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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended September 30, 2004



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
|- | -----------------------------------------------------------------------------------------



For the transition period from  to



Commission File No. 0-27206



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SPACEHAB, Incorporated

(Exact name of registrant as specified in this charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Washington                                                     |  | 91-1273737                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



12130 Highway 3,
Building 1

Webster, Texas 77598-1504

(713) 558-5000



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The number of shares of Common Stock outstanding as of November 10, 2004:



|             |  |                             
|------------ |  | ----------------------------
|Class        |  | Number of Shares Outstanding
|Common Stock |  | 12,605,851                  



Indicate by check mark whether the
registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports, and (2) has
been subject to such filing requirements for the past 90 days.    Yes   x    No ̈



Indicate by check mark whether the registrant
is an accelerated filer (as defined in rule 12b-2 of the Exchange Act).    Yes ̈No  x



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##### Table of Contents

SPACEHAB, INCORPORATED AND SUBSIDIARIES

SEPTEMBER 30, 2004 QUARTERLY REPORT ON FORM 10-Q



TABLE OF CONTENTS



|            |  |                                                                                                                  |  |     
|----------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|            |  |                                                                                                                  |  | Page
|DEFINITIONS |  | 2                                                                                                               
|            |  |                                                                                                                 
|PART 1 -    |  | FINANCIAL INFORMATION                                                                                            |  |     
|            |  |                                                                                                                 
|Item 1.     |  | Unaudited Condensed Consolidated Financial Statements                                                            |  | 3   
|            |  |                                                                                                                 
|            |  | Unaudited Condensed Consolidated Balance Sheets as of September 30, 2004 and June 30, 2004                       |  | 3   
|            |  |                                                                                                                 
|            |  | Unaudited Condensed Consolidated Statements of Operations for the three months ended September 30, 2004 and 2003 |  | 4   
|            |  |                                                                                                                 
|            |  | Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2004 and 2003 |  | 5   
|            |  |                                                                                                                 
|            |  | Notes to Unaudited Condensed Consolidated Financial Statements                                                   |  | 6   
|            |  |                                                                                                                 
|Item 2.     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 13  
|            |  |                                                                                                                 
|Item 3.     |  | Quantitative and Qualitative Disclosures about Market Risk                                                       |  | 22  
|            |  |                                                                                                                 
|Item 4.     |  | Controls and Procedures                                                                                          |  | 22  
|            |  |                                                                                                                 
|PART II -   |  | OTHER INFORMATION                                                                                                |  |     
|            |  |                                                                                                                 
|Item 1.     |  | Legal Proceedings                                                                                                |  | 23  
|            |  |                                                                                                                 
|Item 6.     |  | Exhibits                                                                                                         |  | 24  



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##### Table of Contents

DEFINITIONS



As used in this Form 10-Q, the
abbreviations and acronyms contained herein have the meanings set forth below. Additionally, the terms SPACEHAB, the Company, we, us and our refer to SPACEHAB, Incorporated and its
subsidiaries, unless the context clearly indicates otherwise.



|                |  |                                              
|--------------- |  | ---------------------------------------------
|APB             |  | Accounting Principles Board                  
|ASO             |  | Astrotech Space Operations                   
|Astrotech       |  | Astrotech Space Operations                   
|Boeing          |  | The Boeing Company                           
|CM              |  | Configuration Management                     
|CMC             |  | Cargo Mission Contract                       
|Common Stock    |  | SPACEHAB common stock                        
|FASB            |  | Financial Accounting Standards Board         
|ISS             |  | International Space Station                  
|JAXA            |  | Japan Aerospace Exploration Agency           
|JE              |  | Johnson Engineering Corporation              
|JETIS           |  | Japanese Experiment Thermal Incubator Service
|Lloyds         |  | Lloyds of London                            
|Lockheed Martin |  | Lockheed Martin Corporation                  
|NASA            |  | National Aeronautics and Space Administration
|ORU             |  | Orbital Replacement Unit                     
|PI&C            |  | Program Integration and Control              
|RDM             |  | Research Double Module                       
|ReALMS          |  | Research and Logistics Mission Support       
|SEC             |  | Securities and Exchange Commission           
|SFAS            |  | Statement of Financial Accounting Standards  
|SFS             |  | SPACEHAB Flight Services                     
|SGS             |  | SPACEHAB Government Services                 
|SMI             |  | Space Media, Inc.                            
|SPF             |  | Spacecraft Processing Facility               



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PART 1: FINANCIAL INFORMATION



ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



SPACEHAB, INCORPORATED AND SUBSIDIARIES

Unaudited Condensed Consolidated Balance Sheets

(In thousands, except share data)



|                                                                                                                                                      |  |                               |         |   |              |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------- | - | ------------ | - | ------- | -
|                                                                                                                                                      |  | September 30, 2004(unaudited) |         |   | June 30,2004 |  
|ASSETS                                                                                                                                                |  |                               |         |   |              |   |         |  
|Cash and cash equivalents                                                                                                                             |  | $                             |        |   |              | $ | 506     |  
|Restricted cash                                                                                                                                       |  |                               | 558     |   |              |   | 430     |  
|Short-term investments                                                                                                                                |  |                               | 2,911   |   |              |   | 5,037   |  
|Restricted short-term investments                                                                                                                     |  |                               | 2,766   |   |              |   | 1,604   |  
|Accounts receivable, net                                                                                                                              |  |                               | 14,676  |   |              |   | 7,878   |  
|Prepaid expenses and other current assets                                                                                                             |  |                               | 648     |   |              |   | 495     |  
|                                                                                                                                                      |  |                               |         |   |              |   |         |  
|Total current assets                                                                                                                                  |  |                               | 21,559  |   |              |   | 15,950  |  
|Property and equipment, net of accumulated depreciation and amortization of $51,040 and $49,755, respectively                                         |  |                               | 78,420  |   |              |   | 79,600  |  
|Deferred financing costs, net                                                                                                                         |  |                               | 1,070   |   |              |   | 1,163   |  
|Other assets, net                                                                                                                                     |  |                               | 2,124   |   |              |   | 3,212   |  
|                                                                                                                                                      |  |                               |         |   |              |   |         |  
|Total assets                                                                                                                                          |  | $                             | 103,173 |   |              | $ | 99,925  |  
|                                                                                                                                                      |  |                               |         |   |              |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                  |  |                               |         |   |              |   |         |  
|Revolving loan payable                                                                                                                                |  | $                             | 2,492   |   |              | $ | 1,445   |  
|Mortgage loan payable, current portion                                                                                                                |  |                               | 1,946   |   |              |   | 1,946   |  
|Accounts payable                                                                                                                                      |  |                               | 1,605   |   |              |   | 2,424   |  
|Accounts payable-EADS                                                                                                                                 |  |                               | 2,227   |   |              |   | 3,262   |  
|Accrued interest                                                                                                                                      |  |                               | 2,368   |   |              |   | 1,108   |  
|Accrued expenses                                                                                                                                      |  |                               | 2,264   |   |              |   | 3,600   |  
|Accrued subcontracting services                                                                                                                       |  |                               | 2,947   |   |              |   | 2,176   |  
|Deferred revenue, current portion                                                                                                                     |  |                               | 4,006   |   |              |   | 6,340   |  
|                                                                                                                                                      |  |                               |         |   |              |   |         |  
|Total current liabilities                                                                                                                             |  |                               | 19,855  |   |              |   | 22,301  |  
|Accrued contract cost and other                                                                                                                       |  |                               | 218     |   |              |   | 372     |  
|Deferred revenue, net of current portion                                                                                                              |  |                               | 221     |   |              |   | 900     |  
|Mortgage loan payable, net of current portion                                                                                                         |  |                               | 3,216   |   |              |   | 3,692   |  
|Convertible subordinated notes payable                                                                                                                |  |                               | 63,250  |   |              |   | 63,250  |  
|                                                                                                                                                      |  |                               |         |   |              |   |         |  
|Total liabilities                                                                                                                                     |  |                               | 86,760  |   |              |   | 90,515  |  
|Commitments and contingencies                                                                                                                         |  |                               |         |   |              |   |         |  
|Stockholders equity                                                                                                                                  |  |                               |         |   |              |   |         |  
|Preferred Stock, no par value, convertible, 2,500,000 shares authorized, 1,333,334 shares issued and outstanding, (liquidation preference of
$12,000) |  |                               | 11,892  |   |              |   | 11,892  |  
|Common stock, no par value, 30,000,000 shares authorized, 12,721,951 and 12,688,062 shares issued, respectively                                       |  |                               | 83,795  |   |              |   | 83,751  |  
|Less treasury stock, 116,100 and 116,100 shares, respectively                                                                                         |  |                               | (117    | ) |              |   | (117    | )
|Additional paid-in capital                                                                                                                            |  |                               | 16      |   |              |   | 16      |  
|Accumulated deficit                                                                                                                                   |  |                               | (79,173 | ) |              |   | (86,132 | )
|                                                                                                                                                      |  |                               |         |   |              |   |         |  
|Total stockholders equity                                                                                                                            |  |                               | 16,413  |   |              |   | 9,410   |  
|                                                                                                                                                      |  |                               |         |   |              |   |         |  
|Total liabilities and stockholders equity                                                                                                            |  | $                             | 103,173 |   |              | $ | 99,925  |  
|                                                                                                                                                      |  |                               |         |   |              |   |         |  



See accompanying notes to unaudited
condensed consolidated financial statements.



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SPACEHAB, INCORPORATED AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Operations

(In thousands, except share data)



|                                                                |  |                                  |            |   |      |   |            |  
|--------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                |  | Three Months Ended September 30, |           
|                                                                |  | 2004                             |            |   | 2003 |  
|Revenue                                                         |  | $                                | 13,033     |   |      | $ | 18,850     |  
|Costs of revenue                                                |  |                                  | 10,786     |   |      |   | 13,527     |  
|                                                                |  |                                  |            |   |      |   |            |  
|Gross profit                                                    |  |                                  | 2,247      |   |      |   | 5,323      |  
|                                                                |  |                                  |            |   |      |   |            |  
|Operating expenses                                              |  |                                  |            |   |      |   |            |  
|Selling, general and administrative                             |  |                                  | 1,966      |   |      |   | 2,932      |  
|Research and development                                        |  |                                  | 7          |   |      |   |           |  
|Recovery of nonrecurring charge, loss of Research Double Module |  |                                  | (8,244     | ) |      |   |           |  
|                                                                |  |                                  |            |   |      |   |            |  
|Total operating expenses                                        |  |                                  | (6,271     | ) |      |   | 2,932      |  
|                                                                |  |                                  |            |   |      |   |            |  
|Income from operations                                          |  |                                  | 8,518      |   |      |   | 2,391      |  
|Interest expense                                                |  |                                  | (1,458     | ) |      |   | (1,740     | )
|Interest and other income, net                                  |  |                                  | 41         |   |      |   | 33         |  
|                                                                |  |                                  |            |   |      |   |            |  
|Income before income taxes                                      |  |                                  | 7,101      |   |      |   | 684        |  
|Income tax expense                                              |  |                                  | (142       | ) |      |   | (18        | )
|                                                                |  |                                  |            |   |      |   |            |  
|Net income                                                      |  | $                                | 6,959      |   |      | $ | 666        |  
|                                                                |  |                                  |            |   |      |   |            |  
|Income per share:                                               |  |                                  |            |   |      |   |            |  
|Net income per share  basic                                    |  | $                                | 0.55       |   |      | $ | 0.05       |  
|                                                                |  |                                  |            |   |      |   |            |  
|Shares used in computing net income per share  basic           |  |                                  | 12,574,224 |   |      |   | 12,370,955 |  
|                                                                |  |                                  |            |   |      |   |            |  
|Net income per share  diluted                                  |  | $                                | 0.49       |   |      | $ | 0.05       |  
|                                                                |  |                                  |            |   |      |   |            |  
|Shares used in computing net income per share  diluted         |  |                                  | 14,247,860 |   |      |   | 13,745,450 |  
|                                                                |  |                                  |            |   |      |   |            |  



See accompanying notes to unaudited
condensed consolidated financial statements.



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SPACEHAB, INCORPORATED AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

(In thousands)



|                                                                              |  |                                 |        |   |      |   |        |  
|----------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                              |  | Three Months EndedSeptember 30, |       
|                                                                              |  | 2004                            |        |   | 2003 |  
|Cash flows from operating activities                                          |  |                                 |        |   |      |   |        |  
|Net income                                                                    |  | $                               | 6,959  |   |      | $ | 666    |  
|Adjustments to reconcile net income to net cash used in operating activities: |  |                                 |        |   |      |   |        |  
|Depreciation and amortization                                                 |  |                                 | 1,365  |   |      |   | 1,527  |  
|Loss on asset sales and write-offs                                            |  |                                 | 3      |   |      |   |       |  
|Changes in assets and liabilities:                                            |  |                                 |        |   |      |   |        |  
|Increase in accounts receivable                                               |  |                                 | (6,798 | ) |      |   | (1,929 | )
|Increase in prepaid expenses and other current assets                         |  |                                 | (153   | ) |      |   | (368   | )
|Decrease in other assets                                                      |  |                                 | 1,088  |   |      |   | 208    |  
|Decrease in accounts payable, accounts payable-EADS and accrued expenses      |  |                                 | (1,930 | ) |      |   | (832   | )
|Increase (decrease) in accrued subcontracting services                        |  |                                 | 771    |   |      |   | (53    | )
|Decrease in deferred revenue                                                  |  |                                 | (3,013 | ) |      |   | (1,393 | )
|Decrease in long-term contracts costs and other liabilities                   |  |                                 | (154   | ) |      |   |       |  
|                                                                              |  |                                 |        |   |      |   |        |  
|Net cash used in operating activities                                         |  |                                 | (1,862 | ) |      |   | (2,174 | )
|                                                                              |  |                                 |        |   |      |   |        |  
|Cash flows from investing activities                                          |  |                                 |        |   |      |   |        |  
|Payments for flight assets under construction                                 |  |                                 |       |   |      |   | (49    | )
|Purchases of property, equipment and leasehold improvements                   |  |                                 | (95    | ) |      |   | (307   | )
|Proceeds received from sale of property and equipment                         |  |                                 |       |   |      |   | 11     |  
|Sale of short-term investments                                                |  |                                 | 964    |   |      |   | 2,569  |  
|Investments in restricted cash                                                |  |                                 | (128   | ) |      |   |       |  
|                                                                              |  |                                 |        |   |      |   |        |  
|Net cash provided by investing activities                                     |  |                                 | 741    |   |      |   | 2,224  |  
|                                                                              |  |                                 |        |   |      |   |        |  
|Cash flows from financing activities                                          |  |                                 |        |   |      |   |        |  
|Net borrowing under revolving loan payable                                    |  |                                 | 1,047  |   |      |   | 497    |  
|Payment of mortgage loan                                                      |  |                                 | (476   | ) |      |   | (538   | )
|Payment of convertible notes payable to shareholder                           |  |                                 |       |   |      |   | (1,327 | )
|Proceeds from issuance of common stock, net of expenses                       |  |                                 | 44     |   |      |   | 23     |  
|Purchase of treasury stock                                                    |  |                                 |       |   |      |   | (6     | )
|                                                                              |  |                                 |        |   |      |   |        |  
|Net cash provided by (used in) financing activities                           |  |                                 | 615    |   |      |   | (1,351 | )
|                                                                              |  |                                 |        |   |      |   |        |  
|Net change in cash and cash equivalents                                       |  |                                 | (506   | ) |      |   | (1,301 | )
|Cash and cash equivalents at beginning of period                              |  |                                 | 506    |   |      |   | 1,301  |  
|                                                                              |  |                                 |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                    |  | $                               |       |   |      | $ |       |  
|                                                                              |  |                                 |        |   |      |   |        |  



See accompanying notes to unaudited
condensed consolidated financial statements.



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SPACEHAB, INCORPORATED AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements



1. Basis of Presentation



In the opinion of management, the accompanying unaudited condensed consolidated financial
statements reflect all adjustments, consisting of only normal recurring accruals, except as discussed elsewhere within, necessary for a fair presentation of the consolidated financial position of SPACEHAB, Incorporated and subsidiaries
(SPACEHAB or the Company) as of September 30, 2004, and the results of its operations and cash flows for the three months ended September 30, 2004 and 2003. However, the condensed consolidated financial statements are
unaudited, and do not include all related footnote disclosures. Certain amounts presented for prior periods have been reclassified to conform with the fiscal year 2005 presentation.



The consolidated results of operations for the three month period ended September 30, 2004 are not necessarily indicative of the results
that may be expected for the full year. The Companys results of operations have fluctuated significantly from quarter to quarter. The interim unaudited condensed consolidated financial statements should be read in conjunction with the
Companys audited consolidated financial statements appearing in the Companys Annual Report on Form 10-K for the year ended June 30, 2004.



The Companys cash and short-term investments were approximately $6.2 million, of which $3.3 million is restricted, as of September 30, 2004. On October 20, 2004 the
Company received $8.2 million from U.S. National Aeronautics and Space Administration (NASA) in indemnification of losses suffered in the Space Shuttle Columbia accident. Management believes that the Company has sufficient
liquidity, including cash and short-term investments and cash anticipated or expected to be generated from operations to fund ongoing operations beyond the remainder of this fiscal year. We also expect to utilize existing cash, cash anticipated from
future operations and any potential additional proceeds from NASA in settlement of the Companys claims related to losses in the Space Shuttle Columbia tragedy, to support strategies for new business initiatives and reduce long term
debt.



On February 1, 2003, the Space Shuttle Columbia was lost upon
reentry in a tragic accident. SPACEHABs Research Double Module (RDM) was flown aboard the Columbia mission, flight STS-107, carrying research payloads for NASA and other customers. The Company provided the RDM and related
services to NASA under the Research and Logistics Mission Support (ReALMS) contract with NASA. As a result of the accident, the RDM was totally destroyed, leading to the following:



ContractClaim.In January 2004 the Company filed a formal proceeding with
NASA seeking indemnification under the Companys ReALMS contract in the amount of $87.7 million for the value of the Companys RDM and related equipment that was destroyed during the STS-107 Space Shuttle Columbiatragedy. NASA
responded to this contract claim on October 5, 2004. NASAs determination states that its liability is limited under the ReALMS contract to $8.0 million. The Company received payment of $8.2 million, which included $0.2 million of interest,
from NASA in October 2004. The Company has the right to appeal NASAs decision to deny its claim for indemnification in excess of $8.0 million. The appeal can be filed with either the Armed Services Board of Contract Appeals or the U.S. Court
of Federal Claims. SPACEHAB is evaluating its options in appealing NASAs determination.



LloydsComplaint.In January 2004 Lloyds of London (Lloyds), the Companys insurer for the RDM, filed a complaint in the United States District Court for the Western
District of Washington seeking the return of the $17.7 million Lloyds had paid to the Company under the RDM insurance policy alleging that, among other things, (i) such proceeds were paid erroneously primarily due to the fact that NASA had not
paid indemnification due to the Company prior to the payment of the insurance proceeds, (ii) the Company and its insurance broker misled Lloyds in issuing the policy, and (iii) the Company has not cooperated with Lloyds in protecting
Lloyds right of subrogation. In February 2004 Lloyds withdrew its complaint from the United States District Court and filed a similar complaint in Superior Court of the State of Washington. On November 1, 2004 SPACEHAB filed a motion
with the Superior Court of the State of Washington to dismiss under forum non conveniens. The Company believes that Lloyds complaint is without merit and will continue to respond to the complaint accordingly.



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TortClaim.On November 8, 2004 the Company filed a second claim with NASA seeking damages of $79.7 million
under the Federal Tort Claims Act for the loss of the RDM resulting from NASAs alleged negligence leading to the destruction of the Space Shuttle Columbia and the loss of the RDM. The Companys claim represents its loss of $87.7
million less the $8.0 million recovered from NASA. Under federal tort claim procedures, NASA has statutory deadlines for responding to such claims. In the event that the Companys administrative claim is denied, the Company would have the right
to pursue the claim in the Federal District Court.



2. Earnings per Share



The following are reconciliations of the numerators and denominators of
the basic and diluted earnings per share (EPS) computations for the three month periods ended September 30, 2004 and 2003 (in thousands, except per share data):



|                                                      |  |                                       |       |                                       |            |                 |   |                   |  |                     |     |                 |            |  |   |     
|----------------------------------------------------- |  | ------------------------------------- | ----- | ------------------------------------- | ---------- | --------------- | - | ----------------- |  | ------------------- | --- | --------------- | ---------- |  | - | ----
|                                                      |  | Three months ended September 30, 2004 |       | Three months ended September 30, 2003
|                                                      |  | Income(Numerator)                     |       | Shares(Denominator)                   |            | Per ShareAmount |   | Income(Numerator) |  | Shares(Denominator) |     | Per ShareAmount
|Basic EPS:                                            |  |                                       |       |                                       |            |                 |   |                   |  |                     |     |                 |            |  |   |     
|Income available to common stockholders               |  | $                                     | 6,959 |                                       | 12,574,224 |                 | $ | 0.55              |  | $                   | 666 |                 | 12,370,955 |  | $ | 0.05
|Effect of dilutive securities:                        |  |                                       |       |                                       |            |                 |   |                   |  |                     |     |                 |            |  |   |     
|Convertible notes payable                             |  |                                       |      |                                       |           |                 |   |                  |  |                     |    |                 |           |  |   |    
|Options and warrants, using the treasury stock method |  |                                       |      |                                       | 340,302    |                 |   |                  |  |                     |    |                 | 41,161     |  |   |    
|Convertible preferred shares                          |  |                                       |      |                                       | 1,333,334  |                 |   |                  |  |                     |    |                 | 1,333,334  |  |   |    
|                                                      |  |                                       |       |                                       |            |                 |   |                   |  |                     |     |                 |            |  |   |     
|Diluted EPS:                                          |  |                                       |       |                                       |            |                 |   |                   |  |                     |     |                 |            |  |   |     
|Income available to common stockholders               |  | $                                     | 6,959 |                                       | 14,247,860 |                 | $ | 0.49              |  | $                   | 666 |                 | 13,745,450 |  | $ | 0.05
|                                                      |  |                                       |       |                                       |            |                 |   |                   |  |                     |     |                 |            |  |   |     



Convertible notes payable outstanding
as of September 30, 2004, convertible into 4,642,202 shares of common stock at $13.625 per share and due October 2007, were not included in the computation of diluted EPS for the three months ended September 30, 2004 and 2003, as the conversion
price of the convertible notes payable per share were greater than the average market price of the common shares during the periods.



Options to purchase 1,191,697 shares of common stock, at prices ranging from $3.44 to $11.75 per share, were outstanding at September 30, 2004 but were not included in
diluted EPS as the option prices were greater than the average market price of the common shares during the three months ended September 30, 2004. The options expire between October 21, 2004 and February 12, 2011.



Options to purchase 2,100,582 shares of common stock, at prices ranging from $0.93 to $12.00
per share, were outstanding at September 30, 2003 but were not included in diluted EPS as the option prices were greater than the average market price of the common shares during the three months ended September 30, 2003. The options expire between
October 9, 2003 and August 7, 2013.



3. Revenue Recognition



SPACEHABs business units revenue is derived primarily from long-term
contracts with the U.S. Government, U.S. Government contractors and commercial customers. Revenue under these contracts are recognized using the methods described below. Estimating future costs and, therefore, revenues and profits, is a process
requiring a high degree of management judgment. Management bases its estimate on historical experience and on various assumptions that are believed to be reasonable under the circumstances including the negotiation of an equitable adjustment on the
ReALMS contract which was added to the contract as a pricing amendment due to the delay in the return to flight of



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the space shuttle. Costs to complete include, when appropriate, material, labor, subcontracting costs, lease costs,
commissions, insurance and depreciation. Our business segment personnel perform periodic contract status and performance reviews. In the event of a change in total estimated contract cost or profit, the cumulative effect of such change is recorded
in the period that the change in estimate occurs.



A Summary
of Revenue Recognition Methods Follows:



|                                         |  |                                                                             |  |                                                  |  |                                                                                                  
|---------------------------------------- |  | --------------------------------------------------------------------------- |  | ------------------------------------------------ |  | -------------------------------------------------------------------------------------------------
|Business Segment                         |  | Services/Products Provided                                                  |  | Contract Type                                    |  | Method of Revenue Recognition                                                                    
|SPACEHAB Flight Services (SFS)         |  | Commercial Space Habitat Modules, Integration & Operations Support Services |  | Firm Fixed Price                                 |  | Percentage-of-completion based on costs incurred                                                 
|                                         |  |                                                                             | 
|Astrotech Space Operations (Astrotech) |  | Payload Processing Facilities                                               |  | Firm Fixed Price  Mission Specific              |  | Ratably, over the occupancy period of a satellite within the facility from arrival through launch
|                                         |  |                                                                             | 
|                                         |  |                                                                             |  | Firm Fixed Price  Guaranteed Number of Missions |  | For multi-year contract payments recognized ratably over the contract period                     
|                                         |  |                                                                             | 
|SPACEHAB Government Services (SGS)     |  | Configuration Management, Engineering Services                              |  | Cost Plus Award/Fixed Fee                        |  | Reimbursable costs incurred plus award/fixed fee                                                 
|                                         |  |                                                                             | 
|Space Media, Inc. (SMI)                |  | Space-Themed Commercial Products/Activities                                 |  | Retail                                           |  | Internet and retail sales recognized when goods are shipped                                      



For the three months ended September
30, 2004, the Company recognized revenue of approximately $1.8 million under the Japanese Experiment Thermal Incubator Service (JETIS) contract with the Mitsubishi Corporation, representing the Japanese Aerospace Exploration Agency
(JAXA), that was entered into in 2000 and originally scheduled to fly aboard SPACEHABs RDM. Subsequent to the suspension of the space shuttle flights and destruction of SPACEHABs RDM, we contracted for construction of certain
space research equipment and for research space aboard the International Space Station (ISS) and up to three Russian Progress cargo missions with V.J.F. Russian Consulting, representing RSC Energia, a major Russian aerospace
manufacturer and mission operator. Revenue on this contract is recognized on the percentage-of-completion method as costs are incurred.



The ReALMS contract expired January 31, 2004 and support for STS-121, 116, and 118 will continue under a subcontract with Lockheed Martin Corporation (Lockheed
Martin), effective February 1, 2004. SPACEHAB is currently providing these services under letter contract and is in final contract negotiations with Lockheed Martin for this new contract. Pending finalization of contract negotiations with
Lockheed Martin, the Company is providing asset maintenance and continuing services in anticipation of the contractual missions under letter agreements, generally entered into on a month-to-month basis. Revenues for the Lockheed Martin agreement are
being accounted for under the percentage-of-completion method based on costs incurred over the period of the agreement.



For the period ended March 31, 2003, the Company recognized a non-recurring charge of $50.3 million net of insurance proceeds, on the loss of its RDM in the Space Shuttle
Columbia accident. Upon notification by NASA of its acceptance of the Companys claim for indemnification of $8.0 million plus interest of $0.2 million, the Company recognized a recovery of $8.2 million of previously recognized loss in
the period ended September 30, 2004.



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4. Statements of Cash Flows - Supplemental Information



| | (a) | Cash paid for interest costs was $0.1 million and $0.4 million for the three months ended September 30, 2004 and 2003, respectively. The Company did not capitalize any interest
costs during the three months ended September 30, 2004 or 2003.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | The Company paid income taxes of $0.3 million for the three months ended September 30, 2004 and an immaterial amount for the three months ended September 30, 2003.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



5. Credit Facilities



On August 29, 2002 the Company entered into a $5.0 million line of credit with a financial
institution. The term of this credit facility is through August 28, 2005. Covenants include a liquidity ratio and a limited pledge of $5.6 million of the Companys investment account. The restriction on the Companys investment balance is
limited to 111% of the Companys borrowings on the line of credit. In June 2004 the credit agreement was amended again to remove the financial covenant on capital expenditures. As of September 30, 2004 the outstanding balance on this line of
credit was $2.5 million and the restricted investment balance was $2.8 million. The weighted average interest rate for the three months ended September 30, 2004 was 6.35%.



On August 30, 2001 our Astrotech subsidiary completed a $20.0 million financing of its Spacecraft Processing Facility (SPF)
expansion project in Titusville, Florida (the term loan) with a financial institution. The proceeds of this financing were used to complete the construction of the SPF and supporting infrastructure. The term loan was collateralized
primarily by the multi-year payload processing contracts with The Boeing Company (Boeing) and Lockheed Martin and by the building. The net book value of the building as of September 30, 2004 was $32.7 million. Interest accrued on the
outstanding principal balance at a LIBOR-based rate, adjusted quarterly. The term loan was scheduled to mature on January 15, 2011. The term loan was converted from a construction loan to a term loan on December 31, 2001. Amortization of term loan
principal began on January 15, 2002 on a quarterly basis through the maturity date.



On October 1, 2003 Astrotech was notified by Boeing that it was exercising its termination rights with regards to its financial guarantees under the contract agreement with Astrotech for payload processing support services for the Delta
launch vehicle program. Boeing indicated that the decision to terminate its guarantees for future Astrotech services was based on the downturn of the commercial expendable launch market rather than performance related considerations. Astrotech was
in full compliance with the contract terms at the time of the termination. Under the contract provision related to termination of its financial guarantees, Boeing paid Astrotech $17.5 million representing consideration of future contract payments
previously used to collateralize the obligation. On December 31, 2003, the Company repaid $9.5 million of principal on the term loan.



In conjunction with the original financing, a swap agreement was required to be entered into to provide for a fixed rate of interest under the term loan commitment
beginning January 15, 2002. The fixed rate of interest on the outstanding principal balance was 5.62% plus 225 basis points. The objective of the swap was to eliminate the variability of cash flows in the interest payments for the total amount of
the variable rate debt, the sole source of which are changes in the USD-LIBOR-BBA interest rate. Due to the repayment of the Boeing portion of the term loan and the subsequent amendment of the loan agreement, the swap was no longer effective as a
hedge. The unrealized loss in other comprehensive loss for the portion of the debt that was repaid in December 2003 was recorded as interest expense in the period ended December 31, 2003 in the amount of $0.8 million. The Company recognized interest
expense of $0.4 million for the unamortized debt placement costs related to the debt repayment in the period ended December 31, 2003. The Company recognized as additional interest expense the unamortized debt placement costs of $0.2 million and the
balance of the deferred loss on the swap in other comprehensive loss of $0.5 million in the third quarter of fiscal year 2004 in connection with the amendment of the loan agreement.



The term loan agreement was amended on January 29, 2004, whereby the maturity date was shortened to January 2007, the interest rate was
fixed at 5.5% and the hedge requirement was eliminated. For the fiscal year ended June 30, 2004, approximately $11.4 million of principal was repaid and the outstanding balance was $5.6 million as of June 30, 2004. For the three months ended
September 30, 2004, approximately $0.5 million was repaid and the outstanding balance was $5.1 million as of September 30, 2004.



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6. Segment Information



Based on our organization, we operate in four business segments: SFS, Astrotech, SGS, and SMI. SFS was founded to commercially develop space habitat modules to operate
in the cargo bay of the space shuttles. SFS provides access to the modules and integration and operations support services for both NASA and commercial customers. Astrotech provides payload processing facilities and services to serve the satellite
manufacturing and launch services industry. SGS is primarily engaged in providing engineering services and products to the Federal government including NASA. SMI was established in April 2000 to develop space-themed commercial business activities.



On April 3, 2003 the Company changed the name of its Johnson Engineering
Corporation (JE) subsidiary to SPACEHAB Government Services, Incorporated, to more appropriately reflect the subsidiarys strategic direction of operating in the government business section. In the fourth quarter of our fiscal year
ended June 30, 2004 and on a going forward basis, the Other segment represents corporate selling, general and administrative expenses. Segment amounts have been restated based on the revised reporting structure.



The Companys chief operating decision maker utilizes both revenue and income (loss)
before income taxes, in assessing performance and making overall operating decisions and resource allocations.



|                                                      |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      
|----------------------------------------------------- |  | ------- | ------ | -------------------------------- | - | ------ | ---------------- |  | --------------------------- | ------ |  | - | -----
|Three Months Ended September 30, 2004 (in thousands):
|                                                      |  | Revenue |        | Income (Loss)before income taxes |   |        | Net Fixed Assets |  | DepreciationAndAmortization
|SPACEHAB Flight                                       |  | $       | 9,642  |                                  | $ | 10,147 |                  |  | $                           | 31,505 |  | $ | 662  
|Services                                              |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      
|Astrotech                                             |  |         | 1,712  |                                  |   | (231   | )                |  |                             | 46,577 |  |   | 512  
|SPACEHAB                                              |  |         | 1,539  |                                  |   | 227    |                  |  |                             | 58     |  |   | 7    
|Government Services                                   |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      
|Space Media                                           |  |         | 140    |                                  |   | (21    | )                |  |                             |       |  |   |     
|Other                                                 |  |         |       |                                  |   | (3,021 | )                |  |                             | 280    |  |   | 91   
|                                                      |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      
|                                                      |  | $       | 13,033 |                                  | $ | 7,101  |                  |  | $                           | 78,420 |  | $ | 1,272
|                                                      |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      
|                                                     
|Three Months Ended September 30, 2003 (in thousands):
|                                                      |  | Revenue |        | Income (Loss)before income taxes |   |        | Net FixedAssets  |  | DepreciationAndAmortization
|SPACEHAB Flight                                       |  | $       | 11,777 |                                  | $ | 3,139  |                  |  | $                           | 33,523 |  | $ | 704  
|Services                                              |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      
|Astrotech                                             |  |         | 3,373  |                                  |   | 1,605  |                  |  |                             | 48,151 |  |   | 502  
|SPACEHAB                                              |  |         | 3,533  |                                  |   | (238   | )                |  |                             | 220    |  |   | 22   
|Government Services                                   |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      
|Space Media                                           |  |         | 167    |                                  |   | (33    | )                |  |                             |       |  |   |     
|Other                                                 |  |         |       |                                  |   | (3,789 | )                |  |                             | 712    |  |   | 189  
|                                                      |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      
|                                                      |  | $       | 18,850 |                                  | $ | 684    |                  |  | $                           | 82,606 |  | $ | 1,417
|                                                      |  |         |        |                                  |   |        |                  |  |                             |        |  |   |      



7. Stock  Based Compensation



In December 2002 the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based CompensationTransition and Disclosurean amendment of SFAS No. 123. This statement amends SFAS No.
123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value-based method of



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accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS
No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has chosen to continue
to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25 and related interpretations. Accordingly, compensation expense for stock options is measured as the
excess, if any, of the fair market value of the Companys stock at the date of the grant over the exercise price of the related option.



If compensation costs for the Companys stock options were determined based on SFAS No. 123, Accounting for Stock-Based Compensation, the Companys
net income (loss) and earnings per share would have been as follows (in thousands, except per share amounts):



|                                                                                                                                                  |  |                                 |       |   |      |   |      |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ----- | - | ---- | - | ---- | -
|                                                                                                                                                  |  | Three MonthsEnded September 30, |      
|                                                                                                                                                  |  | 2004                            |       |   | 2003 |  
|Net income, as reported                                                                                                                           |  | $                               | 6,959 |   |      | $ | 666  |  
|                                                                                                                                                  |  |                                
|Deduct: Total stock-based compensation expense determined under fair value based method (SFAS No. 123) for all awards, net of related tax
effects |  |                                 | (31   | ) |      |   | (91  | )
|                                                                                                                                                  |  |                                 |       |   |      |   |      |  
|Pro forma net income                                                                                                                              |  | $                               | 6,928 |   |      | $ | 575  |  
|                                                                                                                                                  |  |                                 |       |   |      |   |      |  
|Earnings per share:                                                                                                                               |  |                                 |       |   |      |   |      |  
|Basic - as reported                                                                                                                               |  | $                               | 0.55  |   |      | $ | 0.05 |  
|Diluted - as reported                                                                                                                             |  | $                               | 0.49  |   |      | $ | 0.05 |  
|                                                                                                                                                  |  |                                
|Basic - pro forma                                                                                                                                 |  | $                               | 0.55  |   |      | $ | 0.05 |  
|Diluted - pro forma                                                                                                                               |  | $                               | 0.49  |   |      | $ | 0.04 |  



8. Stock Repurchase



On March 25, 2003 the Board of Directors authorized the Company to repurchase up to $1.0
million of the Companys outstanding common stock at market prices. Any purchases under the Companys stock repurchase program may be made from time to time, in the open market, through block trades or otherwise in accordance with
applicable regulations of the Securities and Exchange Commission (SEC). For the three months ended September 30, 2004, the Company did not repurchase any shares. As of September 30, 2004, the Company had repurchased 116,100 shares at a
cost of $117,320 under the program.



9. Related Party Transaction



The Company engaged in certain transactions with directors, executive
officers, shareholders, and certain former officers during the three months ended September 30, 2004. Following is a description of these transactions:



EADS Space Transportation



Dr. Graul, a member of SPACEHABs Board of Directors, is the Executive Vice President for EADS Space Transportation.



EADS provides unpressurized payload and integration efforts to SPACEHAB on a fixed price
basis in addition to providing engineering services as required. For the three months ended September 30, 2004 and 2003, EADSs payload and integration services included in cost of revenue were approximately $3.4 million and $1.9 million,
respectively.



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V.J.F. Russian Consulting



On January 30, 2004 the Company entered into a subcontract agreement with V.J.F. Russian Consulting. The president of V.J.F. Russian
Consulting, Vladimir Fishel, is a former Vice President of SPACEHAB was receiving severance payments from the Company and working on a part-time employment arrangement for other consulting activities. The services being provided under the
subcontract agreement (valued at $2.6 million) is in support of a contract that SPACEHAB has with the Mitsubishi Corporation in support of JAXA. The amount paid for the three months ended September 30, 2004 was $0.3 million.



On June 1, 2004 the Company entered into a consulting agreement with V.J.F. Russian
Consulting for:



| | (1) | Marketing and promotion of SPACEHAB capabilities and services to RSC Energia, the Russian Federation Space Agency, and other Russian entities involved in the exploration and
development of space;
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (2) | Supporting and assisting SPACEHAB in the negotiation of service contracts and agreements between Russian entities; and
| | --- | ----------------------------------------------------------------------------------------------------------------------



| | (3) | Providing technical expertise and services in support of SPACEHAB activities, under contracts with Russian entities.
| | --- | --------------------------------------------------------------------------------------------------------------------



Total commitments under the consulting agreement are $0.4 million, of which $0.1 million was
paid in the three months ended September 30, 2004.



10. Subsequent Event



Contract Claim. On October 5, 2004 the Company received
NASAs final determination by its Contracting Officer in regards to the Companys claim for indemnification of losses of its RDM and other equipment on the Space Shuttle Columbia. The Contracting Officers determination agreed
with the Companys claim for contractually stipulated losses of $8.0 million, plus interest, but rejected the Companys claims for indemnification and recovery of losses beyond $8.0 million under the contract. The Company received payment
of $8.0 million plus interest of $0.2 million on October 20, 2004. As a result of this final determination by NASA, the Company recorded the $8.2 million in the three months ended September 30, 2004 as a change in estimate from a prior period. The
Company has the right to appeal NASAs decision to deny the claim for indemnification beyond $8.0 million. The appeal can be filed with either the Armed Services Board of Contracts Appeals or the U.S. Court of Federal Claims. SPACEHAB is
evaluating its options in appealing NASAs determination.



LloydsComplaint.In January 2004 Lloyds, the Companys insurer for the RDM, filed a complaint in the United States District Court for the Western District of Washington seeking the return of the $17.7 million
Lloyds had paid to the Company under the RDM insurance policy alleging that, among other things, (i) such proceeds were paid erroneously primarily due to the fact that NASA had not paid indemnification due to the Company prior to the payment
of the insurance proceeds, (ii) the Company and its insurance broker misled Lloyds in issuing the policy, and (iii) the Company has not cooperated with Lloyds in protecting Lloyds right of subrogation. In February 2004 Lloyds
withdrew its complaint from the United States District Court and filed a similar complaint in Superior Court of the State of Washington. On November 1, 2004 SPACEHAB filed a motion with the Superior Court of the State of Washington to dismiss under
forum non conveniens. The Company believes that Lloyds complaint is without merit and will continue to respond to the complaint accordingly.



TortClaim.On November 8, 2004 the Company filed a second claim with NASA seeking damages of $79.7 million under the Federal Tort Claims Act for the loss
of the RDM resulting from NASAs alleged negligence leading to the destruction of the Space Shuttle Columbia and the loss of the RDM. The Companys claim represents its loss of $87.7 million less the $8.0 million recovered from
NASA. Under federal tort claim procedures, NASA has statutory deadlines for responding to such claims. In the event that the Companys administrative claim is denied, the Company would have the right to pursue the claim in the Federal District
Court.



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ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.



The following discussion should be read together with the audited consolidated financial statements and the notes thereto included in this report.



OVERVIEW



This document may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section
21E of the Securities Exchange Act of 1934, including (without limitation) statements under Managements Discussion and Analysis of Financial Condition and Results of Operations and Liquidity and Capital Resources. Such
statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the statements. In addition to those risks and uncertainties discussed herein, such risks and uncertainties include, but
are not limited to, whether the Company will fully realize the economic benefits under its NASA and other customer contracts, continued utilization by NASA and others of the Companys habitat modules and related commercial space assets,
completion of the ISS, continued availability and use of the U.S. space shuttle system, technological difficulties, product demand and market acceptance risks, the effect of economic conditions, uncertainty in government funding and the impact of
competition, delays and uncertainties in future space shuttle and ISS programs, uncertainties related to the governments commitment to President Bushs vision for space exploration, and resolution of the Companys claims
against NASA arising from the loss of the Columbia orbiter and its crew during the STS-107 mission.



Management is pleased that the White House recently issued a new vision for U.S. space leadership. SPACEHAB views the Presidents commitment to space exploration, the human spaceflight program, and the plan for
missions to the Moon, Mars, and beyond as positive indicators that will reinvigorate the space program, likely yielding benefits to the aerospace and space commerce industries. The new vision provides NASA with a clear focus, stabilizes the NASA
Program, and supplies increased funding for the new pursuits.



We believe the
impacts of this vision will materialize over time, and SPACEHAB management will continue to align its business direction to remain a constructive force in the human spaceflight program. In the long term, management believes that the Companys
core competencies offer opportunities to continue to provide high-value services as well as to design, build, and operate assets that could support initiatives beyond low earth orbit. SPACEHAB plans to pursue these new opportunities aggressively. In
the near term, SPACEHABs primary objective is to continue providing services to NASA and the space community in support of the space shuttle and ISS programs. Even with the renewed vision, the Company expects that the space shuttle and ISS
will remain an integral part of the human spaceflight program through at least 2010. SPACEHAB is currently supporting four of the next six scheduled space shuttle flights and is pursuing additional missions that will be important for completing the
final assembly and beginning operation of the ISS.



SPACEHAB is also actively
engaged in defining commercial solutions to ISS on-orbit re-supply and return requirements which could more effectively be satisfied independent of the space shuttle transportation system. These activities, some of which leverage the Companys
international strategic partnerships, include the development of an affordable cargo delivery system based on an expendable launch vehicle, the Russian Progress family of carriers, and a SPACEHAB payload integration architecture to transport
pressurized and unpressurized cargo to and from the ISS. Management further believes that the Companys experience and expertise in the conceptual design, development, ground processing, and on-orbit operations support of payload and crew
accommodations position it well for a role in the development of NASAs Crew Exploration Vehicle, the envisioned next phase in human exploration of space.



During the three months ended September 30, 2004, the SFS Space Commerce Development group was awarded a six-month NASA study contract valued at approximately $1.0
million to support the space agencys new exploration initiatives. As one of a just a handful of the proposals selected from the multitude submitted, SPACEHAB will define concepts for accomplishing human lunar exploration with a focus on
innovative solutions and commercial approaches that could be extensible to Mars and beyond. In addition to this six-month contract effort, the Company may be awarded a contract option that includes an additional six-month effort also expected to be
valued at nearly $1.0 million.



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SPACEHAB operates through three main areas generally related to space flight activities within the aerospace industry:
space assets and mission support services for manned and unmanned space exploration and research missions; commercial and exploratory satellite pre-launch services; and administrative services in support of government space operations. We also
operate a retail space merchandise operation and provide space-related educational services. Because of the diversity among the operations of our activities, we report the results of each business as a separate segment in our consolidated financial
statements. Our consolidated financial results also reflect corporate-level expenses such as general and administrative, interest, and depreciation and amortization, but because of their nature, these items are not reported as a separate segment.



Business Segments



Following is a brief discussion of each of our four business segments, including a list of
key factors that have affected, and are expected to continue to affect, their respective earnings and cash flows. We also present a brief discussion of our corporate-level expenses. This Overview section concludes with a summary of our
current liquidity position and items that could impact our liquidity position in fiscal year 2005 and beyond. This Overview section is merely a summary and should be read together with the remainder of Item 2, Managements
Discussion and Analysis of Financial Condition and Results of Operations, as well as the audited consolidated financial statements, including the notes thereto, and the other information included in the Companys 10-K for year ended June 30,
2004.



SPACEHAB Flight Servicesgenerates revenue by providing space
shuttle-based, turnkey services that include customer access to space via our fleet of pressurized modules and unpressurized pallet carriers; integration and operations support to logistics suppliers transporting their cargo aboard our carriers to
and from the orbiting ISS; and/or integration and operations support to scientists and technologists responsible for experiments performed aboard module and pallet research platforms.



On a space-available basis for each mission, additional revenue can be generated by SFS under commercial contracts with non-NASA customers,
including both government and private customers. Commercial contracts with non-NASA customers will continue to be established directly between SPACEHAB and its commercial customers.



Additionally, during the space shuttle stand-down period, SFS is providing cargo shipment coordination services to NASA for all U.S. cargo
shipped to the ISS via the Russian Progress space vehicle. These services are provided under contract to Lockheed Martin, the Cargo Mission Contract (CMC) contractor to NASA. We are also providing research access to space and on
the ISS to JAXA through RSC Energia, a major Russian aerospace enterprise. SPACEHAB contracted through V.J.F. Russian Consulting with RSC Energia for construction of certain space research equipment, launch vehicle, and research space aboard the
Russian Progress carrier when the originally-scheduled services on the space shuttle were suspended due to the Columbia tragedy.



The primary factors impacting our SFS earnings and cash flows are the number of space shuttle missions flown and the configuration of the cargo handling and research
logistics required for each mission. Our revenues and earnings, if any, from each mission are dependent upon the space assets required in the cargo or research logistics configuration and the mission support services required to employ those assets.
Other factors that have impacted, and are expected to continue to impact, earnings and cash flows for this business unit include:



| | Congress funding for NASA and the allocation of that funding to ISS operations and space shuttle cargo missions
|- | ----------------------------------------------------------------------------------------------------------------



| | The return to flight of the U.S. Space Shuttle
|- | ----------------------------------------------



| | The role of international space research projects flying on future space shuttle missions
|- | -----------------------------------------------------------------------------------------



| | The growth of space exploration programs within NASA and NASAs commitment to the National Vision on Space Exploration regarding enhancement of the role of commercial
enterprise in space exploration programs
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Our ability to control our capital expenditures, particularly those for spare or replacement parts for space assets
|- | -------------------------------------------------------------------------------------------------------------------



Astrotech Space Operations, Inc. revenue is generated from various fixed-price
contracts with launch service providers in both the commercial and government markets. The services and facilities Astrotech provides to its customers support the final assembly, checkout, and countdown functions associated with preparing a
satellite for



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launch. This preparation may include: the final assembly and checkout of the satellite, check-out and installation of the
solid rocket motors, loading of the liquid propellants, encapsulation of the satellite in the launch vehicle payload fairings, and command and control of the satellite during pre-launch countdown.



The earnings and cash flows generated from our Astrotech operations are related to the number
of commercial satellite launches, which reflects the growth in the satellite-based communication industries, and the requirement to replace aging satellites. Other factors that have impacted, and are expected to continue to impact, earnings and cash
flows for this business include:



| | Our ability to control our capital expenditures, which primarily are limited to maintenance and safety, environ-mental and reliability projects, and other costs through disciplined
management and safe, efficient operations
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | The continuing unavailability of government-owned facilities at the major domestic launch sites that can offer compatible services, leading to an increase in government use of
Astrotech services
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



SPACEHAB Government Services, Inc.
expands SPACEHABs core business of supporting people living and working in space. Specifically, SGS has proven capabilities supporting the Government in the areas of large-scale configuration and data management programs such as the ISS;
specialized hardware design, development, and fabrication; low- to high-fidelity mockup design and construction; and safety and quality support services. This business unit offers a wide array of products and services in these varied fields and
brings over thirty years of advanced ideas and solid execution of these innovations to its customers. SGS is currently under contract to provide configuration management services within the Program Integration and Control (PI&C)
contract of which ARES Corporation is the prime contractor.



Our earnings in
SGS operations are dependent on our ability to continue to win contracts with NASA or other government entities through the competitive bidding process and our performance under those contracts in achieving performance bonuses. Other factors that
have impacted, and are expected to continue to impact, earnings and cash flows for this business include:



| | Continuation through 2008 of our PI&C contract with the ISS Program
|- | -------------------------------------------------------------------



| | Our ability to maintain small business qualification under NASA contracting rules
|- | ---------------------------------------------------------------------------------



| | Our ability to control costs within our budget commitments
|- | ----------------------------------------------------------



Space Media, Incorporatedoperates a retail store and internet store offering space-themed products and is engaged in space-related educational programs and other
space-themed activities. Revenue and earnings in our retail operations are dependent upon general enthusiasm for the space exploration program, advertising and promotion, and competition.



Corporate and Other. Significant items impacting future earnings and cash flows include:



| | Interest expense is expected to decrease in fiscal year 2005 due to the repayment of a substantial portion of our mortgage debt during fiscal year 2004 from proceeds from
Boeings early termination of their satellite preparation contract with our Astrotech subsidiary
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | General and administrative costs, which were reduced in fiscal year 2004 due to staff reductions and the closing of our Washington D.C. corporate office, and our ability to continue
to manage future overhead costs
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | The ultimate settlement of our claim against NASA for indemnification of our losses on the Space Shuttle Columbia mission and/or our Tort Claim
|- | -----------------------------------------------------------------------------------------------------------------------------------------------



| | Income taxes, with respect to which we currently only pay alternative minimum tax and minimal state income taxes; income taxes will also be impacted by our ability to realize our
significant deferred tax assets, including loss carry forwards
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Liquidity. As of September 30, 2004 we had cash on hand and in short-term investments of $6.2 million. Our $5.0 million revolving credit facility, which includes a potential restriction on $5.6 million of our short-term investments
if fully utilized, had a balance drawn of $2.5 million as of September 30, 2004, and requires approximately $3.3 million of restricted cash and investments. On October 20, 2004 the Company received payment of $8.2 million from NASA in
indemnification of losses suffered by the Company in the Space Shuttle Columbiaaccident. Our ability to



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maintain sufficient liquidity in the future will depend on a number of factors including our ability to acquire future
business, control our costs and manage capital expenditures, the return to flight of the space shuttle and the continued activity in the commercial and governmental satellite launch industry.



We expect that our operating cash flows over the remainder of the current fiscal year will be
sufficient to satisfy our capital expenditures, debt maturities, interest expenses, and operating commitments. In order to increase our liquidity and to provide capacity to ultimately redeem our subordinated convertible notes due in October 2007; to
fund capital expenditures for stand-by spare parts for our modules; and for costs of developing and submitting proposals for new government contracts, we will seek to replace or amend our $5.0 million revolving credit facility to remove its
restriction on our short-term investments and to increase the amount available under the facility.



Over the longer term we believe that the space shuttle return to flight and the Nations Vision for Space Exploration will lead to increased activity and related cash flows from operations for our SFS business
segment. The Company has recently been awarded contract with NASA for the study of the space agencys new exploration initiatives; additions to its contract with Lockheed Martin for ISS configuration hardware and contract additions in its
satellite processing business, reflecting increased activity in the space exploration and commercial satellite industries. However, there can be no assurance that the space shuttle will return to flight in the near term or that we will be able to
win future contracts with NASA, other national space agencies, or commercial space enterprises, or to successfully exploit other business opportunities. Failure to achieve such events would have a material adverse effect on our financial condition
and results of operations and could adversely affect our ability to redeem our subordinated convertible notes when they mature in October 2007.



Revenue



The Companys revenue for the three months ended September 30, 2004 and 2003 was generated primarily from the ReALMS contract, Lockheed Martin letter contract, and contracts with related commercial customers in
the SFS segment; the remaining contracts under the FCSD contract and the PI&C contract in the SGS segment; and its contract with Lockheed Martin in the Astrotech segment. Revenue for SMI was immaterial for the three months ended September 30,
2004 and 2003. Astrotech recognized scheduled idle time at its facilities during the quarter ended September 30, 2004, recognizing revenue primarily from the pro-rata guarantee under its contract with Lockheed Martin.



On February 1, 2003 the Companys RDM was lost in the STS-107 tragedy. The net book
value of the RDM was $67.9 million, which, net of insurance proceeds of $17.7 million, was recognized as a loss in the third quarter of fiscal year 2003. The $8.0 million plus interest of $0.2 million paid by NASA as indemnification for the
Companys loss of the RDM is recognized as a recovery of previously recognized loss in the quarter ended September 30, 2004. At this time the Company does not plan to replace the RDM. SPACEHABs SFS business segment has two additional
modules and other flight assets available to support the Companys current NASA requirements. These modules and assets can also be used to support future NASA requirements. Based on public statements made by NASA, the Company believes the
shuttle will return to flight; however, that return is currently expected to be no earlier than May 2005.



SPACEHABs SFS business segment is supporting NASAs return-to-flight activities and is continuing its operations in preparation for shuttle missions including STS-114, 121, 116, and 118 (in order of their
anticipated flight sequence). SFS is preparing a cargo carrier for STS-114, the External Stowage Platform 2 (ESP2), that will be deployed and permanently mounted to the ISS. SPACEHAB contracted directly with NASAs prime ISS
contractor, Boeing, for the STS-114 mission. For STS-121, a new mission added to the NASA ReALMS contract during the period ended December 31, 2003, SPACEHAB is scheduled to provide its non-deployable unpressurized carrier to NASA for transport of
several critical ISS Orbital Replacement Unit (ORU) spares. For both STS-116 and 118, missions previously placed under ReALMS, SPACEHAB is scheduled to provide its pressurized single module and its unpressurized non-deployable carrier
for transport of critical cargo and ORUs to and from the ISS. The Company has successfully completed negotiations with Boeing and Lockheed Martin for the respective contract equitable adjustments required to continue uninterrupted support to ongoing
STS-114, 121, 116 and 118 mission preparation activities during the shuttle down period following the Columbia tragedy. As previously described, the ReALMS



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contract expired January 31, 2004 and support for missions STS-121, 116 and 118 is continuing under a subcontract
agreement to Lockheed Martin, effective February 1, 2004. SPACEHAB is currently providing these services under a letter contract and is in final contract negotiations with Lockheed Martin for this new contract. Additionally, after approximately
April 15, 2004, SFS no longer is subcontracting its module mission integration, operations and sustaining engineering technical support to Boeing. Most module mission tasks previously performed by Boeing personnel are now being performed by
SPACEHABs SFS personnel and selected NASA cargo integration tasks on SPACEHAB module missions are now being performed by Lockheed Martin as a part of their CMC with NASA. This decision enables SFS to continue to provide services to NASA and is
consistent with the direction of the ISS Program Office.



In January 2004 the
Company initiated activity under the JETIS contract with the Mitsubishi Corporation, representing JAXA, that was entered into in 2000 and originally scheduled to fly aboard SPACEHABs RDM. Subsequent to the suspension of the space shuttle
flights and destruction of SPACEHABs RDM, the Company contracted for construction of certain space research equipment and for research space aboard the ISS and up to three Russian Progress cargo missions with V.J.F. Russian Consulting,
representing RSC Energia, a major Russian aerospace manufacturer and mission operator. The first experiment was successfully launched on the Russian Progress spacecraft on August 11, 2004.



During the three months ended September 30, 2004 and 2003, deferred revenue decreased by $3.0
million and $1.4 million, respectively, as the Company recognized revenue on contracts where milestone payments had been received in prior periods. Management expects further reduction of deferred revenue through the remainder of the next fiscal
year which will result in revenue recognition on contracts for which the related cash was received in a prior period.



Costs of Revenue



SPACEHAB has several types of costs of revenue in its business segments. Costs of revenue for SFS include integration and operations expenses associated with the performance of two types of efforts: (i) sustaining
engineering in support of all missions under a contract and (ii) mission specific support. Costs associated with the performance of the contracts using the percentage-of-completion method of revenue recognition are expensed as incurred. Costs
associated with the cost-plus award and fixed-fee contracts are expensed as incurred by SGS. Other costs of revenue include depreciation expense and costs associated with the Astrotech payload processing facilities. Flight related insurance covering
transportation of the SPACEHAB modules from SPACEHABs payload processing facility to the space shuttle, in-flight insurance, and third-party liability insurance are also included in costs of revenue and are recorded as incurred. Selling,
general and administrative and interest and other expenses are recognized when incurred.



Non-Recurring Charge



For the period
ended March 31, 2003, the Company recognized a non-recurring charge of $50.3 million net of insurance proceeds, on the loss of its RDM in the Space Shuttle Columbia accident. Upon notification by NASA of its acceptance of the Companys
claim for indemnification of $8.0 million plus interest of $0.2 million, the Company recorded the $8.2 million as an increase in accounts receivable and a decrease in operating expense for the three months ended September 30, 2004.



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##### Table of Contents

RESULTS OF OPERATIONS



For the three months ended September 30, 2004 as compared to the three months ended September 30, 2003.



Revenue. Revenue decreased approximately 31% to $13.0 million as compared to $18.9
million for the three months ended September 30, 2004 and 2003, respectively (in millions).



|                             |  |                   |      |                   |   |              |  |   |               |   |  |     |   
|---------------------------- |  | ----------------- | ---- | ----------------- | - | ------------ |  | - | ------------- | - |  | --- | --
|                             |  | September 30,2004 |      | September 30,2003 |   | DollarChange |  |   | PercentChange |  
|SPACEHAB Flight Services     |  | $                 | 9.6  |                   | $ | 11.8         |  | $ | (2.2          | ) |  | (19 | )%
|Astrotech Space Operations   |  |                   | 1.7  |                   |   | 3.4          |  |   | (1.7          | ) |  | (50 | )%
|SPACEHAB Government Services |  |                   | 1.5  |                   |   | 3.5          |  |   | (2.0          | ) |  | (57 | )%
|SMI                          |  |                   | 0.2  |                   |   | 0.2          |  |   | (0.0          | ) |  | (0  | )%
|                             |  |                   |      |                   |   |              |  |   |               |   |  |     |   
|                             |  | $                 | 13.0 |                   | $ | 18.9         |  | $ | (5.9          | ) |  | (31 | )%
|                             |  |                   |      |                   |   |              |  |   |               |   |  |     |   



Revenue from the SFS business segment
has been adversely affected by the temporary grounding of the shuttle fleet due to the STS-107 tragedy in February 2003, partially offset by revenue from the Lockheed Martin letter contract, and other contract revenue. The following summarizes the
significant items:



| | Decrease in ReALMS revenue of $10.6 million from September 30, 2003 to September 30, 2004 due to the ReALMS contract closeout
|- | -----------------------------------------------------------------------------------------------------------------------------



| | Increase in revenue from Lockheed Martin letter contract of $5.3 million for essentially the same services as previously provided under the ReALMS contract
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| | Increase in ESP2 revenue of $2.1 million due to the expected launch in May 2005
|- | -------------------------------------------------------------------------------



| | Revenue from the JETIS contract of $1.8 million that was started in the third quarter of fiscal 2004
|- | ----------------------------------------------------------------------------------------------------



| | Other contract revenue decrease of $0.8 million
|- | -----------------------------------------------



The decrease of revenue at the Astrotech Space Operations (Astrotech) business unit is primarily due to Boeings termination of the fixed guarantee
payments to ASO. During the period ended September 30, 2003 Boeings total guaranteed revenue was $1.7 million. During the quarter ended September 30, 2004, Astrotech underwent scheduled downtime between launches recognizing contractually
guaranteed revenues of $0.8 million and $0.6 million from missions that began in fourth quarter of fiscal year 2004 and other contract revenue of $0.3 million.



The decrease in revenue at the SGS business segment is primarily due to the closeout of the Stowage, Engineering and Decal Contract (SEDC) and
Configuration Management (CM) contract in December 2003 partially offset by the PI&C contract which started in January 2004. The following summarizes the significant items:



| | Revenue decrease of $1.8 million due to the closeout of the SEDC contract in December 2003
|- | ------------------------------------------------------------------------------------------



| | Revenue decrease of $1.3 million due to the closeout of the CM contract in December 2003
|- | ----------------------------------------------------------------------------------------



| | Revenue increase of $1.4 million due to the startup of the PI&C contract in January 2004
|- | ----------------------------------------------------------------------------------------



| | Other contract revenue decrease of $0.3 million
|- | -----------------------------------------------



Costs of Revenue. Costs of revenue for the three months ended September 30, 2004 decreased by 20% to approximately $10.8 million, as compared to $13.5 million for
the prior years quarter (in millions).



|                             |  |                   |      |                   |   |              |  |   |               |   |  |     |   
|---------------------------- |  | ----------------- | ---- | ----------------- | - | ------------ |  | - | ------------- | - |  | --- | --
|                             |  | September 30,2004 |      | September 30,2003 |   | DollarChange |  |   | PercentChange |  
|SPACEHAB Flight Services     |  | $                 | 7.6  |                   | $ | 8.6          |  | $ | (1.0          | ) |  | (12 | )%
|Astrotech                    |  |                   | 1.9  |                   |   | 1.7          |  |   | 0.2           |   |  | 12  | % 
|SPACEHAB Government Services |  |                   | 1.2  |                   |   | 3.1          |  |   | (1.9          | ) |  | (61 | )%
|SMI                          |  |                   | 0.1  |                   |   | 0.1          |  |   | (0.0          | ) |  | (0  | )%
|                             |  |                   |      |                   |   |              |  |   |               |   |  |     |   
|                             |  | $                 | 10.8 |                   | $ | 13.5         |  | $ | (2.7          | ) |  | (20 | )%
|                             |  |                   |      |                   |   |              |  |   |               |   |  |     |   



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##### Table of Contents

Costs of revenue from the SFS business segment has been adversely affected by the temporary grounding of the shuttle
fleet due to the STS-107 tragedy in February 2003, partially offset by costs of revenue from the Lockheed Martin letter contract, the termination of Boeing as a subcontractor for module services, and other contract costs of revenue. The following
summarizes the significant items:



| | Decrease in ReALMS costs of revenue of $6.3 million from September 30, 2003 to September 30, 2004 due to the ReALMS contract closeout
|- | -------------------------------------------------------------------------------------------------------------------------------------



| | Costs of revenue from Lockheed Martin letter contract of $3.2 million that started in the third quarter of fiscal year 2004
|- | ---------------------------------------------------------------------------------------------------------------------------



| | Increase in ESP2 costs of revenue of $1.8 million due to the expected launch in May 2005
|- | ----------------------------------------------------------------------------------------



| | Costs of revenue of $0.7 million from JETIS that was started in the third quarter of fiscal 2004
|- | ------------------------------------------------------------------------------------------------



| | Other costs of revenue decreases of $0.4 million, primarily resulting from the termination of Boeing as a subcontractor for module services
|- | -------------------------------------------------------------------------------------------------------------------------------------------



Astrotechs increase in costs of revenue is due to increased mission support costs and
increase in the costs of operations at the satellite processing facilities.



The decrease in costs of revenue at the SGS business segment is primarily due to the closeout of the SEDC and CM contracts in December 2003 partially offset by the PI&C contract. The following summarizes the significant items:



| | Costs of revenue decrease of $1.5 million due to the closeout of the SEDC contract in December 2003
|- | ---------------------------------------------------------------------------------------------------



| | Costs of revenue decrease of $1.1 million due to the closeout of the CM contract in December 2003
|- | -------------------------------------------------------------------------------------------------



| | Costs of revenue increase of $1.2 million due to the startup of the PI&C contract in January 2004
|- | -------------------------------------------------------------------------------------------------



| | Other costs of revenue decreases of $0.5 million due to less contract activities in first quarter 2005 as compared to first quarter of fiscal year 2004
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------



Operating Expenses. Operating expenses, other than the recovery of non-recurring
charge for the loss of the RDM, decreased to $2.0 million for the three months ended September 30, 2004 as compared to approximately $2.9 million for the three months ended September 30, 2003. The primary factors attributable to this decrease are
the Companys on-going reductions in staff and facilities. In addition, the Company recorded NASAs settlement of the Companys contract claim for the loss of its RDM in the Columbia accident in the amount of $8.2 million.
During the period ended September 30, 2004, the Company recognized legal expenses of $0.1 million relating to its claims against NASA for loss of the RDM and response to Lloyds complaint regarding its payment of insurance proceeds on the
accident.



For the period ended September 30, 2004, there were no significant
bid and proposal efforts. In the period ended September 30, 2003, the Company incurred bid and proposal costs of $0.2 million primarily relating to the Mission Integration Contract (MIC) proposal. Operating expenses also are lower in
this period as compared to last years quarter due to the Companys ongoing cost reduction efforts and staffing reductions in selling, general and administrative expenses. Research and development expenses were immaterial for the three
months ended September 30, 2004 and 2003 as the Company continued to emphasize utilizing its existing asset base and limiting new investments in research and development.



Interest Expense. Interest expense was approximately $1.5 million for the three months ended September 30, 2004 as compared to
approximately $1.7 million for the three months ended September 30, 2003. The decrease in interest expense is primarily due to the amendment and partial prepayment of the mortgage loan for the Astrotech facilities which resulted in decreased
interest expense in this period and on a going forward basis.



Interest and
Other Income. Interest and other income was immaterial for the three months ended September 30, 2004 and September 30, 2003. Interest income is earned on the Companys short-term investments. Interest of $0.2 million due on NASAs
indemnification under the RDM claim is included as recovery of previously recognized non-recurring loss.



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Income Taxes. Based on the Companys projected effective tax rate for fiscal year 2004, the Company recorded
$0.1 million for tax expense for the three months ended September 30, 2004 as compared to a minimal tax expense during the three months ended September 30, 2003.



Net Income. Net income for the three months ended September 30, 2004 was approximately $7.0 million or $0.55 per share basic and
$0.49 per share diluted on 12,574,224 and 14,247,860 shares, respectively, as compared to net income of approximately $0.7 million or $0.05 per share basic and diluted on 12,370,955 and 13,745,450 shares, respectively, for the three months ended
September 30, 2003.



Liquidity and Capital Resources



Historically, the Company obtained operating and capital investment funds from the proceeds
of its initial public offering of common stock and an offering of Series B Senior Convertible Preferred Stock. The Company also completed a private placement offering of convertible subordinated notes to support capital investments required for
development and construction of space flight assets.



The Companys
primary source of liquidity is cash flow from operations and short-term investments. The principal uses of cash flow that affect the Companys liquidity position include both operational expenditures and debt service payments. Management is
focused on increasing the Companys cash flow and on managing cash effectively through limiting cash investments in long-term assets.



The Company currently maintains a working capital line of credit facility totaling $5.0 million in order to ensure appropriate levels of liquidity. The term of this
credit facility is through August 28, 2005. Covenants include a liquidity ratio and a limited pledge of $5.6 million of the Companys investment account. The restriction on the Companys investment balance is limited to 111% of the
Companys borrowings on the line of credit. As of September 30, 2004, amounts unused and available under this credit facility were $2.5 million.



Cash Flows From Operating Activities.Cash used by operations for the three months ended September 30, 2004 and 2003 was $1.9 million and $2.2 million,
respectively. The significant items affecting the differences in cash flows from operating activities for the three months ended September 30, 2004 as compared to the three months ended September 2003 are discussed below:



| | Net income for the three months ended September 30, 2004 was $7.0 million as compared to net income for the three months ended September 30, 2003 of $0.7 million. Included in net
income for the quarter ended September 30, 2004 is $8.2 million recognized as recovery of a previously reported non-recurring loss. This amount is included in accounts receivable as of September 30, 2004 and was collected in October of 2004
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Depreciation and amortization for the three months ended September 30, 2004 was $1.4 million as compared to $1.5 million for period ended September 30, 2003 due to some assets
reaching end of useful life during the period ended September 30, 2004
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Changes in assets for the three months ended September 30, 2004 consumed cash from operations of $5.9 million. This change is due primarily to the recording of the NASA claim
settlement of $8.2 million partially offset by the decrease of accounts receivable at Astrotech due to the anticipated downtime during the period and decrease in deferred mission costs due to the launch for the JETIS project
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Changes in liabilities for the three months ended September 30, 2004 consumed cash from operations of $4.3 million. This change is primarily due to the decrease in accounts payable
and accrued expenses of $1.3 million and the decrease in deferred revenue of $3.0 million. The decrease in deferred revenue is due to the first launch for the JETIS contract during the three months ended September 30, 2004
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Cash Flows From Investing Activities.For the three months ended September 30, 2004
and 2003, cash flows provided by investing activities were $0.7 million and $2.2 million, respectively. The significant items affecting the differences in cash flows from investing activities for the three months ended September 30, 2004 as compared
to the three months ended September 2003 are discussed below:



| | There were minor purchases of property and equipment of $0.1 million for the three months ended September 30, 2004 as compared to $0.4 million for the three months ended September
30, 2003
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | For the period ended September 30, 2004, cash flows from investing activities were primarily generated from the sale of short-term investments of $1.0 million as compared to $2.6
million for the three months ended September 30, 2003
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Cash
Flows From Financing Activities.For the three months ended September 30, 2004 and 2003, cash flows provided by (used in) financing activities were $0.6 million and ($1.4) million, respectively. The significant items affecting the differences in
cash flows from financing activities for the three months ended September 30, 2004 as compared to the three months ended September 2003 are discussed below:



| | For the three months ended September 30, 2004, the Company borrowed $1.0 million under the revolving credit facility as compared to $0.5 million for the three months ended September
30, 2003 used to reduce accounts payable and accrued expenses
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | For the three months ended September 30, 2004, the Company paid $0.5 million under various credit agreements as compared to $1.9 million for the three months ended September 30,
2003. This reduction is primarily due to the final payment to Alenia Spazio S.P.A during the three months ended March 31, 2004
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



On March 25, 2003 the Board of Directors authorized the Company to repurchase up to $1.0 million of the Companys outstanding common stock at market prices. Any
purchases under the Companys stock repurchase program may be made from time to time, in the open market, through block trades or otherwise in accordance with applicable regulations of the Securities and Exchange Commission. As of September 30,
2004, the Company had repurchased 116,100 shares at a cost of $117,320 under the program. The Company will continue to evaluate the stock repurchase program and the funds authorized for the program.



Contract Claim.In January 2004 the Company filed a formal proceeding with NASA
seeking indemnification under the Companys ReALMS contract in the amount of $87.7 million for the value of the Companys RDM and related equipment that was destroyed during the STS-107 Space Shuttle Columbiatragedy. NASA responded
to this contract claim on October 5, 2004. NASAs determination states that its liability is limited under the ReALMS contract to $8.0 million. The Company received payment of $8.2 million, which included $0.2 million of interest, from NASA in
October 2004. The Company has the right to appeal NASAs decision to deny its claim for indemnification in excess of $8.0 million. The appeal can be filed with either the Armed Services Board of Contract Appeals or the U.S. Court of Federal
Claims. SPACEHAB is evaluating its options in appealing NASAs determination.



Lloyds Complaint.In January 2004 Lloyds, the Companys insurer for the RDM, filed a complaint in the United States District Court for the Western District of Washington seeking the return of the $17.7 million
Lloyds had paid to the Company under the RDM insurance policy alleging that, among other things, (i) such proceeds were paid erroneously primarily due to the fact that NASA had not paid indemnification due to the Company prior to the payment
of the insurance proceeds, (ii) the Company and its insurance broker misled Lloyds in issuing the policy, and (iii) the Company has not cooperated with Lloyds in protecting Lloyds right of subrogation. In February 2004 Lloyds
withdrew its complaint from the United States District Court and filed a similar complaint in Superior Court of the State of Washington. On November 1, 2004 SPACEHAB filed a motion with the Superior Court of the State of Washington to dismiss under
forum non conveniens. The Company believes that Lloyds complaint is without merit and will continue to respond to the complaint accordingly.



TortClaim.On November 8, 2004 the Company filed a second claim with NASA seeking damages of $79.7 million under the Federal Tort Claims Act for the loss
of the RDM resulting from NASAs alleged negligence leading to the destruction of the Space Shuttle Columbia and the loss of the RDM. The Companys claim represents its loss of $87.7 million less the $8.0 million recovered from
NASA. Under federal tort claim procedures, NASA has statutory deadlines for responding to such claims. In the event that the Companys administrative claim is denied, the Company would have the right to pursue the claim in the Federal District
Court.



Management continues to focus its efforts on improving the overall
liquidity of the Company through identifying new business opportunities within the areas of the Companys core competencies, reducing operating expenses, and limiting cash commitments for future capital investments and new asset development.
SGS was pursuing significant new contracts to provide services for the ISS. On November 5, 2003 NASA notified the Company that it was not



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awarded the ISS Mission Integration contract. Additionally, the Boeing teams bid for the Cargo Mission contract
with NASA, of which SGS was a subcontractor, was not selected for contract award. As the result of the loss of these contract awards, the Company has made significant adjustments to its staffing and cost base structure during the period ended
December 31, 2003. The Company reduced staffing by 67 employees in the quarter ended December 31, 2003 as a result of NASAs award decisions. On October 1, 2003 the Company announced that it would close its corporate office in Washington, D.C.
by December 31, 2003 and consolidate those operations into its headquarters in Houston, Texas. The Company took these actions as part of its continuing efforts to further reduce operating expenses and improve profitability. The Company subleased its
Washington, D.C. facility for the remaining lease period which is under lease through May 31, 2006. The Company has continued to restrict new capital investment and new asset development, limiting projects to those required to support current
contracts and facility maintenance. Additionally, management continues to evaluate operating expenses in an effort to reduce or eliminate costs not required to effectively operate the Company.



The Companys cash and short-term investments were approximately $6.2 million as of
September 30, 2004. On October 20, 2004 the Company received $8.2 million from NASA in indemnification of losses suffered in the Space Shuttle Columbia accident. Management believes that the Company has sufficient liquidity, including cash
and short-term investments and cash anticipated or expected to be generated from operations to fund ongoing operations beyond the remainder of this fiscal year. The Company also expects to utilize existing cash, cash anticipated from future
operations and any potential additional proceeds from NASA in settlement of the Companys claims related to losses in the Space Shuttle Columbia tragedy, to support strategies for new business initiatives and reduce long-term debt.



The Companys contractual obligations as of September 30, 2004 are as
follows (in thousands):



|                                    |  |                      |        |                               |   |                |  |                |       |                  |   |                  |  |            |        |  |   |    |  |   |      
|----------------------------------- |  | -------------------- | ------ | ----------------------------- | - | -------------- |  | -------------- | ----- | ---------------- | - | ---------------- |  | ---------- | ------ |  | - | -- |  | - | -----
|Contractual Obligations             |  | AtSeptember 30, 2004 |        | Remaining in Fiscal Year 2005 |   | FiscalYear2006 |  | FiscalYear2007 |       | Fiscal Year 2008 |   | Fiscal Year 2009 |  | Thereafter
|Long-term Debt                      |  | $                    | 63,250 |                               | $ |               |  | $              |      |                  | $ |                 |  | $          | 63,250 |  | $ |   |  | $ |     
|Loan payable under credit facility  |  |                      | 2,492  |                               |   | 2,492          |  |                |      |                  |   |                 |  |            |       |  |   |   |  |   |     
|Mortgage Loan Payable               |  |                      | 5,162  |                               |   | 1,469          |  |                | 2,057 |                  |   | 1,636            |  |            |       |  |   |   |  |   |     
|V.J.F. Russian Consultant Agreement |  |                      | 300    |                               |   | 135            |  |                | 165   |                  |   |                 |  |            |       |  |   |   |  |   |     
|V.J.F. Russian Subcontract          |  |                      | 1,150  |                               |   | 750            |  |                | 400   |                  |   |                 |  |            |       |  |   |   |  |   |     
|Capital Leases                      |  |                      | 2      |                               |   | 2              |  |                |      |                  |   |                 |  |            |       |  |   |   |  |   |     
|Operating leases1                   |  |                      | 7,372  |                               |   | 1,880          |  |                | 1,348 |                  |   | 760              |  |            | 441    |  |   | 91 |  |   | 2,852
|                                    |  |                      |        |                               |   |                |  |                |       |                  |   |                  |  |            |        |  |   |    |  |   |      
|Total Contractual Cash Obligations2 |  | $                    | 79,728 |                               | $ | 6,728          |  | $              | 3,970 |                  | $ | 2,396            |  | $          | 63,691 |  | $ | 91 |  | $ | 2,852

---

(excluding interest
payments)



|1    - | For the remainder of fiscal year 2005, the Company expects to receive net payments of $0.5 million for subleases. For fiscal years 2006, 2007, and 2008, the Company expects to
receive net payments of approximately $0.7 million, $0.5 million, and $0.3 million, respectively, for subleases.
|------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2    - | Does not include commitment to Dayna Justiz, President of The Space Store, for compensation that can be earned as a result of the agreement date June 19, 2000. The agreement states
that Dayna Justiz can earn up to $375,000 as additional compensation if she meets certain financial goals in the management of The Space Store, the retail arm of SMI. The yearly amount is equal to five percent of The Space Stores net
after-tax operating income during each fiscal year until such time an aggregate amount of $375,000 has been earned. At this time, we have not recorded a liability for this obligation due to the uncertainty of the obligation being incurred.
|------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 3. Quantitative and Qualitative Disclosures about Market Risk



The Company has no material changes to the disclosure made on this matter in the Companys Annual Report on Form 10-K for the year ended June 30, 2004.



ITEM 4. Controls and Procedures



Under the
supervision and with the participation of the Companys management, including its principal executive officer and principal financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls
and procedures as of the end of the period covered by this quarterly report, and, based on its evaluation, the Companys principal executive officer and principal financial officer have concluded that these



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controls and procedures are effective. There have been no changes in the Companys internal control over financial
reporting that occurred during the Companys last fiscal quarter that have materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



Disclosure controls and procedures are the Companys controls and other procedures that
are designed to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commissions rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that we
file under the Exchange Act is accumulated and communicated to its management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.



Section 404 of the Sarbanes Oxley Act of 2002 requires the Company to perform an evaluation
of its internal control over financial reporting and have its auditors attest to such evaluation. The Company has been actively preparing for the implementation of this requirement by, among other things, establishing an ongoing program to perform
the system and process evaluation and testing necessary for compliance. The Company is not an accelerated filer under the rules of the SEC and, therefore, will not be subject to these requirements until its fiscal year ending June 30, 2006. While
the Company anticipates that it will be able to comply on a timely basis with this requirement, unforeseen delays may occur which could prevent the Company from achieving timely compliance. If the Company fails to complete its evaluation on a timely
basis and in a satisfactory manner, or if its auditors are unable to attest on a timely basis to the adequacy of the Companys internal control, the Company may be subject to additional regulatory scrutiny and to a loss of public confidence in
its internal control over financial reporting.



PART II - OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



Contract
Claim.In January 2004 the Company filed a formal proceeding with NASA seeking indemnification under the Companys ReALMS contract in the amount of $87.7 million for the value of the Companys RDM and related equipment that was
destroyed during the STS-107 Space Shuttle Columbiatragedy. NASA responded to this contract claim on October 5, 2004. NASAs determination states that its liability is limited under the ReALMS contract to $8.0 million. The Company
received payment of $8.2 million, which included $0.2 million of interest, from NASA in October 2004. The Company has the right to appeal NASAs decision to deny its claim for indemnification in excess of $8.0 million. The appeal can be filed
with either the Armed Services Board of Contract Appeals or the U.S. Court of Federal Claims. SPACEHAB is evaluating its options in appealing NASAs determination.



Lloyds Complaint.In January 2004 Lloyds, the Companys insurer for the RDM, filed a complaint in the United
States District Court for the Western District of Washington seeking the return of the $17.7 million Lloyds had paid to the Company under the RDM insurance policy alleging that, among other things, (i) such proceeds were paid erroneously
primarily due to the fact that NASA had not paid indemnification due to the Company prior to the payment of the insurance proceeds, (ii) the Company and its insurance broker misled Lloyds in issuing the policy, and (iii) the Company has not
cooperated with Lloyds in protecting Lloyds right of subrogation. In February 2004 Lloyds withdrew its complaint from the United States District Court and filed a similar complaint in Superior Court of the State of Washington. On
November 1, 2004 SPACEHAB filed a motion with the Superior Court of the State of Washington to dismiss under forum non conveniens. The Company believes that Lloyds complaint is without merit and will continue to respond to the complaint
accordingly.



TortClaim.On November 8, 2004 the Company filed a
second claim with NASA seeking damages of $79.7 million under the Federal Tort Claims Act for the loss of the RDM resulting from NASAs alleged negligence leading to the destruction of the Space Shuttle Columbia and the loss of the RDM.
The Companys claim represents its loss of $87.7 million less the $8.0 million recovered from NASA. Under federal tort claim procedures, NASA has statutory deadlines for responding to such claims. In the event that the Companys
administrative claim is denied, the Company would have the right to pursue the claim in the Federal District Court.



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ITEM 6. EXHIBITS



The following
exhibits are filed herewith:



|   |  |      |  |                                                                                                                         
|-- |  | ---- |  | ------------------------------------------------------------------------------------------------------------------------
|a) |  | 31.1 |  | Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.                
|   |  |     
|   |  | 31.2 |  | Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.                
|   |  |     
|   |  | 32.1 |  | Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|   |  |     
|   |  | 32.2 |  | Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



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SIGNATURE



Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.



|                        |  |                                                  
|----------------------- |  | -------------------------------------------------
|                        |  | SPACEHAB, INCORPORATED                           
|                        | 
|Date: November 12, 2004 |  | /s/ Michael E. Kearney                           
|                        |  | Michael E. Kearney                               
|                        |  | President and Chief Executive Officer            
|                        | 
|                        |  | /s/ Brian K. Harrington                          
|                        |  | Brian K. Harrington                              
|                        |  | Senior Vice President and Chief Financial Officer



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