**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

 

**Washington,D.C. 20549**

 

**FORM 10-QSB**

 
| **ý** | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d OF THE SECURITIES EXCHANGE ACT OF 1934 )** |
|------------|----------------------------------------------------------------------------------------------|

 

**For the quarterly period ended March 31,2005**

 
| **o** | **TRANSITIONAL  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|-------|------------------------------------------------------------------------------------------------------|

 

**For thetransition period from                to                **

 

**Commissionfile number 0-115404**

 

**HYPERSPACE COMMUNICATIONS, INC.**

(Name of small business issuer as specifiedin its charter)

 
| **COLORADO**                                                    | ** ** | **84-1577562**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (IRS Employer  identification No.) |
|                                                            |       |                               |
| **8480 East Orchard Road,  Greenwood Village, Colorado 80111**  |
| (Address of principal  executive offices)                       |
|                                                            |       |                               |
| **(303) 566-6500**                                         |
| (Issuer’s telephone  number)                               |

 

Check whether the issuer (1) filedall reports required to be filed by Section 13 or 15(d) of theExchange Act during the preceding twelve months (or for such shorter periodthat the issuer was required to file such reports), and (2) has been subjectto such filing requirements for the past 90 days.

 

Yes  ý   No  o

 

As of March 31, 2005 there were3,732,429 shares of the issuer’s no par value Common Stock outstanding.

 

Transitional Small Business DisclosureFormat. Yes  o   No  ý

 

Table of Contents

 

 

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**ITEM 1: FINANCIAL STATEMENTS**

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Balance Sheet**

 
| ** **                                                                                                               | ** ** | **March 31,** | ** **     | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|--------------------|----------------|-----------------------|------------|
| ** **                                                                                                               | ** ** | **2005**           | ** **     | **2004**              | ** ** |
| ** **                                                                                                               | ** ** | **(Unaudited)**    | ** **     | ** **            | ** ** |
| **ASSETS**                                                                                                               |       |               |           |                  |       |
|                                                                                                                     |       |               |           |                  |       |
| **Current  Assets**                                                                                                      |       |               |           |                  |       |
| **Cash and  Cash Equivalents**                                                                                           | ** ** | **$**              | **5,038,290**  | ** **            | **$**      | **5,875,481** | ** ** |
| **Accounts  Receivable, net of an allowance for doubtful accounts of $30,507 in 2005 $0  in 2004**                       | ** ** | **$**              | **112,033**    | ** **            | **$**      | **158,998** | ** ** |
| **Other  Current Assets**                                                                                                | ** ** | **$**              | **236,568**    | ** **            | **$**      | **106,182** | ** ** |
| **Total  Current Assets**                                                                                                | ** ** | **$**              | **5,386,891**  | ** **            | **$**      | **6,140,661** | ** ** |
| ** **                                                                                                               | ** ** | ** **         | ** **     | ** **            | ** ** |
| **Non-Current  Assets**                                                                                                  | ** ** | ** **         | ** **     | ** **            | ** ** |
| **Property &  Equipment, net of accumulated depreciation of $316,749 and $301,456**                             | ** ** | **$**              | **95,489**     | ** **            | **$**      | **110,782** | ** ** |
| **Capitalized  software, net of accumulated amortization of $611,782 and $593,121**                                      | ** ** | **$**              | **279,910**    | ** **            | **$**      | **298,570** | ** ** |
| **Total  Non-Current Assets**                                                                                            | ** ** | **$**              | **375,399**    | ** **            | **$**      | **409,352** | ** ** |
| ** **                                                                                                               | ** ** | ** **         | ** **     | ** **            | ** ** |
| **TOTAL  ASSETS**                                                                                                        | ** ** | **$**              | **5,762,290**  | ** **            | **$**      | **6,550,013** | ** ** |
| ** **                                                                                                               | ** ** | ** **         | ** **     | ** **            | ** ** |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIT**                                                                          | ** ** | ** **         | ** **     | ** **            | ** ** |
| ** **                                                                                                               | ** ** | ** **         | ** **     | ** **            | ** ** |
| **Current  Liabilities**                                                                                                 | ** ** | ** **         | ** **     | ** **            | ** ** |
| **Accounts  Payable**                                                                                                    | ** ** | **$**              | **341,837**    | ** **            | **$**      | **230,484** | ** ** |
| **Accrued  Compensation**                                                                                                | ** ** | **$**              | **126,479**    | ** **            | **$**      | **83,522** | ** ** |
| **Deferred  Revenue**                                                                                                    | ** ** | **$**              | **109,432**    | ** **            | **$**      | **122,016** | ** ** |
| **Current  Portion of Notes Payable & Debt**                                                                    | ** ** | **$**              | **713,388**    | ** **            | **$**      | **721,965** | ** ** |
| **Total  Current Liabilities**                                                                                           | ** ** | **$**              | **1,291,136**  | ** **            | **$**      | **1,157,987** | ** ** |
| ** **                                                                                                               | ** ** | ** **         | ** **     | ** **            | ** ** |
| **Long Term  Liabilities**                                                                                               | ** ** | ** **         | ** **     | ** **            | ** ** |
| **Long term  Portion of Notes Payable**                                                                                  | ** ** | **$**              | **425,000**    | ** **            | **$**      | **425,000** | ** ** |
| **Total Long  Term Liabilities**                                                                                         | ** ** | **$**              | **425,000**    | ** **            | **$**      | **425,000** | ** ** |
| **Total  Liabilities**                                                                                                   | ** ** | **$**              | **1,716,136**  | ** **            | **$**      | **1,582,987** | ** ** |
|                                                                                                                     |       |               |           |                  |       |
| **Commitments &  Contingencies**                                                                                |       |               |           |                  |       |
|                                                                                                                     |       |               |           |                  |       |
| **Shareholders’  Deficit**                                                                                          |       |               |           |                  |       |
| ** **                                                                                                               |       |               |           |                  |       |
| **Preferred  Stock, no par value; 1,000,000 shares authorized; no shares issued and  outstanding at 2005 and 2004**      | ** ** | **—**         | ** **     | **—**            | ** ** |
| ** **                                                                                                               | ** ** | ** **         | ** **     | ** **            | ** ** |
| **Common  Stock, no par value, 15,000,000 shares authorized; 3,732,429 shares issued  and outstanding at 2005 and 2004** | ** ** | **$**              | **12,087,134** | ** **            | **$**      | **12,087,134** | ** ** |
| **Accumulated  Deficit**                                                                                                 | ** ** | **$**              | **(8,040,980** | **)**                 | **$**      | **(7,120,108** | **)** |
| **Total Shareholders’  Deficit**                                                                                    | ** ** | **$**              | **4,046,154**  | ** **            | **$**      | **4,967,026** | ** ** |
|                                                                                                                     |       |               |           |                  |       |
| **TOTAL  LIABILITIES AND EQUITY**                                                                                        | ** ** | **$**              | **5,762,290**  | ** **            | **$**      | **6,550,013** | ** ** |

 

See accompanying notes to financial statements.

 

2

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**HYPERSPACE COMMUNICATIONS, INC.**

**Unaudited Statements of Operations for theThree Months Ended March 31, 2005 and 2004.**

 
| ** **                                                        | ** ** | **2005**      | ** **   | **2004**      | ** ** |
|-------------------------------------------------------------------|------------|---------------|--------------|---------------|------------|
| **Revenues**                                                      | ** ** | ** **    | ** **   | ** **    | ** ** |
| **License  Fees**                                                 | ** ** | **$**         | **39,641**   | ** **    | **$**      | **86,198** | ** ** |
| **Service &  Other**                                     | ** ** | **$**         | **49,374**   | ** **    | **$**      | **49,926** | ** ** |
| **Total  Revenues**                                               | ** ** | **$**         | **89,015**   | ** **    | **$**      | **136,124** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Cost of  Revenue**                                              | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Amortization  of Capitalized Software**                         | ** ** | **$**         | **18,661**   | ** **    | **$**      | **30,488** | ** ** |
| **Customer  Support**                                             | ** ** | **$**         | **37,886**   | ** **    | **$**      | **27,903** | ** ** |
| **Total  Cost of revenue**                                        | ** ** | **$**         | **56,547**   | ** **    | **$**      | **58,391** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Gross  Profit**                                                 | ** ** | **$**         | **32,468**   | ** **    | **$**      | **77,733** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Operating  Expenses**                                           | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Research &  Development**                              | ** ** | **$**         | **97,359**   | ** **    | **$**      | **116,221** | ** ** |
| **Sales &  Marketing**                                   | ** ** | **$**         | **255,250**  | ** **    | **$**      | **120,410** | ** ** |
| **General &  Administrative**                            | ** ** | **$**         | **596,935**  | ** **    | **$**      | **348,864** | ** ** |
| **Total  Operating Expenses**                                     | ** ** | **$**         | **949,544**  | ** **    | **$**      | **585,495** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Loss  from Operations**                                         | ** ** | **$**         | **(917,076** | **)**         | **$**      | **(507,762** | **)** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Other  (Income)/Expense**                                       | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Interest  Expense, net of interest income of $27,397 and $13**  | ** ** | **$**         | **3,796**    | ** **    | **$**      | **175,404** | ** ** |
| **Other  Expenses**                                               | ** ** | **$**         | **—**   | ** **    | **$**      | **2,539** | ** ** |
| **Gain on  Settlement**                                           | ** ** | **$**         | **—**   | ** **    | **$**      | **(440,999** | **)** |
| **Total  Other (Income)/Expense**                                 | ** ** | **$**         | **3,796**    | ** **    | **$**      | **(263,056** | **)** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Net Loss**                                                      | ** ** | **$**         | **(920,872** | **)**         | **$**      | **(244,706** | **)** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Preferred  Dividends**                                          | ** ** | **$**         | **—**   | ** **    | **$**      | **23,857** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Net Loss  attributable to Common Shareholders**                 | ** ** | **$**         | **(920,872** | **)**         | **$**      | **(268,563** | **)** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Basic  and diluted weighted average Common Shares outstanding** | ** ** | **3,732,429** | ** **   | **1,383,954** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **   | ** **    | ** ** |
| **Basic  and diluted loss per Common Share**                      | ** ** | **$**         | **(0.25**    | **)**         | **$**      | **(0.19** | **)** |

 

See accompanying notes to financial statements.

 

3

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**HYPERSPACE COMMUNICATIONS, INC.**

**Unaudited Statements of Cash Flows For TheThree Months Ended March 31, 2005 and 2004.**

 
| ** **                                                                      | ** ** | **2005**   | ** **    | **2004**   | ** ** |
|---------------------------------------------------------------------------------|------------|------------|---------------|------------|------------|
| **OPERATING ACTIVITIES**                                                        | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Net Loss**                                                                    | ** ** | **$**      | **(920,872**  | **)**      | **$**      | **(244,706** | **)** |
| **Adjustments to reconcile net  loss to net cash used in operating activities** | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Depreciation**                                                                | ** ** | **$**      | **15,293**    | ** ** | **$**      | **21,650** | ** ** |
| **Amortization/impairment of  capitalized software**                            | ** ** | **$**      | **18,660**    | ** ** | **$**      | **30,488** | ** ** |
| **Settlement of liability for  reduced amount**                                 | ** ** | **$**      | **—**    | ** ** | **$**      | **(440,999** | **)** |
| **Options issued to employees**                                                 | ** ** | **$**      | **—**    | ** ** | **$**      | **24,334** | ** ** |
| **Warrants issued for debt issue  costs and interest**                          | ** ** | **$**      | **—**    | ** ** | **$**      | **34,281** | ** ** |
| **Conversion preference with debt**                                             | ** ** | **$**      | **—**    | ** ** | **$**      | **80,662** | ** ** |
| **Stock for services**                                                          | ** ** | **$**      | **—**    | ** ** | **$**      | **22,500** | ** ** |
| **Accrued interest included in  notes payable**                                 | ** ** | **$**      | **(7,415**    | **)**      | **$**      | **1,791** | ** ** |
| **Accretion of Debt Issue Costs**                                               | ** ** | **$**      | **—**    | ** ** | **$**      | **33,269** | ** ** |
| **Provision for Bad Debt**                                                      | ** ** | **$**      | **30,507**    | ** ** | **$**      | **—** | ** ** |
| **Changes in Assets and  Liabilities**                                          | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Accounts Receivable**                                                         | ** ** | **$**      | **16,458**    | ** ** | **$**      | **65,440** | ** ** |
| **Other Current Assets**                                                        | ** ** | **$**      | **(130,386**  | **)**      | **$**      | **5,610** | ** ** |
| **Accounts Payable**                                                            | ** ** | **$**      | **111,353**   | ** ** | **$**      | **(101,168** | **)** |
| **Accrued Compensation**                                                        | ** ** | **$**      | **42,957**    | ** ** | **$**      | **(6,433** | **)** |
| **Deferred Revenue**                                                            | ** ** | **$**      | **(12,584**   | **)**      | **$**      | **(2,662** | **)** |
| **Net Cash Used in Operating  Activities**                                      | ** ** | **$**      | **(836,029**  | **)**      | **$**      | **(475,943** | **)** |
| ** **                                                                      | ** ** | ** ** | ** **    | ** ** | ** ** |
| **INVESTING ACTIVITIES**                                                        | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Net Cash Used in Investing  Activities**                                      | ** ** | **$**      | **—**    | ** ** | **$**      | **—** | ** ** |
| ** **                                                                      | ** ** | ** ** | ** **    | ** ** | ** ** |
| **FINANCING ACTIVITIES**                                                        | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Net Proceeds from Notes Payable**                                             | ** ** | **$**      | **—**    | ** ** | **$**      | **1,090,500** | ** ** |
| **Payment of Note Payable**                                                     | ** ** | **$**      | **(1,162**    | **)**      | **$**      | **(16,000** | **)** |
| **Net Proceeds from the Issuance  of Preferred Stock**                          | ** ** | **$**      | **—**    | ** ** | **$**      | **43,750** | ** ** |
| **Payment of Offering Costs**                                                   | ** ** | **$**      | **—**    | ** ** | **$**      | **(25,000** | **)** |
| **RCI Settlement**                                                              | ** ** | **$**      | **—**    | ** ** | **$**      | **(42,500** | **)** |
| **Net cash provided by financing  activities**                                  | ** ** | **$**      | **(1,162**    | **)**      | **$**      | **1,050,750** | ** ** |
| ** **                                                                      | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Net cash increase (decrease)  for period**                                    | ** ** | **$**      | **(837,191**  | **)**      | **$**      | **574,807** | ** ** |
| ** **                                                                      | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Cash at beginning of period**                                                 | ** ** | **$**      | **5,875,481** | ** ** | **$**      | **27,429** | ** ** |
| ** **                                                                      | ** ** | ** ** | ** **    | ** ** | ** ** |
| **Cash at end of period**                                                       | ** ** | **$**      | **5,038,290** | ** ** | **$**      | **602,236** | ** ** |

 

*Statements of Cash Flows*

 

Supplemental disclosure of cash flow information:

 

Cash paid for interest for the three months ended March 31, 2005and 2004 was $38,608 and $25,414, respectively.

 

No cash was paid for income taxes for the three months ended March 31,2005 and 2004.

 

Supplemental disclosure of non-cash activity:

 

During the three months ended March 31,2004, $228,652 of notes payable was converted to common stock, at $3.50 pershare.

 

During the three months ended March 31,2004, the Company issued $25,000 of common stock in exchange for deferredoffering costs.

 

During the three months ended March 31,2004, the Company accrued dividends on Series A preferred stock in theamount of $23,857.

 

See accompanying notes to financial statements.

 

4

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**HYPERSPACE COMMUNICATIONS, INC.**

**Notes to Financial Statements *(Information with Respect to the Three Months Ended***

***March 31, 2005and 2004 is Unaudited)***

 

***Note 1—Descriptionof Business***

HyperSpace Communications, Inc. (the Company) was formed in February 2001as a company organized under the laws of the State of Colorado. The Company,based in Denver, Colorado, produces and markets HyperWebÔand HyperTunnelÔ software products, which accelerate web andclient/server-based applications over wider area networks, both terrestrial andwireless, thereby increasing performance and throughput and lowering costs forbandwidth, hardware, software, IT overhead and human resources while increasingemployee productivity and customer satisfaction. The Company’s objective is tomake its customers more efficient and profitable through higher performance ofmission-critical applications.

 

On March 21, 2005, the Company incorporated awholly owned subsidiary by the name of Spud Acquisition Corporation (“Spud”).Spud is organized under the laws of the state of Delaware and has nooperations. Spud has been formed to complete the proposed merger with MPC (seenote 6).

 

***Note2—Significant Accounting Policies***

*Interim FinancialInformation*

The unaudited financial statements for thethree months ended March 31, 2005 and 2004 include, in the opinion ofmanagement, all adjustments (consisting of normal recurring adjustments)necessary to present fairly the Company’s financial position, results ofoperations and cash flows. Operating results for the three months ended March 31,2005 are not necessarily an indication of the results that may be expected forthe entire fiscal year. HyperSpace Communications, Inc. hasprepared the accompanying unaudited financial statements pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”).

 

These financial statements and notes should be readin conjunction with the 10-KSB filed with the SEC on March 31, 2005. Thefootnotes below are those that have changes from the footnotes accompanying thefinancial statements at December 31, 2004 in the aforementioned 10-KSB.

 

The accompanying financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and liquidation ofliabilities in the ordinary course of business. Although the Company hasincurred substantial losses since inception, the Company completed an IPO on October 1,2004 and accordingly, no adjustments are necessary to the financial statementsas a result of a going concern uncertainty. Due to the change in the Company’sbusiness, as contemplated by the proposed merger with MPC, and notwithstandingany break-up fee which may be payable by MPC, not consummating the merger mayresult in continued losses and cash flow problems. The Company does, howeverexpect to have sufficient cash to fund operations through March 31, 2006.

 

The Company reports comprehensive income (loss) in accordance withthe provisions of SFAS 130, “Reporting Comprehensive Income.” SFAS 130establishes standards for reporting comprehensive income and its components infinancial statements. The difference between reported net income andcomprehensive income (loss) is not considered material for the periodspresented.

 

5

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*License fee revenue:*For software license agreements that do not require significant modification orcustomization of the software, we recognize revenue when evidence of anon-cancelable, signed contingency-free agreement exists, any acceptancetesting is complete, delivery of the product has occurred, the license fee isfixed or determinable and collection is probable. In all other instances, wedefer revenue. We record deferred revenue as a current liability until all theelements to be delivered at a future date and vendor specific evidence ofacceptance have occurred.

 

We consider receipt of an approved customer purchase order or theapproval of a legal agreement to be persuasive evidence of an arrangement.Delivery generally occurs when the customer has received an electronic mediacopy of the software or where we have evidence that the customer has downloadedthe software from our website.

 

Ifa license agreement provides acceptance provisions that grant customers a rightof refund or replacement only if the licensed software does not perform inaccordance with its published specifications, we defer revenue recognitionuntil acceptance by the customer or lapse of the acceptance period. Typically,our software licenses do not include significant post-delivery obligations tobe fulfilled by us.

 

Generally,we follow the abovementioned policy regardless of whether we are selling to theultimate end-user or to a reseller, provided the reseller agrees to the sameterms as discussed above.

 

However,a certain number of reseller agreements relate to sales into foreign countries,where the license fee is payable over a number of future installments. Althoughthese foreign reseller agreements generally have no contingent deal terms, thelikelihood of foreign resellers making future installment payments is heavilydependent on their success at reselling our software. This payment risk ishigher in certain countries than others due to the high cost of successfulcollection efforts and low probability of successful litigation efforts. Webelieve that the risk is higher in countries exclusive of what the US CommerceDepartment classifies (for software export permit purposes) as the “EU + 8”.The “EU+8 countries” include: Austria, Australia, Belgium, CzechRepublic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy,Japan, Luxembourg, Netherlands, New Zealand, Norway, Poland, Portugal, Spain,Sweden, Switzerland, United Kingdom. Our policy for license sales to foreign resellers, therefore, innon-EU + 8 countries, will be to recognize revenues on a cash received basis.

 

Duringthe quarter ended March 31, 2005, we signed an agreement with a Russianreseller which met the criteria of this policy. No revenues have beenrecognized during the quarter then ended.

 

*Concentrations ofCredit Risk*

The Company is subject to the risks ofconcentration of credit risk in a few customers. During the three months ended March 31,2005, the Company had three customers that accounted for 41% of revenues. Thesecustomers accounted for only 4% of the total accounts receivable at March 31,2005 since payment was received from two of these customers within the quarter.The remaining customer paid in April 2005.

 

At March 31, 2005, three customersaccounted for 63% of the total accounts receivable. One customer accounted for47%, however, payments representing one-third of the total amount owed were notdue at March 31, 2005.

 

As of March 31, 2005, and periodicallythroughout the reported years, the Company has maintained balances in operatingaccounts in excess of the U.S. Federal Deposit Insurance Corporation (FDIC)insured $100,000 limit. The Company has not experienced any losses in suchaccounts and management believes the Company is not exposed to any significantcredit risk related to cash.

 

*Allowance for DoubtfulAccounts*

The Company maintains an allowance fordoubtful accounts at an amount estimated to be sufficient to provide adequateprotection against losses resulting from collecting less than full payment onreceivables. Overdue accounts are reviewed, and an additional allowance isrecorded when determined necessary to state receivables at an estimatedrealizable value. In judging the adequacy of the allowance for doubtfulaccounts, the Company considers multiple factors including historical bad debtexperience, the general economic environment, and the aging of its receivables.A considerable amount of judgment is required when assessing the realization ofreceivables, including assessing the probability of collection and the

 

6

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current creditworthiness of each customer.

 

As of March 31, 2005, the Company hasdetermined and recorded a reserve of $31,000 for doubtful accounts for twonon-U.S. customers. One customer, a large European mobile telecommunicationsprovider, has historically paid late but despite extensive collection efforts,the days outstanding on the unpaid amount is past their historic payment windowof six months. The other customer is a reseller who has not made the final ofthree payments on a license sale. We believe that this is due to theirunsuccessful efforts to ramp up their re-sale of the product to a largecustomer of theirs. This was not a contingency in the signed license agreement.The Company intends to pursue payment but has reserved 100% of the remainingoutstanding balance.

 

*Stock-BasedCompensation*

The Company has determined the value of stock-based compensationarrangements under the provisions of APB Opinion No. 25 “Accounting forStock Issued to Employees”; and will make pro forma disclosures required underSFAS No. 123,”Accounting for Stock-Based Compensation.” SFAS No. 123permits the use of either a fair value based method or the method defined inAPB No. 25 to account for stock-based compensation arrangements. Companiesthat elect to use the method provided in APB No. 25 are required todisclose the pro forma net income (loss) and earnings per share that would haveresulted from the use of the fair value based method. The Company will besubject to the provisions of the recently promulgated SFAS No. 123R in thefirst quarter of fiscal 2006 and has not yet adopted any of its provisions.

 
| ** **                                                                                                           | ** ** | **Three months ended** | ** **     |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------------|----------------|
| ** **                                                                                                           | ** ** | **March 31,**     | ** **     |
| ** **                                                                                                           | ** ** | **2005**               | ** **     | **2004** | ** ** |
| **Net loss  available to common shareholders-as reported**                                                           | ** ** | **$**                  | **(920,872**   | **)** | **$** | **(268,563** | **)** |
| ** **                                                                                                           | ** ** | ** **             | ** **     | ** ** | ** ** |
| **Add:  stock-based employee compensation included in net income**                                                   | ** ** | **$**                  | **—**     | ** ** | **$** | **24,334** | ** ** |
| ** **                                                                                                           | ** ** | ** **             | ** **     | ** ** | ** ** |
| **Deduct:  total stock-based employee compensation expense determined under fair market  value method for an award** | ** ** | **$**                  | **(150,803**   | **)** | **$** | **(275,691** | **)** |
| ** **                                                                                                           | ** ** | ** **             | ** **     | ** ** | ** ** |
| **Net loss  available to common shareholders—pro forma**                                                        | ** ** | **$**                  | **(1,071,675** | **)** | **$** | **(519,920** | **)** |
| ** **                                                                                                           | ** ** | ** **             | ** **     | ** ** | ** ** |
| **Basic  loss per common share—as reported**                                                                    | ** ** | **$**                  | **(0.25**      | **)** | **$** | **(0.19** | **)** |
| ** **                                                                                                           | ** ** | ** **             | ** **     | ** ** | ** ** |
| **Basic  loss per common share—pro forma**                                                                      | ** ** | **$**                  | **(0.29**      | **)** | **$** | **(0.38** | **)** |

 

The fair value of each option grant isestimated on the date of grant using the Black-Scholes option-pricing model.All options are granted at fair market value on the date of the grant. Nooptions have been re-priced or had their maturities extended during the firstquarter of 2005. In terms of the provisions of our Incentive Option Plans,employees, with vested options, who leave the employment of the Company, arerequired to exercise or forfeit their options within 90 days after leavingemployment regardless of the exercise period of the initial grant.

 

The following are the weighted-average assumptions used at March 31,2005 and 2004 for all Black-Scholes calculations in the financial statements:

 
| ** **                  | ** ** | **March 31,** | ** ** |
|-----------------------------|------------|--------------------|------------|
| ** **                  | ** ** | **2005**           | ** ** | **2004** | ** ** |
|                        |       |               |       |   |   |
| Approximate  risk free rate |       | 4.3                | %          | 3.2 | % |
| Average  expected life      |       | 6.5 years          |       | 10 years |   |
| Dividend  yield             |       | —             | %          | — | % |
| Volatility                  |       | 25.00              | %          | 25.00 | % |

 

Our estimated volatility is determined by a review of certain small-capindices. We believe that our actual volatility since our IPO is not reflectiveof future volatility. This treatment is permitted by FASB 123. Under the newFASB 123R, which will apply to us effective January 1, 2006, we will, as anew public company, be permitted to use a peer group comparison because ourhistorical volatility will not be longer than the expected terms of theoutstanding options. However, we will no longer be permitted to use indices. We

 

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are currently determining the way we will adopt FASB 123R.

 

*Basic Loss Per Share*

The Company applies the provisions of Statement of Financial AccountingStandard NO. 128, “Earnings Per Share” (FAS 128). For the three-months ended March 31,2005 and 2004, total stock options, stock warrants and convertible debt of5,110,599 and 1,454,671 respectively were not included in the computation ofloss per share because their effect was antidilutive; however, if the Companywere to achieve profitable operations in the future, they could potentiallydilute such earnings. The Company’s basic and diluted loss per share isequivalent and accordingly, only basic loss per share has been presented.

 

***Note 3—NotesPayable and Debt***

 
| ** **                                             | ** ** | **March 31,** | ** **    | **December 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------|---------------|-----------------------|------------|
| ** **                                             | ** ** | **2005**           | ** **    | **2004**              | ** ** |
| ** **                                             | ** ** | **(Unaudited)**    | ** **    | ** **            | ** ** |
| ** **                                             | ** ** | ** **         | ** **    | ** **            | ** ** |
| **Convertible Bridge Loans**                           | ** ** | **$**              | **1,088,940** | ** **            | **$**      | **1,089,627** | ** ** |
| ** **                                             | ** ** | ** **         | ** **    | ** **            | ** ** |
| **Note Payable to Founder**                            | ** ** | **$**              | **49,448**    | ** **            | **$**      | **57,338** | ** ** |
| ** **                                             | ** ** | ** **         | ** **    | ** **            | ** ** |
| **Total Notes Payable and Bridge  Loans**              | ** ** | **$**              | **1,138,388** | ** **            | **$**      | **1,146,965** | ** ** |
| ** **                                             | ** ** | ** **         | ** **    | ** **            | ** ** |
| **Long-term Portion of  Convertible Bridge Loans**     | ** ** | **$**              | **425,000**   | ** **            | **$**      | **425,000** | ** ** |
| ** **                                             | ** ** | ** **         | ** **    | ** **            | ** ** |
| **Current portion of Notes  Payable and Bridge Loans** | ** ** | **$**              | **713,388**   | ** **            | **$**      | **721,965** | ** ** |

 

All amounts are inclusive of accrued interest.

 

With respect to the Convertible Bridge Loans, $620,000 is due September 2005and $425,000 is due April 2006 including any unpaid interest which isaccrued at 12% per annum. The Holder shall have the right, at any time prior topayment (or pre-payment), to convert all or any part of the then outstandingbalance of principal and interest under this Note into shares of common stockat the conversion price of $4.375 and $3.50 per share, respectively. The noteshave detachable warrants for purchase of common stock. The value of thewarrants was recorded as interest expense in 2004. All assets of the Companycollateralize the notes. A beneficial conversion feature of $233,662 wasrecorded on the notes, which was recorded as interest expense when the debt wasissued in 2004. These notes have registration rights.

 

With respect to the Founder’s Note, he has the right, at any time priorto payment (or pre-payment), to convert all or any part of the then outstandingbalance of principal and interest under this Note into shares of common stockat the conversion price of $3.50 per share. The note matures in June 2005.Interest is accrued at 9% on the outstanding principal balance of this note.

 

***Note 4—Related PartyTransactions***

The Company’s policies prohibit loans to Directors, Officers andEmployees. There were no such loans outstanding at any time during the quarterended March 31, 2005.

 

The Company has a loan outstanding from its founder that arose prior toour IPO. During the quarter ended March 31, 2005, $273 was accrued on thisnote while $7,000 of accrued interest and $1,162 of principal was repaid. Moredetails are provided in Note 3 – Notes Payable and Debt.

 

Bathgate Capital Partners is no longer considered to be a related partysince it has been more than 12 months since a Managing Director of that companyresigned from HyperSpace’s Board of Directors.

 

***Note 5—IncomeTaxes***

The Company did not provide a current or deferred federal, state orforeign income tax provision or benefit for any of the periods presentedbecause it has experienced recurring operating losses. The Company has provideda full valuation allowance on the deferred tax asset, consisting primarily ofthe net operating loss, because of uncertainty regarding whether it will berealized. Tax benefit from net operating losses and timing differences arecalculated at an estimated blended federal and Colorado tax rate of 37.3%.

 

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***Note 6—******Proposed Acquisition of MPC Computers, Inc. (“MPC”)***

On March 21, 2005 we, along with Gores Technology Group, LLC, orGores, and MPC Computers, LLC, or MPC announced the execution of an Agreementand Plan of Merger dated as of March 20, 2005 by and among HyperSpace,Spud Acquisition Corp., a Delaware corporation and a wholly owned subsidiary ofours, GTG PC Holdings, LLC, a Delaware limited liability company and GTG-MicronHolding Company, LLC. MPC is the wholly owned subsidiary of GTG PC Holdings,LLC. We plan to issue approximately 4.25 million warrants at $3 per shareand 1.275 million warrants at $5.50 per share to the current owners of MPC. Forfurther details on this proposed transaction, please refer to the followingForms filed with the SEC: 8-K dated March 21, 2005 and 8-KA filed on March 25,2005.

 

We expect to incur approximately $1.5 million in professional fees anddeal costs to consummate this transaction. Approximately $400,000 are costswhich will be incurred regardless of whether the merger is consummated or not.As of March 31, 2005, approximately $158,000 of costs relating to theproposed merger had been incurred and have been capitalized as Other CurrentAssets in the Balance Sheet.

 

The consummation of the acquisition is subject to the approval by ourshareholders of the Agreement and the approval by the shareholders of Gores,and other closing conditions.

 

**ITEM 2. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**A NOTE ABOUT FORWARD-LOOKING STATEMENTS**

 

The statements, other than statements of historical fact, included inthis report are forward-looking statements. Forward-looking statementsgenerally can be identified by the use of forward-looking terminology such as “may,”“will,” “expect,” “intend,” “estimate,” “anticipate,” “plan,” “seek,” or “believe.”We believe that the expectations reflected in such forward-looking statementsare accurate. However, we cannot be assured that such expectations willoccur. Our actual future performance could differ materially from such statements.These forward-looking statements are subject to risks and uncertainties thatcould cause actual results and events to differ materially. For a detaileddiscussion of these risks and uncertainties please see the “Risk Factors”contained in our 10K-SB dated December 31, 2004 which can be viewed at theSEC’s website at www.secgov or through a link on our websitewww.ehyperspace.com. These forward-looking statements apply only as of the dateof this report; as such, they should not be unduly relied upon for currentcircumstances. Except as required by law, we are not obligated to releasepublicly any revisions to these forward-looking statements that might reflectevents or circumstances occurring after the date of this report or those thatmight reflect the occurrence of unanticipated events.

 

***Our Business***

 

**Company Overview**

We are a Colorado-based software company that was formed in 2001. Wedevelop, produce, and market worldwide network acceleration and datacompression software. We offer two software products. Our initial softwareproduct HyperWebTM, was introduced in late 2001. In January 2004, weintroduced our second product, HyperTunnelTM. These software products addressthe growing need for real-time application acceleration and improved businesscommunications over wired and wireless networks.

 

We completed an initial public offering, or “IPO”, in October 2004.We raised approximately $7.1 million after offering costs and expenses.

 

As discussed elsewhere in this document, we are preparing to engage ina merger that, if approved by our shareholders and consummated, would result inus acquiring 100% of the outstanding equity interest of GTG PC Holdings, LLC,the parent of MPC Computers, LLC, or MPC. MPC is a provider of computingsolutions to customers in the federal government, state and local governmentand education and mid-market enterprise markets offering a broad range ofcustomized computing products and services, including hardware, software andrelated information technology (IT) consultative services.

 

9

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**Business Overview**

We did not achieve our internal revenue and profitability goals during2004 and we see significant challenges in growing quarterly revenue for theremainder of 2005 if we remain a stand-alone entity.

 

Following our IPO, we encountered the following circumstances in ourmarket:

•                  Realizedpoor results on our marketing initiatives,

•                  Recordedpoor results from our existing OEM channels and international agents,

•                  Haddifficulty in engaging new agents and OEM channels,

•                  Sawthat many hardware and software providers began including compression andnetwork acceleration in their base product, and

•                  Determinedthat our competitors had become stronger financially through additionalfinancing or merging.

 

We have concluded that we cannot achieve the necessary revenue growth,and resulting profitability, with our existing financial resources or existingsales and marketing strategy. Therefore, we believe that, without a significantchange in our sales and marketing strategy, which would require substantialfinancial resources, we will continue to lose ground and have a difficult timein growing or projecting future revenues or reaching profitability.

 

As a result, we decided in the fourth quarter of 2004, to change ourstrategy to accelerate our growth. We felt that we either needed to align ourinterests with an organization that was offering more of a solution to buyers(thereby diversifying away from compression and network acceleration) or anorganization that had well established products, customers and an establisheddistribution channel (whereby our software products could be included withtheir products in sales they are already making). We engaged an investmentbanking firm in late 2004 and began to seek merger and acquisition opportunitieswhich met our criteria.

 

In the first quarter of 2005, we determined that merging with an ITorganization that had the following characteristics would be most attractive:

•                  Existingdistribution channels,

•                  Alarge, geographically dispersed sales force with established relationships,

•                  Anexisting installed base of customers,

•                  Agood reputation which lends to the introduction of new offerings,

•                  Productsto which our software is complimentary,

•                  Productswhere our software is easily bundled, and

•                  Anestablished marketing organization.

 

After a comprehensive process, which will be explained in detail in aproxy statement to be filed with the SEC, we determined that the MPCacquisition would provide us with many of the abovementioned characteristicsand offer us the best chance to grow revenues for our products . Particularly,we believe that MPC can assume most of the sales and marketing activities thatwe have been unsuccessfully attempting to build and establish. We also believethat there is an opportunity for sales of our software products through MPC’sexisting sales channels and to MPC’s existing installed base of customers. Webelieve that this approach to achieve revenue growth of our software productsoffers a higher probability of success than that of continuing to exist as astand-alone entity.

 

As we moved ahead on our merger strategy we made the decision to reduceour investments in sales and marketing in the first quarter of 2005.Specifically, we decided to reduce headcount expansion, cut back on marketingresearch and begin to eliminate outbound telemarketing activities which werenot producing desired results. These actions have negatively impacted both therevenue growth for the first quarter ended March 31, 2005 and the expectedsecond quarter 2005 revenue growth.

 

During the quarter ended March 31, 2005 we signed a salesdistribution agreement with MPC. We have delivered training to MPC on oursoftware products and MPC has launched our products to their salesprofessionals with goals and incentives. We will continue to work toward asuccessful strategy to increase the sales of our products.

 

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**Proposed Acquisition of MPC Computers, LLC. (“MPC”)**

The terms of the Agreement and Plan of Merger for the proposedacquisition of MPC are provided in Note 6 to the financial statements.

 

Consummation of the transactions contemplated by the Agreement isconditioned upon (1) approval by our shareholders and the members ofGTG-Micron Holding Company LLC, (2) the receipt of all required regulatoryapprovals, (3) the filing of an amendment to the Articles of Incorporationauthorizing shares of Common Stock sufficient to complete the merger andincreasing the size of our 2004 Equity Incentive Plan and (4) variousother conditions set forth in the Agreement. While it is anticipated that thetransaction will be completed in August or September 2005, theAgreement terminates if the Merger is not completed by September 30, 2005.In the event of a termination of the Merger Agreement under certaincircumstances, we or GTG-Micron Holding Company, LLC may be required to pay theother a termination fee as set forth in the Agreement.

 

If this merger with MPC closes, the nature of our business and oursales and marketing strategy will change. A significant change will be that weexpect MPC leadership will manage the sale of our products and that ourproducts will be bundled with those of MPC so that our software solutions willbe offered as part of the hardware purchase. We expect to continue to focus onour OEM/Partner strategy where our software solution is built into the offeringof OEMs and partners. We expect to continue to sell our software-only solutionsas we do today to general prospects and MPC’s installed base of customers. Wealso expect to reduce our General and Administrative expenses and lose theservices of our CEO and COO, both of whom are expected to leave us after themerger closes. It is contemplated that our current Chairman will become Chairmanand CEO, and our current CFO will become CFO of the combined entity. Thecombined entity will, however, experience increased cost by virtue of being alarger public company.

 

For more information regarding the proposed merger, please refer to theproxy statement which will be filed with the United States Securities andExchange Commission, or SEC. This proxy statement will contain importantinformation about the proposed merger. These materials are not yet finalized.Our investors and security holders are urged to read the proxy statement, andany other relevant materials filed by us, because they will contain importantinformation about the proposed merger. The materials may be obtained for freeat the SEC’s website at *www.sec.gov.*In addition, the documents filed with the SEC by us may be obtained free ofcharge from our website at*www.ehyperspace.com.*

 

We operate our business and conduct our development work from ourheadquarters in Denver, Colorado. Independent sales agents and partners workout of offices owned or rented by them. We had 11 full-time employees as of March 31,2005.

 

KEY INDICATIONS OF FINANCIAL CONDITION ANDPERFORMANCE

 

Comparison of the Three-Months ended March 31,2005 to 2004 (Unaudited)

 
| ** **                                        | ** ** | **Three Months Ended** | ** **    |
|---------------------------------------------------|------------|------------------------|---------------|
| ** **                                        | ** ** | **2005**               | ** **    | **2004** | ** ** | **% Change** | ** ** |
| **Revenues**                                      | ** ** | **$**                  | **89,015**    | ** ** | **$** | **136,124** | ** ** | **-35** | **%** |
| ** **                                        | ** ** | ** **             | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Expenses**                                      | ** ** | ** **             | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Cost of  Revenue**                              | ** ** | **$**                  | **56,547**    | ** ** | **$** | **58,391** | ** ** | **-3** | **%** |
| **Research &  Development**              | ** ** | **$**                  | **97,359**    | ** ** | **$** | **116,221** | ** ** | **-16** | **%** |
| **Sales  and Marketing**                          | ** ** | **$**                  | **255,250**   | ** ** | **$** | **120,410** | ** ** | **112** | **%** |
| **General &  Administrative**            | ** ** | **$**                  | **596,935**   | ** ** | **$** | **348,864** | ** ** | **71** | **%** |
| **Total  Operating Expenses**                     | ** ** | **$**                  | **1,006,091** | ** ** | **$** | **643,886** | ** ** | **56** | **%** |
| ** **                                        | ** ** | ** **             | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Loss  from Operations**                         | ** ** | **$**                  | **(917,076**  | **)** | **$** | **(507,762** | **)** | **81** | **%** |
| ** **                                        | ** ** | ** **             | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Other  (Income)/Expense**                       | ** ** | **$**                  | **3,796**     | ** ** | **$** | **(239,199** | **)** | **-102** | **%** |
| ** **                                        | ** ** | ** **             | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Net Loss  attributable to Common Shareholders** | ** ** | **$**                  | **(920,872**  | **)** | **$** | **(268,563** | **)** | **243** | **%** |

 

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***Revenues:***Ourrevenues are derived from software license sales, annual maintenance contractson those sales, consulting fees, training fees, per-user-per month recurringrevenues for ISP customers and per-user/per-site-per-month fees for a partnerwho sells our products to multi-location customers as an alternative to costlyadditional bandwidth and hardware additions.

 

For the three months ended March 31, 2005 compared to 2004,revenues were 35% lower. In 2005, we sold licenses to 3 customers with anaverage license sale of approximately $13,000 while in 2004 we sold licenses to7 different customers with an average license sale of approximately $12,000.The company does not see the average license sale increase as a trend or apredictor of future license sales. Additionally, in 2005, maintenance revenuedecreased compared to the same period in 2004 by approximately $8,000 due tothe declining overall level of new license sales. The reduction in revenues in2005 compared to 2004 was primarily due to fewer customers purchasing ourproducts.

 

OnMarch 27, 2005, we entered into an $84,000 license reseller agreement witha customer based in Russia that intends to resell our software into the Russiantelecommunications industry. The license will be paid for quarterly over thenext two years. The first payment of $7,000 was due, and has been received in April 2005.In terms of our revenue recognition policy we will recognize revenues from thisagreement on the cash received basis. No revenues have been recognized duringthe quarter ended March 31, 2005.

 

***Cost of Revenue:***Thiscategory is comprised of amortization of capitalized software development costsand customer support costs, which include personnel costs that relate topre-and post-sales support of our products. Cost of Revenue decreased 3% in thethree-month period ended March 31, 2005 compared to the same period in2004 and is attributed to a 39% reduction in amortization of capitalizeddevelopment costs for HyperWebTM which was fully amortized in December, 2004offset by a 36% increase in customer support costs resulting from the hiring ofan additional customer service resource in March 2004. The increaserepresents three full months of service in 2005 versus one month of service inthe same period in 2004.

 

***Research &Development Costs:***Research and development expenses consistprimarily of compensation related to the cost of software engineeringpersonnel, third party consultants, prototype expenses related to the design,development, testing and enhancement of our software products, hardware andsoftware used in the design, development and support of our products. Thisexpense category is the non-capitalized portion of these costs. For the threemonths ended March 31, 2005 compared to the same period in 2004, Researchand Development (R&D) costs decreased by 16%. This was mainly due toreduced compensation costs in the area of product management as we transferredone person from R&D to focus on M&A activities which are now classifiedunder the G&A expense category.

 

***Sales &Marketing:***In the three months ended March 31,2005, sales and marketing expenses increased 112% or $135,000 compared to 2004.This increase was attributed to increases in sales and marketing post our IPOin conjunction with our stated use of funds. Specifically, the increases inSales and Marketing expenses are due to the following:

 

•                     Salespersonnel costs increased $32,000 or 53% and is due mostly to increasedcompensation costs for our COO, hired in March 2004, compared to the costof previous sales leadership and the hiring of our new VP of ChannelDevelopment in January 2005. We had no such position in 2004.

 

•                     OtherSales expenses increased $27,000 and is due to a placement fee incurred for ourVP of Channel Development.

 

•                     Marketingexpenses increased $76,000 and this increase is attributable to costs forre-design of the Company website of $25,000; a two-month media campaign in theamount of $16,000, and

 

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Public Relations and Marketing Communicationconsulting fees of $35,000. For the same period in 2004, the Company onlyincurred costs of approximately $10,000 for marketing campaigns due to limitedcash resources prior to the IPO.

 

***General &Administrative Expenses:***General andadministrative (“G&A”) expenses consist primarily of employee compensationfor executives and administrative personnel, office costs such astelecommunications, legal and accounting fees, rent and depreciation. In thefirst quarter of 2005, G&A expenses increased $248,000 or 71% compared tothe first quarter of 2004. We have capitalized $158,000 of non-payroll costsrelating to the proposed acquisition of MPC and these costs are not included inthis category.

 

The specific causes of the changes betweenperiods were due to:

 

•                  In2005, the incremental G&A costs related to being a public company wereapproximately $118,000 and included Board of Director costs, Investorrelations, D&O Insurance, Legal & Accounting, Transfer Agency,printing and compliance costs. In 2004, we incurred a lower level of publiccompany costs as we prepared ourselves for the IPO.

 

•                  In2005, compensation costs increased $98,000 or 49% due to salary increases forour CEO and CFO, the reclassified costs for our VP of Business Development whowas in a product management role in the same period in 2004 and was involved inmanaging our M&A activities in 2005 and the fact that our CFO was afull-time employee in 2005 versus 2004.

 

•                  In2005, we recorded a Bad Debt expense of $31,000 for two non-US customers. Onecustomer has historically paid late but the days outstanding on the unpaidamount is past their historic payment window of six months. The other customeris a reseller who has not made the final of three payments on a license sale.The Company intends to pursue payment but has reserved 100% of the remainingoutstanding balance.

 

•                  In2005, we incurred $24,000 in non-capitalizable expenses associated with ourmerger and acquisition strategy. These were related to the costs of exploringpotential mergers and acquisitions that did not materialize.

 

•                  OtherG&A expenses decreased by $23,000 and this was mostly attributable to adecrease in depreciation due to assets being fully amortized in 2004, reducedtravel costs and a reduction in IT costs.

 

***Other(Income) Expense:***This category increased $243,000or 102% in the quarter ended March 31, 2005 versus the same period in2004. Decreased interest costs of $172,000 in 2005 compared to 2004 were offsetby an increase in other income/expense of $415,000 attributable to a $441,000gain on settlement of the RCI Note recorded in March 2004 and decreasedpreferred dividends of $24,000. The decrease in interest income/expense of$172,000 was due to no new debt issuance costs in the first quarter of 2005 andrealization of interest income on IPO funds maintained in an interest-bearinginvestment account.

 

The interest charge was higher in 2004 due tothe higher amount of debt outstanding at the beginning of the period, loan feesincurred with new debt issued in 2004, and imputed interest recorded onwarrants issued and on debt with conversion features below fair value. The gainrecorded in 2004 on the RCI note was the result of a settlement of $42,500 forthe amount owed Remote Communications, Inc. (RCI) on the promissory notedated March 2001. Preferred Dividends decreased from 2004 due to theconversion of all preferred stock to common stock in 2004.

 

***Incometaxes:*******We make noprovision for income taxes because since inception we have not been profitable.We have a net operating loss carry-forward available to offset future federaland state income tax expenses to an amount that approximates our accumulateddeficits. Our net operating loss carry-forward will expire in varying amountsfrom 2021 to 2023. The utilization of the net operating loss carry-forward asan offset to future taxable income is subject to the limitations under U.S.federal income tax

 

13

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laws. One such limitation is imposed wherethere is a greater than 50% change in ownership of our Company.

 

Off Balance Sheet Transactions

Wehave no off balance sheet transactions.

 

Duringour normal course of business, we have made certain indemnities, commitmentsand guarantees under which it may be required to make payments in relation tocertain transactions.

 

Corporate Group and Segment Information

We are not, and never have been, part of any corporate group. We do nothave segment information because all of our activities are devoted to thedevelopment and sale of software. We have no discontinued operations.

 

Use of Estimates and Critical AccountingPolicies

This discussion and analysis of the financial condition and results ofoperations is based upon our financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.In order to prepare these financial statements, we are required to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses and related disclosures of contingent assetsand liabilities. On an ongoing basis, we evaluate our estimates, includingthose related to the valuation of long-lived assets; valuation allowancesincluding sales return reserves, allowances for doubtful accounts and otherliabilities, such as product warranty reserves. We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances.

 

Actual results may differ from theseestimates under different assumptions or conditions. Our use of estimates andcritical accounting policies are described in more detail in the notes to ourfinancial statements and in the 10-KSB filed on March 31, 2005. There havebeen no changes to the accounting policies described in the 10-KSB.

 

Liquidity and Capital Resources 

Since inception we have financed our operations through the privateplacements of equity securities, convertible debt, loans from our Founder andother members of our Board of Directors, a loan from RCI for the acquisition ofRCI’s assets, short-term loans, partial payment of various consultants andemployees with stock and /or options as part compensation for their services, aline of credit and our net proceeds of $7.1 million from our IPO.

 

We used cash from operations of $836,000 for the quarter ended March 31,2005 compared to a use of cash of $476,000 in the first quarter of 2004. Thelower revenues and increased operating cost explanations provided above explainthis increased use of cash. Cash flow from financing activity decreased due tothe fact that in the first quarter of 2004, we raised bridge loans to fundoperations prior to our IPO in an amount of approximately $1 million. We had nonew financing activities which raised cash in the first quarter of 2005.

 

Theproposed merger with MPC calls for us to have cash on hand at closing (no laterthan July 31, 2005) of at least $3.5 million. Under our current operatingplan, which continues modest investments in R&D and sales and marketing,and at the same time begins to reduce G&A expenses, we expect to be able tomeet this target.

 

Shouldwe not consummate the merger with MPC, we will seek alternative channelsthrough which to distribute our products and increase emphasis on ourOEM/Reseller channel strategy. We will reduce our G&A expenses but expectto continue with our M&A Strategy. Under this scenario, we expect to haveenough cash on hand to continue these operations through 2005. By reducing salesand marketing expenses and increasing our OEM/Reseller emphasis we may fallbehind in the market to the point that we are unable to generate sufficientrevenues and profits to sustain our business through 2006.

 

Shouldthe proposed merger not be consummated, a breakup fee may be payable by oneparty to the other. Our breakup fee, in certain circumstances is $500,000. Ifwe are required to pay GTG-Micron

 

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HoldingCompany, LLC a breakup fee we would have sufficient cash to continue operationsin 2005, but may not have sufficient cash to continue operations in 2006.

 

However, not consummating the proposed transaction with MPC willsignificantly limit our ability to enter into another transaction because we:

•                  Will have depleted capital resources,

•                  Will have lost valuable time,

•                  May have a share price which is notattractive to sellers, and

•                  May have harmed our reputation.

 

The following table summarizes our contractual and lease obligations atMarch 31, 2005:

 
| ** **                           | ** ** | **Total** | ** ** | **3/31/2006** | ** ** | **3/31/2007** | ** ** | **3/31/2008** | ** ** |
|--------------------------------------|------------|-----------|------------|---------------|------------|---------------|------------|---------------|------------|
| Office Lease                         |       | $         | 77,513     |          | $          | 77,513        |       | $             | —     |   | $ | — |   |
| Due to  Related Party                |       | $         | 49,448     |          | $          | 49,448        |       | none          |       | none |   |
| Officer’s  Employment Agreement |       | $         | 90,000     |          | $          | 90,000        |       | $             | —     |   | $ | — |   |
| Notes  Payable                       |       | $         | 1,088,940  |          | $          | 663,940       |       | $             | 425,000    |   | none |   |
| Total                                |       | $         | 1,305,901  |          | $          | 880,901       |       | $             | 425,000    |   | $ | — |   |

 

The office lease for our corporate officeexpires in February 2006 and is based on a fixed annual fee of $14 persquare foot payable in equal monthly installments.

 

We have entered into employment agreements with our Chairman, VicePresident of Development and one other employee. These agreements bear standardemployment terms and conditions. The minimum future amounts are not accrued orreflected in the table above, as they are based on continued employment. Inaddition, certain employees who do not have Employment Agreements, have anoffer letter or other agreements with us, which state that under certaincircumstances, they may receive a severance payment if the Company terminatestheir employment. Should we be liable to all such employees, the maximum amountdue is less than $50,000. This is not shown in the table above.

 

Subsequentto the announcement of the proposed merger, we have been in the process ofrenegotiating the Employment Agreement with our CEO. This agreement is not yetfinalized and amounts are not reflected in the table above.

 

Wehave renegotiated an offer letter agreement with our COO who will leave thecompany regardless of the consummation of the proposed merger. The renegotiatedagreement calls for normal confidentiality and non-compete provisions andstipulates that the COO assist with the proposed merger and transitionresponsibilities in her current capacity. Employment will continue until threemonths after the closing of the proposed merger. The stock options issued andheld by our COO will continue to vest on their normal schedule, however, allvested stock options held by our COO must be exercised by July 1, 2007 orbe forfeited. The agreed upon settlement to this officer is included in thetable above.

 

From early February 2005, we have incurred costs relatingspecifically to the proposed merger with MPC and expect to continue to incurcosts through closing and thereafter. We have three categories of costs that wewill incur with respect to the proposed merger:

•                  *Fixed Costs to Closing*: We have and will incur legal, proxy,accounting, filing, tax, printer, fairness opinion, travel and other costs bypursuing this merger and seeking the appropriate regulatory approvals. Thesecosts will be incurred regardless of whether the proposed merger isconsummated. Assuming the transaction closes in August or September 2005,we expect to incur at least $400,000 in such fixed costs.

•                  *Variable Costs to Closing*: We will incur costs to Bathgate Capital,our investment banking firm, if the proposed merger transaction is consummated.Under the terms of our revised arrangement with Bathgate, we will pay them$350,000 upon closing of the transaction, issue them a one-year convertiblenote at 5% in the amount of $550,000 (convertible into our common stock at anytime prior to repayment at $3 per share) and issue them 200,000 warrants topurchase shares of our common stock with a five year life and exercisable at $3per share.

•                  *Costs after Closing*: If the proposed merger is consummated, weexpect to incur costs relating to reducing our workforce including severancepayments and Employment Agreement amounts,

 

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termination fees, additional D&O Insurance,increased American Stock Exchange fees, increased travel costs, increased costsrelating to compliance particularly to integrate the merged companies’ internalcontrols and procedures to comply with the relevant provisions of theSarbanes-Oxley Act of 2002, increased legal and audit costs, increased Board ofDirector and Audit Committee expenses and other integration costs. All of theseitems will be discussed in greater detail in the proxy statement that we filewith respect to the proposed merger.

 

**ITEM 3. CONTROLS AND PROCEDURES**

 

We have performed an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of our disclosure controls andprocedures, as such terms are defined under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended. Based upon thatevaluation, our management, including our Chief Executive Officer and ChiefFinancial Officer, concluded that our disclosure controls and procedures wereeffective as of the end of the period covered by this quarterly report. Therehave been no changes in our internal control over financial reporting duringthe three months ending March 31, 2005 that have materially affected, oris reasonably likely to have had a material affect on our internal controlsover financial reporting.

 

In designing and evaluating the disclosure controls and procedures, ourmanagement recognizes that any controls and procedures, no matter how welldesigned and implemented, can provide only reasonable assurance of achievingthe desired control objectives, and management’s duties require it to make itsbest judgment in evaluating the cost-benefit relationship of potential controlsand procedures.

 

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**PART II. OTHER INFORMATION**

 

*ITEM 1. LEGAL PROCEEDINGS*

 

None.

 

*ITEM 2. UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS*

 

None.

 

*ITEM 3. DEFAULTS UPON SENIOR SECURITIES*

 

None.

 

*ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS*

 

None.

 

*ITEM 5. NONE*

 

None.

 

*ITEM 6. EXHIBITS*

 

Exhibit 31.1 – Certification of Chief Executive Officer ofHyperSpace Communications, Inc. pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

 

Exhibit 31.2 – Certification of Chief Financial Officer ofHyperSpace Communications, Inc. pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

 

Exhibit 31.3 – Certification of Chairman of HyperSpaceCommunications, Inc. pursuant to Section 302 of the Sarbanes-OxleyAct of 2002.

 

Exhibit 32.1 – Certification of Chief Executive Officer ofHyperSpace Communications, Inc. pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

Exhibit 32.2 – Certification of Chief Financial Officer of HyperSpaceCommunications, Inc. pursuant to Section 906 of the Sarbanes-OxleyAct of 2002.

 

Exhibit 32.3 – Certification of Chairman of HyperSpaceCommunications, Inc. pursuant to Section 906 of the Sarbanes-OxleyAct of 2002.

 

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*SIGNATURES*

 

In accordance with the requirements of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                    | HyperSpace Communications, Inc. |
|-------------------------|--------------------------------------|
|                    |                                 |
|                    |                                 |
| Date: May 12, 2005 | /s/ Mark Endry                       |
|                    | Mark Endry                           |
|                    | President and CEO               |
|                    |                                 |
|                    |                                 |
| Date: May 12, 2005 | /s/ Mark Pougnet                     |
|                    | Mark Pougnet                         |
|                    | Chief Financial Officer              |

 

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*EXHIBIT INDEX*

 

Exhibit 31.1 – Certification of Chief Executive Officer ofHyperSpace Communications, Inc. pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

 

Exhibit 31.2 – Certification of Chief Financial Officer ofHyperSpace Communications, Inc. pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

 

Exhibit 31.3 – Certification of Chairman of HyperSpaceCommunications, Inc. pursuant to Section 302 of the Sarbanes-OxleyAct of 2002.

 

Exhibit 32.1 – Certification of Chief Executive Officer ofHyperSpace Communications, Inc. pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

Exhibit 32.2 – Certification of Chief Financial Officer ofHyperSpace Communications, Inc. pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

Exhibit 32.3 – Certification of Chairman of HyperSpaceCommunications, Inc. pursuant to Section 906 of the Sarbanes-OxleyAct of 2002.

 

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