluded that theCompany’s disclosure controls and procedures, as of the end of such period, areeffective in timely making known to them information relating to the Companyand the Company’s consolidated subsidiaries required to be disclosed in theCompany’s reports filed or submitted under the Exchange Act.

 

**(b)Changes in Internal Controls**

 

There has been no change in the Company’s internal control overfinancial reporting or in other factors during the year or quarter endedSeptember 30, 2003 that has materially affected, or is reasonablylikely to materially affect, the Company’s internal control over financialreporting subsequent to the date of the evaluation referred to above.

 

**PART III**

 

**Item 9. ****Directors, ExecutiveOfficers, Promoters and Control Persons; Compliance with Section 16(a) ofthe Exchange Act**

 

Thefollowing are the directors and executive officers of the Company:

 

SheldonB. Nelson, 42, has served as President, Chief Executive Officer and Chairman ofthe Board of the Company since November 1998. From 1983 to 1998, he wasPresident of 4-12 Electronics Corporation, a provider of products and servicesto the Canadian satellite, cable, broadcasting and SMATV industries. Inaddition to his day-to-day responsibilities during his tenure at 4-12Electronics, Mr. Nelson developed the Company into one of Canada’s largestprivate cable system operators. Mr. Nelson is a graduate of GonzagaUniversity, in Spokane, WA. He graduated from the School of Business Administrationin 1983, Magna cum Laude, and was the recipient of the School of BusinessAdministrations’ Award of Excellence.

 

RobertDyck, 45, joined the Board of Directors in May 2000. He has been presidentof WRE Development Ltd. since 1978. WRE Development Ltd. owns,develops and manages residential rental properties throughout the U.S. andCanada. Mr. Dyck is also co-owner of Norquay Management, a residentialproperty management venture. He has overseen the expansion of a property anddevelopment portfolio now valued at more that C$100 million. Mr. Dyckhas substantial experience in the supervision of new apartment construction,analysis of acquisition opportunities for development and investment purposesand review of new technologies to increase the efficiency of the propertyportfolio. Mr. Dyck’s seat on the Board expired on May 20, 2002 and heretired from the Board on January 31, 2003.

 

DouglasG. Hooper, 43, joined the Board of Directors in May 2000. He is currentlyan acquisitions and finance consultant, who has extensive experience as aventure capitalist and mergers and acquisition specialist in the mineralexploration, industrial processing and software industries. He was Presidentand CEO of Sand River Resources Ltd. from 1995 to 1997. Mr. Hooper wasa founder and President of TelSoft Mobile Data Inc. from 1992 to 1995, nowMobile Data Solutions, Inc., a wireless communications software company.In that position, he developed and implemented corporate strategy and wasresponsible for raising capital, strategic alliances and mergers andacquisitions.

 

47

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JohnEdward Boyle, 59, joined the Board of Directors in May 2000. From 1998 to2001 he was President and CEO of Multivision (Pvt.) Ltd., a cable televisioncompany. From 1996 to 1997, Mr. Boyle was President and CEO of PowerTelTV Inc., a digital wireless cable company. As founding President and CEOof ExpressVu Inc. (1995-1996), Mr. Boyle was responsible for takingone of Canada’s first national direct-to-home satellite services fromconception to launch readiness while raising public awareness of DTH. Prior to1995, Mr. Boyle has also held executive positions with Tee-CommElectronics, Regional Cablesystems and Canadian Satellite Communications Inc.(Cancom). As Vice-President of Regional Companies at Cancom, and later as VicePresident of Market Development at Regional Cablesystems, he led the licensingor acquisition of over 1,000 Canadian 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 Systems Operatorfor 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 Securities Exchange Act of 1934 requires the Company’s directors,executive officers and persons who own beneficially more than 10% of theCompany’s common stock to file with the Securities and Exchange Commission(“SEC”) initial reports of ownership and reports of changes in ownership ofcommon stock and other equity securities of the Company. Officers, directorsand greater than 10% stockholders are required by SEC regulation to furnish theCompany with copies of all Section 16(a) reports they file. To theCompany’s knowledge, based solely on review of the copies of such reportsfurnished to the Company or advice that no filings were required, during fiscalyear 2003 all officers, directors and greater than 10% beneficial owners compliedwith the Section 16(a) filing requirements.

 

48

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**Item10.  Executive Compensation**

 

**COMPENSATION OF EXECUTIVE OFFICERS**

 

Thefollowing table sets forth certain information regarding compensation paidduring each of the Company’s last three fiscal years to our chief executiveofficer and other executive officers whose total annual salary and bonusesexceeded $100,000 (the “named executive officers”).

 

**SUMMARY COMPENSATION 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 GRANTED IN FISCAL YEAR 2002**

 

TheCompany granted no options to any named executive officer and director duringfiscal year ending September 30, 2003. However, options previously issuedto the above named executive officers and the directors were repriced from$0.60 per share to $0.33 per share.

 

**COMPENSATION OF DIRECTORS**

 

Eachdirector who is not an employee or full time consultant of the Company is paid$1,000 (cdn) per month and an attendance fee of $1,000 (cdn), plusout-of-pocket expenses, for each Board or committee meeting attended. Duringfiscal year ended September 30, 2000, Messrs. Boyle, Dyck and Hoopereach received a five-year, fully-vested option to purchase 50,000 shares ofcommon stock as additional compensation for two years of Board service.  During the fiscal year endedSeptember 30, 2002, Messrs. Boyle, Dyck and Hooper each received anadditional five-year, fully-vested option to purchase 50,000 shares of commonstock as additional compensation for two additional years of Board Service.These options are currently priced at $0.33 per share. Mr. Huguez, who joinedthe Board in October 2003, is paid $1,000 (us) per month and an attendancefee of $1,000 (us), plus out-of-pocket expenses, for each Board or committeemeeting attended. On November 14, 2003, Mr. Huguez received a five-yearoption to purchase 100,000 shares of common stock as additional compensationfor two years of Board service, one

 

49

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half vested immediately andthe remainder at one year.  Theseoptions are currently priced at $0.65 per share.

 

**Item11.  Security Ownership of CertainBeneficial Owners and Management**

 

Thefollowing table sets forth information with respect to beneficial ownership ofour outstanding stock as of September 30, 2003 by (i) each personknown to the Company to be the beneficial owner of more than 5% of theCompany’s common stock; (ii) each of the Company’s directors; (iii) eachexecutive officer named in the Summary Compensation Table; and (iv) all ofthe Company’s executive officers 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 | % |

 

----

(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.

 

**Item12.  Certain Relationships and RelatedTransactions**

 

Therehave been no such transactions during the past two fiscal years, other thantransactions with the Joint Venture prior to October 1, 2002 when itbecomes a 100% owned entity (see Note 8). Revenue for the year endedSeptember 30, 2002 includes $280,818 from sales of receivers to JointVenture and charges primarily for installation and management fees. The Companyalso receives certain payments from DIRECTV on behalf of the Joint Venture. TheCompany did not have any material net receivables from or payables to the JointVenture at September 30, 2002.

 

50

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**Item13.  Exhibits and Reports OnForm 8-K**

 

OnOctober 2, 2003 we filed an 8-K disclosing the appointment of a new memberto our Board of Directors.

 

OnAugust 18, 2003 we filed an 8-K disclosing the transaction with AvalonDigital Joint Venture and the sale of certain of its subscribers.

 

OnJune 9, 2003, we filed an 8-K disclosing the repricing of certain optionsin the 2001 Stock Option Plan.

 

The Company files herewith the following Exhibits:

 

Exhibit 4.15 - Form of Warrant to Purchase Common Stock, datedNovember 14, 2003, to various purchasers in the Company’sNovember 2003 private placement of units.

 

Exhibit4.16 - Form of Subscription Agreement, dated November 14, 2003, to variouspurchasers in the Company’s November 2003 private placement of units.

 

Exhibit 10.22 – DIRECTV MDU System Operator Agreement datedSeptember 29, 2003 (redacted).

 

Exhibit 31.1 – Certification pursuant to Section 302.

 

Exhibit 32.1 – Certification pursuant to Section 906.

 

**Item 14.  Principal Accountant Fees and Services**

 

JH Cohn, LLPhas served as the Company’s Principal Accountant since January 1, 2002.Their fees billed to the Company for the past two fiscal years are set forthbelow:

 
|               |   | **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’sAudit Committee did not have a pre-approval policy for the fees of theprincipal accountant.  It is in theprocess of adopting such a policy.

 

51

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Actof 1934, the registrant has duly caused this amended report to be signed on itsbehalf by the undersigned thereunto duly authorized.

 

 
|   | MDU COMMUNICATIONS  INTERNATIONAL, INC. |
|--------|----------------------------------------------|
|   |                                         |
|   | By:                                          | /s/  SHELDON  NELSON |
|   |                                         | Sheldon Nelson*Chief Financial Officer*March 16, 2004 |

 

 

Pursuantto the requirement of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **Signature**                     |   | **Title**                                 |   | **Date**       |
|-----------------------------------|--------|-------------------------------------------|--------|----------------|
|                              |   |                                      |   |           |
| /s/  SHELDON  B. NELSON |   |                                      |   |           |
| Sheldon  B. Nelson                |   | Principal Executive  Officer and Director |   | March 16, 2004 |
|                              |   |                                      |   |           |
| /s/  DOUGLAS  G. HOOPER |   |                                      |   |           |
| Douglas  G. Hooper                |   | Director                                  |   | March 16, 2004 |
|                              |   |                                      |   |           |
| /s/  JOHN  EDWARD BOYLE |   |                                      |   |           |
| John  Edward Boyle                |   | Director                                  |   | March 16, 2004 |
|                              |   |                                      |   |           |
| /s/  EDWARD  HUGUEZ     |   |                                      |   |           |
| Edward Huguez                     |   | Director                                  |   | March 16, 2004 |

 

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