**UNITED STATES**

**SECURITIESAND 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 endedSeptember 30, 2004**

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

 

**For the transitionperiod from                to**

 

**Commission file number0-115404**

 

**HYPERSPACECOMMUNICATIONS, 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 or 15(d) of the ExchangeAct during the preceding twelve months (or for such

shorter period that theissuer was required to file such reports), and (2) has

been subject to such filingrequirements for the past 90 days.

 

Yes   o   No ý

 

As of September 30,2004, there were 1,926,534 shares of the issuer’s no par value Common Stockoutstanding.

 

Transitional Small BusinessDisclosure Format. Yes  o   Noý

 

Table of Contents

 

 

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**ITEM 1: FINANCIAL STATEMENTS**

 

 

 

2

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HYPERSPACE COMMUNICATIONS, INC.

Balance Sheet

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

**2004** | ** **     | **December 31,**

**2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|----------------|---------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **Unaudited**                    | ** **     | ** **                      | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                                                           |       |                             |           |                            |       |
| **Current  Assets**                                                                                                                                                                                                                                                                                                                                                                                  |       |                             |           |                            |       |
| **Cash**                                                                                                                                                                                                                                                                                                                                                                                             |       | $                                | 109,375        |                            | $          | 27,429 |   |
| **Accounts  Receivable, net of an allowance for doubtful accounts of $3,391 in 2004 $0 in  2003**                                                                                                                                                                                                                                                                                                    |       | $                                | 108,905        |                            | $          | 291,913 |   |
| **Other  Current Assets**                                                                                                                                                                                                                                                                                                                                                                            |       | $                                | 17,114         |                            | $          | 13,361 |   |
| **Total  Current Assets**                                                                                                                                                                                                                                                                                                                                                                            |       | $                                | 235,394        |                            | $          | 332,703 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **Non-Current  Assets**                                                                                                                                                                                                                                                                                                                                                                              |       |                             |           |                            |       |
| **Property  & Equipment, net**                                                                                                                                                                                                                                                                                                                                                                   |       | $                                | 126,075        |                            | $          | 127,806 |   |
| **Capitalized  software, net of accumulated amortization of $356,381 and $471,157**                                                                                                                                                                                                                                                                                                                  |       | $                                | 329,070        |                            | $          | 420,536 |   |
| **Intangible  Asset, at cost**                                                                                                                                                                                                                                                                                                                                                                       |       | $                                | 31,530         |                            | $          | 31,530 |   |
| **Deferred  Offering Costs**                                                                                                                                                                                                                                                                                                                                                                         |       | $                                | 1,489,347      |                            | $          | — |   |
| **Total  Non-Current Assets**                                                                                                                                                                                                                                                                                                                                                                        |       | $                                | 1,976,022      |                            | $          | 579,872 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **TOTAL  ASSETS**                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **$**                            | **2,211,416**  | ** **                      | **$**      | **912,575** | ** ** |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIT**                                                                                                                                                                                                                                                                                                                                                      |       |                             |           |                            |       |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **Current  Liabilities**                                                                                                                                                                                                                                                                                                                                                                             |       |                             |           |                            |       |
| **Accounts  Payable**                                                                                                                                                                                                                                                                                                                                                                                |       | $                                | 1,452,814      |                            | $          | 220,993 |   |
| **Accrued  Compensation**                                                                                                                                                                                                                                                                                                                                                                            |       | $                                | 116,286        |                            | $          | 103,611 |   |
| **Deferred  Revenue**                                                                                                                                                                                                                                                                                                                                                                                |       | $                                | 133,186        |                            | $          | 152,089 |   |
| **Current  Portion of Notes Payable & Debt**                                                                                                                                                                                                                                                                                                                                                     |       | $                                | 1,295,470      |                            | $          | 1,255,842 |   |
| **Total  Current Liabilities**                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **$**                            | **2,997,756**  | ** **                      | **$**      | **1,732,535** | ** ** |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **Long  Term Liabilities**                                                                                                                                                                                                                                                                                                                                                                           |       |                             |           |                            |       |
| **Long  term Portion of Notes Payable & Debt**                                                                                                                                                                                                                                                                                                                                                   |       | $                                | 425,000        |                            | $          | — |   |
| **Total  Long Term Liabilities**                                                                                                                                                                                                                                                                                                                                                                     | ** ** | **$**                            | **425,000**    | ** **                      | **$**      | **—** | ** ** |
| **Total  Liabilities**                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **$**                            | **3,422,756**  | ** **                      | **$**      | **1,732,535** | ** ** |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **Commitments  & Contingencies**                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **Shareholders’  Deficit**                                                                                                                                                                                                                                                                                                                                                                      |       |                             |           |                            |       |
| ** **                                                                                                                                                                                                                                                                                                                                                                                           |       |                             |           |                            |       |
| **Series A  Convertible Preferred Stock, no par value; convertible to common stock at  original issuance price, plus cumulative dividends of 10% per annum; limited  to the first 5 years following issuance; liquidation preference of $941,753  (2003); convertible upon public offering; 1,000,000 authorized; all converted  to equity (2004) and 211,714 (2003) shares issued and outstanding** |       | $                                | —         |                            | $          | 926,250 |   |
| **Common  Stock, no par value, 15,000,000 shares authorized; 1,926,534 and 1,378,541  shares issued and outstanding at 2004 and 2003, respectively**                                                                                                                                                                                                                                                 |       | $                                | 4,912,767      |                            | $          | 2,180,555 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **Accumulated  Deficit**                                                                                                                                                                                                                                                                                                                                                                             |       | $                                | (6,124,107     | )                               | $          | (3,926,765 | ) |
| **Total  Shareholders’ Deficit**                                                                                                                                                                                                                                                                                                                                                                | ** ** | **$**                            | **(1,211,340** | **)**                           | **$**      | **(819,960** | **)** |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       |                             |           |                            |       |
| **TOTAL  LIABILITIES AND EQUITY**                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **$**                            | **2,211,416**  | ** **                      | **$**      | **912,575** | ** ** |

 

See accompanying notes to financial statements.

 

3

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HYPERSPACE COMMUNICATIONS, INC.

Unaudited Statements of Operations for the Three Months and Nine MonthsEnded September 30, 2004 and 2003.

 
| ** **                                                    | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
| ** **                                                    | ** ** | **2004**               | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues                                                      |       |                   |       |   |   |   |   |   |   |
| License Fees                                                  |       | $                      | 64,478     |   | $ | 198,104 |   | $ | 157,962 |   | $ | 606,109 |   |
| Service  & Other                                          |       | $                      | 54,743     |   | $ | 52,235 |   | $ | 167,643 |   | $ | 134,547 |   |
| Total  Revenues                                               |       | $                      | 119,221    |   | $ | 250,338 |   | $ | 325,605 |   | $ | 740,656 |   |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Cost of  Revenue                                              |       |                   |       |   |   |   |   |   |   |
| Amortization  of Capitalized Software                         |       | $                      | 30,488     |   | $ | 53,520 |   | $ | 91,465 |   | $ | 160,559 |   |
| Customer  Support                                             |       | $                      | 52,134     |   | $ | 39,113 |   | $ | 120,278 |   | $ | 103,945 |   |
| Research  & Development                                   |       | $                      | 227,441    |   | $ | 12,793 |   | $ | 451,138 |   | $ | 117,326 |   |
| Total Cost  of Revenues                                       |       | $                      | 310,063    |   | $ | 105,426 |   | $ | 662,881 |   | $ | 381,830 |   |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Operating  Expenses                                           |       |                   |       |   |   |   |   |   |   |
| Sales &  Marketing                                        |       | $                      | 218,115    |   | $ | 65,227 |   | $ | 507,580 |   | $ | 474,540 |   |
| General  & Administrative                                 |       | $                      | 335,606    |   | $ | 158,126 |   | $ | 910,919 |   | $ | 655,755 |   |
| Total  Operating Expenses                                     |       | $                      | 553,721    |   | $ | 223,353 |   | $ | 1,418,499 |   | $ | 1,130,295 |   |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Loss from  Operations                                         |       | $                      | (744,563   | ) | $ | (78,441 | ) | $ | (1,755,775 | ) | $ | (771,469 | ) |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Other  (Income) / Expense                                     |       |                   |       |   |   |   |   |   |   |
| Interest  Expense, net                                        |       | $                      | 266,015    |   | $ | 54,781 |   | $ | 803,658 |   | $ | 197,309 |   |
| Other Income                                                  |       | $                      | (1,137     | ) | $ | (1,075 | ) | $ | 6,417 |   | $ | (14,142 | ) |
| Gain on  Settlement                                           |       | $                      | —     |   | $ | — |   | $ | (440,999 | ) | $ | — |   |
| Total Other  (Income) / Expense                               |       | $                      | 264,878    |   | $ | 53,706 |   | $ | 369,076 |   | $ | 183,167 |   |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Net Loss                                                      |       | $                      | (1,009,441 | ) | $ | (132,148 | ) | $ | (2,124,851 | ) | $ | (954,636 | ) |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Preferred  Dividends                                          |       | $                      | 24,449     |   | $ | — |   | $ | 72,489 |   | $ | — |   |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Net Loss  attributable to Common Shareholders                 |       | $                      | (1,033,890 | ) | $ | (132,148 | ) | $ | (2,197,340 | ) | $ | (954,636 | ) |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Basic and  diluted weighted average common shares outstanding |       | 1,488,421              |       | 1,299,970 |   | 1,444,612 |   | 1,297,181 |   |
|                                                          |       |                   |       |   |   |   |   |   |   |
| Basic and  diluted loss per common share                      |       | $                      | (0.69      | ) | $ | (0.10 | ) | $ | (1.52 | ) | $ | (0.74 | ) |

 

See accompanying notes to financial statements.

 

4

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HYPERSPACE COMMUNICATIONS, INC.

Statements of Cash Flows For The Nine Months Ended September 30,2004 and 2003

 

*Statements of Cash Flows*

 
| ** **                                                                                              | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2004**                                         | ** ** | **2003** | ** ** |
| ** **                                                                                              | ** ** | **(unaudited)**                                  | ** ** | **(unaudited)** | ** ** |
| Cash flows  from operating activities                                                                   |       |                                             |       |   |   |
| Net loss                                                                                                |       | $                                                | (2,197,340 | ) | $ | (954,636 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities                             |       |                                             |       |   |   |
| Depreciation                                                                                            |       | 53,857                                           |       | 67,488 |   |
| Amortization/impairment  of capitalized software                                                        |       | 91,466                                           |       | 160,559 |   |
| Impairment  of intangible assets                                                                        |       | —                                           |       | 70,867 |   |
| Settlement  of liability for reduced amount                                                             |       | (440,999                                         | )          | 21,841 |   |
|                                                                                                    |       |                                             |       | — |   |
| Options  issued to employees                                                                            |       | 27,332                                           |       | — |   |
| Options  issued to officer from founder                                                                 |       | —                                           |       | 3,353 |   |
| Warrants  issued for debt issue costs and interest                                                      |       | 242,429                                          |       | 12,500 |   |
| Conversion  preference with debt                                                                        |       | 82,863                                           |       | 31,180 |   |
| Options for  services                                                                                   |       | —                                           |       | 21,008 |   |
| Stock for  services                                                                                     |       | 22,500                                           |       | 14,261 |   |
| Stock issued  to employees                                                                              |       | 33,200                                           |       | — |   |
| Accrued  interest included in notes payable                                                             |       | 49,155                                           |       | — |   |
| Accrued  interest included in related party notes payable                                               |       | 3,779                                            |       | — |   |
| Accretion of  debt issue costs                                                                          |       | 64,406                                           |       | 14,842 |   |
| 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                                           |       | — |   |
| Changes in  assets and liabilities                                                                      |       |                                             |       |   |   |
| Accounts  receivable                                                                                    |       | 183,008                                          |       | 138,614 |   |
| Other  current assets                                                                                   |       | (3,753                                           | )          | (12,546 | ) |
| Accounts  payable – trade                                                                          |       | (143,204                                         | )          | 213,960 |   |
| Accrued  liabilities                                                                                    |       | 19,468                                           |       | (129,366 | ) |
| Deferred  revenue                                                                                       |       | (18,903                                          | )          | 29,187 |   |
|                                                                                                    |       | 493,858                                          |       | 657,750 |   |
| Net cash  used in operating activities                                                                  |       | (1,703,482                                       | )          | (296,888 | ) |
|                                                                                                    |       |                                             |       |   |   |
| Cash flows  from investing activities                                                                   |       |                                             |       |   |   |
| Purchase of  property and equipment                                                                     |       | (52,126                                          | )          | (5,731 | ) |
| Purchase of  capitalized software                                                                       |       | —                                           |       | (304,794 | ) |
| Purchase of  intangibles                                                                                |       | —                                           |       | (22,885 | ) |
| Net cash  used in investing activities                                                                  |       | (52,126                                          | )          | (333,410 | ) |
|                                                                                                    |       |                                             |       |   |   |
| Cash flows  from financing activities                                                                   |       |                                             |       |   |   |
| Proceeds  from line of credit                                                                           |       | —                                           |       | 80,000 |   |
| Proceeds  from (payments of) related-party note payable                                                 |       | —                                           |       | 45,000 |   |
| Proceeds  from notes payable, net                                                                       |       | 1,650,000                                        |       | 466,000 |   |
| Proceeds  from issuance of common stock                                                                 |       | 227,304                                          |       | — |   |
| Receipts from  issuance of preferred stock                                                              |       | 43,750                                           |       | 50,000 |   |
| Payment of  current liability                                                                           |       | (42,500                                          | )          | — |   |
| Payment on  note payable                                                                                |       | (16,000                                          | )          | — |   |
| Payment of  offering costs                                                                              |       | (25,000                                          | )          | — |   |
| Net cash  provided by financing activities                                                              |       | 1,837,554                                        |       | 641,000 |   |
|                                                                                                    |       |                                             |       |   |   |
| Net increase  (decrease) in cash                                                                        |       | 81,946                                           |       | 10,702 |   |
|                                                                                                    |       |                                             |       |   |   |
| Cash –  beginning of year                                                                          |       | 27,429                                           |       | 51,169 |   |
|                                                                                                    |       |                                             |       |   |   |
| Cash – end  of period                                                                              |       | $                                                | 109,375    |   | $ | 61,871 |   |
|                                                                                                    |       |                                             |       |   |   |
| Cash Paid  for Interest                                                                                 |       | $                                                | 4,274      |   | $ | 8,107 |   |
|                                                                                                    |       |                                             |       |   |   |
| Cash Paid  for Income Taxes                                                                             |       | $                                                | 0          |   | $ | 0 |   |

 

5

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*Statements of Cash Flows*

Supplemental disclosure of non-cash activity:

 

During the nine months ended September 30,2004 (unaudited), $728,213 of notes payable was converted to common stock, at$3.50 per share.

 

During the nine months ended September 30,2004 (unaudited), the Company issued $8,125 of common stock in exchange fordeferred offering costs.

 

During the nine months ended September 30,2004 (unaudited) the Company accrued dividends on Series A preferred stock inthe amount of $87,992.

 

During the nine months ended September 30,2004 (unaudited), the Company funded purchases of $1,456,222 in deferredoffering cost through the use of accounts payable.

 

During the six months ended September 2004,the Company converted $75,000 of related party notes payable to common stock.

 

During the sixmonths ended September 2004, the Company converted 970,000 of preferredstock and 87,992 of preferred dividends to common stock.

 

See accompanying notes to financial statements.

 

6

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HYPERSPACE COMMUNICATIONS, INC.

Notes to Financial Statements

*(Information with Respect to the Three andNine Months Ended*

*September 30, 2004 and 2003 isUnaudited)*

 

***Note 1—Descriptionof Business***

 

HyperSpace Communications, Inc. (theCompany) was formed in February 2001 as a company organized under the lawsof the State of Colorado. The Company, based in Denver, Colorado, manufacturesand 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 companies more efficient and profitable through higher performance ofmission-critical applications.

 

In March 2001, the Company acquiredsubstantially all of the assets of Remote Communications, Inc. (“RCI”).The assets of RCI included various computer programs, source code and theexpertise of RCI’s management.

 

***Note2—Significant Accounting Policies***

*Interim FinancialInformation*

The unaudited financial statements as of September 30,2004 and for the nine months ended September 30, 2004 and 2003 include, inthe opinion of management, all adjustments (consisting of normal recurringadjustments) necessary to present fairly the Company’s financial position,results of operations and cash flows. Operating results for the nine monthsended September 30, 2004 are not necessarily an indication of the resultsthat may be expected for the entire fiscal year. HyperSpaceCommunications, Inc. has prepared the accompanying unaudited financialstatements pursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”). The Company has no subsidiaries. These financial statementsand notes should be read in conjunction with its Prospectus filed with the SECon September 30, 2004. The footnotes below are those that have changesfrom the footnotes accompanying the financial statements at June 30, 2004in the aforementioned Prospectus.

 

7

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The accompanying financial statements havebeen prepared on a going concern basis, which contemplates the realization ofassets and liquidation of liabilities in the ordinary course of business.Although the Company has incurred substantial losses since inception, theCompany completed an IPO on October 1, 2004 as further noted in theSubsequent Event footnote. Accordingly, no adjustments are necessary to thefinancial statements as a result of a going concern uncertainty.

 

The Company reports comprehensive income(loss) in accordance with the provisions of SFAS 130, “ReportingComprehensive Income.” SFAS 130 establishes standards for reportingcomprehensive income and its components in financial statements. The differencebetween reported net income and comprehensive income (loss) is notconsidered material for the periods presented.

 

*Concentrations ofCurrency Risk*

The Company’s operations are subject to thecustomary risks of doing business abroad, including, but not limited to,currency fluctuations, custom duties, various import controls and othernon-tariff barriers, restrictions on the transfer of funds, commodity risks,general economic market conditions, adaptability of technology, and politicalinstability. To date, these factors have not had a material adverse impact onthe Company’s operations. Other than certain European agreements, which areusually denominated in Euros or GBP, most non-U.S. agreements are denominatedin U.S. Dollars. In the future, if the number of Euro denominated agreements issignificant, the Company may consider buying forward currency contracts toprotect against currency fluctuations. For the three and nine months ended September 30,2004, the Company recorded a $1,056 gain and an $8,432 loss respectively, inforeign currency translations due to Euro denominated sales agreements.

 

At September 30, 2004, the Company had$40,503 in non-US Dollar denominated accounts receivable.

 

*Concentrations ofCredit Risk*

Due to its growing customer base, the Companyis subject to the risks of concentration of credit risk in a few customers.During the three months ended September 30, 2004, the Company had:

•                  Two customersthat accounted for 57% of revenues

•                  62% of itsrevenues from non-US customers

During the nine months ended September 30,2004 the Company had:

•                  Five customersthat accounted for 32% of revenues

•                  50% of itsrevenues from non-US customers

 

At September 30, 2004, one customeraccounted for 46% of the total accounts receivable.  This customer paid approximately one-third ofthe amount of owed subsequent to the end of the quarter.

 

*Deferred StockOffering Costs*

As of September 30, 2004, the Companywas in the process of finalizing its Initial Public Offering (“IPO”) and hadcapitalized $1.489million in offering costs. The Company listed its units onthe American Stock Exchange on October 1, 2004.  Expenses related to the offering have beencapitalized as a Non-current asset and accounted for as deferred

 

8

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offering costs.  These costs will be charged against the grossproceeds received in October 2004.

 

*Stock-BasedCompensation*

The Company has determined the value of stock-basedcompensation arrangements under the provisions of APB Opinion No. 25 “Accountingfor Stock Issued to Employees”; and will make pro forma disclosures requiredunder SFAS No. 123,”Accounting for Stock-Based Compensation.” SFASNo. 123 permits the use of either a fair value based method of the methoddefined in APB No. 25 to account for stock-based compensationarrangements. Companies that elect to use the method provided in APBNo. 25 are required to disclose the pro forma net income (loss) andearnings per share that would have resulted from the use of the fair valuebased method. No stock based compensation awards were made during the quarterended September 30, 2003.

 
| ** **                                                                                                           | ** ** | **September 30,** | ** **     |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------------|----------------|
| ** **                                                                                                           | ** ** | **Three Months Ended** | ** **     | **Nine Months Ended** | ** ** |
| ** **                                                                                                           | ** ** | **2004**               | ** **     | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Net loss  available to common shareholders—as reported**                                                      | ** ** | **$**                  | **(1,033,890** | **)** | **$** | **(132,148** | **)** | **$** | **(2,197,340** | **)** | **$** | **(954,636** | **)** |
| **Add:  stock-based employee compensation included in net income**                                                   | ** ** | **$**                  | **—**     | ** ** | **$** | **—** | ** ** | **$** | **27,332** | ** ** | **$** | **—** | ** ** |
| **Deduct:  total stock-based employee compensation expense determined under fair market  value method for an award** | ** ** | **$**                  | **32,676**     | ** ** | **$** | **153,977** | ** ** | **$** | **336,044** | ** ** | **$** | **169,374** | ** ** |
| **Net loss  available to common shareholders—pro forma**                                                        | ** ** | **$**                  | **(1,066,566** | **)** | **$** | **(286,125** | **)** | **$** | **(2,506,052** | **)** | **$** | **(1,124,010** | **)** |
| **Basic  loss per common share—as reported**                                                                    | ** ** | **$**                  | **(0.69**      | **)** | **$** | **(0.10** | **)** | **$** | **(1.52** | **)** | **$** | **(0.74** | **)** |
| **Basic  loss per common share—pro forma**                                                                      | ** ** | **$**                  | **(0.72**      | **)** | **$** | **(0.22** | **)** | **$** | **(1.73** | **)** | **$** | **(0.87** | **)** |

 

The fair value of each option grant isestimated on the date of grant using the Black-Scholes option-pricing model.

 

The following are the weighted-averageassumptions used for all Black-Scholes calculations in the financialstatements:

 

| ** **                  | ** ** | **September 30,** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **2004**               | ** ** | **2003** | ** ** |
| ** **                  | ** ** | ** **             | ** ** | ** ** | ** ** |
| Approximate  risk free rate |       | 3.47                   | %          | 2.9 | % |
| Average  expected life      |       | 5.5 years              |       | 10 years |   |
| Dividend  yield             |       | —                 | %          | — | % |
| Volatility                  |       | 25.00                  | %          | 25.00 | % |

 

For the nine months ended September 30,2004 the Company recorded stock options granted to employees as an expense inits Statement of Operations and an addition to common stock. This was based onthe difference between the exercise price and the fair value of the commonstock. For the three months ended September 30, 2004, the Company did notrecord any expense for the 20,000 stock options granted to employees

 

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because the exercise price was above the fairvalue of the common stock. The fair value was of the common stock wasdetermined by the Black-Scholes pricing model valuation of the Unit price ofthe IPO. This was $4.09 per common share.

 

***Note 3—NotesPayable and Debt***

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

**2004** | ** **    | **December 31,**

**2003** | ** ** |
|----------------------------------------------------|------------|----------------------------------|---------------|---------------------------------|------------|
| ** **                                         | ** ** | **Unaudited**                    | ** **    | ** **                      | ** ** |
| **Convertible  Bridge Loans**                      | ** ** | **$**                            | **1,117,159** | ** **                      | **$**      | **577,149** | ** ** |
| **Bridge  Loans Received from Directors**          | ** ** | **$**                            | **404,372**   | ** **                      | **$**      | **—** | ** ** |
| **Note  Payable**                                  | ** ** | **$**                            | **53,534**    | ** **                      | **$**      | **—** | ** ** |
| **Note  Payable to Founder**                       | ** ** | **$**                            | **57,051**    | ** **                      | **$**      | **128,272** | ** ** |
| **Line-of-Credit**                                 | ** ** | **$**                            | **95,500**    | ** **                      | **$**      | **95,500** | ** ** |
| **Amounts  due to RCI**                            | ** ** | **$**                            | **—**    | ** **                      | **$**      | **483,499** | ** ** |
| **Debt  Issuance Costs**                           | ** ** | **$**                            | **(7,146**    | **)**                           | **$**      | **(28,578** | **)** |
| ** **                                         | ** ** | **$**                            | **1,720,470** | ** **                      | **$**      | **1,255,842** | ** ** |
| **Long-term  Portion of Convertible Bridge Loans** | ** ** | **$**                            | **(425,000**  | **)**                           | **$**      | **—** | ** ** |
| ** **                                         | ** ** | **$**                            | **1,295,470** | ** **                      | **$**      | **1,255,842** | ** ** |

 

All amounts are inclusive of accrued interest.

 

The Bridge Loans and Notes Payable have beenissued at various interest rates between 9% and 12% per annum. On September 30,2004: certain Bridge Loans, and accrued interest, were automatically convertedto equity and certain other Bridge Loans, and accrued interest, voluntarilyconverted to equity. All Bridge Loans were issued in conjunction with warrantsto purchase common stock.

 

The Bridge Notes Received from Directors in August 2004had 200,000 detachable warrants to purchase common stock. The value of thesewarrants of $208,148 was booked as interest expense during the quarter ended September 30,2004. These Bridge Notes received from Directors were repaid in October 2004.

 

During the quarter-ended September 30,2004, the founder assumed the liability for this bank Line-of-Credit which hehad previously guaranteed. The Company therefore has an obligation to repay thefounder, not the bank. This obligation was settled in October 2004.

 

## ***Note 4—Shareholders’ Equity***

On July 17,2004, the Board of Directors approved an amendment to the articles ofincorporation including reducing the number of authorized shares of no parcommon stock to 15 million and conducting a 1:14 reverse split of sharesoutstanding. All share and per share amounts for the periods presented in theaccompanying condensed consolidated financial statements have beenretroactively adjusted for the effects of this stock split.

 

*Preferred Stock*

Between April 2003 and January 2004,the Company issued 221,714 Series A preferred shares at $4.38 per sharefor a total of $970,000. Holders of Series A preferred stock were entitledto receive cumulative annual dividends, at the rate of 10% of the originalissue

 

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amount. These shares have a mandatoryconversion feature if the Company consummates a public offering of the Company’scommon stock for total proceeds of at least $3 million. As the Companycompleted an IPO on October 1, 2004, in excess of $3 million, these shares,and accrued preferred dividends to September 30, 2004, in the amount of$87,993, have been converted into 241,827 ordinary shares of the Company at September 30,2004.

 

*Convertible Debt*

On September 30, 2004, Convertible Debtin the amount of $455,000 in principal and $25,846 in accrued interest wasconverted into 137,385 ordinary shares of Company stock. In addition, ourFounder converted $75,000 of his short-term Loan to the Company into 21,429ordinary shares. On July 15, 2004, $18,703 in accrued interest, due todebt holders who had previously converted their debt to equity, converted thisaccrued interest into 5,343 ordinary shares of the Company.

 

***Note5—Related Party Transactions***

Related party transactions consist of thefollowing:

 

During the quarter ended September 30,2004 the founder and Chairman of the Board converted $75,000 of his notepayable into common stock at $3.50 per share. The remaining balance is repayable in September 2005 and bearsinterest at 9% per annum.

 

During the March & April, 2004, adirector purchased $55,000 of convertible notes and warrants in the bridge noteand warrant offering at the same terms as other participants and includedwarrants of 2,357. On September 30, 2004 this director converted this noteand accrued interest in the amount of $58,991 into common stock of the Companyat $3.50 per share.

 

On July 31, 2004 we issued $20,000 worthof common stock (4,484 common shares) to our CFO at $4.46 per share ascompensation.

 

In August 2004 the Company issued$400,000 in additional bridge loans for working capital and general corporatepurposes. These bridge loans were raised from the Founder, CEO and members ofthe Board of Directors. Such loans bear interest at 12% per annum and arerepayable within 180 days. In connection with these bridge loans, theCompany issued one warrant to purchase a share of common stock for each $2.00loaned. The 200,000 warrants issued as part of this transaction are exercisableat $4.46, per share, and expire in August 2009. This loan and $5,425 inaccrued interest was repaid in October 2004.

 

The Company’s policies prohibit loans toDirectors, Officers and Employees. There were no such loans.

 

***Note 6—IncomeTaxes***

The Company did not provide a current ordeferred federal, state or foreign income tax provision or benefit for any ofthe periods presented because it has experienced recurring operating losses.The Company has provided a full valuation allowance on the deferred tax asset,consisting primarily of the net operating loss, because of uncertaintyregarding

 

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whether it will be realized. Tax benefit fromnet operating losses and timing differences are calculated at an estimatedblended federal and Colorado tax rate of 37.3%.

 

***Note 7—Commitmentsand Contingencies***

*Litigation*

In the normal course of business, the Companymay be party to litigation from time to time. The Company maintains insuranceto cover certain actions and believes that resolution of such litigation willnot have a material adverse effect on the Company. The Company’s management isnot aware of any pending or threatened litigation against the Company.

 

***Note8—Settlements***

In March 2001, the Company purchased theassets of RCI with an outstanding note of $353,403 at 0% interest and due on March 5,2004. In January 2004, the Company filed certain claims against RCIclaiming a breach of the terms of the sale of the assets. In March 2004,the Company settled all aspects of this claim, in full, for $42,500 andrecorded a gain on this settlement in the amount of $440,999.

 

***Note 9—SubsequentEvents***

On October 1, 2004 the Company’sRegistration Statement on Form SB-2 was declared effective by the USSecurities and Exchange Commission and the Company sold its units to theunderwriters on a firm commitment basis and listed its units on the AmericanStock Exchange under the symbol HCO.U. In the initial public offering theCompany sold 1.8 million units to underwriters at $5.0325 per unit, which isnet after the underwriter’s discount of 8.5% ($5.50 per unit prior to thediscount). The net proceeds to the Company, after deducting the offering costsand expenses were approximately $7 million. The underwriters paid for the unitson October 6, 2004. As part of the underwriting agreements, the Companywill have certain obligations to its underwriters.

 

On October 27, 2004, the Company announcedthat it has been notified by the representatives of the underwriter for itsIPO, that the American Stock Exchange has been notified of the pendingseparation of its Units.  On November 5, 2004 the Units were separatedinto common stock and warrants that will trade individually on the AMEX underthe symbols HCO and HCO.WS, respectively.  The Units cease to exist.

 

 

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

 

**A NOTE ABOUT FORWARD-LOOKINGSTATEMENTS**

 

The statements, other than statements ofhistorical fact, included in this report are forward-looking statements.Forward-looking statements generally can be identified by

 

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the use of forward-looking terminology suchas “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “plan,” “seek,”or “believe.” We believe that the expectations reflected in suchforward-looking statements are accurate. However, we cannot be assuredthat such expectations will occur. Our actual future performance could differmaterially from such statements. These forward-looking statements are subjectto risks and uncertainties that could cause actual results and events to differmaterially. For a detailed discussion of these risks and uncertainties please seethe “Risk Factors” contained in our Prospectus dated September 30, 2004which can be viewed at the SEC’s website at www.secgov or through a link on ourwebsite www.ehyperspace.com. These forward-looking statements apply only as ofthe date of this report; as such, they should not be unduly relied upon forcurrent circumstances.  Except asrequired by law, we are not obligated to release publicly any revisions tothese forward-looking statements that might reflect events or circumstancesoccurring after the date of this report or those that might reflect theoccurrence of unanticipated events.

 

### Overview

We are a Colorado-based software company thatclosed an initial public offering on October 6, 2004. We raisedapproximately $7 million after offering costs and expenses. Further, we havebeen in the application acceleration (some call this WAN optimization orcompression) business since March 2001. Our two software product linesare: HyperWebTM and HyperTunnelTM. These products are discussed in more detail inour Prospectus dated September 30, 2004, under the “Business” section.These products are designed to address the growing need for real-timeapplication acceleration and improved business communications over wired andwireless networks. The goals of our products are to make our customers moreefficient and profitable by increasing the performance of their internal andexternal business applications through deployment of application accelerationsoftware that is cost effective, easy to use and easy to install.

 

From inception to the end of 2003, we wereprimarily engaged in the development of our software products. In 2002, webegan to market and sell our software products. Despite having limitedresources to launch a comprehensive marketing and sales initiative we didachieve some successes. These occurred mostly through referrals, a limitednumber of sales agents and via leads developed by customers finding us througha web search. In late 2003, we determined the need to make larger investmentsin marketing and sales. This was needed to expand the sales & marketingreach, launch HyperTunnelTM and to reduce reliance on customers finding us for theirnetwork needs through a websearch. We determined that we needed to hire new business developmentleadership, develop a more comprehensive sales agent program, develop a moreorganized approach to international business development and launch anOEM/Partnership initiative.

 

From March 2004 to September 2004, wehave spenta significant amount of time on two key items:

 

***TheIPO:*** Three of our four officers spentsubstantially all of their time in preparing for our IPO and completing thetransaction. The significant demands placed on us by therequirements of the Sarbanes-Oxley Act of 2002, the detailed SEC review processand the requirements of the capital markets meant that

 

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little time was left for these seniorofficers to participate in business development activities and processes. Inaddition, because we were funding IPO costs prior toreceipt of proceeds from the offering, we had to be very circumspect about howworking capital was used. This meant that we were unable to launch any aspectsof its new marketing & sales strategy until after completion of the IPO.

 

***NewMarketing & Sales Approach:***In March 2004,we hired a new executive officer responsible for Marketing & Sales. Asignificant portion of the time between March and September 2004 wasspent on the following: Determining and changing the internal sales team,evaluating existing sales agents, identifying and bringing on new sales agents,identifying international partners and determining a strategy for OEM/Partners.July and August were slower sales months for software sales(particularly internationally) and we have experienced significant lead timesinvolved in engaging new agents and partners. During this time frame a numberof our competitors launched extensive advertising campaigns that we believesignificantly reduced the number of customers who found us via a web-searchcompared to the prior year. In addition, our competitors appeared in a numberof technology industry analyst reports. Our lack of funds resulted in our beingrelatively unknown to most technology industry analysts who usually requiresome type of fee arrangement for coverage.

 

In addition, our new product HyperTunnelTMoffers per-user-per-month recurring pricing options as opposed to the one-timeperpetual license fee we have historically sold. In 2004, we have signed tensuch recurring revenue license agreements. While not adding materially torevenue to date, we expect that they will generate revenues over the multipleyears of their agreements.

 

As a result of these factors, the level ofour revenues for the nine months ended September 30, 2004 has decreasedcompared to the same period in 2003.

 

***Third QuarterDevelopments***: During the quarter ended September 30,2004, we had several business development successes. These include:

•                  Signed three ISPagreements (two internationally).

•                  Signed an OEMagreement with a network monitoring company.

•                  Signed anddeveloped sales agency/distributor agreements covering the followingterritories: Argentina, Chile, Peru, Uruguay, Pakistan & India.

•                  Re-engaged witha US-based sales agent who consummated a sale during the quarter.

•                  Enjoyed amaintenance renewal rate of more than 90% compared with the historic average of68%.

 

In addition, during the quarter ended September 30,2004, we were busy with some significant product enhancements. The newenhancements further improve the performance and reliability of oursoftware-based approach to acceleration of branch office and remote and mobileuser application traffic. Our driver architecture approach eliminatesconfiguration problems frequently associated with the proxy-based approach usedby competitors and makes use of a hardened technology that has been proven forheavy network use by the industry’s leading VPN providers prior to beingincluded into

 

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the HyperTunnelTM product. Additionally, theseenhancements allow the HyperTunnelTM product to be deployed on older Windowsoperating systems, such as Windows 98, used by certain of our HyperSpace® ISPcustomers and prospects. This product enhancement broadens our appeal into theISP market since many ISP users are still using Windows 98 operating systems.

 

#### Our Business

We will initially focus our marketing onbranch offices, remote & mobile workers and ISPs/ASPs.  Our revenue growth depends significantly oncontinued growth in the application acceleration market, the success of our newmarketing & sales plans, the length of the sales cycle, our ability todevelop and maintain strong partnering relationships with our indirect channelpartners, our ability to expand and enhance our current product offerings, ourability to respond to technological change, the average selling price ofour products and general economic conditions.

 

We face challenges in growing our revenue, aswe have been unable to make adequate investments in marketing and salesactivities from inception. HyperTunnelTM was launched in January 2004 withno marketing support. We have developed a sales and marketing plan to achievethis revenue growth, but only recently obtained the capital to implement theplan.

 

We are currently selling our products and services into the enterprise,state & local governments and ISP markets. To meet the needs of differentmarkets, we generally sell our software product as a one-time perpetual licensesale with an optional annual maintenance agreement, on a per-user/per-month feeor on a per-site/per-month fee basis. Our sales agents usually have a local,international or industry vertical focus and our targeted OEM/Partneragreements aim to include our product inside of theirs.  We generate revenue through both directend-user sales and agent/distribution channel sales. We face challenges thatour agent/distributors have other products they sell and that a competitor mayoffer them more attractive incentives. International agent/distributors aredifficult to engage due to custom, language and distance issues.

 

We are subject to a rapidlychanging technological environment. While our current products are inproduction and being used by customers, we will need to continue to expandthese offerings to stay competitive and differentiate ourselves from ourcompetitors. Our ability to keep current with the demands of technology iscritical to our success. Our software products must work, and provide noticeablebenefits during a test phase inside each prospect customer’s network. Networksare very complex environments. We plan to continue to invest in researchand development activities to enhance existing products and develop newfeatures in response to customer demands.

 

We operate all of our business out of ourmetro-Denver, Colorado location. All sales agents and partners work out ofoffices owned or rented by them. We also conduct all of our development workfrom our metro-Denver location where we had 15 full-time employees as of September 30,2004.

 

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KEYINDICATIONS OF FINANCIAL CONDITION AND PERFORMANCE

 

#### Comparison of the Three- and Nine-Months ended September 30,2004 to 2003

 
| ** **                        | ** ** | **September 30,** | ** **     |
|-----------------------------------|------------|------------------------|----------------|
| ** **                        | ** ** | **Three Months Ended** | ** **     | **Nine Months Ended** | ** ** |
| ** **                        | ** ** | **2004**               | ** **     | **2003** | ** ** | **%****Change** | ** ** | **2004** | ** ** | **2003** | ** ** | **%****Change** | ** ** |
| **Revenues**                      | ** ** | **$**                  | **119,221**    | ** ** | **$** | **250,338** | ** ** | **-52** | **%** | **$** | **325,605** | ** ** | **$** | **740,656** | ** ** | **-56** | **%** |
| **R&D  Costs**                | ** ** | **$**                  | **227,441**    | ** ** | **$** | **12,793** | ** ** | **1678** | **%** | **$** | **451,138** | ** ** | **$** | **117,326** | ** ** | **285** | **%** |
| **Amortization  of Software**     | ** ** | **$**                  | **30,488**     | ** ** | **$** | **53,520** | ** ** | **-43** | **%** | **$** | **91,465** | ** ** | **$** | **160,559** | ** ** | **-43** | **%** |
| **Customer  Support Costs**       | ** ** | **$**                  | **52,134**     | ** ** | **$** | **39,113** | ** ** | **33** | **%** | **$** | **120,278** | ** ** | **$** | **103,945** | ** ** | **16** | **%** |
| **Sales  & Marketing**        | ** ** | **$**                  | **218,115**    | ** ** | **$** | **65,227** | ** ** | **234** | **%** | **$** | **507,580** | ** ** | **$** | **474,540** | ** ** | **7** | **%** |
| **General  & Administrative** | ** ** | **$**                  | **335,606**    | ** ** | **$** | **158,126** | ** ** | **112** | **%** | **$** | **910,919** | ** ** | **$** | **655,755** | ** ** | **39** | **%** |
| **Loss  from Operations**         | ** ** | **$**                  | **(744,563**   | **)** | **$** | **(78,441** | **)** | **849** | **%** | **$** | **(1,755,775** | **)** | **$** | **(771,469** | **)** | **128** | **%** |
| **Interest  Expense**             | ** ** | **$**                  | **(266,015**   | **) ** | **$** | **(54,781** | **) ** | **386** | **%** | **$** | **(803,658** | **) ** | **$** | **(197,309** | **) ** | **307** | **%** |
| **Gain on  Settlement**           | ** ** | **$**                  | **—**     | ** ** | **$** | **—** | ** ** | **0** | **%** | **$** | **440,999** | ** ** | **$** | **—** | ** ** | **n/a** | ** ** |
| **Other**                         | ** ** | **$**                  | ******1,137**  | **** | **$** | ******1,075** | **** | **6** | **%** | **$** | **(6,417** | **) ** | **$** | ******14,142** | **** | **-145** | **%** |
| **Net Loss**                      | ** ** | **$**                  | **(1,009,441** | **)** | **$** | **(132,148** | **)** | **664** | **%** | **$** | **(2,124,851** | **)** | **$** | **(954,636** | **)** | **123** | **%** |

 

***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 nine months ended September 30, 2004 compared to 2003,revenues were 56% lower. Other than the focus on the IPO and the changes tomarketing and sales plans described above, the following are more detailedcauses of the decline:

•                  In2003 we made license sales to 19 different customers with an average licensesale of $32,000. In 2004 we made license sales to 15 different customers withan average license sale of $11,000.  Theaverage deal size is lower in 2004 due to the absence of three large sales thatoccurred in 2003 that were all approximately $75,000 each. Our lack ofmarketing resources coupled with increased market presence of our competitorsduring 2004 resulted in fewer large sale opportunities for us.

•                  In2004, we did generate revenue from three recurring revenue ISP agreements, aPartnership agreement and the initial consulting revenues from an OEMagreement.

•                  Wealso believe that the number of customers who find us by a website search hasdecreased in 2004. We believe that increased advertising by our competitors hasreduced the number of prospects who would conduct a web search for oursolution.

•                  In2003, we generated revenues through one-time referrals by certain agents. Thesewere individuals who were not exclusively devoted to selling but who merelyleveraged certain relationships. While successful in 2003, we do not

 

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believe thatit is a sustainable model; therefore, in 2004, we began to seek, engage andinvest in agents who are professionals in selling IT technology. This causedmost of 2004 to be a period of transition where very few agents were actively producingrevenue for us.

 

For the three months ended September 30,2004 compared to the same period in 2003, revenues were 52% lower (45% lowerhad we not deferred revenue recognition on first time sales into a newinternational territory with a new sales agent.) Most of the same reasonsabove, which explain the reduction from 2003 for the nine months, apply to thethree-month period as well. During the three months ended September 30,2004, we did achieve a maintenance renewal rate in excess of 90% that exceedsour historic rate of 68%.

 

Additionally, it should benoted that most of our larger competitors have opened offices in manyinternational locations and have developed strong sales agent relationships. Anumber of these international locations were openedduring the first nine months of 2004. Due to our limited funds to invest inmarketing and sales prior to the IPO, we were not been able to conduct broadinternational expansion initiatives. We had a single international agent until July 2004,when we increased this agent number to four. Now that the IPO is complete weare adding international capabilities with Europe being the primary initialfocus. At a time when our international revenues are rising as a percentage oftotal sales – 36% in calendar 2003, 44% for the nine months ended September 30,2004 and 63% for the three months ended September 30, 2004 – therebydemonstrating the international appeal of our products, not having a morerobust international presence may have resulted in missed sales opportunities.

 

***Research & Development Costs:  *** Research and Development (R&D)  Expenses consist primarilyof compensation related to the cost of software engineering personnel, thirdparty consultants, prototype expenses related to the design, development,testing and enhancement of our software products, facilities costs and hardwareand software used in the design, development and support of our products. Thisexpense category is the non-capitalized portion of these costs.

 

During the nine months ended September 30,2004 compared to the same period in 2003, this expense category increased byover 280%. This was a result of the following:

•                  Increasedheadcount for development staff.

•                  In 2003 asignificant amount of R&D payroll costs were being capitalized asdevelopment costs for the HyperTunnelTM product that was released in January 2004.No capitalization of R&D payroll or other development costs occurred in2004.

•                  A $60,000expense for third party software relating to the HyperTunnelTM product.

•                  Theestablishment of a formal Product Management function in 2004.

 

R&D costs for the three months ended September 30, 2004compared to the same period for 2003 were higher by approximately $220,000 formost of the same reasons as described above for the nine-month periodcomparison.

 

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***Amortization of CapitalizedSoftware:***This category represents the write-offof previously capitalized software development costs; it includes the sametypes of expense categories as in R&D costs above.

 

The reduction in both the nine- and three-month periods are the resultof a significant portion of previously capitalized development costs becomingfully amortized in 2003. Even though we did launch HyperTunnelTM in January 2004,and therefore commenced amortization (over 5 years the estimated useful life),this did not offset the larger amounts that had been incurred for thedevelopment of HyperWebTM. In 2003 our average monthly amortization wasapproximately $18,000 per month while in 2004 it is approximately $10,000 permonth.

 

***Customer SupportCosts:*** Thisexpense category includes personnel costs that relate to pre- and post-salessupport of our products. All of our support resources are currently based inour metro-Denver office. Currently our staff works varying shifts to meetsupport requirements from different time zones. Their roles primarily coverpre-sales support including assisting customers taking evaluation tests,customer support under maintenance agreements and other post sale technicalsupport, telephone/web support, and providing access to all software updatesand upgrades.

 

The increase in both the nine- and three-month periods is a result ofour adding an additional customer service resource during 2004. This is tosupport additional pre-sale evaluation testing, increase the level of contactwith customers (which has resulted in a higher level of maintenance renewals)and support customers and prospects in disbursed time zones around the world.

 

***Marketing& Sales: ***ThroughMarch 2004 our approach has been comprised of:

•                  Targeted salesefforts through referral partners at enterprises with a focus on reaching theinformation technology organization responsible for the performance of mission-criticalapplications and maintenance of network performance.

•                  Maintaining awebsite and agreements with the Google and Yahoo! keyword search engines thatdirect those who are curious about compression and acceleration solutions toour website.

•                  Attending alimited number of conferences and conducting limited public relations.

•                  Engaging ahandful of Colorado-based employees and consultants and a single UnitedKingdom-based agent to facilitate sales efforts.

 

In March 2004, we hired a new executiveto be responsible for Marketing & Sales; her plans and achievements aredocumented above.

 

In the nine- and three-months ended September 30,2004 compared to the same 2003 period, we increased expenditures 7% (toapproximately $500,000) and 234% respectively. The three months ending September 30,2003 had particularly low expenditures primarily due to zero agent orconsultant costs and the reduction to only two full-time employees. Expenses in2004 reflect the additional payroll costs of our new sales executive and seniorsales staff as well as a modest increase compared to 2003 in

 

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various marketing initiatives including awhite paper and attendance at various ISP conferences.

 

***General& Administrative Expenses:*** General and administrative (“G&A”)expenses consist primarily of employee compensation for executives andadministrative personnel, office costs such as telecommunications, legal andaccounting fees, rent and depreciation.  Wehave capitalized costs relating to the IPO and as such they are not included inthis category.

 

For the nine months ended September 30,2004 compared to the same period in 2003, G&A was higher by $255,000. Thiswas due to the following:

•                  In2003 our Founder acted as Chairman and CEO. In October 2003, the positionswere split and we hired a new Chief Executive Officer. The Founder became ourChairman and reduced his compensation. This resulted in a net additionalcompensation expense of approximately $266,000.

•                  In2004 we also hired a new Chief Financial Officer. In 2003 we had a CFO for partof the year and a part-time Controller for the remainder. Due to our financingand IPO plans we incurred a higher level of compensation for our new CFO. Thisresulted in additional compensation expense of approximately $42,000.

•                  Offsettingthese increases were lower amounts spent on consultants in the amount of$25,000 and eliminating a Human Resources manager that saved $24,000.

 

The increase of $177,000 in the third quarterof 2004 compared to the same period in 2003 was attributable to the samefactors as discussed above under the nine-month’s ending September 30explanation.

 

We expect to incur greater administrativecosts in the future as we are now a public reporting company and we must nowcomply with recently enacted laws and regulations affecting public companies,including increased accounting and legal fees, complying with the provisions ofthe Sarbanes-Oxley Act of 2002 and other current and future rules andregulations required by the SEC, the American Stock Exchange and the FinancialAccounting Standards Board (FASB). In addition, we will have greater costsrelated to the addition of an Audit and Corporate Governance Committee andcertain types of insurance policies linked to being a public company. There maybe other additional costs, which could be substantial, as a result of theCompany having become a public entity.

 

General and administrative expensesrepresented disproportionate percentages of our revenues. If we are successfulin implementing our sales and marketing plan, our general and administrativeexpenses should continue to decline as a percentage of revenue.

 

***InterestExpense:***We incurred interest expense on loansfrom convertible and other debt, a loan from our Founder, imputed interest onwarrants issued in connection with debt offerings, imputed interest on theconversion feature of our debt, a note payable to RCI,

 

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credit card /late fees and line of creditcosts. The interest charge was higher in 2004 for both periods due to thehigher amount of debt outstanding, the increased number of issuances and theimputed interest recorded on warrants issued and on debt with conversionfeatures below fair value.

 

In the nine months ended September 30,2004 compared to the same 2003 period, interest was higher by $606,000 due to:

•                  A greater amountattributable to bridge loan interest and loan issuance fees of $73,000.

•                  A greater amountattributable to imputed interest on warrants issued in conjunction with debtissuances of $367,000.

•                  Imputed interestrecorded on debt issued with conversion features below fair value in the amountof $199,000.

•                  These increasesare offset by interest expense of $22,000 in 2003 attributable to the RCI debt.

 

In the three months ended September 30,2004 compared to same 2003 period, interest was higher by $211,000 due to thereasons mentioned above.

 

***Gainon settlement of RCI note:***  We purchased certain assets from RemoteCommunications, Inc. (RCI) in March 2001. The purchase price (net,after certain liabilities from RCI, was paid by us in the form of a promissorynote upon closing of the transaction) was $353,000 to be paid in March 2004.

 

In March 2004, we settled the amountowed to RCI regarding the initial purchase of assets in 2001. Under oursettlement, we agreed to pay RCI $42,500 as settlement in full for allliabilities owing and any claims due under our purchase agreement. Accordingly,in the financial statements for the quarter ended March 31, 2004, wereduced the value of the note payable to RCI to $42,500, reversed thepreviously accrued compensation to RCI officers and recorded a gain on thesettlement of this liability in the amount of $441,000.

 

***Incometaxes:***  Wemake no provision for income taxes because since inception we have not beenprofitable. We have a net operating loss carry-forward available to offsetfuture federal and state income tax expenses to an amount that approximates ouraccumulated deficits. Our net operating loss carry-forward will expire invarying amounts from 2021 to 2023. The utilization of the net operating losscarry-forward as an offset to future taxable income is subject to thelimitations under U.S. federal income tax laws. One such limitation is imposedwhere there is a greater than 50% change in ownership of our Company.

 

#### Off Balance Sheet Transactions

We are not party to any off balance sheettransactions. We have no subsidiaries or equity ownership in any other entity.We have no guarantees or obligations other than those, which arise out ofnormal business operations with customers, i.e., a sale of software, which iscovered by customer agreements limiting, in part, our liability.

 

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#### Corporate Group and Segment Information

We are not, and never have been, part of anycorporate group. We do not have segment information because all of our activitiesare devoted to the development and sale of software. We have no discontinuedoperations.

 

#### Use of Estimates and Critical Accounting Policies

This discussion and analysis of the financialcondition and results of operations is based upon our financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. In order to prepare these financial statements,we are required to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses and related disclosuresof contingent assets and liabilities. On an ongoing basis, we evaluate ourestimates, including those related to the valuation of long-lived assets;valuation allowances including sales return reserves, allowances for doubtfulaccounts and other liabilities, such as product warranty reserves. We base ourestimates on historical experience and on various other assumptions that arebelieved to be reasonable 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 Prospectus dated September 30, 2004.There have been no changes to the accounting policies described in thatprospectus during the quarter ended September 30, 2004.

 

#### Liquidity and Capital Resources 

Since inception we have financed ouroperations through the private placements of equity securities, convertibledebt, loans from our Founder and other members of our Board of Directors, aloan from RCI for the acquisition of RCI’s assets, short-term loans, partialpayment of various consultants and employees with stock and /or options as partcompensation for their services and, to a lesser extent, a line of credit.

 

As of September 30, 2004, our existingcash resources were insufficient to execute our business plan. We did, however,raise net proceeds of $7 million from our IPO, as discussed in the SubsequentEvents footnote of the financial statements. Currently, our working capitalrequirements exceed our ability to generate sufficient revenues to fundoperations. Based on our current business plan and known business conditions,we believe that the funds received in the IPO are sufficient to fund operationsfor the next 12 months.

 

During the nine months ended September 30,2004 we raised $1.92 million as follows:

•                  $50,000 in ashort-term loan from a single individual.

•                  $1.2 million in February to April 2004 in our 2004convertible debt offering. Of this amount $155,000 converted to equity on September 30,2004.

 

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•                  In August 2004we raised $400,000 in additional bridge loans for working capital and generalcorporate purposes. These bridge loans were raised from our Founder, CEO andmembers of our Board of Directors.

•                  $227,000 wasreceived from the exercise of warrants and options between July and September 2004.

•                  We issued$43,000 in Series A preferred stock in January 2004, which converted intocommon stock on September 30, 2004.

 

As detailed in the Prospectus dated September 30,2004, and in the financial statements above; our Founder, all Series APreferred Shareholders and all remaining convertible note holders from debtraised prior to 2004 and certain 2004 convertible note holders converted theirholdings to equity on September 30, 2004.

 

We had cash and cash equivalents of $27,000at December 31, 2003. This and the $1.92 million cash raised frominvesting activities, described above, was used as follows:

•                  Repay old debtin the amount of $83,000.

•                  Purchaseproperty and equipment in the amount of $52,000.

•                  Fund operationsfor the nine months ended September 30, 2004 in the amount of $1.7 millionbeing the cash loss from operations for the nine-month period.

This leaves cash balance on hand of $109,000at September 30, 2004.

 

The grossproceeds received from the offering in October 2004 were $9.9 million.Underwriters deducted 8.5% of proceeds for their discount and 3% in allowableexpenses. We incurred $1.6 million in other expenses related to the IPO. Thisleaves us with net proceeds of $7 million.

 

The following table summarizes our contractualand lease obligations at September 30, 2004:

 
| ** **            | ** ** | **Total** | ** ** | **9/30/2005** | ** ** | **9/30/2006** | ** ** | **9/30/2007** | ** ** |
|-----------------------|------------|-----------|------------|---------------|------------|---------------|------------|---------------|------------|
| Office Lease          |       | $         | 131,773    |          | $          | 93,016        |       | $             | 38,757     |   | $ | — |   |
| Software  Lease       |       | $         | 10,550     |          | $          | 10,550        |       | $             | —     |   | $ | — |   |
| Operating  Leases     |       | $         | 684        |          | $          | 684           |       | $             | —     |   | $ | — |   |
| Line-of-Credit        |       | $         | 95,500     |          | $          | 95,500        |       | none          |       | none |   |
| Due to  Related Party |       | $         | 57,051     |          | $          | 57,051        |       | none          |       | none |   |
| Notes  Payable        |       | $         | 1,370,178  |          | $          | 945,178       |       | $             | 425,000    |   | none |   |
|                  |       | $         | 1,665,736  |          | $          | 1,201,979     |       | $             | 463,757    |   | $ | — |   |

 

The operating leases are for office equipmentand the software lease is for Siebel Systems, Inc. software. The office leasefor our corporate office expires in February 2006 and is based on a fixedannual fee of $14 per square foot payable in equal monthly installments.

 

We have entered into employment agreementswith certain members of our senior management team including our Chairman,Chief Executive Officer and Vice President of Development. These agreementsbear standard employment terms and conditions. Only our Chief Executive Officerearns a guaranteed bonus based on continued employment. As of September 30,2004, he has been paid his guaranteed 2004

 

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bonus for that period.  The minimum amounts are not accrued, as theyare based on continued employment and therefore no employment related amountsare included in the table above.

 

**ITEM 3.  CONTROLS AND PROCEDURES**

 

We have performed an evaluation, under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of our disclosurecontrols and procedures, as such terms are defined under Rule 13a-15(e)promulgated under the Securities Exchange Act of 1934, as amended. Based uponthat evaluation, our management, including our Chief Executive Officer andChief Financial Officer, concluded that our disclosure controls and procedureswere effectiveas of the end of the period covered by this quarterly report. Other than theadditional controls, which serve to enhance internal controls overfinancial reporting,implemented by virtue of becoming a public company,therehave been no changes in our internal control overfinancial reporting during the three months ending September 30,2004 that have materially affected, or isreasonably likely to have had a material affect on our internal controls over financial reporting.The enhanced controls overfinancial reporting include the:

 

•       Creation of a Code of Ethics for Seniorofficers.

•       Establishment of an independent Audit andCorporate Governance Committee.

•       Engagement of independent auditors toperform certain procedures with respect to each quarter-end report.

 

In designing and evaluating the disclosure controlsand procedures, our management recognizes that any controls and procedures, nomatter how well designed and implemented, can provide only reasonable assuranceof achieving the desired control objectives, and management’s duties require itto make it best judgment in evaluating the cost-benefit relationship of potentialcontrols and procedures.

 

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**PART II. OTHER INFORMATION**

 

*ITEM 1. **LEGAL PROCEEDINGS***

 

None.

 

*ITEM 2. **UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS***

 

a)     Allshareholder transactions during the quarter ended September 30, 2004include:

 

•                  95,580shares issued on July 15 and September 30 for certain 2002/2003convertible debt holders who converted $334,533 of principal and accruedinterest into equity.

•                  43,206shares issued with respect to warrant exercised for $164,813.

•                  18,887options exercised for $62,500.

•                  7,444shares issues for $33,200 in compensation for two employees.

•                  21,429shares issued to our Founder for converting $75,000 of his loan to the Company.

•                  47,148shares issued to certain 2004 convertible note holders who elected to convert$165,016 in principal and interest on September 30, 2004.

•                  241,827shares issued to Series A Preferred Shareholders for $1,057,933 in face valueand accrued preferred dividends on September 30, 2004.

 

Ofthe amounts listed above, only the second and third items raised new funds forthe Company. All of the other items converted various types of debt to equity;these were monies raised to fund operations since inception. The $227,310raised from the exercise of warrants and stock options was used to fundoperations in 2004 prior to the completion of the IPO.

 

b)    TheSecurities and Exchange Commission declared our registration statement, filedon Form SB-2 under the Securities Act of 1933 in connection with the initialpublic offering of our units (one share of common stock, no par value,and two warrants) effective on September 30, 2004. The underwriters wereCapital Growth Financial, LLC and Pali Capital.

 

Our initial public offering commenced on October 1, 2004. All1,800,000 units registered under the Registration Statement, were sold tounderwriters at a unit price of $5.50 per unit at the closing October 6,2004. All of the units were sold by us and there were no selling shareholdersin the offering.

 

Theaggregate gross proceeds from the shares of the units sold were $9.9 million.The aggregate net proceeds to us were $8.6 million after deducting $1.3 millionin underwriting discounts and expenses. From these net proceeds we paid $1.6million in other costs incurred in connection with the offering. This resultsin proceeds after deducting all IPO expenses of $7 million.

 

Sincereceipt of these proceeds, we have repaid approximately $550,000 in debt, asdescribed in the “Use of Proceeds” section of the Prospectus.

 

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We have granted the underwriters an option, exercisable for 45 daysafter the date of the IPO, to purchase up to 270,000 additional units solely tocover over-allotments, if any, at the same price as the initial units offered.If the underwriters fully exercise the over-allotment option, the additionalproceeds will be $1.485 million before underwriting discounts and allowableexpenses and $1.359 million after such expenses.

 

c)      N/A

*ITEM 3.DEFAULTS UPON SENIOR SECURITIES*

 

None.

 

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

 

None.

 

*ITEM 5.OTHER INFORMATION*

 

None.

 

*ITEM 6.EXHIBITS*

 

 

Exhibit 31.1 – Certification of Chief Executive Officer of HyperSpaceCommunications, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

 

Exhibit 31.2 – Certification of Chief Financial Officer of HyperSpaceCommunications, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

 

Exhibit 32.1 – Certification of Chief Executive Officer of HyperSpaceCommunications, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

 

Exhibit 32.2 – Certification of Chief Financial Officer of HyperSpaceCommunications, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

 

*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:  November  12, 2004 | /s/ Mark Endry                  |   |
|                           | Mark Endry                      |
|                           | President and CEO          |
|                           |                            |
|                           |                            |
| Date:  November  12, 2004 | /s/ Mark Pougnet                |   |
|                           | Mark Pougnet                    |
|                           | Chief Financial Officer         |

 

 

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*EXHIBIT INDEX*

 

Exhibit 31.1 – Certification of Chief Executive Officer of HyperSpaceCommunications, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

 

Exhibit 31.2 – Certification of Chief Financial Officer of HyperSpaceCommunications, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

 

Exhibit 32.1 – Certification of Chief Executive Officer of HyperSpaceCommunications, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

 

Exhibit 32.2 – Certification of Chief Financial Officer of HyperSpaceCommunications, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

 

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