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

 

**Washington,D.C. 20549**

 

**FORM 10-QSB**

 

**ý****        QUARTERLYREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarterly period endedJune 30, 2005**

 

**o****        TRANSITIONALREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For thetransition periodfrom                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) filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the preceding twelve months (or for suchshorter period that the issuer was required to file such reports), and(2) has been subject to such filing requirements for the past90 days.

 

Yes  ý   No  o

 

As of June 30, 2005 there were 3,737,110shares of the issuer’s no par value Common Stock outstanding.

 

Transitional Small Business DisclosureFormat. Yes  o   No  ý

 

Table of Contents

 

 

----

 

 

**ITEM 1: FINANCIAL STATEMENTS**

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Balance Sheet**

 
| ** **                                                                                                                                           | ** ** | **June 30,**    | ** **     | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|----------------|------------------|------------|
| ** **                                                                                                                                           | ** ** | **2005**        | ** **     | **2004**         | ** ** |
| ** **                                                                                                                                           | ** ** | **(Unaudited)** | ** **     | ** **       | ** ** |
| **ASSETS**                                                                                                                                           |       |            |           |             |       |
|                                                                                                                                                 |       |            |           |             |       |
| **Current Assets**                                                                                                                                   |       |            |           |             |       |
| **Cash and Cash Equivalents**                                                                                                                        | ** ** | **$**           | **4,226,792**  | ** **       | **$**      | **5,875,481** | ** ** |
| **Accounts Receivable, net of an allowance  for doubtful accounts of $30,507and $0, respectively**                                                   | ** ** | **$**           | **71,922**     | ** **       | **$**      | **158,998** | ** ** |
| **Other Current Assets**                                                                                                                             | ** ** | **$**           | **497,455**    | ** **       | **$**      | **106,182** | ** ** |
| **Total Current Assets**                                                                                                                             | ** ** | **$**           | **4,796,169**  | ** **       | **$**      | **6,140,661** | ** ** |
| ** **                                                                                                                                           | ** ** | ** **      | ** **     | ** **       | ** ** |
| **Non-Current Assets**                                                                                                                               | ** ** | ** **      | ** **     | ** **       | ** ** |
| **Property & Equipment, net of  accumulated depreciation of $332,042 and $301,456, respectively**                                                | ** ** | **$**           | **80,196**     | ** **       | **$**      | **110,782** | ** ** |
| **Capitalized Software, net of accumulated  amortization of $630,443 and $593,121, respectively**                                                    | ** ** | **$**           | **261,249**    | ** **       | **$**      | **298,570** | ** ** |
| **Total Non-Current Assets**                                                                                                                         | ** ** | **$**           | **341,445**    | ** **       | **$**      | **409,352** | ** ** |
| ** **                                                                                                                                           | ** ** | ** **      | ** **     | ** **       | ** ** |
| **TOTAL ASSETS**                                                                                                                                     | ** ** | **$**           | **5,137,614**  | ** **       | **$**      | **6,550,013** | ** ** |
| ** **                                                                                                                                           | ** ** | ** **      | ** **     | ** **       | ** ** |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                        | ** ** | ** **      | ** **     | ** **       | ** ** |
| ** **                                                                                                                                           | ** ** | ** **      | ** **     | ** **       | ** ** |
| **Current Liabilities**                                                                                                                              | ** ** | ** **      | ** **     | ** **       | ** ** |
| **Accounts Payable**                                                                                                                                 | ** ** | **$**           | **438,985**    | ** **       | **$**      | **230,484** | ** ** |
| **Accrued Compensation**                                                                                                                             | ** ** | **$**           | **88,332**     | ** **       | **$**      | **83,522** | ** ** |
| **Deferred Revenue**                                                                                                                                 | ** ** | **$**           | **96,213**     | ** **       | **$**      | **122,016** | ** ** |
| **Current Portion of Notes Payable & Debt**                                                                                                      | ** ** | **$**           | **1,125,991**  | ** **       | **$**      | **721,965** | ** ** |
| **Total Current Liabilities**                                                                                                                        | ** ** | **$**           | **1,749,521**  | ** **       | **$**      | **1,157,987** | ** ** |
| ** **                                                                                                                                           | ** ** | ** **      | ** **     | ** **       | ** ** |
| **Long Term Liabilities**                                                                                                                            | ** ** | ** **      | ** **     | ** **       | ** ** |
| **Long term Portion of Notes Payable**                                                                                                               | ** ** | **$**           | **—**     | ** **       | **$**      | **425,000** | ** ** |
| **Total Long Term Liabilities**                                                                                                                      | ** ** | **$**           | **—**     | ** **       | **$**      | **425,000** | ** ** |
| **Total Liabilities**                                                                                                                                | ** ** | **$**           | **1,749,521**  | ** **       | **$**      | **1,582,987** | ** ** |
|                                                                                                                                                 |       |            |           |             |       |
| **Shareholders’ Equity**                                                                                                                        |       |            |           |             |       |
| **Preferred Stock, no par value; 1,000,000  shares authorized; no shares issued and outstanding at 2005 and 2004**                                   | ** ** | **—**      | ** **     | **—**       | ** ** |
| **Common Stock, no par value, 15,000,000  shares authorized; 3,737,110 and 3,732,429 shares issued and outstanding at  2005 and 2004, respectively** | ** ** | **$**           | **12,089,496** | ** **       | **$**      | **12,087,134** | ** ** |
| **Accumulated Deficit**                                                                                                                              | ** ** | **$**           | **(8,701,403** | **)**            | **$**      | **(7,120,108** | **)** |
| **Total Shareholders’ Equity**                                                                                                                  | ** ** | **$**           | **3,388,093**  | ** **       | **$**      | **4,967,026** | ** ** |
|                                                                                                                                                 |       |            |           |             |       |
| **TOTAL LIABILITIES AND EQUITY**                                                                                                                     | ** ** | **$**           | **5,137,614**  | ** **       | **$**      | **6,550,013** | ** ** |

 

See accompanying notes to financial statements.

 

2

----

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Unaudited Statements of Operations for theThree and Six Months Ended June 30, 2005 and 2004.**

 
| ** **                                                        | ** ** | **June 30,**           | ** **   |
|-------------------------------------------------------------------|------------|------------------------|--------------|
| ** **                                                        | ** ** | **Three months ended** | ** **   | **Six months ended** | ** ** |
| ** **                                                        | ** ** | **2005**               | ** **   | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenues**                                                      | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **License Fees**                                                  | ** ** | **$**                  | **36,270**   | ** ** | **$** | **14,626** | ** ** | **$** | **75,911** | ** ** | **$** | **100,824** | ** ** |
| **Service & Other**                                           | ** ** | **$**                  | **39,993**   | ** ** | **$** | **55,634** | ** ** | **$** | **89,367** | ** ** | **$** | **105,560** | ** ** |
| **Total Revenues**                                                | ** ** | **$**                  | **76,263**   | ** ** | **$** | **70,260** | ** ** | **$** | **165,278** | ** ** | **$** | **206,384** | ** ** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Cost of Revenue**                                               | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Amortization of Capitalized Software**                          | ** ** | **$**                  | **18,661**   | ** ** | **$** | **30,488** | ** ** | **$** | **37,321** | ** ** | **$** | **60,977** | ** ** |
| **Customer Support**                                              | ** ** | **$**                  | **12,079**   | ** ** | **$** | **40,243** | ** ** | **$** | **49,966** | ** ** | **$** | **68,144** | ** ** |
| **Total Cost of Revenue**                                         | ** ** | **$**                  | **30,740**   | ** ** | **$** | **70,731** | ** ** | **$** | **87,287** | ** ** | **$** | **129,121** | ** ** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Gross Profit**                                                  | ** ** | **$**                  | **45,523**   | ** ** | **$** | **(471** | **)** | **$** | **77,991** | ** ** | **$** | **77,263** | ** ** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating Expenses**                                            | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Research & Development**                                    | ** ** | **$**                  | **83,148**   | ** ** | **$** | **107,476** | ** ** | **$** | **180,507** | ** ** | **$** | **223,697** | ** ** |
| **Sales & Marketing**                                         | ** ** | **$**                  | **114,530**  | ** ** | **$** | **169,055** | ** ** | **$** | **369,780** | ** ** | **$** | **289,465** | ** ** |
| **General & Administrative**                                  | ** ** | **$**                  | **510,057**  | ** ** | **$** | **226,449** | ** ** | **$** | **1,106,992** | ** ** | **$** | **575,313** | ** ** |
| **Total Operating Expenses**                                      | ** ** | **$**                  | **707,735**  | ** ** | **$** | **502,980** | ** ** | **$** | **1,657,279** | ** ** | **$** | **1,088,475** | ** ** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loss from Operations**                                          | ** ** | **$**                  | **(662,212** | **)** | **$** | **(503,451** | **)** | **$** | **(1,579,288** | **)** | **$** | **(1,011,212** | **)** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Other (Income)/Expense**                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest Expense, net**                                         | ** ** | **$**                  | **(1,982**   | **)** | **$** | **361,503** | ** ** | **$** | **1,814** | ** ** | **$** | **536,909** | ** ** |
| **Other Expense**                                                 | ** ** | **$**                  | **193**      | ** ** | **$** | **5,749** | ** ** | **$** | **193** | ** ** | **$** | **8,289** | ** ** |
| **Gain on Settlement**                                            | ** ** | **$**                  | **—**   | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **(440,999** | **)** |
| **Total Other (Income)/Expense**                                  | ** ** | **$**                  | **(1,789**   | **)** | **$** | **367,252** | ** ** | **$** | **2,007** | ** ** | **$** | **104,199** | ** ** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net Loss**                                                      | ** ** | **$**                  | **(660,423** | **)** | **$** | **(870,703** | **)** | **$** | **(1,581,295** | **)** | **$** | **(1,115,411** | **)** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Preferred Dividends**                                           | ** ** | **$**                  | **—**   | ** ** | **$** | **24,184** | ** ** | **$** | **—** | ** ** | **$** | **48,040** | ** ** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net Loss attributable to Common  Shareholders**                 | ** ** | **$**                  | **(660,423** | **)** | **$** | **(894,887** | **)** | **$** | **(1,581,295** | **)** | **$** | **(1,163,451** | **)** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic and diluted weighted average Common  Shares outstanding** | ** ** | **3,734,621**          | ** **   | **1,451,013** | ** ** | **3,733,531** | ** ** | **1,417,483** | ** ** |
| ** **                                                        | ** ** | ** **             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic and diluted loss per Common Share**                       | ** ** | **$**                  | **(0.18**    | **)** | **$** | **(0.62** | **)** | **$** | **(0.42** | **)** | **$** | **(0.82** | **)** |

 

See accompanying notes to financial statements.

 

3

----

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Unaudited Statements of Cash Flows For TheSix Months Ended June 30, 2005 and 2004.**

 
| ** **                                                                                                 | ** ** | **For the Six Months Ended  June 30,** | ** **     |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|----------------|
| ** **                                                                                                 | ** ** | **2005**                               | ** **     | **2004** | ** ** |
| **OPERATING ACTIVITIES**                                                                                   |       |                                   |           |   |   |
| **Net Loss**                                                                                               | ** ** | **$**                                  | **(1,581,295** | **)** | **$** | **(1,115,411** | **)** |
| **Adjustments to reconcile net loss to net cash  used in operating activities**                            | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **Depreciation**                                                                                           | ** ** | **$**                                  | **30,586**     | ** ** | **$** | **38,564** | ** ** |
| **Amortization/impairment of capitalized  software**                                                       | ** ** | **$**                                  | **37,321**     | ** ** | **$** | **60,977** | ** ** |
| **Settlement of liability for reduced amount**                                                             | ** ** | **$**                                  | **—**     | ** ** | **$** | **(440,999** | **)** |
| **Options issued to employees**                                                                            | ** ** | **$**                                  | **—**     | ** ** | **$** | **27,333** | ** ** |
| **Warrants issued for debt issue costs and  interest**                                                     | ** ** | **$**                                  | **—**     | ** ** | **$** | **34,281** | ** ** |
| **Conversion preference with debt**                                                                        | ** ** | **$**                                  | **—**     | ** ** | **$** | **82,863** | ** ** |
| **Stock for services**                                                                                     | ** ** | **$**                                  | **—**     | ** ** | **$** | **22,500** | ** ** |
| **Reduction of conversion price on debt to  induce conversion and maturity extension on convertible debt** | ** ** | **$**                                  | **—**     | ** ** | **$** | **150,800** | ** ** |
| **Warrants issued to induce conversion and  maturity extensions on convertible debt**                      | ** ** | **$**                                  | **—**     | ** ** | **$** | **76,454** | ** ** |
| **Accrued interest included in notes payable**                                                             | ** ** | **$**                                  | **(19,832**    | **)** | **$** | **47,400** | ** ** |
| **Accretion of Debt Issue Costs**                                                                          | ** ** | **$**                                  | **—**     | ** ** | **$** | **14,288** | ** ** |
| **Provision for Bad Debt**                                                                                 | ** ** | **$**                                  | **30,507**     | ** ** | **$** | **—** | ** ** |
| **Changes in Assets and Liabilities**                                                                      | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **Accounts Receivable**                                                                                    | ** ** | **$**                                  | **56,570**     | ** ** | **$** | **260,298** | ** ** |
| **Other Current Assets**                                                                                   | ** ** | **$**                                  | **(391,274**   | **)** | **$** | **(8,435** | **)** |
| **Accounts Payable**                                                                                       | ** ** | **$**                                  | **208,501**    | ** ** | **$** | **(118,905** | **)** |
| **Accrued Liabilities**                                                                                    | ** ** | **$**                                  | **4,811**      | ** ** | **$** | **(79,482** | **)** |
| **Deferred Revenue**                                                                                       | ** ** | **$**                                  | **(25,804**    | **)** | **$** | **(44,735** | **)** |
| **Net Cash Used in Operating Activities**                                                                  | ** ** | **$**                                  | **(1,649,909** | **)** | **$** | **(992,209** | **)** |
| ** **                                                                                                 | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **INVESTING ACTIVITIES**                                                                                   | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **Purchase of Property and Equipment**                                                                     | ** ** | **$**                                  | **—**     | ** ** | **$** | **(52,126** | **)** |
| **Net Cash Used in Investing Activities**                                                                  | ** ** | **$**                                  | **—**     | ** ** | **$** | **(52,126** | **)** |
| ** **                                                                                                 | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **FINANCING ACTIVITIES**                                                                                   | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **Net Proceeds from Notes Payable**                                                                        | ** ** | **$**                                  | **—**     | ** ** | **$** | **1,250,000** | ** ** |
| **Payment of Note Payable**                                                                                | ** ** | **$**                                  | **(1,142**     | **)** | **$** | **(18,228** | **)** |
| **Net Proceeds from the Issuance of Preferred  Stock**                                                     | ** ** | **$**                                  | **—**     | ** ** | **$** | **43,750** | ** ** |
| **Payment of Offering Costs**                                                                              | ** ** | **$**                                  | **2,362**      | ** ** | **$** | **(25,000** | **)** |
| **RCI Settlement**                                                                                         | ** ** | **$**                                  | **—**     | ** ** | **$** | **(42,500** | **)** |
| **Net cash provided by financing activities**                                                              | ** ** | **$**                                  | **1,220**      | ** ** | **$** | **1,208,022** | ** ** |
| ** **                                                                                                 | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **Net cash increase (decrease) for period**                                                                | ** ** | **$**                                  | **(1,648,689** | **)** | **$** | **163,687** | ** ** |
| ** **                                                                                                 | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **Cash at beginning of period**                                                                            | ** ** | **$**                                  | **5,875,481**  | ** ** | **$** | **27,429** | ** ** |
| ** **                                                                                                 | ** ** | ** **                             | ** **     | ** ** | ** ** |
| **Cash at end of period**                                                                                  | ** ** | **$**                                  | **4,226,792**  | ** ** | **$** | **191,116** | ** ** |

 

4

----

 

*Statements of Cash Flows*

 

Supplemental disclosure of cash flow information:

 

Cash paid for interest for the six months ended June 30, 2005 and2004 was $82,547 and $27,057, respectively.

 

No cash was paid for income taxes for the six months ended June 30,2005 and 2004.

 

Supplemental disclosure of non-cash activity:

 

During the six months ended June 30,2004, $228,652 of notes payable was converted to common stock, at $3.50 pershare.

 

During the six months ended June 30,2004, the Company issued $8,125 of common stock in exchange for deferredoffering costs.

 

During the six months ended June 30,2004, the Company accrued dividends on Series A preferred stock in theamount of $48,040.

 

See accompanying notes to financial statements.

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Notes to Financial Statements *(Information with Respect to the Three and Six MonthsEnded***

***June 30, 2005and 2004 is Unaudited)***

 

***Note 1—Descriptionof Business***

HyperSpace Communications, Inc. (the Company) produces and marketsHyperWebÔ and HyperTunnelÔsoftware products, which accelerate web and client/server-based applicationsover wider area networks, both terrestrial and wireless, thereby increasingperformance and throughput and lowering costs for bandwidth, hardware,software, IT overhead and human resources while increasing employeeproductivity and customer satisfaction. The Company’s objective is to make itscustomers more efficient and profitable through higher performance ofmission-critical applications.

 

OnMarch 21, 2005, the Company incorporated a wholly owned subsidiary by thename of Spud Acquisition Corporation (“Spud”). Spud is organized under the lawsof the state of Delaware and has no operations. Spud has been formed tocomplete the proposed merger with MPC Computers, Inc. (“MPC”).

 

OnMarch 21, 2005, the Company, along with Gores Technology Group, LLC (“Gores”)and MPC, announced the execution of an Agreement and Plan of Merger dated as ofMarch 20, 2005 by and among the Company, Spud Acquisition Corp., a Delawarecorporation and a wholly owned subsidiary of the Company, GTG PC Holdings, LLC,a Delaware limited liability company and GTG-Micron Holding Company, LLC. MPCis the wholly owned subsidiary of GTG PC Holdings, LLC. The shareholder vote onthe merger proposal is scheduled for July 22, 2005. For further details on thisproposed transaction, please refer to the various documents filed with the SECincluding the Definitive Proxy Statement filed with the SEC on June 17, 2005.

 

***Note 2—SignificantAccounting Policies***

*Interim Financial Information*

The unaudited financial statements for the three and six months endedJune 30, 2005 and 2004 include, in the opinion of management, alladjustments (consisting of normal recurring adjustments) necessary to presentfairly the Company’s financial position, results of operations and cash flows.Operating results for the six months ended June 30, 2005 are notnecessarily an indication of the results that may be expected for the entirefiscal year. HyperSpace Communications, Inc. has prepared theaccompanying unaudited financial statements pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”).

 

Thesefinancial statements and notes should be read in conjunction with the 10-KSBfiled with the SEC on March 31, 2005. The footnotes below are those thathave changes from the footnotes accompanying the financial statements atDecember 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 onOctober 1, 2004 and accordingly, no adjustments are necessary to thefinancial statements as a result of a going concern uncertainty. Due to thechange in the Company’s business, as contemplated by the proposed merger withMPC, and notwithstanding any break-up fee that may be payable by MPC, notconsummating the merger may result in continued losses and cash flow problems.The Company does, however, expect to have sufficient cash to fund operationsthrough June 30, 2006.

 

5

----

 

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.

 

*License fee revenue:*For software license agreements that do not require significant modification orcustomization of the software, the Company recognizes revenue when evidence ofa non-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, theCompany defers revenue. The Company records deferred revenue as a currentliability until all the elements to be delivered at a future date and vendorspecific evidence of acceptance have occurred.

 

The Company considers receipt of an approved customer purchase order orthe approval 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 the Company has evidence that the customer hasdownloaded the 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, the Company defers revenuerecognition until acceptance by the customer or lapse of the acceptance period.Typically, the Company’s software licenses do not include significantpost-delivery obligations to be fulfilled by us.

 

Generally,the Company follows the abovementioned policy regardless of whether we areselling to the ultimate end-user or to a reseller, provided the reseller agreesto the same terms as discussed above.However, a certain number of reseller agreements relate to sales intoforeign countries, where the license fee is payable over a number of futureinstallments. Although these foreign reseller agreements generally have nocontingent deal terms, the likelihood of foreign resellers making futureinstallment payments is heavily dependent on their success at reselling theCompany’s software. This payment risk is higher in certain countries thanothers due to the high cost of successful collection efforts and lowprobability of successful litigation efforts. The Company believes that therisk is higher in countries exclusive of what the US Commerce Departmentclassifies (for software export permit purposes) as the “EU + 8”. The “EU+8countries” include: Austria, Australia, Belgium, Czech Republic, Denmark,Finland, France, Germany, Greece, Hungary, Ireland, Italy, Japan, Luxembourg,Netherlands, New Zealand, Norway, Poland, Portugal, Spain, Sweden, Switzerland,United Kingdom. The Company’s policyfor license sales to foreign resellers, therefore, in non-EU + 8 countries,will be to recognize revenues on a cash received basis.

 

Duringthe six months ended June 30, 2005, the Company signed an agreement with aRussian reseller that met the criteria of this policy. The Company recognized$7,000 as revenue during the quarter ended June 30, 2005 based on receipt ofthe first installment payment.

 

*Concentrations of Credit Risk*

 

The Company is subject to the risks of concentration of credit risk ina few customers. During the three months ended June 30, 2005, the Companyhad:

 

•      Threecustomers that accounted for 34% of revenues

•      34%of its revenues from non-US customers

 

During the six months ended June 30, 2005 the Company had:

•      Threecustomers that accounted for 29% of revenues

•      19%of its revenues from non-US customers

 

At June 30, 2005, one customer accounted for 24% of the totalaccounts receivable.  This customer paidthe remaining amount owed subsequent to the end of the quarter.

 

As of June 30, 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.

 

6

----

 

*Allowance for Doubtful Accounts*

The Company maintains an allowance for doubtful accounts at an amountestimated to be sufficient to provide adequate protection against lossesresulting from collecting less than full payment on receivables. Overdueaccounts are reviewed, and an additional allowance is recorded when determinednecessary to state receivables at an estimated realizable value. In judging theadequacy of the allowance for doubtful accounts, the Company considers multiplefactors including historical bad debt experience, the general economicenvironment, and the aging of its receivables. A considerable amount ofjudgment is required when assessing the realization of receivables, includingassessing the probability of collection and the current creditworthiness ofeach customer.

 

As of June 30, 2005, the Company has determined and recorded areserve of approximately $31,000 for doubtful accounts for two non-U.S.customers. One customer, a large European mobile telecommunications provider,has historically paid late but despite extensive collection efforts, the daysoutstanding on the unpaid amount is past their historic payment window of sixmonths. The other customer is a reseller who has not made the final one-thirdpayment on a license sale. The Company believes that this is due to thereseller’s unsuccessful efforts to ramp up the sale of our products to one oftheir large customers. There is no contingency in the signed license agreement,and therefore, the Company intends to pursue full payment but has reserved 100%of the remaining outstanding balance of $13,000.

 

*Stock-Based Compensation*

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** | ** **   | **Six months ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------------------|--------------|----------------------|------------|
| ** **                                                                                                          | ** ** | **June 30,**           | ** **   | **June 30,**         | ** ** |
| ** **                                                                                                          | ** ** | **2005**               | ** **   | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Net loss available to common shareholders—as  reported**                                                     | ** ** | **$**                  | **(660,423** | **)**                | **$**      | **(894,887** | **)** | **$** | **(1,581,295** | **)** | **$** | **(1,163,451** | **)** |
| ** **                                                                                                          | ** ** | ** **             | ** **   | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Add: stock-based employee compensation  included in net income**                                                  | ** ** | **$**                  | **—**   | ** **           | **$**      | **2,999** | ** ** | **$** | **—** | ** ** | **$** | **27,333** | ** ** |
| ** **                                                                                                          | ** ** | ** **             | ** **   | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Deduct: total stock-based employee  compensation expense determined under fair market value method for an award** | ** ** | **$**                  | **—**   | ** **           | **$**      | **(30,676** | **)** | **$** | **(150,803** | **)** | **$** | **(306,367** | **)** |
| ** **                                                                                                          | ** ** | ** **             | ** **   | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net loss available to common shareholders—pro  forma**                                                       | ** ** | **$**                  | **(660,423** | **)**                | **$**      | **(922,564** | **)** | **$** | **(1,732,098** | **)** | **$** | **(1,442,485** | **)** |
| ** **                                                                                                          | ** ** | ** **             | ** **   | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic loss per common share—as reported**                                                                    | ** ** | **$**                  | **(0.18**    | **)**                | **$**      | **(0.62** | **)** | **$** | **(0.42** | **)** | **$** | **(0.82** | **)** |
| ** **                                                                                                          | ** ** | ** **             | ** **   | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic loss per common share—pro forma**                                                                      | ** ** | **$**                  | **(0.18**    | **)**                | **$**      | **(0.64** | **)** | **$** | **(0.46** | **)** | **$** | **(1.02** | **)** |

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option-pricing model. All options are granted at fairmarket value on the date of the grant. No options have been re-priced or hadtheir maturities extended during the six months ended June 30, 2005. In termsof the provisions of our Incentive Option Plans, employees, with vestedoptions, who leave the employment of the Company, are required to exercise orforfeit their options within 90 days after leaving employment regardless of theexercise period of the initial grant.

 

There were no options granted during the quarter ended June 30, 2005and the following table provides the weighted-average assumptions used atJune 30, 2004 for all Black-Scholes calculations in the financialstatements:

 

| ** **                 | ** ** | **June 30,** | ** ** |
|----------------------------|------------|--------------|------------|
| ** **                 | ** ** | **2005**     | ** ** | **2004** | ** ** |
|                       |       |         |       |   |   |
| Approximate risk free rate |       | N/A          |       | 3.4 | % |
| Average expected life      |       | N/A          |       | 10 years |   |
| Dividend yield             |       | N/A          |       | — | % |
| Volatility                 |       | N/A          |       | 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

 

7

----

 

apply to us effective January 1, 2006, we will, as a new publiccompany, be permitted to use a peer group comparison because the period of ourhistorical volatility will not be longer than the expected terms of theoutstanding options. However, we will no longer be permitted to use indices. Weare 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 six months endedJune 30, 2005 and 2004, total stock options, stock warrants andconvertible debt of 5,066,726 and 1,511,885 respectively were not included inthe computation of loss per share because their effect was antidilutive;however, if the Company were to achieve profitable operations in the future,they could potentially dilute such earnings. The Company’s basic and dilutedloss per share is equivalent and accordingly, only basic loss per share hasbeen presented.

 

# ***Note 3 – OtherCurrent Assets***

 

We expect to incur approximately $1.5 million in professional fees anddeal costs to consummate the merger with MPC. As of June 30, 2005, we incurred approximately $451,000 of costsrelating to the proposed merger and have capitalized these costs as OtherCurrent Assets in the Balance Sheet.

 

***Note 4—NotesPayable and Debt***

 
| ** **                                             | ** ** | **June 30,**    | ** **    | **December 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------|---------------|------------------|------------|
| ** **                                             | ** ** | **2005**        | ** **    | **2004**         | ** ** |
| ** **                                             | ** ** | **(Unaudited)** | ** **    | ** **       | ** ** |
|                                                   |       |            |          |             |       |
| **Convertible Bridge Loans**                           | ** ** | **$**           | **1,076,264** | ** **       | **$**      | **1,089,627** | ** ** |
| **Note Payable to Founder**                            | ** ** | **$**           | **49,727**    | ** **       | **$**      | **57,338** | ** ** |
| **Total Notes Payable and Bridge Loans**               | ** ** | **$**           | **1,125,991** | ** **       | **$**      | **1,146,965** | ** ** |
| **Long-term Portion of Convertible Bridge  Loans**     | ** ** | **$**           | **—**    | ** **       | **$**      | **425,000** | ** ** |
| **Current Portion of Notes Payable and Bridge  Loans** | ** ** | **$**           | **1,125,991** | ** **       | **$**      | **721,965** | ** ** |

 

All amounts are inclusive of accrued interest.

 

With respect to the Convertible Bridge Loans, $620,000 is dueSeptember 2005 and $425,000 is due April 2006 including any unpaidinterest which is accrued at 12% per annum. The Holder shall have the right, atany time prior to payment (or pre-payment), to convert all or any part of thethen outstanding balance of principal and interest under this note into sharesof common stock at the conversion price of $4.375 and $3.50 per share,respectively. The notes have detachable warrants for purchase of common stock.The value of the warrants was recorded as interest expense in 2004. All assetsof the Company collateralize the notes. A beneficial conversion feature of$233,662 was recorded on the notes, which was recorded as interest expense whenthe debt was issued in 2004. These notes have registration rights.

 

With respect to the Note Payable to Founder, the Founder has the right,at any time prior to payment (or pre-payment), to convert all or any part ofthe then outstanding balance of principal and interest under this note intoshares of common stock at the conversion price of $3.50 per share. The notematured in June 2005 and is callable at any time by the Founder. Interestis accrued at 9% on the outstanding principal balance of this note.

 

***Note 5—Related PartyTransactions***

The Company’s policies prohibit loans to Directors, Officers andEmployees. There were no such loans outstanding at any time during the quarterended June 30, 2005.

 

The Company has a loan outstanding from its Founder that arose prior toour IPO. During the six months ended June 30, 2005, the Company paidaccrued interest and repaid a small amount of principal on this note. Moredetails are provided in Note 3 – Notes Payable and Debt.

 

***Note 6—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

 

8

----

 

will be realized. Tax benefit from net operating losses and timingdifferences are calculated at an estimated blended federal and Colorado taxrate of 37.3%.

 

***Note 7—******Proposed Acquisition of MPC Computers, Inc. (“MPC”)***

On March 21, 2005, the Company, along with Gores Technology Group,LLC (“Gores”) and MPC, announced the execution of an Agreement and Plan ofMerger dated as of March 20, 2005 by and among the Company, SpudAcquisition Corp., a Delaware corporation and a wholly owned subsidiary of theCompany, GTG PC Holdings, LLC, a Delaware limited liability company andGTG-Micron Holding Company, LLC. MPC is the wholly owned subsidiary of GTG PCHoldings, LLC. The shareholder vote on the merger proposal is scheduled forJuly 22, 2005. For further details on this proposed transaction, please referto the various documents filed with the SEC including the Definitive ProxyStatement filed with the SEC on June 17, 2005.

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION 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 suchstatements. These forward-looking statements are subject to risks and uncertaintiesthat could 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 network acceleration and data compressionsoftware. We offer two software products. Our initial software productHyperWebTM, was introduced in late 2001. In January 2004, we introduced oursecond product, HyperTunnelTM. These software products address the growing needfor real-time application acceleration and improved business communicationsover wired and wireless networks.

 

We completed an initial public offering, or “IPO”, inOctober 2004. We raised approximately $7.1 million after offering costsand expenses.

 

As discussed elsewhere in this document and in various filings with theSEC since March 21, 2005, we are preparing to engage in a merger that, ifapproved by our shareholders and consummated, would result in us acquiring 100%of the outstanding equity interest of GTG PC Holdings, LLC, the parent of MPCComputers, LLC, or MPC. MPC is a provider of computing solutions to customersin the federal government, state and local government and education andmid-market enterprise markets offering a broad range of customized computingproducts and services, including hardware, software and related informationtechnology (IT) consultative services.

 

**Business Overview**

 

In the last few months many of our competitors have announced that theyare being acquired or merging with other competitors. We believe this is areflection of their difficulties growing revenue on a stand-alone companybasis. We believe the combined assets, resources and larger market presence ofthe merged competitors will increase the difficulty of selling our products ona stand-alone basis.

 

After a comprehensive process, which is explained in detail in theDefinitive Proxy Statement filed with the SEC on June 17, 2005, we determinedthat the MPC acquisition would provide us with the best chance to grow revenuesfor our products.

 

9

----

 

Particularly, we believe that MPC can assume most of the sales andmarketing activities that we have been unsuccessfully attempting to build andestablish. We also believe that there is an opportunity for sales of oursoftware products through MPC’s existing sales channels and to MPC’s existinginstalled base of customers. We believe that this approach to achieve revenuegrowth of our software products offers a higher probability of success thanthat of continuing to exist as a stand-alone entity.

 

As we moved ahead on our merger strategy, we made the decision to reduceour investments in sales and marketing. Specifically, we decided to reduceheadcount expansion, cut back on marketing research and begin to eliminateoutbound telemarketing activities that were not producing desired results.These actions have negatively impacted the revenue growth for the six monthsended June 30, 2005.

 

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 12 full-time employees/regularcontractors as of June 30, 2005.

 

KEY INDICATIONS OF FINANCIAL CONDITION ANDPERFORMANCE

 

Comparison of the Three and Six Months endedJune 30, 2005 to 2004 (Unaudited)

 
| ** **                                        | ** ** | **June 30,**            | ** **   |
|---------------------------------------------------|------------|-------------------------|--------------|
| ** **                                        | ** ** | **Three  Months Ended** | ** **   | **Six  Months Ended** | ** ** |
| ** **                                        | ** ** | **2005**                | ** **   | **2004** | ** ** | **% Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **% Change** | ** ** |
| **Revenues**                                      | ** ** | **$**                   | **76,263**   | ** ** | **$** | **70,260** | ** ** | **9** | **%** | **$** | **165,278** | ** ** | **$** | **206,384** | ** ** | **-20** | **%** |
|                                              |       |                    |         |   |   |   |   |   |   |   |   |   |   |
| **Expenses**                                      |       |                    |         |   |   |   |   |   |   |   |   |   |   |
| **Cost of  Revenue**                              | ** ** | **$**                   | **30,740**   | ** ** | **$** | **70,731** | ** ** | **-57** | **%** | **$** | **87,287** | ** ** | **$** | **129,121** | ** ** | **-32** | **%** |
| **Research  & Development**                   | ** ** | **$**                   | **83,148**   | ** ** | **$** | **107,476** | ** ** | **-23** | **%** | **$** | **180,507** | ** ** | **$** | **223,697** | ** ** | **-19** | **%** |
| **Sales  and Marketing**                          | ** ** | **$**                   | **114,530**  | ** ** | **$** | **169,055** | ** ** | **-32** | **%** | **$** | **369,780** | ** ** | **$** | **289,465** | ** ** | **28** | **%** |
| **General  & Administrative**                 | ** ** | **$**                   | **510,057**  | ** ** | **$** | **226,449** | ** ** | **125** | **%** | **$** | **1,106,992** | ** ** | **$** | **575,313** | ** ** | **92** | **%** |
| **Total  Operating Expenses**                     | ** ** | **$**                   | **738,475**  | ** ** | **$** | **573,711** | ** ** | **29** | **%** | **$** | **1,744,566** | ** ** | **$** | **1,217,596** | ** ** | **43** | **%** |
|                                              |       |                    |         |   |   |   |   |   |   |   |   |   |   |
| **Loss  from Operations**                         | ** ** | **$**                   | **(662,212** | **)** | **$** | **(503,451** | **)** | **32** | **%** | **$** | **(1,579,288** | **)** | **$** | **(1,011,212** | **)** | **56** | **%** |
|                                              |       |                    |         |   |   |   |   |   |   |   |   |   |   |
| **Other  (Income)/Expense**                       | ** ** | **$**                   | **(1,789**   | **)** | **$** | **391,436** | ** ** | **-100** | **%** | **$** | **2,007** | ** ** | **$** | **152,239** | ** ** | **-99** | **%** |
|                                              |       |                    |         |   |   |   |   |   |   |   |   |   |   |
| **Net Loss  attributable to Common Shareholders** | ** ** | **$**                   | **(660,423** | **)** | **$** | **(894,887** | **)** | **-26** | **%** | **$** | **(1,581,295** | **)** | **$** | **(1,163,451** | **)** | **36** | **%** |

 

***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 six months ended June 30, 2005 compared to 2004, revenues were20% lower. In the six months ended June 30, 2005, we sold licenses to 6customers with an average license sale of approximately $13,000 while in 2004,we sold licenses to 10 customers with an average license sale of approximately$10,000. Maintenance revenue decreased 15% in the six months ended June 30,2005 compared to the same period in 2004 due to the declining overall level ofnew license sales in the last 6 months. The reduction in revenues in 2005compared to 2004 was primarily due to fewer customers purchasing our productsand, due to the limited number of transactions, we do not see the increasedaverage license sale as a trend.

 

For the three months ended June 30, 2005 compared to 2004, totalrevenues were 9% higher. In 2005, we sold licenses to 3 customers with anaverage license sale of approximately $12,000, while in 2004, we sold licensesto 3 different customers with an average license sale of approximately $5,000.The increase in license sales in the quarter ended June 30, 2005 versus 2004was offset by a decrease in maintenance revenue of 28%. As mentioned above, dueto the limited number of transactions in the three-month period for 2005 and 2004,we do not see the increased average license sale as a trend.

 

InMarch 2005, we entered into an $84,000 license reseller agreement with acustomer based in Russia that intends to resell

 

10

----

 

oursoftware into the Russian telecommunications industry. The license will be paidfor quarterly over the next two years. We recognized $7,000 as revenue in thequarter ended June 30, 2005 based on the first payment received in April 2005.In terms of our revenue recognition policy we will recognize revenues from thisagreement on the cash received basis.

 

***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 32% inthe six-month period ended June 30, 2005 compared to the same period in2004. This decrease is attributed to a 39% reduction in amortization ofcapitalized development costs for HyperWebTM which was fully amortized inDecember, 2004, and a 27% decrease in customer support costs as we reducedcontract customer support personnel in response to declining revenues.  The decrease in amortization of capitalizeddevelopment costs for HyperWeb and the elimination of temporary customerservice resources contributed to a decrease in cost of revenue for the threemonths ended June 30, 2005 of 57%.

 

***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 sixmonths and three months ended June 30, 2005 compared to the same period in2004, Research and Development (R&D) costs decreased by 19% and 23%respectively. This was mainly due to reduced compensation costs in the area ofproduct management as we transferred one person from R&D to focus onM&A activities which are now classified under the G&A expense category.

 

***Sales &Marketing:***In the six months ended June 30,2005, sales and marketing expenses increased 28% or $80,000 compared to 2004.This increase was attributed to the following:

 

•      Marketingexpenses increased $64,000 and is attributable to costs incurred in 2005 forre-design of the Company website of $25,000, a two-month media campaign of$16,000, Public Relations and Marketing Communication consulting fees of$35,000 and other fees, including lead generation costs, of approximately$25,000. For the same period in 2004, we only incurred costs of approximately$37,000 for marketing campaigns due to limited cash resources prior to the IPO.

•      Sales Commissions decreased $26,000 due toreduced commissions to third-party sales agents.

•      Allother Sales and Marketing expenses increased $38,000 due to a placement feeincurred for our VP of Channel Development of $26,000 and increased payroll andtravel costs associated with personnel changes in 2005.

 

In the three months ended June 30, 2005, sales and marketing expensesdecreased 32% or $55,000 compared to the same period in 2004 reflecting thereduction in our investments in this area and the change in distributionstrategy. In addition to the sales commissions decrease of $26,000 explainedabove, the Q2 reduction is attributable to the following:

 

•      Marketingexpenses decreased $16,000 in 2005 versus 2004 and is mostly due to ourdecision to reduce and eliminate our marketing initiatives.

•      Sales personnel costs decreased $18,000 or16% and the decrease is attributable to the change in personnel in 2005 versus2004.

 

***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. For thesix months and three months ended June 30, 2005, G&A expenses increased$532,000 or 92% and $284,000 or 125% respectively compared to the same periodsin 2004. We have capitalized $451,000 of non-payroll costs relating to theproposed acquisition of MPC and these costs are not included in this category.

 

The specific causes of the changes between periods were due to:

 

•      In2005, the incremental G&A costs related to being a public company wereapproximately $283,000 and $165,000 for the six and three months ended June 30,2005 respectively. These costs included Board of Director costs, Investorrelations, D&O Insurance, Legal & Accounting, Sarbanes-Oxleycosts, Transfer Agency, printing and compliance costs. In 2004, we incurred alower level of public company costs prior to becoming a public company.

 

•      In2005, compensation costs for the six and three months ended June 30, 2005increased $232,000 and $134,000 respectively and are due to a salary increasefor our CEO, the reclassified costs for our VP of Business Development who wasin a product management role in the same period in 2004 and was involved in

 

11

----

 

managing our M&A activities in 2005 andthe fact that our CFO was a full-time employee in 2005 versus 2004.

 

•      Inthe six months ended June 30, 2005, we recorded a Bad Debt expense of $31,000for two non-US customers. One customer has historically paid late but the daysoutstanding on the unpaid amount is past their historic payment window of sixmonths. The other customer is a reseller who has not made the final of threepayments on a license sale. The Company intends to pursue payment but hasreserved 100% of the remaining outstanding balance.

 

•      Inthe six months ended June 30, 2005, we incurred $24,000 in non-capitalizableexpenses associated with our merger and acquisition strategy. These wererelated to the costs of exploring potential mergers and acquisitions that didnot materialize. We did not have a merger and acquisition strategy in 2004.

 

•      OtherG&A expenses decreased by $38,000 for the six months ended June 30, 2005compared to 2004 and this was attributable to decreased travel costs incurredby our CEO, a reduction in IT costs due to one-time purchases of computerhardware and software in 2004, reduced fundraising costs in 2005, offset by anincrease in temporary personnel costs in 2005 for general office support.

 

***Other (Income)Expense:***For the six and three months ended June30, 2005, this category reflected a net expense decrease of  $150,000 or 99% and $393,000 or 100%respectively versus the same periods in 2004. The specific causes for thechanges between periods are as follows:

 

•      Interestcosts decreased $535,000 and $363,000 for the six and three months ended June30, 2005 respectively, compared to 2004, and these decreases were attributableto the higher amount of debt outstanding in 2004 versus 2005, loan feesincurred with new debt issued in 2004, imputed interest recorded in 2004 onwarrants issued and on debt with conversion features below fair value andrealization of interest income in 2005 on IPO funds maintained in aninterest-bearing investment account. We issued no new debt or warrants to datein 2005.

 

•      Otherexpense decreased $8,000 and $6,000, respectively for the six and three monthsended June 30, 2005 and is attributable to reduced foreign exchange losses.Gain on Settlement reflects a decrease of $441,000 and is attributable the gainrecorded in March 2004 on settlement of the RCI Note. Preferred dividendsdecreased $48,000 and $24,000 respectively for the six and three months endedJune 30, 2004 and is attributable to the conversion of all preferred stock tocommon stock in 2004.

 

***Income taxes:*******We make no provision for income taxes because sinceinception we have not been profitable. We have a net operating losscarry-forward available to offset future federal and state income tax expensesto an amount that approximates our accumulated deficits. Our net operating losscarry-forward will expire in varying amounts from 2021 to 2023. The utilizationof the net operating loss carry-forward as an offset to future taxable incomeis subject to the limitations under U.S. federal income tax laws. One suchlimitation is imposed where there is a greater than 50% change in ownership ofour company.

 

# ***Off BalanceSheet Transactions***

Wehave no off balance sheet transactions.

 

# ***CorporateGroup 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 ofEstimates and Critical Accounting Policies***

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 these estimates under differentassumptions or conditions. Our use of estimates and critical accountingpolicies are described in more detail in the notes to our financial statementsand in the 10-KSB filed on March 31,

 

12

----

 

2005. There have been no changes to the accounting policies describedin the 10-KSB as of June 30, 2005.

 

# ***Liquidity andCapital 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, payment of various consultants and employeeswith stock and /or options as part compensation for their services, a line ofcredit and our net proceeds of $7.1 million from our IPO.

 

We used cash from operations of $1.7 million for the six months endedJune 30, 2005 compared to a use of cash of $1.0 million in the first sixmonths of 2004. Approximately $0.1 million of the increase is attributable tocosts related to the proposed acquisition of MPC. The lower revenue andincreased operating cost explanations provided above explain the remainingincreased use of cash. Cash flow from financing activity decreased due to thefact that in the first quarter of 2004, we raised bridge loans to fundoperations prior to our IPO of approximately $1.2 million. We had no newfinancing activities that raised cash in the first six months of 2005.

 

The following table summarizes our contractual and lease obligations atJune 30, 2005:

 
| ** **                          | ** ** | **Total** | ** ** | **6/30/2006** | ** ** | **6/30/2007** | ** ** | **6/30/2008** | ** ** |
|-------------------------------------|------------|-----------|------------|---------------|------------|---------------|------------|---------------|------------|
| Office Lease                        |       | $         | 54,259     |          | $          | 54,259        |       | $             | —     |   | $ | — |   |
| Due to Related Party                |       | $         | 49,727     |          | $          | 49,727        |       | none          |       | none |   |
| CEO/COO Employment Agreements       |       | $         | 472,500    |          | $          | 367,500       |       | $             | 105,000    |   | $ | — |   |
| Board of Directors’ Agreements |       | $         | 32,000     |          | $          | 32,000        |       | $             | —     |   | $ | — |   |
| Notes Payable                       |       | $         | 1,076,264  |          | $          | 1,076,264     |       | none          |       | none |   |
| Total                               |       | $         | 1,684,750  |          | $          | 1,579,750     |       | $             | 105,000    |   | $ | — |   |

 

The office lease for our corporate office expires in February 2006and is based on a fixed annual fee of $14 per square foot payable in equalmonthly 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 an offerletter 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.

 

We have renegotiated an employment agreement with our CEO and an offerletter agreement with our COO, both of whom will leave the company aftercompletion of the proposed merger with MPC. Additionally, if the proposedmerger is consummated, four current board directors, including the CEO, willresign. The specific terms of the amended agreements can be found in theDefinitive Proxy Statement filed with the SEC on June 17, 2005 and the agreedupon settlements to the officers and directors are included in the table above.

 

On May 1, 2005, we engaged a public relations firm whose compensation,per the services agreement, includes a grant of 12,500 shares of restrictedcommon stock valued at $50,000. The agreement stipulates that the stock grantwill only be issued if the firm is still engaged as of August 1, 2005.  Since the performance commitment has not beenreached, we have not included this obligation in the table above and have notrecognized any expense in our financial statements for the three and six monthsended June 30, 2005.

 

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 is consummatedand we expect to incur at least $500,000 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

 

13

----

 

(convertible into our common stock at any time priorto repayment at $3 per share) and issue them 200,000 warrants to purchaseshares of our common stock with a five year life and exercisable at $3 pershare.

•      *Costs after Closing*: If the proposed merger is consummated, weexpect to incur costs relating to reducing our workforce including severancepayments and Employment Agreement amounts, termination fees, additional D&OInsurance, increased American Stock Exchange fees, increased travel costs,increased costs relating to compliance particularly to integrate the mergedcompanies’ internal controls and procedures to comply with the relevantprovisions of the Sarbanes-Oxley Act of 2002, increased legal and audit costs,increased Board of Director and Audit Committee expenses and other integrationcosts. All of these items are discussed in greater detail in the DefinitiveProxy Statement filed with the SEC.

 

As part of the proposed merger agreement, we have agreed, upon closingof the merger, to provide a general guaranty to MPC’s new line-of-credit withWachovia Financial. The guaranty is supported by a general security agreementon our assets (which is subordinate to the security on our notes payable) andplacement of $1.5 million in a restricted account. The funds in the restrictedaccount become unrestricted if MPC meets certain “excess cash availability”tests as calculated under the Wachovia facility. We are permitted to make a$1.5 million payment directly to MPC in lieu of establishing a restrictedaccount. The details of the Wachovia facility are discussed in greater detailin a Form 8-K filed with the SEC on July 12, 2005.

 

**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 and six months ending June 30, 2005 that have materiallyaffected, or is reasonably likely to have had a material affect on our internalcontrols over 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.

 

14

----

 

**PART II. OTHER INFORMATION**

 

*ITEM 1. LEGAL PROCEEDINGS*

 

None.

 

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

 

All shareholder transactions during the quarter ended June 30,2005 include:

 

•      4,499shares issued with respect to the cashless exercise of options.

•      182shares issued with respect to the cashless exercise of warrants.

 

*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 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.

 

15

----

 

*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: July 19, 2005 | /s/ Mark Endry                       |
|                     | Mark Endry                           |
|                     | President and CEO               |
|                     |                                 |
|                     |                                 |
| Date: July 19, 2005 | /s/ Mark Pougnet                     |
|                     | Mark Pougnet                         |
|                     | Chief Financial Officer              |

 

16

----

 

*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.

 

17

----