** **

**U.S. SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-KSB**

 
|  **(Mark One)**                                                                                                                                                                           |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **ý**                                                                                                                                                                                     | **ANNUAL  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934.** |
|                                                                                                                                                                                           |
| **For the fiscal year ended December 31,  2004**                                                                                                                                          |
|                                                                                                                                                                                           |
| **o**                                                                                                                                                                                          | **TRANSACTION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934.** |
|                                                                                                                                                                                           |
| **For the transition period from                             to** |
| **Commission  file number 0-115404**                                                                                                                                                           |

 

**HYPERSPACE COMMUNICATIONS, INC.**

(Name of SmallBusiness Issuer in Its Charter)

 
| **Colorado**                                                                       | ** ** | **84-1577562**                        |
|------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or  Other Jurisdiction of Incorporation or  Organization)                   |       | (I.R.S.  Employer Identification No.) |
|                                                                               |       |                                  |
| **8480 E. Orchard Rd, Greenwood Village, CO**                                      | ** ** | **80111**                             |
| (Address of  principal executive offices)                                          |       | (Zip Code)                            |
|                                                                               |       |                                  |
| **(303)  566-6500**                                                                |
| (Issuer’s  Telephone Number, Including Area Code)                             |
|                                                                               |       |                                  |
| Securities  registered under Section 12(b) of the Exchange Act:          |
| Common  Stock, no par value: **American Stock Exchange**                           |
| Warrants to  Purchase Common Stock: **American Stock Exchange**                    |
|                                                                               |       |                                  |
| Securities  registered under Section 12(g) of the Exchange Act: **None** |

 

Check whether the issuer:  (1) filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act duringthe past 12 months), and (2) has been subject to such filing requirementsfor the past 90 days.  **ý**YES   o  NO

 

Check if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B contained in this form, and no disclosure will becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-KSBor any amendment to this Form 10-KSB. **ý**

 

State the issuer’s revenues for its most recent fiscal year: $457,850.

 

As of March 24, 2005, 3,732,429 common shares were outstanding andthe aggregate market value of the common shares (based upon the average bid andasked prices on such date) of the Registrant held by non-affiliates wasapproximately $10.93 million.

** **

Documents Incorporated by Reference: None. 

 

Transitional Small Business Disclosure Format:   o YES  **ý******NO

 

 

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**A NOTE ABOUT FORWARD-LOOKINGSTATEMENTS**

##### **Thestatements, other than statements of historical fact, included in this reportare forward-looking statements. Forward-looking statements generally can beidentified by the use of forward-looking terminology such as “may,” “will,” “expect,”“intend,” “estimate,” “anticipate,” “plan,” “seek,” or “believe.” We believethat the expectations reflected in such forward-looking statements areaccurate. However, we cannot be assured that such expectations willoccur. Our actual future performance could differ materially from suchstatements. These forward-looking statements are subject to risks anduncertainties that could cause actual results and events to differ materially.For a detailed discussion of these risks and uncertainties please see the “RiskFactors” section of this Annual Report. These forward-looking statementsapply only as of the date of this report; as such, they should not be undulyrelied upon for current circumstances. Except as required by law, we are not obligated to release publicly anyrevisions to these forward-looking statements that might reflect events orcircumstances occurring after the date of this report or those that mightreflect the occurrence of unanticipated events.**

 

##### **PART I**

 

##### **Item 1. DESCRIPTIONOF BUSINESS**

 

**Company Overview**

Wedevelop, produce, and market worldwide network acceleration and datacompression software. We offer two software products. Our initialsoftware product HyperWebTM, was introduced in late 2001. In January 2004,we introduced our second product, HyperTunnelTM. These software products address the growing need for real-timeapplication acceleration and improved business communications over wired andwireless networks. Our mission is to make purchasers of our products moreefficient by increasing the performance of their internal and external mission-criticalapplications through deployment of network application acceleration softwarethat is cost effective, easy to use and easy to install.

 

Asdescribed below, we are preparing to engage in a merger that, if consummated,would result in us acquiring 100% of the outstanding equity interest  of GTG PC Holdings, LLC., the parent of MPCComputers, LLC,  or MPC. MPC is aprovider of computing solutions to customers in the federal government, stateand local government and education and mid-market enterprise markets offering abroad range of customized computing products and services, including hardware,software and related information technology (IT) consultative services.     

 

##### **Background**

We are a Colorado-based software company that was formed in 2001. Wecompleted an initial public offering, or “IPO” in October 2004. We raisedapproximately $7.1 million after offering costs and expenses.

 

Network acceleration and data compression, our current business withHyperWebTM and HyperTunnelTM, is a subset of the software industry. Historicallyour direct competition in this space came from a small number of largercompetitors and several small, private companies. Many of these companies soldtheir solutions as a bundled hardware and software solution

 

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while we focused on software only. In late 2004 and early 2005 severalof these companies merged. As a result, we view the industry as one intransition. 

 

From inception through to our initial public offering we generatedsales largely through customers who found us on the Internet or through word-of-mouthand personal relationships. 

 

During 2004, we hired new sales leadership and began to develop andimplement a new strategic sales and marketing strategy. Our sales and marketingstrategy changed from one in which we sold directly to individual organizationsto one which involves seeking partners and distributors to sell our productincluded in their own. Since our sales and marketing strategy is in atransitional stage we focus on basic success metrics, such as revenue growth,expense management and achieving business plan milestones. 

 

##### **2004 Activity**

During2004 

•                  We transitioned into a publicly tradedcompany with our October 2004 IPO.

•                  We launched our second product, HyperTunnelTMand released several product improvements for both products. 

•                  We developed and started implementation of anew sales and marketing strategy.

•                  We closed two Partner/OEM deals that aredirectly in line with our new strategy, but are not yet providing significantrevenue.

•                  We launched our merger and acquisitioneffort. 

 

Ouractivities were not successful in:

•                  Achieving revenue and profitability targets.

•                  Establishing a strong presence forHyperTunnelTM in the market.

 

Each of these items is described below.

 

**Corporate Improvements**

We spent a substantial portion of time between March and October preparingfor our IPO and completing the transaction. During 2004 we transitioned thecompany from a private company to a publicly traded one. This involvedupgrading, documenting and implementing new controls and procedures as requiredby the Securities and Exchange Commission, or SEC, the American Stock Exchange,or Amex, rules and the Sarbanes-Oxley Act of 2002. We also created anAudit and Corporate Governance Committee and a Compensation Committee incompliance with SEC and AMEX requirements. In this regard, with our limitedresources we had a single non-cash Material Weakness as defined by the SarbanesOxley act of 2002 which related to a non-cash financial input error in theBlack-Scholes valuation calculation for options issued to certain contractorsduring the fourth quarter of 2004. This is more fully explained in Item 8A.

 

**Product Improvements**

In early 2004 we launched oursecond product, HyperTunnelTM. HyperTunnelTM provides bi-directional accelerationfor wide area networks, web traffic, images, network applications such asMicrosoft® Outlook, and client server applications.

 

During 2004,we completed significant product enhancements for the HyperTunnelTM product. Thenew enhancements, some of which were completed as late as December 2004,further improve the performance, scalability, applicability and reliability ofour software-based approach to acceleration of branch office and remote andmobile user application traffic. Scalability testing was completed in late 2004by an external testing organization. This testing helped us identify and, bylate December, eliminate some product bugs and establish server configurationparameters that we believe will help improve the success rate of productevaluations.

 

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During 2004 we also made improvements to the HyperWebTM product. 

 

**Sales and Marketing Strategy**

In 2004, we hired a new Chief OperatingOfficer to manage our sales and marketing function. Our efforts on sales andmarketing initiatives have not yet produced the desired results. We expect tomake major changes in this area during the coming year.

 

**New Partner/OEM Channel Agreements Signed**

In October 2004, we announced an OEM agreement with Xaffire Inc®,a provider of live Web session capture and playback technology. This agreementenables Xaffire to sell and distribute a new, integrated version of HyperSpace’sHyperWebTM software with its XfireTM Web application management tools.

 

*The HyperWebTMcapability extends Xfire’s content capture and replay functionality to  a broad range of Web server and operatingsystem environments, including Microsoft® IISTM 6 and Sun® Server iPlanetTM, andgives customers the option to purchase HyperWebTM’s data compression andacceleration capabilities. Xaffire expects to begin customer trials of thiscombined solution in early 2005. To date we have not recorded any materialrevenue from this relationship.*

 

*In December 2004,we announced a reseller agreement with iDirect Technologies, Inc., oriDirect, a company that designs, develops, and markets satellite-basedbroadband access solutions targeted at the enterprise, government, carrier andeducational sectors, that need fast, flexible, and geographically dispersedtwo-way internet/intranet acces*s. We havegranted iDirect certain exclusivity to sell HyperWebTM in the satellite space.In order for iDirect to maintain certain exclusivity rights, it will have togenerate a minimum of $900,000 in sales of HyperWebTM, measured at periodicintervals, over the two year term of the agreement, less than half of which isrequired during the first year.  IDirectplaced an initial order under the contract in December 2004.

 

Under terms of the agreement, iDirect will deploy HyperWebTM in thesatellite broadband access market space. HyperWebTM will be part of a bundled service package offered iDirect’scustomers seeking to accelerate their downloads. We have trained iDirect’ssales staff and we are currently in the pilot phase with certain iDirectcustomers.

 

**Merger &Acquisition Growth Strategy**

Webelieve that there is a growing trend in IT whereby buyers seek to purchasemore of the overall technology solution from a single provider. We believe thatsales of our product depend on a combination with another entity that has anestablished customer base and proven sales channels. We believe that includingour product with other technology products will provide a greater overalltechnology solution and the greatest opportunity to grow our revenues andprofitability in the short-term. 

 

Ourinitial plans for mergers and acquisitions focused on smaller acquisitions ofcompanies offering complementary products. As we started to pursue thosecompanies we found them to be early stage venture backed companies that facedchallenges including negative cash flow, minimal revenue, and balance sheetliquidity constraints. As a result of these findings we adjusted our plans to rule outcompanies with those challenges focusing on larger more established companies.

 

##### **ProposedAcquisition of MPC Computers, LLC. (“MPC”)**

On March 21, 2005 we, alongwith Gores Technology Group, LLC, or Gores, and MPC Computers, LLC, or MPCannounced the execution of an Agreement and Plan of Merger

 

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dated as of March 20, 2005by and among HyperSpace, Spud Acquisition Corp., a Delaware corporation and awholly owned subsidiary of ours, GTG PC Holdings, LLC, a Delaware limitedliability company and GTG-Micron Holding Company, LLC.  MPC is the wholly owned subsidiary of GTG PC Holdings,LLC.  

 

Under the terms of theAgreement and plan of merger which has been approved by the majority of ourBoard of Directors, Spud Acquisition Corp. will merge with and into GTG PCHoldings, LLC, with GTG PC Holdings, LLC surviving the merger and becoming awholly owned subsidiary of ours.  

 

As consideration, we will issuean aggregate of 4.3 million shares of our no par value common stock pluswarrants to purchase 5 million shares of common stock at an exercise price of$3.00 per share and warrants to purchase 1.5 million shares of common stock atan exercise price of $5.50 per share. Approximately 15% of these shares andwarrants will be retained by us and reserved for future distribution by us toMPC management as part of an overall incentive plan. After the consummation ofthe transaction, our existing shareholders will own approximately 51% ofoutstanding common stock of the combined entity.

 

Consummationof the transactions contemplated by the Agreement is conditioned upon (1) approvalby our shareholders and the members of GTG-Micron Holding Company LLC, (2) thereceipt of all required regulatory approvals, (3) the filing of anamendment to the our Articles of Incorporation authorizing shares of CommonStock sufficient to complete the merger and (4) various other conditionsset forth in the Agreement. Additionally, we, GTG-Micron Holding Company LLCand certain of our officers and directors will enter into a Registration RightsAgreement upon the consummation of the merger. While it is anticipated that thetransaction will be completed in May or June 2005, the Agreementterminates if the Merger is not completed by September 30, 2005. In theevent of a termination of the Merger Agreement under certain circumstances, weor GTG-Micron Holding Company, LLC may be required to pay the other atermination fee as set forth in the Agreement. 

 

##### **If this merger with MPC closes, the nature of our business and oursales and marketing strategy will change. A significant change will be that weexpect to bundle some of our products with those of MPC so that our softwaresolutions will be offered as part of the hardware purchase. We expect tocontinue to focus on our OEM/Partner strategy where our software solution isbuilt into the offering of OEMs and partners. We expect to continue to sell oursoftware only solutions as we do today to general prospects and MPC’s installedbase of customers.**

 

Formore information regarding the proposed merger, please refer to the proxystatement which will be filed with the United States Securities and ExchangeCommission, or SEC. This proxy statement will contain important informationabout the proposed merger. These materials are not yet completed. Our investorsand security holders are urged to read the proxy statement when filed, and anyother relevant materials filed by us, because they will contain, importantinformation about the proposed merger. The preliminary materials, when theybecome available, may be obtained for free at the SEC’s website at *www.sec.gov.* In addition, the documentsfiled with the SEC by us may be obtained free of charge from our website at*www.ehyperspace.com.*

 

**Revenue Targets**

We did not achieve our revenue and profitability goals during 2004 andexpect to face challenges achieving revenue and earning goals in early 2005with HyperWebTM and HyperTunnelTM. 

 

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We had limited funds prior to the IPO. Marketing and sales initiativescould not be started until after completion of the IPO in the fourth quarter of2004. During this time many of our competitors were expanding their sales andmarketing efforts. The competitors appeared in a number of technology industryanalyst reports and were very active in establishing offices internationally.We did not respond to our competitors due to our working capital constraints.

 

Scalability testing of HyperTunnelTM was delayed until completion of theIPO so we did not have server configuration parameters to improve the successof various prospects HyperTunnelTM evaluation tests until late December. Severalevaluation tests failed as we tried to establish server configurationparameters during the evaluation, which resulted in several prospectivecustomers abandoning their interest in HyperTunnelTM.

 

While engaging new agents and partners and hiring new sales employees,we have experienced long lead times before they become productive. Some of theemployees, agents and partners failed to produce the desired results and weterminated our relationship with them after a reasonable ramp up period.

 

Early recommendations from our outsourced marketing group that resultedin an outbound telemarketing campaign into certain market segments did notgenerate sufficient leads to deliver the intended results.

 

We were late to enter the North America ISP market. The ISP market inNorth America was saturated by a few larger competitors. We did make progressin the international ISP market, but it is difficult to aggressively pursuethat approach without an international location. We have decided to limit ourinvestment of sales and marketing resources in the ISP market.

 

**Our Business and Technology**

Our HyperWebTM and HyperTunnelTM software products speed up the deliveryof information over computer networks (including the Internet, wireless,broadband, private and dial-up networks). By speeding up the delivery ofinformation over networks, we accelerate the applications running on networkedcomputers. Accelerating the applications allows the users of the applicationsto get more work done in a shorter period of time, and, in some instances, caneven allow a company to deploy slower, lower cost, communication circuitsbetween computers on the network (i.e., reduce bandwidth requirements),reducing monthly bandwidth expenses. Further, our software products allowcompanies to deploy business applications over network connections that,without our software, would otherwise be too slow to support effectively thebusiness applications deployed.             

 

HyperWebTM and HyperTunnelTM are targeted at the following opportunities:

 

•                  e-commerce websites;

 

•                  Businesses or organizations with multiple locations;

 

•                  Operation of applications delivered via web servers(such as SFA, CRM, financial applications and Enterprise Resource Planning, orERP, applications) that place heavy demands on the networks that connect theapplications;

 

•                  Businesses with mobile and distributed/home workerswho need fast access to email and mission-critical applications;

 

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•                  Providers of network and application services toothers, including Internet service providers, or ISPs, hosting companies,online entertainment and media companies, outsourcing companies and remoteaccess service providers;

 

•                  Independent software vendors in need of a bundledsolution to accelerate their network based applications; 

 

•                  Businesses operating in rural areas or countries wherehigh-speed networks are difficult to obtain and/or expensive; and

 

•                  Service Providers in need of a bundled solution toaccommodate their services.

 

We are subject to a rapidlychanging technological environment. While our current products are in operationand being used by customers, we will need to continue to expand these offeringsto stay competitive and differentiate ourselves from our competitors. Ourability to keep current with the demands of technology is critical to oursuccess. Our products must work, and provide noticeable benefits during a testphase inside each prospect customer’s network. Networks are very complexenvironments causing us to experience some difficulty with the integration of HyperTunnelTMinto some networks during evaluations. We believe we have eliminated many ofthe challenges with software and configuration changes based on earlyexperiences. We plan to continue to invest in research and developmentactivities to enhance existing products in response to customer demands.

 

We do not require governmental approval forour current products other than obtaining approval from the US Department ofCommerce for the export of our software products internationally. There are noknown existing or probable governmental regulations that may have a significantimpact on our business. We do not incur material amounts of time complying withenvironmental laws. 

 

**Network Acceleration Market Competition**

Themarkets for our products are competitive and subject to change. We track andcategorize competitors in three distinct markets: (1) web-basedapplications; (2) networked applications (including networkedclient/server applications, WAN optimization, WAN acceleration, LAN-to-LANacceleration); and (3) ISPs. We originally experienced competition for ourproducts from the following categories: 

•                  Otheracceleration products,

•                  ISP specificacceleration solutions, 

•                  The softwareproducts that our products are designed to enhance,

•                  The computer operatingsystems,

•                  Routingtechnologies, and

•                  Networkbandwidth availability and the difficulty of procurement.

 

Marketing research done in thefourth quarter of 2004 expanded the categories to include:

•                  Edge cachingsolutions,

•                  Delta cacheencoding solutions,

•                  Protocoloptimization solutions,

•                  Infrastructureaccess solutions including Citrix and VPN providers, and 

•                  Open-sourceprojects.  

 

**Intellectual Property**

Werely on a combination of patent, copyright and trademark laws, and on tradesecrets, confidentiality agreements and other contractual provisions to protectour proprietary rights. These measures afford only limited protection. We havetwo issued U.S. patents and two

 

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publishedU.S. patent applications.  Currently,none of our technology is patented in Europe or the Asia/Pacific region. In March of2003 we filed certain international applications, which will extend, throughthe 3rd quarter of 2005, our ability to file foreign regional or foreignnational applications to obtain patent protection in European Union countriesfor our issued U.S. patents. We cannot assure you that our means of protectingour proprietary rights in the U.S. or abroad will be adequate or thatcompetitors will not independently develop similar technologies.

 

**Employees and Facilities**

Allof our 13 employees and contractors are currently located at our corporateheadquarters in Greenwood Village, Colorado. We lease 6,644 square feet at anannual rate of $93,016, which expires in February 2006. All of ouroperations, including customer support, software engineering and administrationtake place there. We have no other owned or leased locations. All non-Colorado-basedsales agents operate out of facilities not owned or leased by us.

 

Anyadditional employees are expected to be located at our corporate headquarters.Our employees are not represented by any collective bargaining agreements withrespect to their employment. We do not foresee any unusual challenges in addingto our employee base. Other than certain testing and quality assurance, we donot outsource any of our software development. We will continue to evaluatethis practice and, if circumstances or economic factors change, we mayoutsource portions of our software development in the future. TheCompany does not expect to hire any non-US employees during 2005. 

 

During 2004, we adopted a401(k) plan. Participation in the 401(k) is available to all employees. TheCompany may make discretionary contributions to the 401(k). In 2004, we made avoluntary contribution of $6,800 to the 401(k) plan on behalf employees, noneof whom were officers. 

 

**Dependence on Major Customers**

Historicallywe have been subject to the risks of concentration of credit risk in a fewcustomers at any point in time because of large individual sales and thereforelarge receivables to a relatively small number of customers. As sales and thenumber of customers increase, we expect that the credit concentration risk willbe reduced.

 

Inregard to overall revenues, during 2003, we had three customers that accountedfor approximately 32% of total revenues and in 2004, our largest threecustomers accounted for 28% of our revenues. While we seek to expand salesvolume to existing customers by increasing the size of existing licenseagreements, consummating sales for additional applications to current customersand selling to other divisions within the same customer, we are not dependenton this strategy alone. 

 

Sinceinception, we have recorded about two-thirds of our revenues from sales made toU.S. based organizations. We expect this percentage to change. Within the next12 months, we may see increased revenues coming from non-U.S.-basedorganizations. In 2004, 46% of our revenues were to non-US based buyers (36% in2003). For non-US revenues, we do not believe that we are dependent on anysingle country. 

 

**RISK FACTORS**

*Investing in our securities involves a highdegree of risk. You should carefully consider the following risk factors, andother information contained in this annual report, including our financialstatements and the related notes thereto. Described below are the principalrisks that we expect to face, however they are not the only risks we may face.Additional risks and uncertainties that we do not presently know about, or havenot yet identified, may also*

 

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*adversely affect our business. Our business,operating results and financial condition could be seriously harmed and youcould lose your entire investment by the occurrence of any of the followingrisks, or by unforeseen risks not listed below.*

 

***Risks Related to OurCompany***

*** ***

***Since inception wehave incurred losses, and we will incur losses in the future. This raisesdoubts about our ability to continue as a going concern in the long term, couldimpede our growth, and may cause you to lose the value of your investment.***

In 2003 we had revenues of $983,219 and incurred net losses availableto common shareholders of $1,854,412; and in 2004 we had revenues of $457,850and net losses available to common shareholders of $3,193,343 after reflectinga gain of $440,999 on the settlement of a note payable and accrued compensationto Remote Communications, Inc.

 

Our revenue fell from 2003 to 2004 by more than 50%. While we believethat this was impacted by the reasons described above (i.e. time and effortspent on the IPO, launch of a new product line and a change in marketing andsales strategies) we may not be able to continue to grow our revenues as we didfrom inception in 2001 to 2002 and then again from 2002 to 2003.  

 

As of December 31, 2004, we had an accumulated operating deficitof approximately $7. 1 million (net of a $1.2 million required accountingadjustment as a result of termination of our subchapter S corporation status,therefore actual losses of $8.4 million since inception). We expect tocontinue to incur losses for the foreseeable future.

 

***We need additionalcapital to continue operations and to execute on our business plan. Such additionalcapital may not be available and you could lose the value of your investment.***

We are not able to fund our operations from cash generated by ourbusiness, and we do not expect to be able to do so in the near future. We haveprincipally financed our operations through the private placement of shares ofour common and preferred stock, debt and our IPO in October 2004. If wefail to generate sufficient revenues and cash flow to fund operations, ourgrowth will be limited, unless we are able to obtain additional capital throughequity or debt financings. Our inability to grow revenues substantially reducesour chances of attaining profitability.

 

We believe that our existing capital resources will enable us tomaintain our current operations through 2005. However, we may be required toraise additional funds due to the slower revenue growth we are currentlyexperiencing, needs that may arise due to pursuing our inorganic growthstrategy or other unforeseen circumstances. If our working capital requirementsvary from those currently planned, we will require additional financing soonerthan anticipated. A future financing may not be available in sufficient amountsor on terms acceptable to us. If adequate funds are not available or are notavailable on acceptable terms, we may be forced to liquidate and you will loseyour entire investment. Moreover, it is conceivable that such funds, ifreceived, will not be adequate for us to fund our future growth, take advantageof unanticipated opportunities, develop or enhance services or products, orotherwise respond to competitive pressures.

 

***Raising additionalcapital will substantially dilute existing shareholders.***

If we are able to raise additional funds through the sale of equity orconvertible securities, the financing will likely be dilutive to existingshareholders.

 

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***Our limited historyof product sales and the unsuccessful launch of our new sales and marketingstrategy make it difficult to evaluate our prospects and the merits ofinvesting in our securities.***

We began our business in early 2001. For approximately one year, wewere primarily engaged in the research and development of our initial product,HyperWebTM, which was our only product until January 2004 when wecommercially released HyperTunnelTM, which has no meaningful sales to date. In2004 we changed our sales and marketing strategy which did not producedintended results. We have a limited amount of sales and financial data that youcan use to evaluate our business. You must consider our prospects in light ofthe risks, expenses and challenges of attempting to introduce new products andstrategies in changing markets.  We maynot address these risks, and our sales and marketing strategy may not prove tobe successful. If we are not successful, you will lose all of your investment.

 

***Sales of HyperWebTM,the product that constitutes substantially all of our sales to date, maydecrease over time thereby decreasing our revenues from such sales, which mayincrease our net loss and shareholders’ deficit.***

Several of our direct and indirect competitors have developed or aredeveloping technologies that perform similar functions to HyperWebTM, whichaccounts for substantially all of our revenues to date. Due to the increasingnumbers of competitors with large amounts to spend on sales and marketing,competitors who are offering a greater breadth of solutions to buyers themarket for our HyperWebTM product may decrease over time, be subject toincreased price competition, and/or possibly obsolescence. 

 

***If HyperTunnelTM doesnot generate sufficient sales, then our business may fail and you may lose thevalue of your investment.***

HyperTunnelTM was released in January 2004 and has generated nomeaningful revenue to date. Although we believe HyperTunnelTM addresses customerneeds, our expected revenue growth has not occurred. The revenues generatedfrom HyperTunnelTM in 2004 were less than expected due to many reasonsincluding: our inability to support it with an appropriate marketing budget,our experiencing some difficulty with the integration of HyperTunnelTM intocomplex networks during evaluations and it has proven to be more complex forpotential customers to evaluate during the test/evaluation phase thanHyperWebTM. Based on our early experiences we believe we have resolved most ofthese challenges. HyperWebTM customers have not yet made any purchases ofHyperTunnelTM and we cannot assure you that they will be interested inpurchasing HyperTunnelTM. We cannot assure you that our current and prospectivecustomers will perceive HyperTunnelTM as adequately addressing their needs orthat the demand for HyperTunnelTM will generate revenue sufficient to meet ouroperating expenses or fund our future operations.

 

***Any mergers oracquisitions we consummate could result in dilution to our existingshareholders and could be difficult to integrate which could cause difficultiesin managing our business, resulting in a decrease in the value of yourinvestment.***

Evaluatingacquisition targets is difficult and acquiring other businesses involves risk.Consummation of a transaction whereby businesses are acquired or merged isdifficult and high proportions of such transactions are unsuccessful or fail toreach their goals. 

 

Asan organization, we do not have experience in acquiring, merging companies orthe integration that follows a transaction. We have evaluated, and expect tocontinue to evaluate, a wide array of potential strategic transactions. Any ofthese transactions would be material to our financial condition and results ofoperations. In pursuingthis strategy, we are subject to a number of risks, including the following:

•                  difficulty in integrating operationsand retaining acquired personnel;

•                  overvaluation of assets or businesspotential; 

•                  discovery of liabilities not known atthe time a transaction is consummated;

 

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•                  inability to realize any businesssynergies; 

•                  limitations on our ability to retainsales and distribution channels and customers;

•                  diversion of management’s attentionand disruption of our ongoing business; 

•                  limitationson our ability to incorporate acquired technology and rights into our productand service offerings and maintain uniform standards, controls, procedures andpolicies, 

•                  the need to implement or remediate controls,procedures and policies appropriate for being a public company at companiesthat prior to the acquisition lacked these controls, procedures and policies,

•                  diversion of management time and focus fromoperating our business to acquisition integration challenges, and

•                  the need to integrate each company’saccounting, management information, human resource and other administrativesystems to permit effective management

 

In addition, any foreign acquisitions involve unique risks inaddition to those mentioned above, including those related to integration ofoperations across different cultures and languages, currency risks and theparticular economic, political and regulatory risks associated with specificcountries. Also, the anticipated benefit of many of our acquisitions may notmaterialize. Future acquisitions or dispositions could result in potentiallydilutive issuances of our equity securities, the incurrence of debt, contingentliabilities or amortization expenses, or write-offs of goodwill, any of whichcould harm our financial condition. Future acquisitions may require us toobtain additional equity or debt financing, which may not be available onfavorable terms or at all. 

 

***We have entered into an agreement to merge with theparent company of MPC Computers, LLC. If we do not consummate this merger, wemay experience a drop in the price of our stock and we will have consumed alarge amount of our senior management’s time and incurred significant costs.***

As described above, we have entered into an agreement to merge with theparent company of MPC Computers, LLC. Certain members of our senior managementteam have spent a large amount of time on the pending merger. We have alsoincurred certain fixed costs which will have to be settled regardless of theconsummation of the merger. Even though there is a break-up fee which may bepayable to us in certain circumstances, it is highly probable that we will havedone significant harm to our business and reputation if the merger is notconsummated. If this occurs the price of our stock will likely drop, and itwill be very difficult to continue to function as a viable entity. 

 

***We have recentlyimplemented a new sales and marketing strategy that has not yet proved to besuccessful. We currently have a limited active distribution system in place andif we do not expand our sales and distribution capabilities, then we will notbe able to achieve revenue growth.***

We can no longer rely on reacting to customers who actively seek datacompression and application acceleration solutions to sell our products. Wemust expand our product offering and/or expand our direct and indirect salesand distribution efforts in order to increase our sales. Our efforts so far,and our new sales team, have not been successful achieving revenue goals associatedwith the new strategy. We might not be able to build a sales and marketinggroup or hire and retain personnel with the appropriate experience and talentto build sales and marketing capability. If we are not able to do so, we willnot be able to achieve revenue growth.

 

***Although we haveadded some strategic alliances we may not be able to continue to do so, oradditional alliances and relationships may take longer to cultivate than we***

 

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***expect. If so thiswill impede our revenue growth and could cause the value of your investment todecrease.***

We must continue to establish and extend relationships that enable usto sell our products. These include alliances with hardware and software firms,providers of complementary technologies and services, system integrators, ITvendors with existing relationships with buyers, OEM’s, network consultants andresellers, communication service providers and other third-party resellers.Currently we have few substantial strategic alliances, all of which are in theearly stages of development and none of which are contributing materialrevenues. We expect strategic alliances to become a valuable component of ourbusiness. Without a number of strategic alliances who sell our products, we mayhave to devote substantially more of our already limited resources to sales andmarketing, and our efforts may not be as effective as those who have suchalliances. Our competitors have more resources and have been working withstrategic alliances for longer than us. They may offer more favorable termsthan us to establish strategic alliances. The better producing alliances maynot be available to us. If we fail to develop and maintain these alliances ourbusiness and operating results will be harmed because our ability to grow ourrevenues will suffer, and you may lose your entire investment.

 

***We have indefinitelydelayed expansion of our international sales efforts, which may significantlyaffect our ability to grow revenues.***

A material amount of our revenueshave historically come from non-US sources. Approximately 46% of our revenuesin 2004 came from international sales (in 2003 this was 36%). Most of theseinternational sales came from word-of-mouth or customers who found us afterconducting a web search. We cannot rely on such methods to sustain or grow ourinternational sales in the future. We believe that many of our competitors havemade large investments in establishing such relationships over the last year.In most cases we have been unable to match such investments. Due to limitedresources, our planned international expansion has been delayed indefinitely.We will continue to rely on international customers finding us as the onlymeans to international sales for the foreseeable future. As such, we are likelyto face reduced international interest in our product and reduced sales comingfrom international customers. 

 

***If our products donot operate with the wide variety of changing hardware, software applicationand operating system environments used by our customers, then our prospectivecustomers will not purchase our products.***

We currently serve, and for the foreseeable future will serve, acustomer base that uses a wide variety of changing computer hardware, softwareapplications and operating systems. Every entity’s network is extremely complexand usually has multiple components, applications, providers and locations.When problems occur, or expected network optimization results are not obtained,it is difficult to identify the source of the problem or the cause. Prospectivecustomers may not allow us to play an active role during the evaluation of ourproducts. When expected network optimization results are not obtained duringthe testing phase, we usually incur additional sales costs and divert theattention of our engineering personnel from our other product developmentefforts. While resolving the issue, prospective customers may test competitorproducts or lose interest in our solution altogether.

 

Moreover, market acceptance of our products requires that we support awide variety of hardware, software applications and versions, and operatingsystems efficiently and cost effectively. Until late October 2004 ourHyperTunnelTM product did not support older versions of the Windows operatingsystem. That caused our early attempt to pursue the ISP market to fail. If ourproducts are unable to support the variety of these wired and wirelessplatforms, software applications and operating systems implemented by ourcustomers and prospective customers, our customers and prospective customerswill not purchase our products, our results of operations will be adverselyaffected and our revenues will be harmed.

 

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***The sales cycle forHyperTunnelTM is difficult for us to predict, therefore our quarterly operatingresults may fluctuate causing volatility in the price of our securities.***

To market our HyperTunnelTM software, we often need to educate potentialcustomers regarding the strategic value, use and benefits of our products. Thiscan require significant time and resources from our customers and us. Theperiod between our initial contact with a potential customer and the purchaseof our software is unpredictable and subject to delays associated with:devoting appropriate resources to test and evaluate our products, building abusiness case for their usage, approval, consideration of alternative solutionsto their problems and contract negotiation. Our sales cycle varies substantiallyand appears to be driven in part by the severity of the network speed andcongestion difficulties being experienced by our prospective customers. As aresult, our quarterly operating results may fluctuate and the trading price ofour securities may be volatile.

 

***We rely uponpatents, trademarks, copyrights and trade secrets to protect our proprietaryrights that we believe give us a competitive advantage, however, suchintellectual property protections may not be broad enough, could be successfullychallenged and may become useless as competitors independently develop similartechnologies. Moreover, we have not filed for patent, copyright or trademarkprotection in any other jurisdiction besides the U.S. Enforcement ofintellectual property rights is expensive and involves a significant amount ofmanagement resources, which could decrease our revenues, increase ourshareholders’ deficit, and, if we lose, defeat our competitive advantage.***

Our ability to compete depends to a significant degree upon theprotection of our software and other proprietary technology rights. We may notbe able to protect our proprietary technology, and our proprietary rights maynot provide us with a meaningful competitive advantage. To protect ourproprietary technology, we rely on a combination of patents, trademarks,copyrights, trade secrets and non-disclosure agreements, each of which affordsonly limited protection. Any inability to protect our intellectual propertyrights could seriously harm our business, operating results and financialcondition. It is possible that:

 

•                  our pending patent applications may not result inthe issuance of patents;

 

•                  any patents issued to us may not be broad enough toprotect our proprietary rights;

 

•                  any issued patent could be successfully challengedby one or more third parties, which could result in our loss of the right toprevent others from exploiting the inventions claimed in those patents;

 

•                  current and future competitors may independentlydevelop similar technologies, duplicate our products or design around any ofour patents; and

 

•                  former employees, consultants or contractors mayviolate their confidentiality or non-compete agreements with us leading to aloss of proprietary intellectual property.

 

In addition, the laws of some foreign countries do not protect ourproprietary rights in our products to the same extent as the laws of the U.S.We have only filed for patent and trademark protection in the U.S. We have notfiled for protection (patent, trademark, copyright or otherwise) in alljurisdictions where our products are sold. Further, it is possible for a thirdparty to copy or otherwise obtain and use our proprietary technology andinformation without authorization. Policing unauthorized use of our products isdifficult, and litigation may be necessary in the future to enforce ourintellectual property rights. Any litigation could be time consuming andexpensive to prosecute or resolve, result in substantial diversion ofmanagement attention and resources, and materially harm our business, financialcondition and results of operations.

 

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***Potential newaccounting pronouncements could increase the expenses we report on ourfinancial statements, which would decrease our reported income.***

Proposed initiatives could result in changes in accounting rules,including legislative and other proposals. Changes could materially increasethe expenses we report under generally accepted accounting principles andadversely affect our operating results.

 

In December 2004, the FASB issued SFAS 123R “Share-Based Payment,” a revision to FASB No. 123, SFAS 123R replaces existing requirements under SFAS No. 123 and APB Opinion NO. 25, and requires public companies to recognize a compensation expense an amount equal to the fair value of share-based payments granted, such as employee stock options. This is based on the grant-date fair value of those instruments. SFAS 123R also affects the pattern in which compensation cost is recognized, the accounting for employee share purchase plans, and the accounting for income tax effects of share-based payment transactions. For small-business filers such as us, SFAS 123R will be effective for interim periods beginning after December 15, 2005. The Company is currently determining what impact the proposed statement would have on its results of operations and financial position. The impact will largely be due to the selection of either the Black-Scholes or the binominal lattice model for valuing options. Regardless of this, we will recognize additional compensation expense, in our Statement of Operations, commencing in the quarter ending March 31, 2006. 

 

***We expect that ourquarterly financial results will fluctuate and that our quarterly revenues andearnings may not meet our expectations. If our revenues fall below expectationsand we are not able to reduce costs quickly, our operating results will sufferand we will use up our cash resources faster than expected which could cause usto cease operations.***

Our quarterly revenues are difficult to predict. For every quarter in2004, our quarterly revenues decreased compared to the corresponding quarter inthe prior year and have not met our expectations. Since the IPO, we have beenable to reduce certain expected fixed costs as revenues were less thanexpectations. We will not be able to reduce our costs, or delay making certainexpenditures, indefinitely if revenues continue to be below expectations. 

 

The reasons for our revenue uncertainty include but are not limited to:

 

•                  the lack of success we have experienced from our newsales and marketing endeavors;

•                  our competitors’ ability to offer a broader solutionto buyers of application acceleration;

•                  our competitors having stronger sales relationshipsand significantly larger amounts to spend on sales and marketing;

•                  market acceptance of our newly released product;

•                  lack of predictability in sales generated by agentsor through OEM channels;

•                  budget and spending decisions by our customers;

•                  changes in our pricing policies or our competitors’pricing policies; and

•                  the timing of our sales, including theunpredictability of our sales cycles.

 

We experience some seasonality in our revenues. Typically, the summermonths of July and August and the month of January, after the December andyear-end holidays, are very slow for technology sales in North America andEurope. This usually impacts results in the first and third calendar quarters.

 

Our operating expenses include sales and marketing, research anddevelopment, general and administrative expenses and public company costs, arebased on our expectations of future revenues over a number of quarters and are,to a large extent, fixed in the short term. If

 

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revenues fall below our expectations in a quarter we generally becomeaware of this after certain expense levels are committed. Quickly reducing ourfixed costs is very difficult and in some cases not possible for a number ofmonths. This results in our operating results being negatively impacted forthat quarter and a number of future quarters.

 

***If we lose theservices of key personnel, such losses could harm our company.***

Our business relies heavily on the expertise of our key personnel. Weexpect to be losing the services of two senior executives in the future.Replacing such executives with new leadership will be challenging and criticalto our success or failure in the coming year.

 

***We may not be ableto manage our future growth efficiently or profitably, which could decrease ournet income, harm our financial condition and decrease our ability to survive.***

Our ability to market software and related services and implement ourbusiness plan in a rapidly evolving market requires an effective planning andmanagement process including early identification and reaction to trends.Future expansion efforts could be expensive and may strain our managerial andother resources. To manage future growth effectively, we must maintain andenhance our processes, systems and controls, integrate existing and newpersonnel and partners and manage expanded operations and relationships. If wedo not manage growth properly, it could harm our business, operating resultsand financial condition.

 

***Our failure tolicense and integrate third-party technologies could harm our business becausewe may incur increased costs and experience delays procuring or buildingreplacement technologies.***

We may need to license and integrate technologies from third parties,including applications used in our research and development activities, intoour products. These technologies may not be available to us on commerciallyreasonable terms or at all. Our inability to obtain any licenses could delayproduct development until equivalent technology can be identified, licensed andintegrated. This inability in turn would harm our business and operatingresults. Our use of third-party technologies may expose us to increased risks,including, but not limited to, risks associated with the integration of newtechnology into our products, the diversion of our resources from developmentof our own proprietary technology and our inability to generate revenue fromlicensed technology sufficient to offset associated acquisition and maintenancecosts.

 

***Claims that weinfringe upon third parties’ intellectual property rights could be costly todefend or settle, and thus could reduce our income or increase our net loss.***

Litigation regarding intellectual property rights is common in thesoftware industry. We expect that software products and services may beincreasingly subject to third-party infringement claims as the number ofcompetitors in our industry segment grows and the functionality of products indifferent industry segments overlaps. We may from time to time encounterdisputes over rights and obligations concerning intellectual property. Althoughwe believe that our intellectual property rights are sufficient to allow us tomarket our software without incurring liability to third parties, third partiesmay bring claims of infringement against us. Such claims may be with or withoutmerit. Any litigation to defend against claims of infringement or invaliditycould result in substantial costs and diversion of resources. Furthermore, aparty making such a claim could secure a judgment that requires us to paysubstantial damages. A judgment could also include an injunction or other courtorder that could prevent us from selling our software. Our business, operatingresults and financial condition could be harmed by a reduction in income or anincrease in our net loss if any of these events occurred.

 

In addition, we have agreed, and may continue to agree in the future,to indemnify certain of our customers against certain claims that our softwareinfringes upon the intellectual property

 

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rights of others. We could incur substantial costs in defendingourselves and such customers against infringement claims. In the event of aclaim of infringement, our customers and we may be required to obtain one ormore licenses from third parties. We, or our customers, may be unable to obtainnecessary licenses from third parties at a reasonable cost, if at all. Defenseof any lawsuit or failure to obtain any such required licenses could harm our business,operating results and financial condition.

 

***We have entered intoa co-existence agreement with a third party that is using the HyperSpace mark.Confusion about our names could occur which could tarnish our reputation andreduce our product sales.***

We have entered into a co-existence agreement with a third party thatis using the HyperSpace mark. However, confusion about our names could occurwhich could tarnish our reputation and negatively impact our business,including a reduction of product sales.

 

***If the systemsecurity of our software is breached, our business and reputation could sufferand you could lose your entire investment.***

A fundamental requirement for effective use of our products is thesecure transformation and transmission of confidential end-user information.Third parties may attempt to breach the security of our customers. We may besued for any breach in such security and any breach could harm our customers,our business and our reputation. Any imposition of liability, particularly liabilitythat is not covered by insurance or is in excess of insurance coverage, couldharm our reputation and our business and operating results. Also, computers,including those that utilize our software, are vulnerable to computer viruses,physical or electronic break-ins and similar disruptions, which could lead tointerruptions, delays or loss of data. We may be required to expend significantcapital and other resources to rectify problems caused by any security breach.

 

***Insurance isexpensive and it may be difficult for us to obtain appropriate coverage. If wesuffer a significant loss for which we do not have adequate insurance coverage,our income will be reduced or our net loss will increase.***

We have obtained insurance coverage for potential risks and liabilitiesthat we deem necessary and which fall within our budget. Insurance companiesare becoming more selective about the types of risks they will insure. It ispossible that we may:

 

•                  not be able to get sufficientinsurance to meet our needs;

•                  not be able to afford certain typesor amounts of coverage;

•                  not have adequate insurance coverageor insure the correct risks we may face;

•                  have to pay insurance premiums atamounts significantly more than anticipated; or

•                  not be able to acquire any insurancefor certain types of business risks.

 

This could leave us exposed to potential claims or denial of coveragein certain situations. If we were found liable for a significant claim in thefuture, our operating results could be negatively impacted by a reduction inincome or increase in our net loss.

 

***We incur significantcosts as a result of being a public company, making it more difficult for us toachieve profitability.***

As a public company, we incur significant legal, accounting,compliance, Board of Directors, reporting, record keeping and otherexpenses.  Rules and regulations ofthe Securities and Exchange Commission and the American Stock Exchange increaseour general and administrative expenses and make some activities moretime-consuming and costly. These rules and regulations may make it moredifficult and more expensive for us to obtain director and officer liabilityinsurance and we may be required to accept reduced policy limits and coverageor incur substantially higher costs to obtain the same or similar coverage. Asa

 

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result, it may be more difficult for us to attract and retain qualifiedindividuals to serve on our board of directors or as executive officers.

 

***For the yearsended December 31, 2004 and 2003, we were dependent on a small number ofcustomers that comprised a significant portion of our revenues and a failure onour part to expand our customer base will subject us to the risk ofconcentration of credit risk.***

For the years ended December 31, 2004 and 2003, three of ourcustomers accounted for approximately 28% and 32% of our total revenues,respectively. Historically, we have been subject to the risks of concentrationof credit risk in a few customers, which may continue in the future. Weanticipate that concentration levels will decrease as our customer base and newproduct offerings expand in future periods. However, if our customer base doesnot expand we will continue to be subject to the risk of concentration ofcredit risk in a few customers, which could adversely affect our cash flows,and results of operations.

 

***In the event that wedefault on our outstanding secured convertible notes, then our intellectualproperty and other assets may be subject to foreclosure, which couldeffectively put us out of business.***

We have $1.045 million in secured convertible notes outstanding, ofwhich $620,000 becomes due in September of 2005 and $425,000 of whichbecomes due in April of 2006. In addition we have accrued interest onthese notes as of December 31, 2004 in the amount of $44,627. The notesare secured by all of our assets. In the event that we default on the repaymentof the secured convertible notes all of our assets, including our intellectualproperty, will be subject to foreclosure. In the event that we are otherwiseunable to repay the secured convertible notes and our assets are foreclosedupon, we would effectively be put out of business and there would be little tono value to our securities.

 

***Risks Related to OurIndustry***

*** ***

***Our industry ishighly competitive, the market for our products is subject to rapid change andwe may not be able to compete effectively against larger or better-fundedcompanies, which could cause the value of your investment to decline.***

The market for our products is highly competitive, subject to rapidchange and significantly affected by new product introductions and other marketactivities of industry participants. Although we do not currently competeagainst any one entity with respect to all aspects of our software solutions,our products compete against various vendors’ software and hardware productsdesigned to accomplish specific elements of functionality. If we do not keeppace with our competitors, we will be unable to grow and achieve profitability.

 

During the past few quarters some of our competitors have increasedtheir presence in industry publications through advertising, city tours andsubmission of white papers. If we fail to increase our presence in the sameareas it could put us at a competitive disadvantage.

 

Our current and potential competitors may have longer operatinghistories, greater name recognition, significantly greater financial,technical, personnel and other resources. Our competitors may be able torespond more quickly to new or emerging technologies and changes in customerrequirements and, particularly in the case of larger, more established softwareand hardware companies and communications providers, may be able to providecustomers with products and services comparable to ours at lower or ataggressively reduced prices in an effort to increase market share or as part ofa broader package of products or services they are selling to customers. We maybe unable to match or beat competitors’ prices or price reductions, and we mayfail to win customers that choose to purchase application accelerationsolutions as part of a broader products or services package. Competitivepressures could prevent us from gaining market share, reduce our market shareor require us

 

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to reduce the price of our products, any of which could harm ourbusiness and operating results. Additionally, acquisition or consolidation ofour competitors by a large or established information technology firm ornetwork provider would likely further adversely affect our prospects. 

 

***If we fail to managetechnological change, demand for our products and services will drop and ourrevenue will decline.***

The market for application acceleration solutions is in transition andis characterized by rapidly changing technology, evolving industry standards,frequent new service and product introductions, mergers and acquisitions andchanges in customer demands. Our future will depend to a substantial degree onour ability to offer a broad set of products and services that incorporateleading technologies and respond to technological advances and emergingindustry standards and practices on a timely and cost-effective basis. Youshould be aware that:

 

•                  our software solutions may become obsolete upon theintroduction of alternative technologies;

 

•                  the technological life cycles of our products mayend abruptly and, in any event, are difficult to estimate;

 

•                  we may not have sufficient resources to develop oracquire new technologies or to introduce new services capable of competing withfuture technologies or service offerings; and

 

•                  the price of the products and services we providemay decline as rapidly as, or more rapidly than, the price of any competitivealternatives, particularly if the features of our products become widelyadopted through new alternative technologies.

 

We may not be able to respond effectively to the technologicalrequirements of the changing market for data compression and applicationacceleration in network transmission. To the extent we determine that newtechnologies and equipment are required to remain competitive, the development,acquisition and implementation of those technologies and equipment are likelyto continue to require significant capital investment by us. We may not havesufficient capital for these purposes in the future. Even if we raise capitalto develop new technologies, investments in these technologies may not resultin commercially viable technological processes, or there may not be commercialapplications for those technologies. If we do not develop and introduce newproducts and services, and achieve market acceptance in a timely manner, demandfor our products and services will drop and our revenue will decline.

 

***If our products failto perform properly due to undetected errors or similar problems, our businesscould suffer because, among other things, we might have to limit or suspendproduct shipments, or expend significant resources providing enhancements orbug fixes to correct such errors, which would increase our costs and reduce ourincome or increase our net loss.***

Complex software such as ours often contains undetected errors or bugs.Such errors are frequently found during the period immediately followingintroduction of new software or enhancements to existing software. If we detectany errors before we ship a product, we might have to limit or suspend productshipments for an extended period of time while we address the problem. We maynot discover software errors that affect our new or current products orenhancements until after they are deployed and we may need to provideenhancements to correct such errors. After experiencing some challenges duringfield evaluations of early versions of HyperTunnelTM we increased our in houseand outsourced pre-release testing

 

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extensively. Despite testing by us, errors may occur in our software.These errors could result in:

 

•                  damage to our reputation;

 

•                  lost sales;

 

•                  delays in commercial release;

 

•                  product liability claims;

 

•                  delays in or loss of market acceptance of ourproducts;

 

•                  unpaid accounts receivable; and

 

•                  unexpected expenses and diversion of resources toremedy errors.

 

***If we fail tointroduce new products and enhancements in a timely manner, then marketacceptance of our products is less likely, which could allow our competitors togain market share and take away our potential customers, thus decreasing thevalue of your investment.***

New products and enhancements to current products can require longdevelopment and testing periods. Any delays in developing and releasing newproducts or enhancements to existing products could allow our competitors togain market share and harm our business. New products or enhancements may notbe released according to schedule or may contain defects when released.Product release delays or product defects could result in adverse publicity,loss of sales, delay in market acceptance of our products or customer claimsagainst us, any of which could harm our business and operating results. We maybe unable to develop and market product enhancements or new products thatrespond to technological changes, shifting customer tastes or evolving industrystandards, and may experience difficulties that could delay or prevent thedevelopment, introduction and marketing of these products. If we are unable todevelop and introduce new products or enhancements of existing products in atimely manner or if we experience delays in the commencement of commercialshipments of new products and enhancements, our ability to attract and retaincustomers will be harmed.

 

***Risks Relating ToOur Securities***

*** ***

***An active tradingmarket for our securities has not developed and the prices of our securitiesmay be volatile.***

An active sustained trading market for our securities has not yetdeveloped. We do not have any analyst coverage of our securities nor anycommitments to provide research coverage. Our price has been volatile since ourIPO date. The price at which our securities may trade is likely to be highlyvolatile and may fluctuate substantially due to several factors including, butnot limited to, the following:

 

•                  the market perception and reaction to our pendingmerger with MPC and the consummation or lack thereof;

 

•                  volatility in stock market prices and volumes, whichis particularly common among micro cap/small cap companies;

 

•                  lack of research coverage for companies with smallpublic floats;

 

•                  lack of market acceptance of our products;

 

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•                  failure to achieve sustainable financialperformance;

 

•                  actual or anticipated fluctuations in our operatingresults;

 

•                  announcements of technological innovations by us orothers;

 

•                  entry of new or more powerful competitors into ourmarkets or consolidation of existing competitors to create larger, moreformidable competitors;

 

•                  introduction of new products and services by us orour competitors;

 

•                  significant developments with respect to intellectualproperty rights;

 

•                  additions or departures of key personnel;

 

•                  conditions and trends in the communications and hightechnology markets;

 

•                  terrorist attacks either in the U.S. or abroad;

 

•                  general stock market conditions; and

 

•                  the general state of the U.S. and world economies.

 

***Our directors andexecutive officers have substantial control over matters requiring shareholderapproval and as such management may approve actions that are adverse to yourinterests or negatively impact the value of your investment.***

Our executive officers, directors and their affiliates own or controlapproximately 28% of our outstanding common stock. As a result, if such personsact together, they may have the ability to control most matters submitted toour shareholders for approval, including the election and removal of directorsand the approval of any merger, consolidation or sale of all or substantiallyall of our assets. These shareholders may make decisions that are adverse toyour interests. 

 

***Any future sales ofour common stock may depress the prices of our securities and negatively impactthe value of your investment.***

Sales of a substantial number of shares of our common stock into thepublic market, or the perception that these sales could occur, could adversely affectthe prices of our securities or could impair our ability to obtain capitalthrough an offering of equity securities. The shares of common stock sold aspart of our IPO are freely tradable without restriction or further registrationunder the Securities Act of 1933, except for any shares purchased by our “affiliates”as that term is defined by Rule 144. 

 

Pursuant to lock-up agreements, signed in connection with our IPO,approximately 978,000 shares of common stock owned by our officers anddirectors are restricted from being sold until March 2006, (unless therepresentative of the underwriters otherwise agrees) and approximately816,000 shares owned by certain other pre-IPO shareholders are restrictedfor sale until March 30, 2005. When these lockup periods expire, theseshareholders may be able to sell some or all of these securities. These salescould depress our stock price.

 

***The redemption ofthe 3.6 million warrants, issued as part of the IPO, may adversely affectpotential investors by requiring them to sell or exercise the warrants at atime that may be disadvantageous for them.***

 

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Our public warrants will be redeemable at $0.25 per warrant upon30 days written notice to the warrant holder; provided that: (i) thereis then an effective registration statement under the Securities Act coveringthe shares issuable upon exercise of the warrants; (ii) the closing saleprice of our common stock equals or exceeds $9.50 per share for the 20 tradingdays prior to the date of the notice of redemption; and (iii) that12 months has elapsed since the IPO date.

 

Notice of redemption of the warrants could force holders to exercisethe warrants and pay the exercise price therefore at the time when it may bedisadvantageous for them to do so, sell the warrants at the current marketprice when they might otherwise wish to hold the warrants or accept theredemption price which is likely to be substantially less than the market valueof the warrants at the time of redemption.

 

***If a currentprospectus, and possibly state blue sky registration, is not in place, warrantholders will not be able to exercise their warrants.***

Holders of our warrants will be able to exercise their warrants only ifa current registration statement relating to such shares is then in effect and,if an exemption is not otherwise available, only if the shares are qualifiedfor sale under the securities laws of the applicable state or states. We haveundertaken and intend to file and keep current a registration statementcovering the shares of common stock issuable upon exercise of the warrants, butwe cannot assure you that we will be able to do so. If required, we intend toseek to qualify such shares of common stock for sale in those states where theunits are to be offered, but we cannot assure you that such qualification willoccur. The warrants may be deprived of any value if the current registrationstatement covering the shares underlying the warrants is not effective andavailable or, if required, such underlying shares are not or cannot beregistered in the applicable states.

 

***We do not intend topay dividends and you may not experience a return on investment without sellingyour securities.***

We have never declared or paid, nor do we intend in the foreseeablefuture to declare or pay, any cash dividends on our common stock. Since weintend to retain all future earnings to finance the operation and growth of ourbusiness, you will likely need to sell your securities in order to realize areturn on your investment, if any.

** **

***Our amended andrestated articles of incorporation and bylaws contain provisions that coulddelay or prevent a change in control even if the change in control would bebeneficial to our shareholders.***

Our amended and restated articles of incorporation and bylaws containprovisions that could delay or prevent a change in control of our company, evenif it were beneficial to our shareholders to do so. These provisions couldlimit the price that investors might be willing to pay in the future for sharesof our common stock. Among other things, these provisions:

 

•                  authorize the issuance of preferred stock that canbe created and issued by the board of directors without prior shareholderapproval and deter or prevent a takeover attempt;

 

•                  prohibit shareholder action by written consent,thereby requiring all shareholder actions to be taken at a meeting of ourshareholders;

 

•                  prohibit cumulative voting in the election ofdirectors, which would otherwise allow less than a majority of shareholders toelect director candidates;

 

•                  provide that our board of directors is divided intothree classes, each serving three-year terms; and

 

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•                  establish advance notice requirements fornominations for election to the board of directors or for proposing mattersthat can be acted upon by shareholders at shareholder meetings.

 

**Item 2. DESCRIPTION OF PROPERTY**

We do not own any real estate, plants or have any such interests. Welease our facilities and have no ownership or outstanding mortgages on any realestate. Our office lease, for our corporate office, expires in February 2006and is based on a fixed annual fee of $14 per square foot payable in equalmonthly installments.

 

Our Investment Policies do not permit investments in real estateincluding a prohibition against investing in real estate mortgages andsecurities of or interests in persons primarily involved in real estateactivities.

 

**Item 3. LEGAL PROCEEDINGS**

Weare not a party to any litigation and know of no pending legal proceedings,which may involve us. We are a party to normal business disputes during thenormal course of business. None of these disputes are currently expected toresult in litigation. Circumstances may change which may cause disputes toresult in legal proceedings.

 

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

There were no matters submitted to a vote of security holders duringthe fourth quarter of the year ended December 31, 2004.

 

**PART II**

** **

**Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.**

At our IPO on October 1, 2004, our Unitswere quoted on the American Stock Exchange (“AMEX”) under the symbol “HCO.U”.Each Unit acquired at the IPO was comprised of one share of Common Stock andtwo warrants. Prior to that, there was no public market for our securities. On November 5,2004 the Units were separated into common stock and warrants that tradeindividually on the AMEX under the symbols HCO and HCO.WS, respectively. The Units ceased to exist effective November 5, 2004.

 

Thefollowing shows the high and low closing prices per Unit from the IPO date to November 5,2004 as reported on the AMEX:

 

•                  High: $5.60

 

•                  Low: $5.50

 

*Subsequent to the split of the Units:* The following shows the high and low closingprices per share of our Common Stock as reported on the AMEX between November 5and December 31, 2004 (per AMEX records):

 

•                  High: $3.30

 

•                  Low: $2.10

 

Thefollowing shows the high and low closing prices per Warrant as reported on theAMEX between November 5 and December 31, 2004 (per AMEX records):

 

•                  High: $0.75

 

•                   Low: $0.60

 

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*Sales ofsecurities since IPO:* We issued 5,898 shares of CommonStock during the quarter ended December 31, 2004. These were issued tocertain of our warrant holders and option holders who existed prior to the IPO,who were not restricted by the management lock-up period from electing acashless conversion of their positions into shares of our Common Stock.**

* *

As of March 25, 2005, there were approximately 175 registeredholders of our Common Stock. 

 

*Dividends:* Exceptfor dividends, which were accrued on our Series A Preferred Sock (whichwere never declared or paid), all of which were converted to Common Stockimmediately prior to the IPO, we have never declared or paid dividends on ourcapital stock. We currently intend to retain future earnings, if any, for usein our business, and, therefore, we do not anticipate declaring or paying anydividends in the foreseeable future. Payments of future dividends, if any, willbe at the discretion of our board of directors after taking into accountvarious factors, including our financial condition, operating results, currentand anticipated cash needs and plans for expansion.

 

*Securities Authorizedfor Issuance under Equity Compensation Plans:*

 

*We currently maintain two compensation plans that provide for theissuance of our Common Stock to officers and other employees, directors andconsultants. These consist of the HyperSpace 2001 Equity Incentive Plan and theHyperspace 2004 Equity Incentive Plan, each of which have been approved by ourshareholders. The following table sets forth information regarding outstandingoptions and shares reserved for future issuance under the foregoing plans as ofDecember 31, 2004:*

 

**EquityCompensation Plan Information**

** **

**(December31, 2004)**

 

 
| ** **                                              | ** ** | **(a)**                                                                                             | ** ** | **(b)**                                                                            | ** ** | **(c)**                                                                                                                                              | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan Category**                                       | ** ** | **Number of  securities to be issued  upon exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans excluding  securities reflected in  column (a))** | ** ** |
|                                                    |       |                                                                                                |       |                                                                               |       |                                                                                                                                                 |       |
| Equity compensation plans approved by  shareholders:    |       |                                                                                                |       |                                                                               |       |                                                                                                                                                 |       |
|                                                    |       |                                                                                                |       |                                                                               |       |                                                                                                                                                 |       |
| 2001 Equity Incentive Plan                              |       | 658,821                                                                                             |       | $                                                                                  | 3.82       |                                                                                                                                                 | 212,798    |   |
| 2004 Equity Incentive Plan                              |       | —                                                                                              |       | —                                                                             |       | 700,000                                                                                                                                              |       |
|                                                    |       |                                                                                                |       |                                                                               |       |                                                                                                                                                 |       |
| Equity compensation plans not approved by  shareholders |       | —                                                                                              |       | —                                                                             |       | —                                                                                                                                               |       |
|                                                    |       |                                                                                                |       |                                                                               |       |                                                                                                                                                 |       |
| Total                                                   |       | 658,821                                                                                             |       | $                                                                                  | 3.82       |                                                                                                                                                 | 912,798    |   |

 

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*Use of Proceeds:*

The Securities and Exchange Commission declared our registration statement, filed on Form SB-2 under the Securities Act of 1933 (SEC File Number: 333-115404) in connection with the initial public offering of our units (one share of common stock, no par value, and two warrants) effective on September 30, 2004. The underwriters were Capital Growth Financial, LLC and Pali Capital.

 

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

 

Theaggregate gross proceeds from the shares of the units sold were $9.9 million.The aggregate net proceeds to us were $8.7 million after deducting $1.2 millionin underwriting discounts and expenses. From these net proceeds we paid $1.6million in other costs incurred in connection with the offering. This resultsin proceeds after deducting all IPO expenses of $7.1 million.

 

Sincereceipt of these proceeds, we have repaid approximately $518,000 in debt andaccrued interest and repaid the $96,000 bank line of credit, as described inthe “Use of Proceeds” section of the Prospectus. In addition we purchasedDirectors and Officers insurance in the amount of $125,000 and invested $5.4million in short-term interest bearing investments classified as cashequivalents on our Balance Sheets. 

 

**Item 6. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

*Thefollowing discussion and analysis should be read in conjunction with ourfinancial statements and related notes thereto included elsewhere in thisdocument. This discussion contains forward-looking statements that involverisks and uncertainties. Our actual results could differ materially from thoseanticipated in the forward-looking statements as a result of certain factorsincluded in the risks discussed in “Risk Factors”.*

 

##### ***KEYINDICATIONS OF FINANCIAL CONDITION AND PERFORMANCE***

Wehave a limited operating history. As of December 31, 2004, we had anaccumulated deficit of approximately $7.1 million (which is net of$1.2 million accumulated loss due to the termination of our subchapter Scorporation status). We have not been profitable in any of our four years ofoperations. We expect to continue to incur losses in the foreseeable future.

 

***EXECUTIVE SUMMARY***

During 2004, we completed the IPO and made a number of changes to oursales and marketing approach. Prior to the IPO, we were operating under bridgefinancing and were financially constrained, and therefore not able to launchall aspects of our new sales and marketing plan. Following the IPO, themarketing research company we engaged determined that we had lost significantground to our competitors. Our competitors had launched extensive marketingcampaigns in 2004, had been able to develop strong channel relationships andhad invested in international market expansion. This was a change from prioryears when many buyers found products like ours through a web search orresponded to a banner advertisement. By the time we had invested in the salesand marketing initiatives, we found that we were significantly behind ourcompetitors. Due to the late receipt of proceeds we substantially missed ourexpected fourth quarter 2004 internal revenue and earnings targets. With ourcurrent financial resources, we do not believe that we will be able to matchthe sales and marketing investments of our competitors, and as a result webelieve that we will continue to lose ground and have a difficult time inprojecting future revenues.

 

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In 2004, we released HyperTunnelTM. Although we made a few sales ofHyperTunnelTM in 2004, the initial releases had not been extensively tested andwere difficult to configure in potential customer networks. As a result theyperformed poorly during pre-sale customer evaluations and testing. A number ofsales opportunities were lost because of this. As we released subsequentversions of HyperTunnelTM, these issues were addressed but we were notsuccessful in going back to any of these potential customers and getting themto reconsider their buying decision. Although we now believe that HyperTunnelTMis fully functional and will work well in most potential customer evaluations,it is a much more complicated product than HyperWebTM and we need greatercustomer interaction during testing to successfully sell this product. As aresult we did not generate the revenue volume from HyperTunnelTM that weexpected and future sales of HyperTunnelTM will be very difficult to predict.  

 

Some of the new sales and marketing initiatives launched after the IPOhave not been successful. Due to the reasons outlined above, we had difficultyattracting and retaining productive sales personnel. In addition, initiativestargeted toward certain industry verticals and an outbound telemarketingcampaign did not produce the expected results. While we engaged internationalsales agents, and spent a great deal of time and resources with them, they didnot produce anticipated revenue levels. Due to our competitors’ earlierexpenditure of resources and ability to make larger international investments,including establishment of multiple international offices with local employeeswe have decided that making a direct investment in international expansion willnot produce the required level of results at this time. We have decided toredirect our resources to our OEM/Reseller channel as an indirect way ofexpanding our international representation.

 

In 2004 our industry experienced a number of developments whichproduced the following trends:

•                  Competitors closed subsequent venturecapital rounds of funding at levels which exceed our IPO proceeds;

•                  Consolidation of a number of ourcompetitors;

•                  Our HyperTunnelTM product was notpurchased by any of the larger ISPs because they had existing commitments tocompetitors of ours who focused exclusively on the ISP space; 

•                  Mergers of smaller companies withother larger organizations selling into the network space thereby enabling thecombined entity to offer a greater solution;

•                  Many hardware and software providersincluding compression and network acceleration in their base product; and

•                  Buyers of compression and networkacceleration solutions becoming better informed about the providers (due toincreased amounts spent on sales and marketing) meaning that fewer buyers nowuse the web search method of buying.

 

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

 

After a comprehensive process, we determined that MPC acquisition wouldprovide us an established distribution channel for selling our softwareproducts. Information about this proposed acquisition, including its risks,will be presented in a proxy statement filing at a later date.

 

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###### ***RESULTS OFOPERATIONS***

Thefollowing tables show our results of operations for the fiscal years ended December 31,2004 and 2003, both in terms of dollars and in approximate percentages.

 

**Statement of Operations for the years ended December 31,**

 
| ** **                                                            | ** ** | **2004**   | ** **     | **2004**   | ** ** | **2003**   | ** ** | **2003**       | ** ** |
|-----------------------------------------------------------------------|------------|------------|----------------|------------|------------|------------|------------|----------------|------------|
| **Revenues**                                                          | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** |
| **License Fees**                                                      | ** ** | **$**      | **237,109**    | ** ** | **52**     | **%**      | **$**      | **787,541**    | ** ** | **80** | **%** |
| **Service & Other**                                          | ** ** | **$**      | **220,741**    | ** ** | **48**     | **%**      | **$**      | **195,678**    | ** ** | **20** | **%** |
| **Total Revenues**                                                    | ** ** | **$**      | **457,850**    | ** ** | **100**    | **%**      | **$**      | **983,219**    | ** ** | **100** | **%** |
| ** **                                                            | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** |
| **Expenses**                                                          | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** |
| **Research & Development - personnel  costs**                | ** ** | **$**      | **281,787**    | ** ** | **62**     | **%**      | **$**      | **112,243**    | ** ** | **11** | **%** |
| **Research & Development - other**                           | ** ** | **$**      | **100,939**    | ** ** | **22**     | **%**      | **$**      | **38,588**     | ** ** | **4** | **%** |
| **Research & Development - Product  Management**             | ** ** | **$**      | **235,222**    | ** ** | **51**     | **%**      | **$**      | **—**     | ** ** | **0** | **%** |
| **Amortization of Capitalized Software**                              | ** ** | **$**      | **121,965**    | ** ** | **27**     | **%**      | **$**      | **214,194**    | ** ** | **22** | **%** |
| **Impairment of Intangibles**                                         | ** ** | **$**      | **31,530**     | ** ** | **7**      | **%**      | **$**      | **276,296**    | ** ** | **28** | **%** |
| **Customer Support - personnel costs**                                | ** ** | **$**      | **163,992**    | ** ** | **36**     | **%**      | **$**      | **173,959**    | ** ** | **18** | **%** |
| **Sales - personnel costs**                                           | ** ** | **$**      | **489,676**    | ** ** | **107**    | **%**      | **$**      | **299,811**    | ** ** | **30** | **%** |
| **Sales - agent costs**                                               | ** ** | **$**      | **96,194**     | ** ** | **21**     | **%**      | **$**      | **226,561**    | ** ** | **23** | **%** |
| **Sales - other**                                                     | ** ** | **$**      | **8,457**      | ** ** | **2**      | **%**      | **$**      | **20,912**     | ** ** | **2** | **%** |
| **Marketing Expenditures**                                            | ** ** | **$**      | **191,718**    | ** ** | **42**     | **%**      | **$**      | **32,984**     | ** ** | **3** | **%** |
| **Rent**                                                              | ** ** | **$**      | **93,016**     | ** ** | **20**     | **%**      | **$**      | **92,616**     | ** ** | **9** | **%** |
| **Depreciation**                                                      | ** ** | **$**      | **69,150**     | ** ** | **15**     | **%**      | **$**      | **90,177**     | ** ** | **9** | **%** |
| **General & Administrative -  personnel costs**              | ** ** | **$**      | **827,679**    | ** ** | **181**    | **%**      | **$**      | **804,025**    | ** ** | **82** | **%** |
| **General & Administrative - Costs  to be a Public Company** | ** ** | **$**      | **216,243**    | ** ** | **47**     | **%**      | **$**      | **—**     | ** ** | **0** | **%** |
| **General & Administrative - other**                         | ** ** | **$**      | **264,287**    | ** ** | **58**     | **%**      | **$**      | **95,643**     | ** ** | **10** | **%** |
| **Total Operating Expenses**                                          | ** ** | **$**      | **3,191,856**  | ** ** | **697**    | **%**      | **$**      | **2,478,009**  | ** ** | **252** | **%** |
| ** **                                                            | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** |
| **Loss from Operations**                                              | ** ** | **$**      | **(2,734,006** | **)**      | **-597**   | **%**      | **$**      | **(1,494,790** | **)**      | **-152** | **%** |
| ** **                                                            | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** |
| **Other (Income)/Expense**                                            | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** |
| **Interest Expense, net**                                             | ** ** | **$**      | **822,748**    | ** ** | **180**    | **%**      | **$**      | **345,395**    | ** ** | **35** | **%** |
| **Other Expenses**                                                    | ** ** | **$**      | **5,099**      | ** ** | **1**      | **%**      | **$**      | **(1,276**     | **)**      | **0** | **%** |
| **Gain on Settlement**                                                | ** ** | **$**      | **(440,999**   | **)**      | **-96**    | **%**      | **$**      | **—**     | ** ** | **0** | **%** |
| **Preferred Dividends**                                               | ** ** | **$**      | **72,489**     | ** ** | **16**     | **%**      | **$**      | **15,503**     | ** ** | **2** | **%** |
| **Net Loss attributable to Common  Shareholders**                     | ** ** | **$**      | **(3,193,343** | **)**      | **-697**   | **%**      | **$**      | **(1,854,412** | **)**      | **-189** | **%** |

 

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***Fiscal 2004 comparedto fiscal 2003:***

 

***Revenues:***Ourrevenues are derived from software license sales, annual maintenance contractson those sales, consulting fees, fees for custom development, training fees,per-user-per month recurring revenues for ISP customers andper-user/per-site-per-month fees for a partner who sells our products tomulti-location customers as an alternative to costly additional bandwidth andhardware additions.

 

Revenueswere 53% lower in 2004 compared to 2003. The following are what we believe tobe the causes of the decline:

•                  In2003 we sold licenses to 31 different customers with an average selling priceof $25,400. In 2004 we sold licenses to 16 different customers with an averagelicense sale of approximately $15,000. The average license deal size is lower in 2004 due to the absence ofthree large sales that occurred in 2003 that were all in excess of $75,000.Increased market presence by competitors during 2004 resulted in fewer largesale opportunities for us.

•                  In2003, $256,000 in five license sales came from customers who had previouslypurchased from us. In 2004, this was one customer accounting for 1% ofrevenues. The reduction was primarily due to a number of agents who no longerwere active in selling our products.  

•                  In2004, we generated revenue from nine recurring revenue agreements. Theseincluded ISP agreements, a Partnership agreement and the initial consultingrevenues from an OEM agreement. Revenue recognition on a recurring revenueagreement takes place over the life of the agreement instead of coming as alump sum as is the case with a license sale.

•                  Thenumber of customers who found us by a website search decreased in 2004. Webelieve that increased advertising by our competitors has reduced the number ofprospects who would conduct a web search for our solution.

•                  In2003, we generated revenues through one-time referrals by certain agents. Thesewere individuals who were not exclusively devoted to selling but who merelyleveraged relationships. While successful in 2003, we do not believe that it isa sustainable model; therefore, in 2004, we began to seek, engage and invest inagents who are professionals in selling IT technology. This caused most of 2004to be a period of transition where very few agents were actively producingrevenue for us.

•                  Mostof our larger competitors have opened offices in international locations andhave developed strong sales agent relationships. Due to our limited funds toinvest in marketing and sales prior to the IPO, we were not been able toconduct broad international expansion initiatives. At a time when ourinternational revenues are rising as a percentage of total sales (36% incalendar 2003, 46% for 2004) thereby demonstrating the international appeal ofour products, not having a more robust international presence may have resultedin missed sales opportunities.

 

***Research & Development Costs:***Research andDevelopment (R&D) Expenses consist primarily of compensation relatedto the cost of software engineering developers, third party consultants,prototype expenses related to the design, development, testing and enhancementof our software products, facilities costs and hardware and software used inthe design, development and support of our products. This expense category is thenon-capitalized portion of these costs.

 

During 2004 compared to 2003,this expense category increased by over 300% or by more

 

27

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than$450,000. This was a result of the following:

•                  Increasedheadcount for development staff.

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

•                  A $60,000expense for third party software incorporated into the HyperTunnelTM product.

•                  Expensesincurred in releases of HyperTunnelTM post-launch.

•                  Theestablishment of a formal Product Management functionin 2004.

•                  Third partycosts incurred in 2004 to conduct extensive testing of  HyperTunnelTM.

 

***Amortization ofCapitalized Software:***This category represents thewrite-off of previously capitalized software development costs; it includes thesame types of expense categories as in R&D costs above. No new costs werecapitalized during 2004.

 

The 43% reduction in 2004 costs compared to 2003 is a result of asignificant portion of previously capitalized HyperWebTM development costsbecoming fully amortized in 2003. Even though we did launch HyperTunnelTM in January 2004,and therefore commenced amortization (over 5 years the estimated useful life),this did not offset the larger amounts that had been incurred for thedevelopment of HyperWebTM. In 2003 our average quarterly amortization wasapproximately $54,000 per quarter while in 2004 it is approximately $30,000 perquarter.

 

***Impairment ofintangibles:*** We evaluate all of the carrying values of our assets to determine thereasonableness of continued capitalization. We review the facts andcircumstances of our business, which may indicate that the carrying values ofour assets may be impaired. We use future undiscounted cash flows to determinewhether the carrying value of the asset is recoverable. If the carrying valueis less we recognize an impairment loss based on the excess carrying amount ofthe asset over the respective fair value.

 

During 2003, we determined that certain acquired intellectual propertyand trademark and patent costs, which were previously capitalized, no longerhad any value to us and thus were written off. These assets arose primarily asa result of the purchase of the assets of RCI and initial trademark and patentcosts incurred in 2001 and early 2002. The amount written off in 2003 was$85,000.

 

In 2004, we determined that $31,530 in trademark and patent costs,which were previously capitalized, had been pending for an extended period oftime, and are therefore, for accounting purposes, written off.

 

In addition we incurred an impairment expense in 2003 as a result ofthe abandonment of a version of HyperWebTM with particular new featurefunctionality. In July 2003, we abandoned the development of a version ofHyperWebTM with particular new feature functionality and used our limitedresources to complete development of our new product, HyperTunnelTM. As aconsequence, we recorded an impairment of $191,000, representing all previouslycapitalized costs relating to the development of the updated version ofHyperWebTM.

 

***Customer SupportCosts:*** Thisexpense category includes personnel costs that relate to pre- and post-salessupport of our products. Their roles primarily cover pre-sales supportincluding assisting customers taking evaluation tests, customer support undermaintenance agreements and other post sale technical support, telephone/websupport, and providing access to all software updates and upgrades.

 

The 2004 and 2003 amounts compared incurred show a slight decreasereflecting a more

 

28

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cost effective composition of payroll and consultingcosts in this area. 

 

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

•                  Targeted sales efforts throughreferral partners at enterprises with a focus on reaching the informationtechnology organization responsible for the performance of mission-criticalapplications and maintenance of network performance.

•                  Maintaining a website and agreementswith the Google and Yahoo! keyword search engines that direct those who areseeking compression and acceleration solutions to our website.

•                  Attending a limited number ofconferences and conducting limited public relations.

•                  Engaging a handful of Colorado-basedemployees and consultants and a single United Kingdom-based agent to facilitatesales efforts.

 

In 2004 compared to 2003, we increased expenditures by approximately35%. Funds were not available until after the October 2004 IPO so themajority of increased spending did not begin until after that event. Increaseswere due to: 

 

•                  The additional compensation costs ofour new Chief Operating Officer and senior sales staff and those incurred totransition from the previous sales leadership. 

•                  An increase in marketing expendituresof more than $150,000 for many of the initiatives outlined above particularlyfourth quarter costs incurred for Market Research, Website enhancement and anunsuccessful outbound telemarketing campaign.

•                  Costs we incurred to launchHyperTunnelTM into the ISP space.

 

Theseincreases were offset by lower agent costs largely as a result of lower salesvolume as most of them have a commission based compensation structure.

 

***General &Administrative Expenses:*** General and administrative, or G&Aexpenses consist primarily of employee compensation for executives andadministrative personnel, office costs such as telecommunications, legal andaccounting fees, rent, depreciation and the ongoing expenses related to ourpublic company status.  We havecapitalized costs relating to the IPO that were incurred prior to the date ofthe IPO and as such they are not included in this category.

 

For 2004 compared to 2003, G&A was higher by $388,000 or by morethan 36% due to the following:

 

•                  During most of 2003, our founderacted as Chairman and CEO. In October 2003, the positions were split andwe hired a Chief Executive Officer. Our founder retained the position asChairman of the Board. This resulted in additional compensation expense.

•                  In 2004 we hired a Chief FinancialOfficer. In 2003 we had a CFO for part of the year and a part-time Controllerfor the remainder. This resulted in additional compensation expense.

•                  In 2004, we had fewer options grantedand recorded a lower expense of options granted by more than $100,000.

•                  Additional travel costs incurred dueto capital raising activities.

•                  Increased insurance costsparticularly Director and Officer insurance.

•                  We incurred more than $250,000 incosts related to being a publicly traded company. These included Board ofDirectors costs, investor relations, D&O insurance, legal &accounting, transfer agency, printing and compliancecosts. 

•                  Offsetting these increases were loweramounts spent on consultants and eliminating a Human Resources manager.

 

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We expect to incur greateradministrative costs in the future as we are now a public reporting company andwe must now comply with recently enacted laws and regulations affecting publiclytraded companies, including increased accounting and legal fees, complying withthe provisions of the Sarbanes-Oxley Act of 2002 and other current and future rules andregulations required by the SEC, the American Stock Exchange and the Financial AccountingStandards Board (FASB). In addition, we will have greater costs related to theaddition of an Audit and Corporate Governance Committee and certain types ofinsurance policies linked to being a publicly traded company. There may beother additional costs, which could be substantial, as a result of the Companyhaving become a publicly traded entity.

 

G&A expenses represented disproportionate percentages of ourrevenues. If we grow our revenues our G&A expenses should continue todecline as a percentage of revenue.

 

***Interest Expense:***Weincurred interest expense on loans from convertible and other debt, a loan fromour founder, imputed interest on warrants issued in connection with debtofferings, imputed interest on the conversion feature of our debt and line ofcredit costs. The interest charge was higher in 2004 due to the higher amountof debt outstanding, the increased number of debt issuances and the imputedinterest recorded on warrants issued and on debt with conversion features belowfair value.

 

In 2004 compared to 2003, interest was higher by more than $477,000 dueto:

•                  Loan issuance fees of more than$100,000 on the March/April 2004 bridge loans.

•                  A $252,000 greater chargeattributable to imputed interest on warrants issued in conjunction with debtissuances.

•                  Imputed interest recorded on debtissued with conversion features below fair value in the amount of $234,000.

•                  A $29,000 charge for accretion ofdebt issue costs.

•                  Offsetting this was no interest onthe RCI note which was settled in early 2004 and a lower interest charge on thefounder’s note due to a significant portion of the note being converted toPreferred Stock in late 2003 and $75,000 converted to Common Stock prior to theIPO.    

 

***Gain on settlementof RCI note:*** We purchased certain assets from Remote Communications, Inc. (RCI)in March 2001. The purchase price (net, after certain liabilities fromRCI, was paid by us in the form of a promissory note upon closing of thetransaction) was $353,000 to be paid in March 2004.

 

InMarch 2004, we settled the amount owed to RCI regarding the initialpurchase of assets in 2001. Under our settlement, we agreed to pay RCI $42,500as settlement in full for all liabilities owing and any claims due under ourpurchase agreement. Accordingly, in the financial statements for the quarterended March 31, 2004, we reduced the value of the note payable to RCI to$42,500, reversed the previously accrued compensation to RCI officers andrecorded a gain on the settlement of this liability in the amount of $441,000.

 

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

 

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##### ***OFFBALANCE SHEET TRANSACTIONS & GUARANTEES***

We are not party to any offbalance sheet transactions. We have no subsidiaries or equity ownership in anyother entity.

 

During our normal course of business, we havemade certain indemnities, commitments and guarantees under which it may berequired to make payments in relation to certain transactions. These include (i) intellectualproperty indemnities to our customers and licensees in connection with the use,sale and/or license of our products, (ii) indemnities to our lessor inconnection with our facility lease for certain claims arising from suchfacility or lease, (iii) indemnities to vendors and service providerspertaining to claims based on our negligence or willful misconduct, and (iv) indemnitiesinvolving the accuracy of representations in certain contracts. The duration ofthese indemnities and commitments, and in certain cases, may be indefinite. Themajority of these indemnities and commitments do not provide for any limitationof the maximum potential for future payments we could be obligated to make. Wehave not recorded any liability for these indemnities and commitments in theaccompanying consolidated balance sheets.

 

Under our Amended and RestatedArticles of Incorporation, we have agreed to indemnify our officers anddirectors to the fullest extent permitted by Colorado Law. The maximumpotential amount of future payments we could be required to make under theseindemnification agreements is unlimited. However, we have a directors andofficers’ liability insurance policy that limits exposure and enables us torecover a portion of any future amounts paid. As a result of our insurancepolicy coverage, we believe the estimated fair value of these indemnificationagreements is minimal and has no liability recorded for these agreements as ofDecember 31, 2004.

 

Insofar as indemnification forliabilities arising under Federal Securities Laws may be permitted to ourdirectors, officers and controlling persons pursuant to the foregoingprovisions, or otherwise, we have been advised that in the opinion of theSecurities and Exchange Commission such indemnification is against publicpolicy as expressed in Federal Securities Laws and is, therefore,unenforceable.

 

##### ***CORPORATEGROUP AND SEGMENT INFORMATION***

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

 

In fiscal 2004, 54% of our revenue came from the U.S. (2003: 64%), 30%from the European Union (33% in 2003) and 16% from Asia/Pacific and other areas(3% in 2003). Over the next 12 months we expect our revenue from non-U.S.customers to increase as a percentage of revenues.

 

##### ***USEOF ESTIMATES AND CRITICAL ACCOUNTING POLICIES***

This discussion and analysis ofthe financial condition and results of operations is based upon our financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. In order to prepare these financialstatements, we are required to make estimates and judgments that affect thereported amounts of assets, liabilities, revenues and expenses and relateddisclosures of contingent assets and liabilities. On an ongoing basis, weevaluate our estimates, including those related to the valuation of long-livedassets; valuation allowances including sales return reserves, allowances fordoubtful accounts and other liabilities, such as product warranty reserves. Webase our estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances.

 

Actualresults may differ from these estimates under different assumptions orconditions. Our use of estimates and critical accounting policies are describedin more detail in the notes to our financial statements included elsewhere inthis document. There have been no changes to our accounting policies in 2004.

 

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***Revenues:***  We derive revenues from the followingsources: software license revenue and services revenue, which primarilyconsists of maintenance, consulting and training. We recognize revenue inaccordance with the Securities and Exchange Commission’s Staff AccountingBulletin No. 101, “Revenue Recognition in Financial Statements,” theAmerican Institute of Certified Public Accountants’ Statement of Position, orSOP, 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modificationof SOP 97-2, Software Revenue Recognition, with Respect to CertainTransactions,” and other authoritative accounting literature. We determine fairvalue of each element in multiple-element arrangements based on vendor-specificobjective evidence, or VSOE, for all items included in a new customeragreement. We maintain a price lists for various regions where we have statedLicense and Maintenance rates and terms. We base our assessment of VSOE foreach element to the price charged when the same element is sold separately.VSOE for maintenance is determined based upon the customer’s annual renewalrates. During the sales process we make various proposals that illustrate thelicense fee component (License Fee Revenue) and the optional maintenancecomponent (Services Revenue). Customers are not required to buy maintenance sothey actually make dual buying decisions—one for the license and one for themaintenance. The split between these two categories is included in all of ourexecuted customer agreements and billings subsequently sent to them. We use thecontractual split between these two categories to allocate the fair value ofeach because we believe that it represents the fair value. Any other fees orservices as part of a sale are extremely rare and in the cases where they haveoccurred, they have been governed by a separate contract with a separate fee.

 

*License fee revenue:*  For software license agreements that do notrequire significant modification or customization of the software, we recognizerevenue when evidence of a non-cancelable, signed contingency-free agreementexists, any acceptance testing is complete, delivery of the product hasoccurred, the license fee is fixed or determinable and collection is probable.In all other instances, we defer revenue. We record deferred revenue as acurrent liability until all the elements to be delivered at a future date andvendor specific evidence of acceptance have occurred.

 

Weconsider receipt of a customer purchase order to be persuasive evidence of anarrangement. Sales through our distribution channels are evidenced byagreements governing the relationship together with purchase orders from theultimate end customers. Delivery generally occurs when the customer hasreceived an electronic media copy of the software or where we have evidencethat the customer has downloaded the software from our website.

 

Ifa license agreement provides acceptance provisions that grant customers a rightof refund or replacement only if the licensed software does not perform inaccordance with its published specifications, we defer revenue recognitionuntil acceptance by the customer or lapse of the acceptance period. Generally,license agreements have no such provisions and, as the likelihood ofnon-acceptance is remote, we generally recognize revenue when all othercriteria of revenue recognition are met.

 

Typically,our software licenses do not include significant post-delivery obligations tobe fulfilled by us, and payments are due within 30 days from the date ofdelivery. For customers who pay license revenues as monthly subscribers under autility-based pricing model, and where the license allows for payment terms ofmore than 12 months from the date of delivery, we recognize revenue aspayments become due assuming all other conditions for revenue recognition havebeen satisfied.

 

*Services & Other revenue:*  Services, or maintenance, revenue isrecognized ratably over the term of the maintenance agreement, typically oneyear. Consulting services generally do not involve significant modification orcustomization of the licensed software. Consulting and

 

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training revenues are usually charged on atime and materials basis and are recognized as the services are performed.Revenue from fixed price contracts is recognized on a percentage of completion basis, which involves the use of estimates. If we do nothave a sufficient basis to measure the progress towards completion, werecognize revenue when the project is completed or when we receive finalacceptance from the customer. Revenue from agreements for supporting andproviding periodic unspecified upgrades to the licensed software is recorded asunearned revenue and is recognized ratably over the support service period.

 

***Allowance forDoubtful Accounts:*** We maintain an allowance for doubtful accounts at an amount we estimateto be sufficient to provide adequate protection against losses resulting fromcollecting less than full payment on our receivables. Overdue accounts arereviewed, and an additional allowance is recorded when determined necessary tostate receivables at realizable value. In judging the adequacy of the allowancefor doubtful accounts, we consider multiple factors including historical baddebt experience, the general economic environment, and the aging of ourreceivables. A considerable amount of judgment is required when we assess therealization of receivables, including assessing the probability of collectionand the current creditworthiness of each customer. As of December 31, 2004we have determined that no reserve is currently necessary for doubtfulaccounts.

 

***Capitalization ofSoftware Development Costs:***For software costs,both internally developed and purchased from third parties, we follow thefollowing accounting policies:

 

*Pre-Feasibility Stage:*  We expense costs incurred to establish thetechnological feasibility of a software program as they are incurred. For thesepurposes, technological feasibility is considered achieved when all planning,designing, coding, and testing has been sufficiently completed such that we canproduce the program to meet its design specifications.

 

*Post-Feasibility/Pre-Release Stage:*  We capitalize costs incurred followingtechnological feasibility but prior to commercial release and record them atcost. These costs are not applied against revenues generated during thatperiod.

 

*Post-Release Stage:*  Commencing with commercial release of theprogram, we amortize costs that have accumulated in the R&D account overthe program’s expected useful life and we expense as incurred all additionalsoftware costs.

 

Our internal software development costs include application and tooldevelopment, translation, testing and localizationcosts incurred in producing software and associated documentation to belicensed to customers. We also may contract with third parties to develop andtest software that will be licensed to customers. In addition, from time totime we may choose to purchase source code or product rights from third partiesto be integrated with our software.

 

We expense R&D costs relating principally to the design anddevelopment of products (exclusive of costs capitalized) as they are incurred.We expense the costs of developing routine enhancements as R&D costs asincurred because of the short time between the determination of technologicalfeasibility and the date of general release of related products.

** **

***Expensing ofEmployee Stock Options:***  We have adopted the disclosure only provisionof FAS 123 which permits us to disclose in notes to our financialstatements the pro forma net income (loss) and earnings per share that wouldhave resulted from the use of the fair value based method. Thedisclosure only provisions allow us to disclose the pro forma effect on netincome and earnings per share of issuing options to employees rather thanexpensing them based on the fair value of the options.

 

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In accordance with SEC requirements, we expensed options granted toemployees immediately prior to our IPO. We recorded an expense of $27,000 forthe 154,843 options granted to employees, between January 1 and June 30,2004, and $139,000 for the 132,678 options granted to employees in 2003. Theexpense represents the difference between the exercise price of $3.50 at thedate of grant and the estimated fair value of common stock. This treatment isin accordance with APB 25.

 

***Valuation ofLong-Lived and Intangible Assets and Goodwill:***  As required by SFAS 144, “Accounting forImpairment or Disposal of Long-lived Assets,” we regularly perform reviews todetermine if the carrying value of our long-lived assets is impaired. Thepurpose of the review is to identify any facts or circumstances, eitherinternal or external, which indicate that the carrying value of the assetscannot be recovered. Such facts or circumstances might include significantunderperformance relative to expected historical or projected future operatingresults or significant negative industry or economic trends. If such indicatorsare present, we determine whether the sum of the estimated undiscounted cashflows attributable to the assets in question is less than their carrying value.If less, we recognize an impairment loss based on the excess carrying amount ofthe assets over their respective fair values. If quoted market prices forassets are not available, we estimate the fair value based on the present valueof expected future cash flows. The fair value of the asset then becomes theasset’s new carrying value. We recorded an impairment charge in 2003 withrespect to certain capitalized software costs and other intangibles and in 2004with respect to certain capitalized patent costs. 

 

***Guarantees:*** In November 2002, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). FIN 45 requires a guarantor to recognize a liability, at the inception of the guaranty and also include more detailed disclosures with respect to guarantees, including additional disclosures relating to product warranty liabilities. The discussion under the section “Off Balance Sheet Transactions & Guarantees” above is a summary of our agreements that we have determined is within the scope of FIN 45.

 

###### ***Product Reserves:***We currently do not maintain areserve for any warranty or rebate costs. Historically there have been nomaterial warranty claims. Our sales agreements do not provide for anycircumstances that would provide additional warranty claims other than toreplace any defective software. We do not make any specific performanceguarantees. To date, all minor warranty claims have been settled by providingnew copies of the software that was defective. Additionally, we offer a freetrial/evaluation prior to consummating sales that mitigates any post-saleclaims. The trial/evaluation details specific performance in the customer’senvironment, before any purchases are consummated. In addition, to date therehave been no financial claims for installation or performance problemspost-purchase of our products. As our software products are downloaded directlyfrom our website, there are no costs to repair or replace products thatmay be returned. 

######  

Currently we have no sales programs whereby distributors and resellers can earn rebates

 

##### ***RECENTACCOUNTING PRONOUNCEMENTS***

In December 2003, the SEC issued SAB 104, which supersedes SAB 101. While the wording of SAB 104 has changed to reflect the issuance of Emerging Issues Task Force Issue No. 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables” (EITF 00-21), the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 does not have a material effect on the Company’s financial condition or results of operations.

 

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In December 2004, the FASB issued SFAS 123R “Share-Based Payment,” a revision to FASB No. 123, SFAS 123R replaces existing requirements under SFAS No. 123 and APB Opinion NO. 25, and requires public companies to recognize a compensation expense an amount equal to the fair value of share-based payments granted, such as employee stock options. This is based on the grant-date fair value of those instruments. SFAS 123R also affects the pattern in which compensation cost is recognized, the accounting for employee share purchase plans, and the accounting for income tax effects of share-based payment transactions. For small-business filers such as us, SFAS 123R will be effective for interim periods beginning after December 15, 2005. The Company is currently determining what impact the proposed statement would have on its results of operations and financial position. The impact will largely be due to the selection of either the Black-Scholes or the binominal lattice model for valuing options. The adoption of this standard will have no impact on the Company’s cash flows. 

 

##### ***MARKETAND CREDIT RISK***

Financialinstruments, which potentially subject us to concentrations of credit risk,consist primarily of cash, cash equivalents, short-term investments andaccounts receivable. Our cash, cash equivalents and short-term investments aremaintained with accredited financial institutions and investments are placedwith quality issuers. We believe no significant concentration of credit riskexists with respect to these financial instruments. Cash and cash equivalentsconsist primarily of cash on deposit with banks and money market instrumentsthat are stated at cost, which approximate fair market value. We have nocurrent investments in fluctuating net asset value investments.

 

Concentrationsof credit risk occur from time to time as we record large sales relative to ourgrowing customer base. With respect to accounts receivable, we perform ongoingcredit evaluations of our customers. As of December 31, 2004,approximately 67% of the accounts receivable balance was from three customers.One has made a payment on the account and one other is not yet due. Theremaining customer is a repeat customer who is a historic slow payer and theaccount is not in dispute. The customer is one of the five largest telecomorganizations in the European Union. Slow paying non-U.S. customers mayexacerbate foreign currency exchange risk. For 2003 and 2004, the top 3customers accounted for approximately 30% of revenues.

 

Currentlymost sales are in the United States, Canada, Australia and Europe. Almost allof our foreign sales are denominated in US Dollars minimizing our foreigncurrency risk. In future we may not be successful in negotiating most of ourinternational agreements in US Dollars thereby increasing our foreign currencyrisk. Regardless of the contract currency denominations, financial resultscould be affected by factors such as weakening in foreign currency exchangerates vs. the US Dollar or weak economic conditions in worldwide markets. Anystrengthening of the U.S. dollar could make our products less competitive inforeign markets. We currently have no foreign exchange contracts, optioncontracts or other foreign currency hedging arrangements.

 

The Company may, from time to time, be involved in legal proceedings, claims and litigation arising in the ordinary course of business. It is possible the outcome of such legal proceedings, claims and litigation could have a material effect on the operating results or cash flows when resolved in a future period. These matters are not expected to have a material adverse effect upon the Company’s financial statements.

 

We are not dependent on any single supplier for the success of our business.

 

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##### ***RELATEDPARTY TRANSACTIONS***

*We have an outstanding loan from our chairman:*The outstanding balance at December 31, 2004, including accrued interestat 9% is $57,000. This is net of $75,000 that was converted to common stock, at$3.50 per share, prior to the IPO. This loan is repayable in September 2005

 

*Bathgate Capital Partners or Bathgate:* We have incurred fees to Bathgate, aregistered broker-dealer, for raising debt and equity and providing certaininvestment banking services for us. Steven Bathgate controls Bathgate and is aformer director of our company. Mr. Bathgate resigned his board positionin January 2004. We paid the following amounts to Bathgate CapitalPartners in 2003—$8,000 in cash, 25,643 warrants and $35,000 by issuing stock;and in 2004—$102,000 in cash and 15,702 warrants. Since inception, we have usedother non-related organizations to perform similar services, on terms andconditions substantially similar to those in the Bathgate arrangements.Accordingly, we believe that our relationship with Bathgate has been conductedon terms and conditions, which are substantially similar to those otherarrangements. We owe Bathgate $10,000 as of December 31, 2004 and have$20,000 in future commitments to Bathgate.

 

Theinvestment banking agreement with Bathgate also provides for a contingent feeif we consummate a transaction in which they participated either during theterm of their agreement or for a period of 18 months after the termination oftheir agreement. The proposed merger with MPC would qualify under thisagreement. The consummated transaction, a business combination as defined inthe agreement, calls for contingent fees due upon the closing of thetransaction. The minimum fee due under any business combination would be$100,000. Should we consummate the transaction with MPC, we will pay Bathgatethe fees outlined in the next section, Liquidity and Capital Resources. 

 

*Bridge Loans from Officers and Directors:* In August 2004 we raised $400,000 inbridge loans for working capital and general corporate purposes. These bridgeloans were raised from our founder, CEO and certain members of our Board ofDirectors. Such loans bear interest at 12% per annum and are repayable within180 days. In connection with these bridge loans, we issued one warrant topurchase a share of common stock for each $2.00 loaned. The 200,000 warrantsissued as part of this transaction are exercisable at $4.46, per share, andexpire in August 2009. This bridge loan and accrued interest were paid infull October 2004.

 

Ourmanagement has determined that these transactions have been consummated onterms and conditions no less favorable than could be obtained from unaffiliatedthird parties.

 

##### ***LIQUIDITYAND CAPITAL RESOURCES***

From inception to our IPO, wefinanced our operations through the private placements of equity securities,convertible debt, loans from our founder and certain members of our Board ofDirectors, a loan from the company from whom we initially purchased the assetswith which we started our company, short-term loans, partial payment of variousconsultants and employees with stock and /or options as compensation for theirservices and, to a lesser extent, a line of credit.

 

In October 2004, we raised net proceeds of $7.1 million from ourIPO. (The gross proceeds received from the offering were $9.9 million.Underwriters deducted 8.5% of proceeds for their discount and 3% in allowableexpenses. We incurred $1.7 million in other expenses related to the IPOincluding D&O Insurance). 

 

The proposed merger with MPC calls for us to have cash on hand atclosing (no later than July 31, 2005) of at least $3.5 million. Under ourcurrent operating plan, which continues modest investments in R&D and salesand marketing, and at the same time begins to

 

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reduce G&A expenses, we expect to beable to meet this target. 

 

Should we not consummate the merger with MPC, we will continue ourmodest investments outlined above but will add additional sales and marketingresources to increase emphasis on our OEM/Reseller channel strategy. We willreduce our G&A expenses but expect to continue with our M&A Strategy.Under this scenario, we expect to have enough cash on hand to continue theseoperations through 2005. By delaying the addition of sales and marketing andincreasing our OEM/Reseller emphasis we may fall behind in the market to thepoint that we are unable to generate sufficient revenues and profits to sustainour business through 2006.

 

Should the proposed merger not be consummated, a breakup fee may bepayable by one party to the other. Our breakup fee, in certain circumstances is$500,000. If we are required to pay GTG-Micron Holding Company, LLC a breakupfee we would have sufficient cash to continue operations in 2005, but may nothave sufficient cash to continue operations in 2006. 

 

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

•                  Will have depleted capital resources

•                  Will have lost valuable time

•                  May have a share price which isnot attractive to sellers

•                  May have harmed our reputation

 

In such a case there would be a significant doubt as to whether wecould continue as a going concern in 2006.

 

Aspart of our IPO, we issued 3.6 million warrants to shareholders participatingin the IPO. These warrants are callable by us any time after October 1,2005, at $0.25, when our stock closes at or above $9.50 for 20 consecutivetrading days. In such a scenario, and if all of these warrant holders elect toexercise their warrants, we could raise an additional $19.8 million beforeexpenses.  

 

During2004 we raised approximately $9.0 million (net) through a combination of debtand equity as follows:

•                  $7.1 netproceeds from the IPO.

•                  $50,000 in a short-termloan from a single individual (this was repaid with interest in October 2004).

•                  $1.2 millionin February to April 2004 in our 2004 Bridge Loans. Of thisamount $155,000 converted to equity prior to the IPO and $1.045 million isstill outstanding.

•                  In August 2004we raised $400,000 in additional bridge loans for working capital and generalcorporate purposes. These bridge loans were raised from our founder, CEO andmembers of our Board of Directors (this was repaid with interest in October 2004).

•                  $227,000 wasreceived from the exercise of warrants and options. 

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

 

Prior to the IPO, all Series A PreferredShareholders and all remaining convertible note holders from debt raised priorto 2004 and certain 2004 convertible note holders converted their holdings toequity prior to the IPO. In addition, our founder converted $75,000 of his loanto common stock prior to the IPO.

 

We had cash and cash equivalents of $27,000 at December 31, 2003.This and the $9 million cash raised from investing activities, described above,was used as follows:

•                  Repay bridge debt in the amount of$466,000.

•                  Repayment of a line of credit of$96,000.

 

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•                  Settlement of the RCI obligation for$42,500.

•                  Purchase property and equipment inthe amount of $52,000.

•                  Fund operations for year ended December 31,2004 in the amount of $2.6 million.

This leaves cash and cash equivalent balance on hand of $5.8 million atDecember 31, 2004.

 

In 2003, we raised funds from private placements of preferred stock forapproximately $350,000, through an additional issuance of convertible debt andwarrants in the amount of $366,000 and an additional loan from our founder inthe amount of $40,000. Also in 2003, our founder converted $200,000 of debt toequity, and certain note holders converted $650,000 of debt to equity, intransactions that had no net cash impact for us.

 

Of the $1.2 million in 2004 Bridge Loans, $155,000 was converted tocommon stock prior to the IPO. Of the remaining balance, $620,000 are convertible to common stock at the option of the noteholders at $4.375 per share and $425,000 are convertible at $3.50 per share. Ifthe notes are not converted to equity, $620,000 of the notes are to be repaidin September 2005 and $425,000 in April 2006.

 

InAugust 2004 we raised $400,000 in additional bridge loans for workingcapital and general corporate purposes. These bridge loans were raised from ourfounder, CEO and members of our Board of Directors. Such loans bear interest at12% per annum and are repayable within 180 days. In connection with thesebridge loans, we issued one warrant to purchase a share of common stock foreach $2.00 loaned. The 200,000 warrants issued as part of this transaction areexercisable at $4.46 per share, and expire in August 2009. Theseloans were repaid in August 2004.

 

Variation in the timing of our cash receipts and disbursementssignificantly impacts our overall cash flow for a given period.

 

The following table summarizes our contractual and lease obligations atDecember 31, 2004:

 
| ** **                                   | ** ** | **Total** | ** **    | **2005**   | ** ** | **2006**    | ** ** | **Thereafter** | ** **  |
|----------------------------------------------|------------|-----------|---------------|------------|------------|-------------|------------|----------------|-------------|
| **Office Lease**                             | ** ** | **$**     | **100,767**   | ** ** | **$**      | **93,016**  | ** ** | **$**          | **7,751**   | ** ** | **$** | **—** | ** ** |
| **Software Lease**                           | ** ** | **$**     | **5,275**     | ** ** | **$**      | **5,275**   | ** ** | **$**          | **—**  | ** ** | **$** | **—** | ** ** |
| **Operating Leases**                         | ** ** | **$**     | **342**       | ** ** | **$**      | **342**     | ** ** | **$**          | **—**  | ** ** | **$** | **—** | ** ** |
| **Due to Related Party**                     | ** ** | **$**     | **57,338**    | ** ** | **$**      | **57,338**  | ** ** | **none**       | ** **  | **none** | ** ** |
| **Bridge Loans & Accrued Interest** | ** ** | **$**     | **1,089,627** | ** ** | **$**      | **664,627** | ** ** | **$**          | **425,000** | ** ** | **none** | ** ** |
| ** **                                   | ** ** | **$**     | **1,253,349** | ** ** | **$**      | **820,598** | ** ** | **$**          | **432,751** | ** ** | **$** | **—** | ** ** |

 

The operating leases are for office equipment and the software lease isfor Siebel Systems, Inc. software. The office lease for our corporateoffice expires in February 2006 and is based on a fixed annual fee of $14per square foot payable in equal monthly installments. 

 

We have entered into employmentagreements with our Chairman, Chief Executive Officer, Vice President ofDevelopment and one other employee. These agreements bear standard employmentterms and conditions. Our Chief Executive Officer’s contract is a three-yearcontract commencing on October 1, 2004 and calls for a guaranteed 2005bonus of $150,000. All 2004 earned bonus amounts were paid as of December 31,2004. The minimum future amounts are not accrued, as they are based oncontinued employment and therefore no employment related amounts are includedin the table above. 

 

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In addition, certain employeeswho do not have Employment Agreements, have an offer letter or other agreementswith us, which state that under certain circumstances, they may receive aseverance payment if the Company terminates their employment. Should we beliable to all such employees, the maximum amount due is approximately $250,000.   

 

Subsequent to December 31, 2004, we have been in the process ofrenegotiating certain Employment Agreements and offer letters which may haveseverance payment liabilities. In all cases these are intended to reduce thefuture amounts payable by us and provide us with greater flexibility toconsummate the proposed merger. None of these negotiations have been finalizedas of the date of filing of this report, but if the negotiations proceed weexpect to be losing the services of two senior executives in the future.

 

Since December 31, 2004, we have incurred costs relating to theproposed merger with MPC and expect to continue to incur costs through closingand thereafter. We have three categories of costs that we will incur withrespect to the proposed merger:

•                  *Fixed Costs to Closing*:We have and will incur legal, proxy, accounting, filing, tax, printer, fairnessopinion, travel and other costs by pursuing this merger and seeking theappropriate regulatory approvals. These costs will be incurred regardless ofwhether the proposed merger is consummated. Assuming the transaction closes in May orJune 2005, we expect to incur at least $400,000 in such fixed costs.

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

•                  *Costs after Closing*:If the proposed merger is consummated, we expect to incur costs relating toreducing our workforce including severance payments and Employment Agreementamounts, termination fees, additional D&O Insurance, increased AmericanStock Exchange fees, increased travel costs, increased costs relating tocompliance particularly to integrate the merged companies’ internal controlsand procedures to comply with the relevant provisions of the Sarbanes-Oxley Actof 2002, increased legal and audit costs, increased Board of Director and AuditCommittee expenses and other integration costs. All of these items will bediscussed in greater detail in the proxy statement that we file with respect tothe proposed merger.    

 

##### **Item 7.** FINANCIAL STATEMENTS

Reference is made to the Indexto Financial Statements on page F-1 for a listing of the Company’sfinancial statements and notes thereto.

 

**Item 8.****  CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

None.

 

##### **Item 8A.** CONTROLS ANDPROCEDURES  

We have performed an evaluation of theeffectiveness of the design and operation of our “disclosure controls andprocedures” (as defined in Rule 13a-14(c) under the Exchange Act) asof December 31, 2004. This evaluation was conducted under thesupervision and with the participation of our Chief Executive Officer and ChiefFinancial Officer. Disclosure controls and procedures are designed to ensurethat information required to be disclosed by us in the reports we file orsubmit under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported on an accurate and timely basis.

 

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Based on these steps, our ChiefExecutive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures were not effective, to provide reasonableassurance in a timely fashion, that material information required to beincluded in our periodic SEC reports such that our financial statementsare fairly presented in conformity with generally accepted accountingprinciples. 

 

During the course of ouryear-end audit, our independent auditors identified a non-cash financial inputerror in the Black-Scholes valuation calculation for options issued to certaincontractors during the fourth quarter of 2004. The calculation was based on aten year life for these options where the correct term was three years. Thishad the effect of overstating expenses by $37,262 and had a per-share impact of$0.01. In terms of SEC guidelines, any per-share impact of $0.01 or more isconsidered to be material. Accordingly our Chief Executive Officer and ourChief Financial Officer have concluded that the Company has a Material Weaknessas defined by the Sarbanes-Oxley act of 2002 in its disclosure controls andprocedures. This error has been corrected for the financial statements presentedin this document. No financial information containing this error has been filedwith the SEC or published. We engaged an external consultant with financialexpertise and have undertaken an investigation of all of our financial inputschedules and calculations used to prepare our December 31, 2004 financialstatements. Based on this investigation, we have concluded that there are noother financial or computational errors in the preparation of our year-endfinancial statements. We have discussed this with our Audit Committee and Boardof Directors.

 

Managementbelieves that the root cause of the Material Weakness was due to the smallnumber of employees dealing with accounting and financial matters. This hasresulted in a limited ability for financial schedules and calculations, used inpreparation of our financial statements, to undergo close scrutiny before thefinancial data is used to create our financial statements. Management believesthat this problem will be significantly alleviated by the hiring of anadditional finance and accounting professional. Management has discussed thiswith the Audit Committee, and has engaged such a professional. 

 

The Company is committed tomaintaining disclosure controls and procedures that are designed and maintainedto ensure that information required to be disclosed in the reports the Companyfiles with the SEC are recorded, processed and reported accurately. It shouldbe noted that a control system, no matter how well conceived and operated, canprovide only reasonable, not absolute, assurance that the objectives of thecontrol system are met. Because of the limitations in all control systems,including the exercise of judgment in designing, implementing and evaluatingthe controls and procedures, the assumptions used in identifying the likelihoodof future events, and the inability to eliminate misconduct completely, noevaluation of controls can provide absolute assurance that all control issueswithin the Company have been detected.

 

**Item 8B.****OTHER INFORMATION**

None.

 

**PART III**

 

**Item 9.****DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT**

 

Individuals serving asour executive officers and directors and their ages as of March 1, 2005are as follows: 

 

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| **Name**              | ** ** | **Age** | ** ** | **Position**                                      |
|-----------------------|------------|---------|------------|---------------------------------------------------|
| John P. Yeros         |       | 54      |       | Chairman                                          |
| Mark J. Endry         |       | 49      |       | President, Chief Executive  Officer and Director  |
| Mark A. Pougnet       |       | 44      |       | Chief Financial Officer,  Treasurer and Secretary |
| Patricia M. Lee       |       | 47      |       | Chief Operating Officer                           |
| Rina Singer Delmonico |       | 48      |       | Director                                          |
| Lawrence D. Firestone |       | 46      |       | Director                                          |
| David E. Girard       |       | 49      |       | Director                                          |
| James M. Gumina       |       | 59      |       | Director                                          |
| Eric D. Murphy        |       | 44      |       | Director                                          |
| Kent Swanson          |       | 60      |       | Director                                          |

 

JOHN P. YEROS (age54) has served as our Chairman of the Board since he founded our company in March 2001.He also served as our President and Chief Executive Officer from August 2002to October 2003 and our Secretary from July 2004 until February 2005.** **Priorto establishing our company, Mr. Yeros was the founder and Chairman ofMedix Resources (now Ramp Corp.; AMEX:RCO, formerly International NursingServices, Inc.,) from 1988-2000, and President and Chief Executive Officerfrom April 1996 to October 1999. Medix Resourcesdeveloped and marketed software used in the healthcare industry to facilitatecommunications between physicians and related businesses such as labs andpharmacies. International Nursing Services was a temporary staffingagency for nurses. From 1977-1988, Mr. Yeros obtained substantialexperience in the securities industry, serving with the brokerage houses ofMerrill, Lynch, Pierce, Fenner & Smith Incorporated (accountexecutive), E.F. Hutton & Company, Inc. (account executive),Hanifen, Imhoff Inc.(officer and branch manger), and B.C. Christopher(officer and branch and territory manager). Mr. Yeros holds a bachelorsdegree in Education from Wichita State University. 

 

MARK J. ENDRY (age49) has served as our Chief Executive Officer and President since October 2003.Before joining our company in his executive officer role, Mr. Endry servedon our company’s Advisory Board from March 2002 to October 2003.Prior to joining our company, Mr. Endry was Senior Vice President andChief Information Officer for J. D. Edwards & Company, a businesssoftware provider, now Oracle Corporation from November 1995 to September 2003.   During his 8-year career with J.D. Edwards,he was responsible for leading the company’s IT strategies and operations,including managing domestic and international applications, knowledgemanagement, web services, telecommunications and network environments.  Mr. Endry won several industryrecognition awards, including “Colorado CIO of the Year,” and “ComputerworldPremier 100 IT Leader.”

 

MARK A. POUGNET (age 44) has served asour Chief Financial Officer and Treasurer since March 2004 and as ourSecretary since February 2005. Prior to that he was ourinterim Chief Financial Officer from December 2003 to February 2004.From February 2003 to November 2003, Mr. Pougnet was VicePresident of Global Operations of Avaya Communication’s Service ProviderDivision. Avaya is a communication systems, applications and services provider.He also operated a CFO consulting company, Pacific Mountain Consulting, from August 2002to February 2003. From June 2000 to August 2003 he was founder,director and Chief Financial Officer of Avalanche Technology, Inc., acompany involved in the off-shore software development business where hemanaged significant international operations. From April 1997 to June 2000he was a Service Line Director of the Business Process Outsourcing division ofthe audit and consulting firm Arthur Andersen LLP. Mr. Pougnet holds abachelors degree in commerce and a masters in accounting from the University ofNatal in South Africa. He is a member of the Colorado Society of CertifiedPublic Accountants. 

 

PATRICIA M. LEE (age 47) has served asour Chief Operating Officer since March 2004. Prior to joining our companyMs. Lee worked for McDATA Corporation, a worldwide provider of networkstorage solutions, as Vice President, Sales Operations from August 2003 toFebruary 2004 and Vice President, Original Equipment Manufacturing from August 2002to

 

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August 2003. From November 2001 to March 2002  Ms. Lee wasgeneral manager of Pentastar Communications, Inc., a company engaged inthe distribution of US West Inc. broadband products across the UnitedStates. From February 1998 to August 2001 Ms. Lee was VicePresident, Sales with the regional telephone company Qwest Communications International Inc.Prior to Qwest, Ms. Lee was employed forseventeen years in the sales organization of the document management solutionsprovider Xerox Corp. She holds a bachelors degree in Education from EmporiaState University. 

 

RINA SINGERDELMONICO (age 48) has served as a director of our company since September 2003.Ms. Delmonico is the Chief Executive Officer of REN, Inc., a company she founded in April 1997. REN, Inc. isa company that manages implementation of software ranging from financeapplications to call center management suites, from security tools tomanufacturing-facility software. Ms. Delmonico also serves as theExecutive Director of the University of Colorado-Denver’s Center forInformation Technology Innovation and serves on several advisory boards forother universities and corporate entities. She is also a State of ColoradoInformation Management Commissioner, a role to which Colorado Governor BillOwens appointed her. In this capacity, she is intimately involved in helpingthe state’s Chief Information Officer to manage Colorado’s overall IT needs.During her 30 year career in IT she has held key management and high techleadership positions at the following noteworthy business andcorporations:  From March 1996 to January 2000, Ms. Delmonicoserved as Executive Vice President and Chief Information Officer for fitnessequipment manufacturer Schwinn Cycling and Fitness Inc.  SVP of Corporate MIS for****First Data Corporation; Director of IT forManville/Schuller Corp.; and a long-standing, progressively evolving career atCiticorp/Citibank where her last position was SVP of IT for their Nevadasite. Ms. Delmonico holds an Accelerated MBA from the University ofColorado’s Executive MBA program.

 

LAWRENCE D.FIRESTONE (age 46) was appointed as a director of our company in August 2004and will serve as the chair of the audit and corporate governancecommittee.  Mr. Firestone is theSenior Vice President, Chief Financial Officer, Secretary and Treasurer ofApplied Films Corporation (NASDAQ: AFCO), and has served in that role since1999.  Applied Films is a supplier ofthin film deposition equipment to several industries with globaloperations.  From 1996 to 1999 he was VicePresident and Chief Operating Officer for Avalanche Industries, Inc. acontract manufacturing company.  Mr. Firestone’sbackground is in capital finance, public company management, startup, growthand turnaround companies, international operations, acquisitions anddivestitures.  He holds a bachelorsdegree in business administration with a concentration in accounting fromSlippery Rock State College.

** **

DAVID E. GIRARD(age 49) has served as a director of our company since May 2002. Mr. Girardis currently retired. He has held a wide variety of positions during his20 years in the computer software industry. Most recently, from February 2003to February 2004, Mr. Girard served as the senior Vice President ofSales and Service for Cyclone Commerce, a provider of solutions for informationexchange between businesses. From November 1998 until he retired in February 2001,Mr. Girard served as Chief Operating Officer of J.D. Edwards &Company, now PeopleSoft, Inc. In this capacity he was responsible formarketing, product development, and worldwide field operations. Mr. Girardholds a bachelors degree in marketing from the University of Connecticut.

 

JAMES M. GUMINA,Ph.D. (age 59) has served as a director of our company since April 2001.From April 2001 until June of 2003, Dr. Gumina served as ourExecutive Vice President and Chief Culture Officer. Dr. Gumina has spentthe last 23 years of his professional career focusing on organizationdevelopment activities linked to creating, maintaining and enhancing corporatecultures. Prior to joining our company, he served as Vice President, Human Resourcesand Organization Development for J. D. Edwards & Company,now PeopleSoft, Inc. from December 1998 to June 2000. Between June 2000and April 2001 Mr. Gumina operated a private consulting practicefocusing on organizational development

 

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activities,and as of September of 2004, resumed such private consulting practice. Dr. Guminaholds a bachelors degree in psychology from Carroll College, and a masters andPh. D. in psychology from the University of Wisconsin-Milwaukee. 

 

ERIC D. MURPHY(age 44) has served as a director of our company since July 2001.  Mr. Murphy is Senior Partner and VicePresident of Consulting for Computer Sciences Corporation, or CSC, and hasserved in that role since August 2001. CSC is an information technologyservices firm. Prior to CSC, he served as Executive Vice President of Corporateand Business Development for Agilera, Inc., an applications serviceprovider from November 1999 to May 2001. From October 1997 untilNovember 1999, Mr. Murphy was a Partner in the Management Consultingbusiness of Ernst & Young LLP. Mr. Murphy holds a bachelorsdegree in petroleum engineering from Marietta College. 

 

KENT SWANSON (age60) has served as a director of our company since December 2001. Mr. Swansonspent 33 years of his career with Accenture Ltd., an internationalconsulting firm, before retiring in September 2001. As a Senior Partner inthe firm he was responsible for multiple and varied functions, includingmanaging client service delivery for a wide range of industries andgeographies, launching and developing Accenture’s successful global outsourcingbusiness both domestically and internationally, leading both B2B and mobilecommerce initiatives, and serving as interim Chief Executive Officer forExostar, LLC, an aerospace and defense industry eCommerce exchange founded byThe Boeing Company, Lockheed-Martin Corporation, Raytheon Company and BritishAerospace Public Limited Company. Mr. Swanson holds a bachelors degree inbusiness from the University of Minnesota and an MBA from the University ofChicago. 

 

**CODE OF ETHICS**

 

We have adopted a code ofethics that applies to our principal executive officer, principal financialofficer, principal accounting officer or controller and persons performingsimilar functions. The code of ethics is located on our Internet web site athttp://www.ehyperspace.com.  Anyamendments to or waivers from a provision of this code of ethics will be postedon our web site.

 

**POLICY ON SHAREHOLDER COMMUNICATION**

** **

Our policy on shareholdercommunication with the board of directors can be found on our web site athttp://www.ehyperspace.com. Our shareholders may contact the board of directorsas a group or an individual director by U.S. Postal mail directed to theChairman of the board of directors, c/o the Secretary of HyperSpace, at 8480East Orchard Road, Suite 6600, Greenwood Village, Colorado 80111.Shareholder communications received by our secretary will be promptly forwardedto the specified director addressed or to the full board of directors, asapplicable. Shareholders should clearly specify in each communication, the nameof the individual director or group of directors to whom the communication isaddressed.

 

**AUDIT AND CORPORATE GOVERNANCE COMMITTEE**

** **

Our board ofdirectors has established an audit and corporate governance committee, which iscomprised of three independent directors, Messrs. Firestone (chair),Swanson and Murphy. The audit and corporate governance committee assist theboard in overseeing and reviewing: (1) the integrity of our financialreports and financial information provided to the public and to governmentaland regulatory agencies; (2) the adequacy of our internal accountingsystems and financial controls; (3) the annual independent audit of ourfinancial statements, including the independent auditor’s qualifications andindependence; and (4) our compliance with law and

 

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ethicsprograms as established by management and the board. In its audit committeerole, the audit and corporate governance committee:

 

•                  Hashave sole authority to select, evaluate, terminate andreplace our independent auditors;

 

•                  Hashave sole authority to approve in advance all auditand non-audit engagement fees and terms with our independent auditors;

 

•                  Reviewsthe activities, plan, scope of authority, organizational structure andqualifications of any persons overseeing our accounting and financial reportingprocesses and the audits of our financial statements; and

 

•                  Reviewsour audited financial statements, public filings and earnings press releasesprior to issuance, filing or publication.

 

In addition, in itscorporate governance committee role, the committee will develop corporategovernance guidelines for our company and recommend such guidelines to ourboard of directors. The committee reviews and makes recommendations on mattersinvolving general operation of the board and its committees, and will annuallyrecommend to the board nominees for each committee of the board.

 

The specific functionsand responsibilities of the audit and corporate governance committee are setforth in the audit and corporate governance committee charter available on ourweb site at http://www.ehyperspace.com. Mr. Firestone chairs our audit andcorporate governance committee and he qualifies as an audit committee “financialexpert” as defined under SEC and American Stock Exchange rules andregulations and the other members of our audit and corporate governancecommittee satisfy the financial literacy requirements for audit committeemembers under current such rules and regulations.

 

**SECTION 16(a) BENEFICIAL OWNERSHIPREPORTING COMPLIANCE**

** **

Section 16(a) ofthe Securities Exchange Act of 1934, as amended, requires our officers and directorsand persons who own more than 10% of a registered class of our equitysecurities to file reports of ownership and changes in ownership with the SEC.Officers, directors and greater than 10% beneficial owners are required by SECregulation to furnish HyperSpace with copies of all Section 16(a) formsthey file.

*** ***

Based solely onour review of the copies of such forms that we received, or writtenrepresentations from certain reporting persons that no forms were required forthose persons, we believe that, during fiscal year 2004, all filingrequirements applicable to our officers, directors and greater than 10%beneficial owners were complied with by such persons. 

 

**Item 10.****  EXECUTIVE COMPENSATION**

 

**Summary Compensation Table**

 

The followingtable provides information concerning compensation for services rendered toHyperSpace in all capacities for the years ended December 31, 2004, 2003and 2002 by our Chief Executive Officer, each of our other most highlycompensated executive officers whose total salary and bonus exceeded $100,000in 2004. 

 

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| ** **                     | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | ** **       | ** ** | **Long-**   | ** ** | ** **       | ** ** |
|--------------------------------|------------|-------------------------|------------|------------------|------------|------------|------------|------------------|------------|-------------|------------|------------------|------------|
| ** **                     | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | ** **       | ** ** | **Term**    | ** ** | ** **       | ** ** |
| ** **                     | ** ** | **Annual Compensation** | ** ** | **Compensation** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | **Other**        | ** ** | **Awards**  | ** ** | ** **       | ** ** |
| ** **                     | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | **Annual**       | ** ** | **Options** | ** ** | **All Other**    | ** ** |
| **Name and Principal**         | ** ** | ** **              | ** ** | ** **       | ** ** | **Bonus**  | ** ** | **Compensation** | ** ** | **Grants**  | ** ** | **Compensation** | ** ** |
| **Position**                   | ** ** | **Year**                | ** ** | **Salary ($)**   | ** ** | **($)(1)** | ** ** | **($)**          | ** ** | **(#)**     | ** ** | **($)(7)**       | ** ** |
|                           |       |                    |       |             |       |       |       |             |       |        |       |             |       |
| Mark J. Endry                  |       | 2004                    |       | $                | 220,000    |       | $          | 100,000          |       | —      |       | —           |       | — |   |
| Chief Executive Officer        |       | 2003                    |       | $                | 36,164     |       | —     |             | —     |        | 107,143    |             | —     |   |
| & President(4)             |       | 2002                    |       | —           |       | —     |       | —           |       | —      |       | —           |       |
|                           |       |                    |       |             |       |       |       |             |       |        |       |             |       |
| John P. Yeros                  |       | 2004                    |       | $                | 193,029    |       | —     |             | —     |        | —     |             | —     |   |
| Chairman & Assistant  |       | 2003                    |       | $                | 148,000    |       | —     |             | —     |        | —     |             | —     |   |
| Secretary (10)                 |       | 2002                    |       | $                | 98,077     |       | —     |             | —     |        | 3,571      |             | —     |   |
|                           |       |                    |       |             |       |       |       |             |       |        |       |             |       |
| Mark A. Pougnet                |       | 2004                    |       | $                | 159,308    | (2)(3)     | $          | 10,000           |       | —      |       | 31,429           |       | — |   |
| Chief Financial Officer,       |       | 2003                    |       | $                | 5,000      | (2)        | —     |             | —     |        | 8,571      |             | —     |   |
| Treasurer & Secretary |       | 2002                    |       | —           |       | —     |       | —           |       | —      |       | —           |       |
|                           |       |                    |       |             |       |       |       |             |       |        |       |             |       |
| Patricia M. Lee                |       | 2004                    |       | $                | 141,923    |       | $          | 52,500           |       | —      |       | 85,714           |       | — |   |
| Chief Operating                |       | 2003                    |       | —           |       | —     |       | —           |       | —      |       | —           |       |
| Officer(5)                     |       | 2002                    |       | —           |       | —     |       | —           |       | —      |       | —           |       |
|                           |       |                    |       |             |       |       |       |             |       |        |       |             |       |
| Michael P. Lynch               |       | 2004                    |       | $                | 125,000    |       | —     |             | —     |        | 7,429      |             | $          | 1,395 |   |
| VP, Business                   |       | 2003                    |       | $                | 120,031    |       | —     |             | —     |        | —     |             | —     |   |
| Development                    |       | 2002                    |       | $                | 37,500     | (8)        | —     |             | —     |        | 38,571     |             | —     |   |
|                           |       |                    |       |             |       |       |       |             |       |        |       |             |       |
| David J. Bauch                 |       | 2004                    |       | $                | 120,181    |       | —     |             | —     |        | 9,286      |             | $          | 1,621 |   |
| VP, Research &        |       | 2003                    |       | $                | 111,400    |       | —     |             | —     |        | —     |             | —     |   |
| Development                    |       | 2002                    |       | $                | 105,536    |       | —     |             | —     |        | 35,714     |             | —     |   |
|                           |       |                    |       |             |       |       |       |             |       |        |       |             |       |
| *Former Officer:*              |       |                    |       |             |       |       |       |             |       |        |       |             |       |
|                           |       |                    |       |             |       |       |       |             |       |        |       |             |       |
| Vincent T. Jordan              |       | 2004                    |       | $                | 83,750     | (6)        | —     |             | —     |        | —     |             | —     |   |
| Former Chief Operating         |       | 2003                    |       | $                | 100,000    |       | —     |             | —     |        | 6,250      |             | —     |   |
| Officer                        |       | 2002                    |       | $                | 24,171     | (9)        | —     |             | —     |        | 47,143     |             | —     |   |

 

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| (1) Includes  sales commissions.                                                                                                                                |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) Includes fees earned as a  consultant before becoming a full-time employee in March 2004.  Mr. Pougnet became a full-time employee in March 2004. |
| (3) Includes  an award of stock in lieu of salary of $20,000.                                                                                                   |
| (4) Appointed  in October 2003.                                                                                                                            |
| (5) Appointed  in March 2004.                                                                                                                              |
| (6) Mr. Jordan  was our COO until March 2004 and resigned from our company in  September 2004.                                                   |
| (7) Comprised  entirely of a 401(K) voluntary match by HyperSpace.                                                                                              |
| (8) Represents  an award of stock in lieu of salary of $37,500.                                                                                                 |
| (9) Includes  an award of stock in lieu of salary of $12,500.                                                                                                   |
| (10) Mr. Yeros  was our CEO until October 2003.                                                                                                       |

 

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**Option Grants in Fiscal Year 2004**

 

The followingtable provides information regarding stock options granted to the individualslisted in the Summary Compensation Table during the fiscal year ended December 31,2004. 

 
| **Name**          | ** ** | **Number  of  Securities  Underlying  Options  Granted  (#) (1)** | ** ** | **Percent  of Total  Options  Granted to  Employees  in Fiscal  Year (2)** | ** ** | **Exercise  Price ($)** | ** ** | **Expiration  Date** | ** ** |
|-------------------|------------|-------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|-------------------------|------------|----------------------|------------|
| Mark J. Endry     |       | —                                                            |       | —                                                                     |       | —                  |       | —               |       |
| John P. Yeros     |       | —                                                            |       | —                                                                     |       | —                  |       | —               |       |
| Mark A. Pougnet   |       | 21,429                                                            | (3)        | 12                                                                         | %          | $                       | 4.38       |                 | 4/1/2014   |   |
|              |       | 10,000                                                            | (4)        | 5                                                                          | %          | $                       | 2.42       |                 | 12/1/2014  |   |
| Patricia M. Lee   |       | 85,714                                                            | (5)        | 47                                                                         | %          | $                       | 4.38       |                 | 3/22/2014  |   |
| Michael P. Lynch  |       | 7,429                                                             | (6)        | 4                                                                          | %          | $                       | 4.38       |                 | 3/23/2014  |   |
| David J. Bauch    |       | 9,286                                                             | (7)        | 5                                                                          | %          | $                       | 4.55       |                 | 4/20/2014  |   |
| Vincent T. Jordan |       | —                                                            |       | —                                                                     |       | —                  |       | —               |       |

 

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(1)All options aresubject to the terms and conditions of the 2001 Equity Incentive Plan.  The options expire ten years from the date ofgrant, unless cancelled earlier as a result of termination of employment.  The exercise price of the options is the fairmarket value of our common stock on the grant date.  

 

(2)We granted stockoptions to purchase 183,572 shares of our common stock to employees andofficers in 2004.

 

(3)These options vest ona three year schedule, with one-third of the options becoming exercisable oneyear after the date of grant, an additional one-third becoming exercisable oneyear thereafter and the final one-third becoming exercisable one yearthereafter.

 

(4)These options vest infull on December 1, 2005.

 

(5)These options vest ona three year schedule, with one-third of the options becoming exercisable oneyear after the date of grant, an additional one-third becoming exercisable oneyear thereafter and the final one-third becoming exercisable one yearthereafter.

 

(6)These options vest infull on March 23, 2005.

 

(7)These options vest ona two year schedule, with one-half of the options becoming exercisable one yearafter the date of grant, and the final one-half becoming exercisable one yearthereafter.

 

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**Aggregated Option Exercises in Last Fiscal Year andFiscal Year-End Option Values**

 

The followingtable sets forth certain information regarding option exercises in 2004 andoptions held as of December 31, 2004 by each of the individuals listed inthe Summary Compensation Table.

 
| ** **       | ** ** | ** **   | ** ** | ** **   | ** ** | **Number of**         | ** ** | ** **            | ** ** | ** **      | ** ** |
|------------------|------------|--------------|------------|--------------|------------|-----------------------|------------|-----------------------|------------|-----------------|------------|
| ** **       | ** ** | ** **   | ** ** | ** **   | ** ** | **Securities**        | ** ** | **Value of**          | ** ** |
| ** **       | ** ** | ** **   | ** ** | ** **   | ** ** | **Underlying**        | ** ** | **Unexercised**       | ** ** |
| ** **       | ** ** | **Shares**   | ** ** | ** **   | ** ** | **Unexercised**       | ** ** | **In-the-Money**      | ** ** |
| ** **       | ** ** | **Acquired** | ** ** | ** **   | ** ** | **Options Held at**   | ** ** | **Options at**        | ** ** |
| ** **       | ** ** | **On**       | ** ** | **Value**    | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **       | ** ** | **Exercise** | ** ** | **Realized** | ** ** | **2004 (#)**          | ** ** | **2004 ($) (1)**      | ** ** |
| **Name**         | ** ** | **(#)**      | ** ** | **($)**      | ** ** | **Exercisable**       | ** ** | **Unexercisable**     | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Mark J. Endry    |       | —       |       | $            | —     |                  | 50,000     |                  | 71,429     |            | $          | — |   | $ | — |   |
| John P. Yeros    |       | —       |       | —       |       | 0                     |       | 0                     |       | —          |       | — |   |
| Mark A. Pougnet  |       | —       |       | —       |       | 8,571                 |       | 31,429                |       | —          |       | 500 |   |
| Patricia M. Lee  |       | —       |       | —       |       | 0                     |       | 85,714                |       | —          |       | — |   |
| Michael P. Lynch |       | —       |       | —       |       | 25,714                |       | 20,286                |       | —          |       | — |   |
| David J. Bauch   |       | —       |       | —       |       | 35,714                |       | 9,286                 |       | —          |       | — |   |
|                  |            |              |            |              |            |                       |            |                       |            |                 |            |  |  |  |  |  |

 

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(1)Amounts are based onthe closing price of HyperSpace common stock on December 31, 2004, asreported on the American Stock Exchange, which was $2.47. There is no guaranteethat if and when these options are exercised they will have this value. Anoption is “in-the-money” if the fair market value of the underlying sharesexceeds the exercise price of the option. 

 

**Employment Agreements and Termination of Employmentand Change in Control Arrangements**

 

**Mr. Yeros.**  In December, 2004, the Amended & Restated Founder’sEmployment Agreement, negotiated and entered into with  Mr. Yeros prior to the effectivedate of our initial public offering, became effective.  Mr. Yeros’ Amended and Restated Founder’sEmployment Agreement provides (i) for an annual base salary of $200,000; (ii) fora term of  one year, which termautomatically renews for an additional year unless, at least 30 days prior toits expiration, either Mr. Yeros or HyperSpace, delivers written notice tothe other that the term shall not be extended; (iii) that Mr. Yerosis entitled to participate in bonus or incentive compensation plans asdetermined at the discretion of our Board of Directors and entitled to receiveother employee benefits established for our employees to the extent that hequalifies; and (iv) for certain non-competition, non-disclosure, andinvention assignment requirements in favor of HyperSpace. 

 

The Amended & Restated Founder’s Employment Agreement providesthat if Mr. Yeros’ employment is terminated for reasons other than fordeath, disability or cause, he is entitled to receive: (i) his base salaryfor the unexpired term of the agreement plus an additional 18 months, and (ii) healthand medical insurance benefits through the earlier of (a) the unexpiredterm of the agreement plus an additional 18 months, or (b) hisenrollment, at his election, in a separate health and medical insurance benefitprogram.  If Mr. Yeros’ employmentis terminated due to his disability, he and his family are entitled to receivehis base salary and health and medical benefits for the longer of the remainingterm of the agreement or 18 months. If Mr. Yeros’ employment is terminated due to his death, hisdependents (if covered immediately prior to his death) are entitled to receivehealth and medical benefits for the longer of the remaining term of theagreement or 36 months after his death. If Mr. Yeros’ employment is terminated for cause, Mr. Yerosshall be paid, as

 

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severance, not less than an amount equal to thirty days salary.

 

**Mr. Endry.**  In October 2003, we entered into an EmploymentAgreement with Mr. Endry. Mr. Endry’s Employment Agreement wasamended and modified by mutual agreement on May 5, 2004. Mr. Endry’sAmended and Restated Employment Agreement provides for an annual base salary of$200,000, and a three year term (deemed to have commenced as of October 2003)which is automatically extended for successive one year terms, unless we or Mr. Endrydeliver notice to the other that the agreement will not be extended. TheAmended and Restated Employment Agreement provides that Mr. Endry’s baseannual salary will be increased to****$300,000commencing October 2004. Mr. Endry is also entitled to participate inthe Executive Compensation and Bonus Plan, under which he received a bonus of$100,000 in 2004, will receive a bonus of $150,000 in 2005, and thereafter isentitled to receive an annual bonus of not less than 50% of his base salary percalendar year, payable upon completion of certain targeted goals, objectives andmilestones established and approved by our Board of Directors. In connectionwith the Employment Agreement, Mr. Endry was also granted an option topurchase 107,143 shares of common stock from Mr. Yeros at an exerciseprice of $3.50 per share. In the event of a change in control (as determinedunder our 2001 Equity Incentive Plan) or the termination of his employmentwithout cause, all of Mr. Endry’s unvested options will vest immediately. Mr. Endryis also entitled to receive other employee benefits established for ouremployees. Mr. Endry is subject to non-competition, confidentiality andinvention assignment requirements in favor of HyperSpace under his employmentagreement. 

 

If Mr. Endry’s employment is terminated for reasons other than fordeath, disability or cause, he is entitled to receive his base salary for18 months from the date of termination, payable within 30 days afterthe date of termination. The happening of any of the following events permits Mr. Endryto terminate his agreement with us and entitles him to receive payment of hisbase salary for 18 months after his agreement is terminated: our filingfor bankruptcy protection, the sale of substantially all of our assets or ourliquidation, a material change in his duties, compensation or benefits withouthis consent, or a change in control as defined in the Amended and RestatedEmployment Agreement. If, without cause, Mr. Endry’s employment agreementis not renewed, he is entitled to receive his base compensation equal to18 months’ salary as of the date of termination, payable within30 days after the date of termination. If Mr. Endry’s employment isterminated due to his death or disability, he and his dependents are entitledto receive his base salary and health and medical benefits through the date ofhis termination, reduced by any life or disability insurance benefits paid tohim or his estate under policies for which we paid the premiums. 

 

As discussed under the section “Liquidity and Capital Resources”above, the Company is currently in the process of renegotiating Mr. Endry’sEmployment Agreement. 

 

**Mr. Bauch.** In April, 2001, we entered into an Employment Agreement with Mr. Bauch.Mr. Bauch’s Employment Agreement was amended and modified by mutualagreement on April 20, 2004. Mr. Bauch’s Amended and RestatedEmployment Agreement provides for an annual base salary of $111,400 and a twoyear term from the date of the Amended and Restated Employment Agreement, whichis automatically extended for one year terms, unless we or Mr. Bauch delivernotice to the other that the agreement will not be extended. Under theEmployment Agreement and the Amended and Restated Employment Agreement, Mr. Bauchwas granted options to purchase 35,714 shares of common stock at an exerciseprice of $3.50 per share pursuant to our 2001 Equity Incentive Plan and optionsto purchase 9,286 shares of common stock at an exercise price of $4.55 pershare pursuant to our 2001 Equity Incentive Plan, respectively. Mr. Bauchis also entitled to receive other employee benefits established for ouremployees. Mr. Bauch is subject to non-competition, confidentiality andinvention assignment requirements under his employment agreement. 

 

48

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If Mr. Bauch’s employment is terminated for reasons other than fordeath, disability or cause, he is entitled to receive his base salary for90 days from the date of termination. The happening of any of thefollowing events permits Mr. Bauch to terminate his agreement with us andentitles him to receive payment of his base salary for 90 days after hisagreement is terminated: our filing for bankruptcy protection, the sale ofsubstantially all of our assets or our liquidation, a material change in hisduties without his consent, his removal as a member of our Board of Directors.If Mr. Bauch’s employment is terminated due to his death or disability, heand his dependents are entitled to receive his base salary and health andmedical benefits through the date of his termination, reduced by any life ordisability insurance benefits paid to him or his estate under policies forwhich we paid the premiums. 

 

**ITEM 11.****  SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

**SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

The following table sets forth certain information as of March 25,2005 regarding the beneficial ownership of our common stock by: 

 

•                                          each person orentity known by us to own beneficially more than 5%, in the aggregate, of ouroutstanding common stock; 

 

•                                          each of ourexecutive officers; 

 

•                                          each of ourdirectors; and 

 

•                                          all of ourcurrent directors and executive officers as a group. 

 

Except as otherwise indicated, each person named in the table has solevoting and investment power with respect to all of the shares of our commonstock beneficially owned by them. Except as otherwise indicated, the addressfor each shareholder is c/o HyperSpace Communications, Inc.,8480 East Orchard Road, Suite 6600, Greenwood Village, Colorado 80111.

 

Beneficial ownership is determined in accordance with Rule 13d-3under the Securities Exchange Act of 1934. In computing the number of sharesbeneficially owned by a person or a group and the percentage ownership of thatperson or group, shares of our common stock subject to options or warrantscurrently exercisable or exercisable within 60 days after the date of thisprospectus are deemed outstanding, but are not deemed outstanding for thepurpose of computing the percentage ownership of any other person. As of March 25,2005, we had 3,732,429 shares of common stock outstanding.

 
| **Name  and Address of Beneficial Owner**                                  | ** ** | **Amount and  Nature of  Beneficial  Ownership** | ** ** | **Percentage of  Class** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                 |       |                                             |       |                     |       |
| **Executive Officers and Directors**                                       |       |                                             |       |                     |       |
| John P. Yeros (1)                                                          |       | 826,320                                          |       | 21.85                    |       |
| Mark J. Endry (2)                                                          |       | 209,141                                          |       | 5.32                     |       |
| Mark A. Pougnet (3)                                                        |       | 70,198                                           |       | 1.85                     |       |
| Patricia M. Lee (4)                                                        |       | 28,571                                           |       |                     | *          |
| Michael P. Lynch (5)                                                       |       | 43,857                                           |       | 1.16                     |       |
| David J. Bauch (6)                                                         |       | 40,357                                           |       | 1.07                     |       |
| Rina Singer Delmonico (7)                                                  |       | 7,143                                            |       |                     | *          |
| Lawrence D. Firestone (8)                                                  |       | 10,000                                           |       |                     | *          |
| David E. Girard (9)                                                        |       | 79,055                                           |       | 2.08                     |       |
| James M. Gumina (10)                                                       |       | 103,571                                          |       | 2.72                     |       |
| Eric D. Murphy (11)                                                        |       | 17,857                                           |       |                     | *          |
| Kent Swanson (12)                                                          |       | 223,210                                          |       | 5.87                     |       |
| All directors and current executive  officers as a group (12 persons) (13) |       | 1,659,281                                        |       | 43.61                    |       |

 

49

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*                               Less than 1% 

 

(1)Includes 7,143 sharesheld by James Yeros, Mr. Yeros’ brother, 7,143 shares held by WilliamYeros, Mr. Yeros’ brother and 7,143 shares held jointly by Vali Jones andJohn Yeros, Mr. Yeros’ sister and father, respectively. Mr. Yerosdisclaims beneficial ownership of any shares held by his siblings and hisfather. Includes warrants to purchase 50,000 shares of commonstock exercisable within 60 days of February 28, 2005.

 

(2)Includesoptions to purchase 150,000 shares of common stock exercisable within60 days of February 28, 2005, and warrants to purchase 50,000 sharesof common stock exercisable within 60 days of February 28, 2005. 

 

(3)Includesoptions to purchase 65,714 shares of common stock exercisable within60 days of February 28, 2005. 

 

(4)Includesoptions to purchase 28,571 shares of common stock exercisable within60 days of February 28, 2005. 

 

(5)Includesoptions to purchase 33,143 shares of common stock exercisable within60 days of February 28, 2005. 

 

(6)Representsoptions to purchase 40,357 shares of common stock exercisable within60 days of February 28, 2005.

 

(7)Representsoptions to purchase 7,143 shares of common stock exercisable within 60 days of February 28,2005. 

 

(8)Representsoptions to purchase 10,000 shares of common stock exercisable within 60 days ofFebruary 28, 2005.

 

(9)Includesoptions to purchase 14,286 shares of common stock exercisable within60 days of February 28, 2005, and warrants to purchase 50,000 sharesof common stock exercisable within 60 days of February 28, 2005. 

 

(10)Includesoptions to purchase 82,142 shares of common stock exercisable within60 days of February 28, 2005.

 

(11)Includesoptions to purchase 14,286 shares of common stock exercisable within60 days of February 28, 2005.

 

(12)Includes110,000 shares of common stock held by BlueStreak 4 LLC, an entity controlledby Mr. Swanson, options to purchase 16,071 shares of common stockexercisable within 60 days of February 28, 2005, and warrants topurchase 52,357 shares of common stock exercisable within 60 days of February 28,2005.

 

(13)Includesoptions to purchase 307,071 shares of common stock exercisable within60 days of February 28, 2005, and warrants to purchase 202,357 sharesof common stock exercisable within 60 days of February 28, 2005.

 

**Securities Authorized For Issuance Under Equity CompensationPlan.**

 

*HyperSpace 2001 Equity IncentivePlan.*  In February 2001,our Board of Directors adopted,

 

50

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and our shareholders ratified, the HyperSpace 2001 Equity InventivePlan, reserving 1,071,429 shares of common stock (subsequently reserving anadditional 357,143 shares), subject to adjustment for dividends and othercapital stock changes, for issuance under the 2001 Equity Incentive Plan. Weamended the 2001 Equity Incentive Plan in July of 2004 to provide that nomore than 871,619 options or warrants may be issued under the 2001 EquityIncentive Plan. As of March 25, 2005, there are 820,823 optionsoutstanding under the 2001 Equity Incentive Plan. 

 

*HyperSpace 2004 Equity IncentivePlan.*  In July of2004, our Board of Directors adopted, and our shareholders ratified, theHyperSpace 2004 Equity Inventive Plan, reserving an additional 700,000 sharesof common stock, subject to adjustment for dividends and other capital stockchanges, for issuance under the 2004 Equity Incentive Plan. Under the 2004Equity Incentive Plan the Board of Directors, or a committee thereof appointed toadminister the 2004 Equity Incentive Plan, is authorized to issue options (bothtax qualified and non-qualified) or restricted stock awards to directors,officers, employees, and consultants in order to attract, retain, and motivatepersons believed to be necessary to promote our growth and profitability. 

 

Under the 2004 Equity Incentive Plan the Board of Directors, or thecommittee thereof appointed to administer the plan, has the full power,authority, and discretion to select the directors, officers, employees, andconsultants who will participate in the 2004 Equity Incentive Plan, determinethe type (option or restricted stock grant) of awards and amount awards to begranted to participants in the 2004 Equity Incentive Plan, to set the vesting schedule andother terms and conditions of such awards, and to establish, amend, waive ormodify rules for the administration of the 2004 Equity IncentivePlan.  As of March 25, 2005, thereare no options or awards of restricted stock outstanding under the 2004 EquityIncentive Plan. 

 

**EQUITYCOMPENSATION PLAN INFORMATION**

** **

We currentlymaintain two compensation plans that provide for the issuance of our CommonStock to officers and other employees, directors and consultants.  These consist of the HyperSpace 2001 EquityIncentive Plan and the HyperSpace 2004 Equity Incentive Plan, each of whichhave been approved by our shareholders. ** **The following table sets forthinformation regarding outstanding options and shares reserved for futureissuance under the foregoing plans as of December 31, 2004: 

 
| ** **                                              | ** ** | **(a)**                                                                                                 | ** ** | **(b)**                                                                                 | ** ** | **(c)**                                                                                                                                                     | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan  Category**                                      | ** ** | **Number of  securities to  be issued  upon  exercise of  outstanding  options,  warrants and  rights** | ** ** | **Weighted-  average  exercise  price of  outstanding  options,  warrants  and rights** | ** ** | **Number of  securities  remaining  available for  future  issuance  under equity  compensation  plans  (excluding  securities  reflected in  column (a))** | ** ** |
| Equity compensation plans approved by  shareholders:    |       |                                                                                                    |       |                                                                                    |       |                                                                                                                                                        |       |
| 2001 Equity Incentive Plan                              |       | 658,821                                                                                                 |       | $                                                                                       | 3.82       |                                                                                                                                                        | 212,798    |   |
| 2004 Equity Incentive Plan                              |       | —                                                                                                  |       | —                                                                                  |       | 700,000                                                                                                                                                     |       |
|                                                    |       |                                                                                                    |       |                                                                                    |       |                                                                                                                                                        |       |
| Equity compensation plans not approved by  shareholders |       | —                                                                                                  |       | —                                                                                  |       | —                                                                                                                                                      |       |
|                                                    |       |                                                                                                    |       |                                                                                    |       |                                                                                                                                                        |       |
| Total                                                   |       | 658,821                                                                                                 |       | $                                                                                       | 3.82       |                                                                                                                                                        | 912,798    |   |

 

51

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**ITEM 12.****  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

In October of 2003, our founder and Chairman, John P. Yeros,purchased $200,000 worth of our series A preferred stock at a purchaseprice of $4.375 per share, or 45,714 series A preferred shares, at thesame price, and on the same terms as all other series A participants. Inaddition, Mr. Yeros made additional loans to us.  Prior to our initial public offering, Mr. Yerosconverted $75,000 of his loan balance into common stock at $3.50 pershare.  As of December 31, 2004, weowed Mr. Yeros $57,338 in principal and accrued interest on thisloan.   

 

In 2002, BlueStreak 4 LLC, an entity controlled by Kent Swanson, one ofour directors, purchased 110,000 shares of our common stock in a privateoffering at a purchase price of $3.50 per share, at the same price, and on thesame terms as all other participants in the private offering. In May of2003, Mr. Swanson purchased $50,000 worth of convertible notes andwarrants in our 2002-2003 bridge note and warrant purchase offering toaccredited investors, at the same price, and on the same terms as all of theother participants in the bridge note and warrant offering, which notes areconvertible into shares of our common stock at a price of $3.50 per share, with1,786 warrants exercisable at $3.85 per share. In October 2003, Mr. Swansonpurchased $50,000 worth of our series A preferredstock at a purchase price of $4.375 per share, or 11,429 series Apreferred shares, at the same price, and on the same terms as all otherseries A participants. In February and April of 2004, Mr. Swansonpurchased $55,000 worth of convertible notes and warrants in our 2004bridge note and warrant purchase offering to accredited investors, at the sameprice, and on the same terms as all of the other participants in the bridgenote and warrant offering, which notes are convertible into shares of ourcommon stock at a price of $4.375 per share, with 4,125 warrants exercisable at$4.375 per share. In April 2004, Mr. Swanson agreed to convert thisbridge note into common stock prior to this offering. In return, we granted Mr. Swanson4,125 additional warrants and lowered the conversion price of all of Mr. Swanson’swarrants to $3.50 per share. 

 

In August of 2004, to supply to us additional bridge financing, (i) JohnYeros, our founder and Chairman, (ii) Mark Endry, our President, CEO and adirector, (iii) Kent Swanson, a director, and (iv) David Girard, adirector, each purchased from the Company $100,000 worth of unsecuredpromissory notes, bearing interest at 12% per annum, due and payable within180 days, together with 50,000 warrants to purchase common stock at anexercise price of $4.46 per share, expiring August 2009, for an aggregateinvestment of $400,000 and the issuance of an aggregate of 200,000 warrants,exercisable until August 2009, at an exercise price of $4.46 pershare.  We repaid these bridge loans plusall accrued interest in full in October 2004.

 

We have incurred fees to Bathgate Capital Partners, a registeredbroker-dealer, for raising debt and equity for us. Steve Bathgate controlsBathgate Capital Partners and is a former director of our company. Mr. Bathgateresigned his board position in January 2004. We paid the following amountsto Bathgate Capital Partners in 2002—$32,000 in cash and $22,000 by issuingstock; in 2003—$8,000 in cash, 25,643 warrants (exercise price of $3.50 eachand expiring February 12, 2008) and $35,000 by issuing stock; and in 2004,$62,000 in cash, 13,286 warrants in March 2004 (exercise price of $4.38each and expiring March 31, 2009) and 1,786 warrants in April 2004(exercise price of $4.38 per share and expiring April 5, 2009). We paid noother compensation to Bathgate Capital Partners or Mr. Bathgate

 

52

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for theseservices. Since inception, we have used other non-related organizations toperform similar services, on terms and conditions substantially similar tothose in the Bathgate Capital Partners arrangements. Accordingly, we believethat our relationship with Bathgate Capital Partners has been conducted onterms and conditions which are substantially similar to those otherarrangements.  In November 2004 weretained Bathgate Capital Partners to perform certain investment bankingservices for four months.  For suchservices, we pay Bathgate Capital Partners $10,000 per month plus a contingentfee based on certain formulas if we acquire a company based on theirinvolvement.  

 

We have entered into indemnification agreements with each of ourdirectors and officers and certain other employees that may, in some cases, bebroader than the specific indemnification provisions contained in the ColoradoBusiness Corporation Act.  Theindemnification agreements may require us, among other things, to indemnify thedirectors and officers against certain liabilities, other than liabilitiesarising from willful misconduct of a culpable nature, that may arise by reasonof their status or service as directors or officers.  These agreements also may require us toadvance the expenses incurred by the directors and officers as a result of anyproceeding against them as to which they could be indemnified.  We have a directors’ and officers’ insurancepolicy to cover our obligations under these agreements. 

 

All future transactions between HyperSpace and its officers, directors,principal shareholders and affiliates will be approved by a majority of theindependent and disinterested members of the Board of Directors, and will be onterms no less favorable to the Company than could be obtained from unaffiliatedthird parties. 

 

**ITEM 13.****  EXHIBITS**

 
| **Exhibit**** ****No.** | ** ** | **Document Description**                                                                                                                                                           |
|------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                   | ** ** | ** **                                                                                                                                                                         |
| 2.1                          |       | Agreement  and Plan of Merger, dated as of March 20, 2005 by and among the  Registrant, Spud Acquisition Corp., GTG PC Holdings, LLC and GTG-Micron  Holding Company, LLC (1) |
|                         |       |                                                                                                                                                                               |
| 3.1                          |       | Amended and  Restated Articles of Incorporation of the Registrant (2)                                                                                                              |
|                         |       |                                                                                                                                                                               |
| 3.2                          |       | Bylaws of  the Registrant (3)                                                                                                                                                      |
|                         |       |                                                                                                                                                                               |
| 4.1                          |       | Specimen  unit certificate (4)                                                                                                                                                     |
|                         |       |                                                                                                                                                                               |
| 4.2                          |       | Specimen  common stock certificate(3)                                                                                                                                              |
|                         |       |                                                                                                                                                                               |
| 4.3                          |       | 2001 Equity  Incentive Plan(3)                                                                                                                                                     |
|                         |       |                                                                                                                                                                               |
| 4.4                          |       | 2004 Equity  Incentive Plan (5)                                                                                                                                                    |

 

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| 4.5    |   | Form of  Lock-up Agreement for officers and directors (5)                                                                                                                                                                                                                       |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                            |
| 4.6    |   | Form of  Lock-up Agreement for certain shareholders (5)                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                            |
| 4.7    |   | Form of  representatives’ option for purchase of units (6)                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                            |
| 4.8    |   | Form of  Warrant Agreement (6)                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                            |
| 4.9    |   | Form of  Warrant (4)                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                            |
| 4.10   |   | Irrevocable  Proxy and Voting Agreement, dated as of March 20, 2005, by and among GTG PC  Holdings, LLC, GTG-Micron Holding Company, LLC and each of John P. Yeros,  Mark J. Endry, Mark A. Pougnet, David E. Girard, James M. Gumina, Kent  Swanson and BlueStreak 4, LLC. (1) |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.1   |   | Form of  Software License Agreement (3)                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.2   |   | Form of  Software License Agreement—HyperTunnel Subscription (3)                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.3   |   | Form of  Software License Agreement—HyperWeb Subscription (3)                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.4   |   | Founders  Employment Agreement with John P. Yeros (3)                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.5   |   | Executive  Employment Agreement with Mark J. Endry (3)                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.6   |   | Amended and  Restated Employment Agreement with David J. Bauch (3)                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.7   |   | Overture  (Yahoo!) Click Through Agreement (3)                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.8   |   | Google Click  Through Agreement (3)                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.9   |   | Form Bridge  Note and Warrant Purchase Agreement (2002-2003) (3)                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.10  |   | Form Bridge  Note 2004 (3)                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.11  |   | Form Bridge  Warrant 2004 (3)                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.12  |   | Form Peats  Note and Warrant 2004 (3)                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.13  |   | Form Yeros  Note (3)                                                                                                                                                                                                                                                            |

 

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| 10.14  |   | Amended and  Restated Founders Employment Agreement with John P. Yeros (7)                                              |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                         |
| 10.15  |   | Form of 2003  (Yeros) Line of Credit (3)                                                                                     |
|   |   |                                                                                                                         |
| 10.16  |   | Letter  Amendment to Founders Employment Agreement (3)                                                                       |
|   |   |                                                                                                                         |
| 10.17  |   | Sales Agent  Agreement with Simentra Limited (2)                                                                             |
|   |   |                                                                                                                         |
| 10.18  |   | Reseller  Agreement, dated effective as of March 20, 2005, between the Registrant and  MPC Computers, LLC. (1)               |
|   |   |                                                                                                                         |
| 31.1*  |   | Certification  of Chief Executive Officer of the Registrant pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002  |
|   |   |                                                                                                                         |
| 31.2*  |   | Certification  of Chief Financial Officer of the Registrant pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002  |
|   |   |                                                                                                                         |
| 31.3*  |   | Certification  of Chairman of the Registrant pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                 |
|   |   |                                                                                                                         |
| 32.1*  |   | *Certification  of Chief Executive Officer of the Registrant pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                         |
| 32.2*  |   | Certification  of Chief Financial Officer of the Registrant pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002  |
|   |   |                                                                                                                         |
| 32.3*  |   | Certification  of Chairman of the Registrant pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                 |

 

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*              Filed herewith

 

(1)           Incorporated byreference to Exhibit Nos. 2.1, 99.1 and 99.2, respectively, to the Registrant’sCurrent Report on Form 8-K/A, filed with the Securities and Exchange Commissionon March 20, 2005.

 

(2)           Incorporated byreference to Exhibit Nos. 3.1 and 10.17, respectively, to Amendment No. 4 tothe Registrant’s Registration Statement on Form SB-2, filed with the Securitiesand Exchange Commission on August 6, 2004.

 

(3)           Incorporated byreference to Exhibit Nos. 3.2, 4.2, 4.3, 10.1, 10.2, 10.3, 10.4, 10.5, 10.6,10.7, 10.8, 10.9, 10.10, 10.11, 10.12, 10.13, 10.15 and 10.16, respectively, toAmendment No. 1 to the Registrant’s Registration Statement on Form SB-2, filedwith the Securities and Exchange Commission on July 2, 2004.

 

(4)           Incorporated byreference to Exhibit Nos. 4.1 and 4.9, respectively, to Amendment No. 7 to theRegistrant’s Registration Statement on Form SB-2, filed with the Securities andExchange Commission on September 24, 2004.

 

(5)           Incorporated byreference to Exhibit Nos. 4.4, 4.5, and 4.6, respectively, to Amendment No. 3to the Registrant’s Registration Statement on Form SB-2, filed with theSecurities and Exchange Commission on July 23, 2004.

 

(6)           Incorporated byreference to Exhibit Nos. 4.7 and 4.8, respectively, to Post-EffectiveAmendment No. 1 to the Registrant’s Registration Statement on Form SB-2, filedwith the Securities and Exchange Commission on October 1, 2004.

 

(7)           Incorporated byreference to Exhibit No. 10.14 to Post-Effective Amendment No. 2 to theRegistrant’s Registration Statement on Form SB-2, filed with the Securities andExchange Commission on December 28, 2004.

 

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**ITEM 14.****  PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

The firm ofEhrhardt Keefe Steiner & Hottman PC currently serves as ourindependent accountants, and that firm conducted the audit of our accounts forfiscal year 2004.  The Audit andCorporate Governance Committee has appointed Ehrhardt Keefe Steiner &Hottman to serve as independent accountants from September 30, 2004 to September 30,2005 to conduct an audit of our accounts. Representatives of EhrhardtKeefe Steiner & Hottman PC areexpected to be present at the Annual Meeting. They will have the opportunity to make a statement if they desire to doso and are expected to be available to respond to appropriate questions.

 

**Independent Auditor Fees**

 

The aggregate fees billedfor professional services rendered by Ehrhardt Keefe Steiner & HottmanPC for fiscal years 2004 and 2003 are as follows:

 
| ** **           | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------|------------|----------|------------|----------|------------|
| Audit Fees (1)       |       | $        | 39,601     |     | $          | 24,050 |   |
| IPO Related Fees (2) |       | $        | 187,129    |     | $          | — |   |
| Other Fees (3)       |       | $        | —     |     | $          | 3,000 |   |
| Total Fees           |       | $        | 226,730    |     | $          | 27,055 |   |

 

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(1)Audit fees includefees for the audit of our annual financial statements and a, review of ourthird quarter 2004 financial statements

 

 

56

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(2)Includesconsents and other services related to our initial public offering and filingswith the SEC.  In 2003 there wereno such services.

 

(3)Theamount paid in 2003, prior to our initial public offering, was formiscellaneous financial consulting services. In November 2004, the Company retained Deloitte & ToucheLLP to provide tax services.  Ehrhardt Keefe Steiner & HottmanPC provides no tax services and Deloitte & Touche LLP provides noaudit services.

 

**The Auditand Corporate Governance Committee has determined that all services performedby Ehrhardt Keefe Steiner & Hottman PC are compatible with maintainingthe independence of Ehrhardt Keefe Steiner & Hottman PC.**

 

**Audit and Corporate Governance Committee Pre-ApprovalPolicy**

 

The Audit andCorporate Governance Committee has adopted a policy for the pre-approval of allaudit and non-audit services provided by our independent accountants.  The policy is designed to ensure that theprovision of these services does not impair the accountants’ independence.  Under the policy, any services provided bythe independent accountants, including audit, audit-related, tax and otherservices, must be specifically pre-approved by the Audit and CorporateGovernance Committee.

 

The Audit andCorporate Governance Committee may delegate pre-approval authority to one ormore of its members.  The member ormembers to whom such authority is delegated are required to report anypre-approval decisions to the Audit and Corporate Governance Committee at itsnext scheduled meeting.  The Audit andCorporate Governance Committee does not delegate responsibilities topre-approve services performed by the independent accountants to management.

 

For 2004, allaudit and non-audit services provided by our independent accountants werepre-approved.

 

 

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**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the Exchange Act, theregistrant caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|                      | HyperSpace Communications, Inc.  |
|---------------------------|---------------------------------------|
|                      |                                  |
|                      |                                  |
| Date: March 31, 2005 | /s/ Mark J. Endry                     |   |
|                      | Mark J. Endry                         |
|                      | President and Chief Executive Officer |

 

In accordance with the Exchange Act, thisreport has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| **Signature**              | ** ** | **Title**                      | ** **                      | **Date**            |
|----------------------------|------------|--------------------------------|---------------------------------|---------------------|
| ** **                 | ** ** | ** **                     | ** **                      | ** **          |
|                       |       | Chief Executive Officer,       |                            | March 31, 2005 |
| /s/ Mark J. Endry          |       |                           | President and Director          |                |   |
| Mark J. Endry              |       | (Principal Executive  Officer) |                            |                |
|                       |       |                           |                            |                |
|                       |       |                           |                            |                |
|                       |       | Chief Financial Officer,       |                            | March 31, 2005 |
| /s/ Mark A. Pougnet        |       |                           | Treasurer &  Secretary |                |   |
| Mark A. Pougnet            |       | (Principal Financial  Officer  |                            |                |
|                       |       | and Accounting Officer)        |                            |                |
|                       |       |                           |                            |                |
| /s/ John P. Yeros          |       |                           | Chairman of the Board           |                | March 31, 2005 |
| John P. Yeros              |       |                           |                            |                |
| ** **                 | ** ** | ** **                     | ** **                      | ** **          |
| /s/ Rina Singer  Delmonico |       |                           | Director                        |                | March 31, 2005 |
| Rina Singer Delmonico      |       |                           |                            |                |
|                       |       |                           |                            |                |
| /s/ Lawrence D.  Firestone |       |                           | Director                        |                | March 31, 2005 |
| Lawrence D. Firestone      |       |                           |                            |                |
|                       |       |                           |                            |                |
| /s/ David E. Girard        |       |                           | Director                        |                | March 31, 2005 |
| David E. Girard            |       |                           |                            |                |
|                       |       |                           |                            |                |
| /s/ James M. Gumina        |       |                           | Director                        |                | March 31, 2005 |
| James M. Gumina            |       |                           |                            |                |
|                       |       |                           |                            |                |
| /s/ Eric D. Murphy         |       |                           | Director                        |                | March 31, 2005 |
| Eric D. Murphy             |       |                           |                            |                |
|                       |       |                           |                            |                |
| /s/ Kent Swanson           |       |                           | Director                        |                | March 31, 2005 |
| Kent Swanson               |       |                           |                            |                |
|                            |            |                                |                                 |                     |  |  |  |

 

 

58

----

 

**Index to Financial Statements**

** **
| Independent Auditors’ Report                                                                             |   |
|---------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                          |   |
| Financial Statements                                                                                          |   |
|                                                                                                          |   |
| Balance Sheets as of December 31, 2004  and December 31, 2003                                       |   |
|                                                                                                          |   |
| Statement  of Operations for Years Ended December 31, 2004 and 2003                                      |   |
|                                                                                                          |   |
| Statement  of Changes in Shareholders’ Capital for the Years Ended  December 31, 2004 and 2003 |   |
|                                                                                                          |   |
| Statements of Cash Flows for the Years Ended December 31, 2004  and 2003                                 |   |
|                                                                                                          |   |
| Notes to Financial Statements                                                                                 |   |

 

1

----

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Board of Directors and Shareholders

HyperSpace Communications, Inc.

Greenwood Village, Colorado

 

We have audited the accompanying balance sheets of HyperSpaceCommunications, Inc. as of December 31, 2004 and 2003, and therelated statements of operations, changes in shareholders’ equity/ (deficit)and cash flows for the years ended December 31, 2004 and 2003. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We have conducted our audits in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of HyperSpaceCommunications, Inc. as of December 31, 2004 and 2003, and theresults of its operations and its cash flows for the years ended December 31,2004 and 2003 in conformity with U.S. generally accepted accounting principles.

 
|   | /s/ Ehrhardt Keefe Steiner &  Hottman PC |   |
|--------|---------------------------------------------------|--------|

 

January 21, 2005

Denver, Colorado

 

2

----

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Balance Sheets**

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | **December 31,  2004** | ** **     | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|----------------|-----------------------------|------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                        |           |                        |       |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                                                                            |       |                        |           |                        |       |
| **Current Assets**                                                                                                                                                                                                                                                                                                                                                                                                    |       |                        |           |                        |       |
| **Cash and Cash Equivalents**                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **$**                       | **5,875,481**  | ** **                  | **$**      | **27,429** | ** ** |
| **Accounts Receivable**                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **$**                       | **158,998**    | ** **                  | **$**      | **291,913** | ** ** |
| **Other Current Assets**                                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **$**                       | **106,182**    | ** **                  | **$**      | **13,361** | ** ** |
| **Total Current Assets**                                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **$**                       | **6,140,661**  | ** **                  | **$**      | **332,703** | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | ** **                  | ** **     | ** **                  | ** ** |
| **Non-Current Assets**                                                                                                                                                                                                                                                                                                                                                                                                | ** ** | ** **                  | ** **     | ** **                  | ** ** |
| **Property & Equipment, net**                                                                                                                                                                                                                                                                                                                                                                                | ** ** | **$**                       | **110,782**    | ** **                  | **$**      | **127,806** | ** ** |
| **Capitalized software, net of accumulated  amortization of $593,121 and $471,157**                                                                                                                                                                                                                                                                                                                                   | ** ** | **$**                       | **298,570**    | ** **                  | **$**      | **420,536** | ** ** |
| **Intangible Asset, at cost**                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **$**                       | **—**     | ** **                  | **$**      | **31,530** | ** ** |
| **Total Non-Current Assets**                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **$**                       | **409,352**    | ** **                  | **$**      | **579,872** | ** ** |
| **TOTAL ASSETS**                                                                                                                                                                                                                                                                                                                                                                                                      | ** ** | **$**                       | **6,550,013**  | ** **                  | **$**      | **912,575** | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | ** **                  | ** **     | ** **                  | ** ** |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY/(DEFICIT)**                                                                                                                                                                                                                                                                                                                                                              | ** ** | ** **                  | ** **     | ** **                  | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | ** **                  | ** **     | ** **                  | ** ** |
| **Current Liabilities**                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | ** **                  | ** **     | ** **                  | ** ** |
| **Accounts Payable**                                                                                                                                                                                                                                                                                                                                                                                                  | ** ** | **$**                       | **230,484**    | ** **                  | **$**      | **220,993** | ** ** |
| **Accrued Compensation**                                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **$**                       | **83,522**     | ** **                  | **$**      | **103,611** | ** ** |
| **Deferred Revenue**                                                                                                                                                                                                                                                                                                                                                                                                  | ** ** | **$**                       | **122,016**    | ** **                  | **$**      | **152,089** | ** ** |
| **Note Payable to Founder**                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **$**                       | **57,338**     | ** **                  | **$**      | **128,272** | ** ** |
| **Current Portion of Notes Payable &  Debt**                                                                                                                                                                                                                                                                                                                                                                 | ** ** | **$**                       | **664,627**    | ** **                  | **$**      | **1,127,570** | ** ** |
| **Total Current Liabilities**                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **$**                       | **1,157,987**  | ** **                  | **$**      | **1,732,535** | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | ** **                  | ** **     | ** **                  | ** ** |
| **Long Term Liabilities**                                                                                                                                                                                                                                                                                                                                                                                             | ** ** | ** **                  | ** **     | ** **                  | ** ** |
| **Long term Portion of Notes Payable**                                                                                                                                                                                                                                                                                                                                                                                | ** ** | **$**                       | **425,000**    | ** **                  | **$**      | **—** | ** ** |
| **Total Long Term Liabilities**                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **$**                       | **425,000**    | ** **                  | **$**      | **—** | ** ** |
| **Total Liabilities**                                                                                                                                                                                                                                                                                                                                                                                                 | ** ** | **$**                       | **1,582,987**  | ** **                  | **$**      | **1,732,535** | ** ** |
|                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                        |           |                        |       |
| **Commitments & Contingencies**                                                                                                                                                                                                                                                                                                                                                                              |       |                        |           |                        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                        |           |                        |       |
| **Shareholders’ Equity/(Deficit)**                                                                                                                                                                                                                                                                                                                                                                               |       |                        |           |                        |       |
| **Series A Convertible Preferred Stock,  no par value; convertible to common stock at original issuance price, plus  cumulative dividends of 10% per annum; limited to the first 5 years following  issuance; liquidation preference of $941,753 (2003); all converted at the  initial public offering; 1,000,000 authorized; all converted to equity (2004)  and 211,714 (2003) shares issued and outstanding** | ** ** | **$**                       | **—**     | ** **                  | **$**      | **926,250** | ** ** |
| **Common Stock, no par value, 15,000,000  shares authorized; 3,732,429 and 1,378,541 shares issued and outstanding at  2004 and 2003, respectively**                                                                                                                                                                                                                                                                  | ** ** | **$**                       | **12,087,134** | ** **                  | **$**      | **2,180,555** | ** ** |
| **Accumulated Deficit**                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **$**                       | **(7,120,108** | **)**                       | **$**      | **(3,926,765** | **)** |
| **Total Shareholders’ Equity/(Deficit)**                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **$**                       | **4,967,026**  | ** **                  | **$**      | **(819,960** | **)** |
| **TOTAL LIABILITIES AND EQUITY**                                                                                                                                                                                                                                                                                                                                                                                      | ** ** | **$**                       | **6,550,013**  | ** **                  | **$**      | **912,575** | ** ** |

 

See notes to financial statements.

 

3

----

 

**HYPERSPACE COMMUNICATIONS, INC.**

** **

**Statement of Operations for the years ended December 31,**

 
| ** **                                                        | ** ** | **2004**      | ** **     | **2003**      | ** ** |
|-------------------------------------------------------------------|------------|---------------|----------------|---------------|------------|
| **Revenues**                                                      | ** ** | ** **    | ** **     | ** **    | ** ** |
| **License Fees**                                                  | ** ** | **$**         | **237,109**    | ** **    | **$**      | **787,541** | ** ** |
| **Service & Other**                                      | ** ** | **$**         | **220,741**    | ** **    | **$**      | **195,678** | ** ** |
| **Total Revenues**                                                | ** ** | **$**         | **457,850**    | ** **    | **$**      | **983,219** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Cost of Revenue**                                               | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Amortization of Capitalized Software**                          | ** ** | **$**         | **121,965**    | ** **    | **$**      | **405,194** | ** ** |
| **Customer Support**                                              | ** ** | **$**         | **163,992**    | ** **    | **$**      | **268,012** | ** ** |
| **Total Cost of revenue**                                         | ** ** | **$**         | **285,957**    | ** **    | **$**      | **673,206** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Gross Profit**                                                  | ** ** | **$**         | **171,893**    | ** **    | **$**      | **310,013** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Operating Expenses**                                            | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Research & Development**                               | ** ** | **$**         | **617,949**    | ** **    | **$**      | **150,831** | ** ** |
| **Impairment of Intangibles**                                     | ** ** | **$**         | **31,530**     | ** **    | **$**      | **85,296** | ** ** |
| **Sales & Marketing**                                    | ** ** | **$**         | **786,045**    | ** **    | **$**      | **645,589** | ** ** |
| **General & Administrative**                             | ** ** | **$**         | **1,470,375**  | ** **    | **$**      | **923,087** | ** ** |
| **Total Operating Expenses**                                      | ** ** | **$**         | **2,905,899**  | ** **    | **$**      | **1,804,803** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Loss from Operations**                                          | ** ** | **$**         | **(2,734,006** | **)**         | **$**      | **(1,494,790** | **)** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Other (Income)/Expense**                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Interest Expense, net**                                         | ** ** | **$**         | **822,748**    | ** **    | **$**      | **345,395** | ** ** |
| **Other Expenses**                                                | ** ** | **$**         | **5,099**      | ** **    | **$**      | **(1,276** | **)** |
| **Gain on Settlement**                                            | ** ** | **$**         | **(440,999**   | **)**         | **$**      | **—** | ** ** |
| **Total Other (Income)/Expense**                                  | ** ** | **$**         | **386,848**    | ** **    | **$**      | **344,119** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Net Loss**                                                      | ** ** | **$**         | **(3,120,854** | **)**         | **$**      | **(1,838,909** | **)** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Preferred Dividends**                                           | ** ** | **$**         | **72,489**     | ** **    | **$**      | **15,503** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Net Loss attributable to Common  Shareholders**                 | ** ** | **$**         | **(3,193,343** | **)**         | **$**      | **(1,854,412** | **)** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Basic and diluted weighted average Common  Shares outstanding** | ** ** | **2,014,666** | ** **     | **1,300,721** | ** ** |
| ** **                                                        | ** ** | ** **    | ** **     | ** **    | ** ** |
| **Basic and diluted loss per Common Share**                       | ** ** | **$**         | **(1.59**      | **)**         | **$**      | **(1.42** | **)** |

 

See notes to financial statements.

 

4

----

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Statement of Changes in Shareholders’ Capital**

**For the Years Ended December 31, 2004and 2003**

 
| ** **                                                                                             | ** ** | ** **       | ** ** | ** **          | ** **     | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | **Total**            | ** **     |
|--------------------------------------------------------------------------------------------------------|------------|------------------|------------|---------------------|----------------|-----------------|--------------|------------------------|-------------|--------------|----------------|----------------------|----------------|
| ** **                                                                                             | ** ** | **Common Stock** | ** ** | **Preferred Stock** | ** **     | **Accumulated** | ** **   | **Shareholders’** | ** **  |
| ** **                                                                                             | ** ** | **Shares**       | ** ** | **Amount**          | ** **     | **Shares**      | ** **   | **Amount**             | ** **  | **Deficit**  | ** **     | **Equity (Deficit)** | ** **     |
| **Balance—December 31, 2002**                                                                | ** ** | **1,283,642**    | ** ** | **$**               | **1,501,967**  | ** **      | **0**        | ** **             | **$**       | **—**   | ** **     | **$**                | **(2,072,353** | **)** | **$** | **(570,386** | **)** |
| **Common stock issued in conversion of notes**                                                         | ** ** | **78,573**       | ** ** | **$**               | **275,000**    | ** **      | **—**   | ** **             | **—**  | ** **   | **—**     | ** **           | **$**          | **275,000** | ** ** |
| **Accretion of Series A preferred stock  dividends**                                              | ** ** | **—**       | ** ** | **—**          | ** **     | **—**      | ** **   | **—**             | ** **  | **$**        | **(15,503**    | **)**                | **$**          | **(15,503** | **)** |
| **Conversion preference on convertible debt**                                                          | ** ** | **—**       | ** ** | **$**               | **11,144**     | ** **      | **—**   | ** **             | **—**  | ** **   | **—**     | ** **           | **$**          | **11,144** | ** ** |
| **Debt warrants issuance**                                                                             | ** ** | **—**       | ** ** | **$**               | **66,319**     | ** **      | **—**   | ** **             | **—**  | ** **   | **—**     | ** **           | **$**          | **66,319** | ** ** |
| **Option to purchase shares granted Chairman  to CEO**                                                 | ** ** | **—**       | ** ** | **$**               | **112,500**    | ** **      | **—**   | ** **             | **—**  | ** **   | **—**     | ** **           | **$**          | **112,500** | ** ** |
| **Preferred stock issued for cash**                                                                    | ** ** | **—**       | ** ** | **—**          | ** **     | **80,286**      | ** **   | **$**                  | **351,250** | ** **   | **—**     | ** **           | **$**          | **351,250** | ** ** |
| **Preferred stock issued in conversion of  notes**                                                     | ** ** | **—**       | ** ** | **—**          | ** **     | **131,428**     | ** **   | **$**                  | **575,000** | ** **   | **—**     | ** **           | **$**          | **575,000** | ** ** |
| **Stock and stock options issued for services**                                                        | ** ** | **16,326**       | ** ** | **$**               | **74,312**     | ** **      | **—**   | ** **             | **—**  | ** **   | **—**     | ** **           | **$**          | **74,312** | ** ** |
| **Stock options issued to employees**                                                                  | ** ** | **—**       | ** ** | **$**               | **139,313**    | ** **      | **—**   | ** **             | **—**  | ** **   | **—**     | ** **           | **$**          | **139,313** | ** ** |
| **Net loss**                                                                                           | ** ** | **—**       | ** ** | **—**          | ** **     | **—**      | ** **   | **—**             | ** **  | **$**        | **(1,838,909** | **)**                | **$**          | **(1,838,909** | **)** |
| **Balance—December 31, 2003**                                                                | ** ** | **1,378,541**    | ** ** | **$**               | **2,180,555**  | ** **      | **211,714**  | ** **             | **$**       | **926,250**  | ** **     | **$**                | **(3,926,765** | **)** | **$** | **(819,960** | **)** |
| **Accretion of Series A preferred stock  dividends**                                              | ** ** | ** **       | ** ** | ** **          | ** **     | ** **      | ** **   | ** **             | ** **  | **$**        | **(72,489**    | **)**                | **$**          | **(72,489** | **)** |
| **Common stock issued in conversion of notes**                                                         | ** ** | **208,054**      | ** ** | **$**               | **728,202**    | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **728,202** | ** ** |
| **Conversion of a portion of a Loan from  Founder**                                                    | ** ** | **21,429**       | ** ** | **$**               | **75,000**     | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **75,000** | ** ** |
| **Conversion of all Preferred Stock and  Accrued Dividends**                                           | ** ** | **241,827**      | ** ** | **$**               | **1,057,993**  | ** **      | **(221,714** | **)**                  | **$**       | **(970,000** | **)**          | ** **           | ** **     | **$** | **87,993** | ** ** |
| **Conversion preference on convertible debt**                                                          | ** ** | ** **       | ** ** | **$**               | **82,863**     | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **82,863** | ** ** |
| **Debt warrants issuance**                                                                             | ** ** | ** **       | ** ** | **$**               | **286,673**    | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **286,673** | ** ** |
| **Debt warrants issued to induce conversion  and extend debt maturity**                                | ** ** | ** **       | ** ** | **$**               | **76,456**     | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **76,456** | ** ** |
| **Exercise of Warrants**                                                                               | ** ** | **48,451**       | ** ** | **$**               | **164,813**    | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **164,813** | ** ** |
| **IPO Costs**                                                                                          | ** ** | ** **       | ** ** | **$**               | **(2,809,284** | **)**           | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **(1,541,645** | **)** |
| **IPO Proceeds**                                                                                       | ** ** | **1,800,000**    | ** ** | **$**               | **9,900,000**  | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **8,632,361** | ** ** |
| **Options exercised**                                                                                  | ** ** | **19,540**       | ** ** | **$**               | **62,500**     | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **62,500** | ** ** |
| **Preferred stock issued for cash**                                                                    | ** ** | ** **       | ** ** | **$**               | **—**     | ** **      | **10,000**   | ** **             | **$**       | **43,750**   | ** **     | ** **           | ** **     | **$** | **43,750** | ** ** |
| **Reduction of conversion exercise price to  induce conversion to equity and to extend debt maturity** | ** ** | ** **       | ** ** | **$**               | **150,800**    | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **150,800** | ** ** |
| **Stock issued for deferred offering costs**                                                           | ** ** | **1,786**        | ** ** | **$**               | **8,125**      | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **8,125** | ** ** |
| **Stock issued for services**                                                                          | ** ** | **12,801**       | ** ** | **$**               | **55,700**     | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **55,700** | ** ** |
| **Stock options issued for Services**                                                                  | ** ** | ** **       | ** ** | **$**               | **39,406**     | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **39,406** | ** ** |
| **Stock options issued to employees**                                                                  | ** ** | ** **       | ** ** | **$**               | **27,332**     | ** **      | ** **   | ** **             | ** **  | ** **   | ** **     | ** **           | **$**          | **27,332** | ** ** |
| **Net Loss**                                                                                           | ** ** | ** **       | ** ** | ** **          | ** **     | ** **      | ** **   | ** **             | ** **  | **$**        | **(3,120,854** | **)**                | **$**          | **(3,120,854** | **)** |
| **Balance—December 31, 2004**                                                                | ** ** | **3,732,429**    | ** ** | **$**               | **12,087,134** | ** **      | **0**        | ** **             | **0**       | ** **   | **$**          | **(7,120,108**       | **)**          | **$** | **4,967,026** | ** ** |

 

See notes to financial statements.

 

5

----

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Statements of Cash Flows**

 
| ** **                                                                                                 | ** ** | **For the Years Ended   December 31,** | ** **     |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|----------------|
| ** **                                                                                                 | ** ** | **2004**                                    | ** **     | **2003** | ** ** |
| **OPERATING ACTIVITIES**                                                                                   |       |                                        |           |   |   |
| **Net Loss**                                                                                               | ** ** | **$**                                       | **(3,120,854** | **)** | **$** | **(1,838,909** | **)** |
| **Adjustments to reconcile net loss to net  cash used in operating activities**                            | ** ** | ** **                                  | ** **     | ** ** | ** ** |
| **Depreciation**                                                                                           | ** ** | **$**                                       | **69,150**     | ** ** | **$** | **90,177** | ** ** |
| **Amortization/impairment of capitalized  software**                                                       | ** ** | **$**                                       | **121,965**    | ** ** | **$** | **405,194** | ** ** |
| **Impairment of intangible assets**                                                                        | ** ** | **$**                                       | **31,530**     | ** ** | **$** | **85,296** | ** ** |
| **Settlement of liability for reduced amount**                                                             | ** ** | **$**                                       | **(440,999**   | **)** | **$** | **—** | ** ** |
| **Accrued interest included in settlement  payable**                                                       | ** ** | **$**                                       | **—**     | ** ** | **$** | **33,975** | ** ** |
| **Options issued to employees**                                                                            | ** ** | **$**                                       | **27,332**     | ** ** | **$** | **139,313** | ** ** |
| **Warrants issued for debt issue costs and  interest**                                                     | ** ** | **$**                                       | **242,429**    | ** ** | **$** | **9,163** | ** ** |
| **Conversion preference with debt**                                                                        | ** ** | **$**                                       | **82,862**     | ** ** | **$** | **11,144** | ** ** |
| **Options for services**                                                                                   | ** ** | **$**                                       | **39,406**     | ** ** | **$** | **17,171** | ** ** |
| **Stock for services**                                                                                     | ** ** | **$**                                       | **22,500**     | ** ** | **$** | **57,141** | ** ** |
| **Stock Issued to Employees**                                                                              | ** ** | **$**                                       | **33,200**     | ** ** | ** ** | ** ** |
| **Accrued interest included in notes payable**                                                             | ** ** | **$**                                       | **62,974**     | ** ** | **$** | **50,027** | ** ** |
| **Accretion of debt issue costs**                                                                          | ** ** | **$**                                       | **28,578**     | ** ** | **$** | **100,746** | ** ** |
| **Reduction of conversion price on debt to  induce conversion and maturity extension on convertible debt** | ** ** | **$**                                       | **150,800**    | ** ** | **$** | **—** | ** ** |
| **Warrants issued to induce conversion and  maturity extensions on convertible debt**                      | ** ** | **$**                                       | **76,454**     | ** ** | **$** | **—** | ** ** |
| **Options issued to officer from founder**                                                                 | ** ** | **$**                                       | **—**     | ** ** | **$** | **112,500** | ** ** |
| **Other Items**                                                                                            | ** ** | **$**                                       | **—**     | ** ** | **$** | **24,328** | ** ** |
| **Changes in Assets and Liabilities**                                                                      | ** ** | ** **                                  | ** **     | ** ** | ** ** |
| **Accounts Receivable**                                                                                    | ** ** | **$**                                       | **132,915**    | ** ** | **$** | **(22,863** | **)** |
| **Other Current Assets**                                                                                   | ** ** | **$**                                       | **(92,821**    | **)** | **$** | **(5,610** | **)** |
| **Accounts Payable**                                                                                       | ** ** | **$**                                       | **24,998**     | ** ** | **$** | **29,063** | ** ** |
| **Accrued Compensation**                                                                                   | ** ** | **$**                                       | **(20,090**    | **)** | **$** | **18,105** | ** ** |
| **Deferred Revenue**                                                                                       | ** ** | **$**                                       | **(30,073**    | **)** | **$** | **59,888** | ** ** |
| **Net Cash Used in Operating Activities**                                                                  | ** ** | **$**                                       | **(2,557,744** | **)** | **$** | **(624,151** | **)** |
| ** **                                                                                                 | ** ** | ** **                                  | ** **     | ** ** | ** ** |
| **INVESTING ACTIVITIES**                                                                                   | ** ** | ** **                                  | ** **     | ** ** | ** ** |
| **Purchase of Property and Equipment**                                                                     | ** ** | **$**                                       | **(52,126**    | **)** | **$** | **(7,014** | **)** |
| **Purchase of capitalized software**                                                                       | ** ** | **$**                                       | **—**     | ** ** | **$** | **(245,325** | **)** |
| **Net Cash Used in Investing Activities**                                                                  | ** ** | **$**                                       | **(52,126**    | **)** | **$** | **(252,339** | **)** |
| ** **                                                                                                 | ** ** | ** **                                  | ** **     | ** ** | ** ** |
| **FINANCING ACTIVITIES**                                                                                   | ** ** | ** **                                  | ** **     | ** ** | ** ** |
| **Proceeds from Line of Credit**                                                                           | ** ** | **$**                                       | **—**     | ** ** | **$** | **95,500** | ** ** |
| **Line of Credit Repaid**                                                                                  | ** ** | **$**                                       | **(95,500**    | **)** | **$** | **—** | ** ** |
| **Net Proceeds from Notes Payable**                                                                        | ** ** | **$**                                       | **1,650,000**  | ** ** | **$** | **406,000** | ** ** |
| **Payment of Note Payable**                                                                                | ** ** | **$**                                       | **(468,228**   | **)** | **$** | **—** | ** ** |
| **Net Proceeds from the Issuance of Preferred  Stock**                                                     | ** ** | **$**                                       | **43,750**     | ** ** | **$** | **351,250** | ** ** |
| **Warrants & Options exercised for  Cash**                                                        | ** ** | **$**                                       | **227,314**    | ** ** | **$** | **—** | ** ** |
| **RCI Settlement**                                                                                         | ** ** | **$**                                       | **(42,500**    | **)** | **$** | **—** | ** ** |
| **Net Proceeds from the IPO**                                                                              | ** ** | **$**                                       | **9,900,000**  | ** ** | **$** | **—** | ** ** |
| **IPO Cash Expenses**                                                                                      | ** ** | **$**                                       | **(2,756,914** | **)** | **$** | **—** | ** ** |
| **Net cash provided by financing activities**                                                              | ** ** | **$**                                       | **8,457,922**  | ** ** | **$** | **852,750** | ** ** |
| ** **                                                                                                 | ** ** | ** **                                  | ** **     | ** ** | ** ** |
| **Net cash increase for period**                                                                           | ** ** | **$**                                       | **5,848,052**  | ** ** | **$** | **(23,740** | **)** |
| **Cash at beginning of period**                                                                            | ** ** | **$**                                       | **27,429**     | ** ** | **$** | **51,169** | ** ** |
| **Cash at end of period**                                                                                  | ** ** | **$**                                       | **5,875,481**  | ** ** | **$** | **27,429** | ** ** |

 

See notes to financial statements.

 

6

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**HYPERSPACE COMMUNICATIONS, INC.**

**Statements of CashFlows**

 

Supplemental disclosure of cash flow information:

 

Cash paid for interest for the years ended December 31, 2004 and2003 was $199,750 and $126,284, respectively.

 

Nocash was paid for income taxes for the years ended December 31, 2004 and2003.

 

Supplemental disclosure of non-cash activity:

 

During the year ended December 31, 2004, $728,202 of notes payablewas converted to common stock and the Founder converted $75,000 of his Noteinto common stock, both at $3.50 per share.

 

During 2004 the Company raised gross proceeds from the IPO of$9,900,000. From this amount it paid   underwriters discount and expenses of $1,267,639 and paid other costs of$1,489,275.

 

During the year ended December 31, 2004 and 2003, the Companyaccrued dividends on preferred stock of $72,489 and $15,503.

 

In September 2004, the Company converted all of its outstandingPreferred Stock of $970,000 and accrued Preferred Stock dividends of $87,993,into 241,827 shares of Common Stock.

 

See notes to financial statements.

 

7

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**HYPERSPACE COMMUNICATIONS, INC.**

**Notes to Financial Statements**

** **

***Note 1—Descriptionof Business and Summary of Significant Accounting Policies***

*** ***

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

 

*Cash and Cash Equivalents*

* *

The Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. The Company continually monitors its positions with, and the credit quality of, the financial institutions it invests with. Such cash equivalents often exceed federally insured limits. The Company maintains its accounts with financial institutions with high credit ratings. Carrying values approximate fair value.

 

*Concentrations of Credit Risk*

* *

The Company’s operations are subject to the customary risks of doingbusiness abroad, including, but not limited to, currency fluctuations, customduties, various import controls and other non-tariff barriers, restrictions onthe transfer of funds, commodity risks, general economic market conditions,adaptability of technology, and political instability. To date, these factorshave not had a material adverse impact on the Company’s operations. Other thancertain European agreements, which are usually denominated in Euros or GBP,most non-U.S. agreements are denominated in U.S. Dollars. In the future, if thenumber of Euro denominated agreements is significant the Company may considerbuying forward currency cover to protect against currency fluctuations. For theyear ended December 31, 2004 and 2003 the Company recorded $6,297 inforeign currency losses and $24,860, in foreign currency gains, respectively,due to Euro denominated agreements.

 

Due to growing customer base, the Company is subject to the risks ofconcentration of credit risk in a few customers. In 2004 the largest threecustomers accounted for 28% of revenues (32% in 2003) and at December 31,2004 accounted for 67% (73% at December 31, 2003) of the accountsreceivable balance. In addition, for 2004, approximately 54% of revenues (64%in 2003) were derived from sales made to U.S. based organizations or divisions.

 

As of December 31, 2004, and periodically throughout the reportedyears, the Company has maintained balances in operating accounts in excess ofthe U.S. Federal Deposit Insurance Corporation (FDIC) insured $100,000 limit.The Company has not experienced any losses in such accounts and managementbelieves the Company is not exposed to any significant credit risk related tocash.

 

*Allowance for Doubtful Accounts*

* *

The Company maintains anallowance for doubtful accounts at an amount estimated to be sufficient toprovide adequate protection against losses resulting from collecting less thanfull payment on receivables.

 

8

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Overdue accounts are reviewed,and an additional allowance is recorded when determined necessary to statereceivables at realizable value. In judging the adequacy of the allowance fordoubtful accounts, the Company considers multiple factors including historicalbad debt experience, the general economic environment, and the aging of itsreceivables. A considerable amount of judgment is required when assessing therealization of receivables, including assessing the probability of collectionand the current creditworthiness of each customer. As of December 31, 2004and December 31, 2003 the Company has determined that no reserve isnecessary for doubtful accounts.

 

*Software Development Costs*

* *

FASB 86 sets out the following treatment with respect to internallydeveloped software and purchased software from third parties that the Companyfollows:

 

*Pre-Feasibility Stage:*  Costs incurred to establish the technologicalfeasibility of a software program are expensed as incurred. For these purposes,technological feasibility is achieved when all planning, designing, coding, andtesting has been sufficiently completed such that the program can be producedto meet its design specifications.

 

*Post-Feasibility/Pre-Release Stage:*  Costs incurred following technologicalfeasibility but prior to commercial release are capitalized and recorded atcost. These costs are not applied against revenues generated during thatperiod.

 

*Post-Release Stage:*  Commencing with commercial release of theprogram, costs that have accumulated in the R&D account are amortized overthe program’s expected useful life.

 

The Company’s internal software development costs include applicationand tools development, translation, testing andlocalization costs incurred in producing software and associated documentationto be licensed to customers. The Company also may contract with third partiesto develop and test software that will be licensed to customers. In addition,from time to time the Company purchases source code or product rights fromthird parties that will be integrated with the Company’s software.

 

As of December 31, 2004 and December 31, 2003, the Companyhas capitalized software costs (in accordance with the above criteria)associated with its HyperTunnelTM product of $298,570 and $373,213 respectively,net of amortization. HyperTunnelTM was commercially released in January 2004and transferred to fixed assets. The Company is amortizing the costs on astraight-line basis over the estimated life of five years, with amortization of$74,643 for the year ended December 31, 2004. The Company had capitalizedcosts of the HyperWebTM product on a straight-line basis over three years. Thisis fully amortized as of December 31, 2004. As of December 31, 2003,the HyperWebTM balance net of amortization was $47,322. 

 

Research and development (R&D) costs relating principally to thedesign and development of products (exclusive of costs capitalized under SFAS No. 86)are expenses as incurred. The costs of developing routine enhancements areexpensed as R&D costs as incurred because of the short time between thedetermination of technological feasibility and the date of general release ofrelated products.

 

The amortization of capitalized software costs is computed as thegreater of a) the amount determined by ratio of the product’s currentrevenue to its total expected future revenue, or b) the straight-linemethod over the product’s estimated useful life. Amortization expense ofcapitalized software was $121,965 for the year ended December 31, 2004 and$405,194 for the year ended December 31, 2003, and is included in cost ofrevenues in the statements of income. Included in 2003 amortization is animpairment of approximately $191,000 related to one capitalized product nolonger deemed viable.

 

*Property and Equipment*

* *

Property and equipment isstated at cost. Depreciation is provided utilizing the straight-line methodover the estimated useful lives for owned assets, ranging from 2 to5 years.

 

9

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*Intangible Assets*

* *

Intangible assets include theamounts paid by the Company for patent application costs (patents pending),trademarks and intellectual property and are analyzed annually for impairment.Impairment of all trademarks and intellectual property was deemed necessary atyear-end December 2003 resulting in an impairment of $85,296. As of December 31,2004 the remaining capitalized Patent costs of $31,530 were expensed as theyrelated to patents which have been pending for an extended period of time.

 

*Long Lived Assets*

* *

The Company reviews itslong-lived assets for impairment whenever events or changes in circumstancesindicate that the carrying amount of the asset may not be recovered.  The Company looks primarily to theundiscounted future cash flows in its assessment of whether or not long-livedassets have been impaired. As disclosed elsewhere in the financials, for theyear ended December 31, 2003 the Company impaired software of $191,000 andintangibles of approximately $85,000 both related to products no longer used bythe Company. 

 

*Deferred Stock Offering Costs*

* *

Expenses related to theoffering have been accounted for as deferred offering costs. These werecapitalized up to the IPO date and then charged to equity as a charged againstthe gross proceeds received in October 2004.  The total amount so charged was $1,541,645.There are no remaining capitalized costs as of December 31, 2004.

 

*Income Taxes*

* *

The Company recognizes deferredtax liabilities and assets based on the differences between the tax basis ofassets and liabilities and their reported amounts in the financial statementsthat will result in taxable or deductible amounts in future years. The Company’stemporary differences result primarily from capitalized software, deferredrevenue and property and equipment.

 

*Revenue Recognition*

* *

The Company derives revenues from the following sources: softwarelicense revenue and services revenue, which primarily consists of maintenance,consulting and training. The Company recognizes revenue in accordance with theSecurities and Exchange Commission’s Staff Accounting Bulletin No. 101, “RevenueRecognition in Financial Statements,” the American Institute of Certified PublicAccountants’ Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,”as amended by SOP 98-9, “Modification of SOP 97-2, Software RevenueRecognition, with Respect to Certain Transactions,” and other authoritativeaccounting literature.

 

*License Fee Revenue*

* *

For software license agreements that do not require significantmodification or customization of the software, the Company recognizes revenuewhen evidence of a non-cancelable, signed contingency-free agreement exists,any acceptance testing is complete, delivery of the product has occurred, thelicense fee is fixed or determinable and collection is probable. In all otherinstances, revenue is deferred. Deferred revenue is recorded as a currentliability until all the elements to be delivered at a future date and vendorspecific evidence of acceptance have occurred.

 

Delivery of software is persuasive evidence of an arrangement. Salesthrough the Company’s distribution channels are evidenced by agreementsgoverning the relationship together with purchase orders from the ultimate endcustomers. Delivery generally occurs when the customer has received anelectronic media copy of the software or where the Company has evidence thatthe software has been downloaded by the customer from the Company.

 

If provided in a license agreement, acceptance provisions that grantcustomers a right of refund or replacement only if the licensed software doesnot perform in accordance with its published specifications,

 

10

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the Company defers revenue recognitionuntil acceptance by the customer or the acceptance period has lapsed. Generallycustomer agreements have no such provisions and as the likelihood ofnon-acceptance is remote, the Company generally recognizes revenue when allother criteria of revenue recognition are met.

 

Typically, the Company’s software licenses do not include significantpost-delivery obligations to be fulfilled by the Company, and payments are duewithin 30 days from the date of delivery. For customers who pay licensefees based on number of monthly subscribers under a utility-based pricing modeland where the license allows for payment terms of more than 12 months fromthe date of delivery, revenue is recognized as payments become due assuming allother conditions for revenue recognition have been satisfied.

 

*Services Revenue*

* *

Maintenance revenue isrecognized ratably over the term of the maintenance agreement, typically oneyear. Consulting services generally do not involve significant modification orcustomization of the licensed software. Consulting and training revenues areusually charged on a time and materials basis and are recognized as theservices are performed. Revenue from fixed price contracts is recognized on apercentage of completion basis, which involves the useof estimates. If the Company does not have a sufficient basis to measure theprogress towards completion, revenue is recognized when the project iscompleted or when the Company receives final acceptance from the customer.There were no fixed price contracts in place at December 31, 2004 or 2003.Revenue from agreements for supporting and providing periodic unspecifiedupgrades to the licensed software is recorded as unearned revenue and isrecognized ratably over the support service period.

 

*Advertising Costs*

* *

The Company expenses advertising costs as incurred.

 

*Research and Development Costs*

* *

Expenditures made for research and development are charged to expenseas incurred.

 

*Stock-Based Compensation*

* *

The Company has determined thevalue of stock-based compensation arrangements under the provisions of APBOpinion No. 25 “Accounting for Stock Issued to Employees”; and will makepro forma disclosures required under SFAS No. 123,”Accounting forStock-Based Compensation.” SFAS No. 123 permits the use of either a fairvalue based method of the method defined in APB No. 25 to account forstock-based compensation arrangements. Companies that elect to use the methodprovided in APB No. 25 are required to disclose the pro forma net income(loss) and earnings per share that would have resulted from the use of the fairvalue based method.

 
| **Net loss available to common  shareholders—as reported**                                                     | ** ** | **$** | **(3,193,343** | **)**      | **$** | **(1,854,412** | **)**      |
|---------------------------------------------------------------------------------------------------------------------|------------|-------|----------------|------------|-------|----------------|------------|
| **Add: stock-based employee compensation  included in net income**                                                  | ** ** | **$** | **27,332**     | ** ** | **$** | **139,313**    | ** ** |
| **Deduct: total stock-based employee  compensation expense determined under fair market value method for an award** | ** ** | **$** | **(349,582**   | **)**      | **$** | **(249,198**   | **)**      |
| **Net loss available to common  shareholders—pro forma**                                                       | ** ** | **$** | **(3,515,593** | **)**      | **$** | **(1,964,297** | **)**      |
| **Basic loss per common share—as reported**                                                                    | ** ** | **$** | **(1.59**      | **)**      | **$** | **(1.42**      | **)**      |
| **Basic loss per common share—pro forma**                                                                      | ** ** | **$** | **(1.75**      | **)**      | **$** | **(1.51**      | **)**      |

 

The fair value of each optiongrant is estimated on the date of grant using the Black-Scholes option-pricingmodel. All options are granted at fair market value on the date of the grant.No options have been re-priced or had their maturities extended during 2004. Interms of the provisions of our Incentive Option Plans, employees, with vestedoptions, who leave the employment of the Company, are

 

11

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requiredto exercise or forfeit their options within 90 days after leaving employmentregardless of the exercise period of the initial grant.  

 

The following are theweighted-average assumptions used at December 31, 2004 and 2003 for allBlack-Scholes calculations in the financial statements:

 
| ** **                 | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                 | ** ** | ** **            | ** ** | ** ** | ** ** |
| Approximate risk free rate |       | 3.59                  | %          | 2.90 | % |
| Average expected life      |       | 10 years              |       | 5 years |   |
| Dividend yield             |       | —                | %          | — | % |
| Volatility                 |       | 25.00                 | %          | 25.00 | % |

 

For the year ended December 31,2003 and the six months ended June 30, 2004 the Company recorded stockoptions granted to employees as an expense in its Statement of Operations andan addition to common stock. During 2003 the Founder granted the new CEO anoption to purchase 107,143 of his shares of company stock over a three-yearperiod. The Company also recorded compensation for the transaction as thetransaction is deemed to benefit the Company. Both transactions were recorded basedon the difference between the exercise price and the fair value of the commonstock.

 

For stock issued to employeesfor services, the company uses the fair value of the common stock on the dateof issuance to determine the number of shares of common stock to issueemployees. 

 

*Fair Value of Financial Instruments*

* *

The carrying amounts offinancial instruments including cash and cash equivalents, receivables,prepaids, accounts payable and accrued expenses approximated fair value as of December 31,2004 and 2003 because of the relatively short maturity of these instruments.The carrying amounts of notes payable and debt issued approximated fair valueas of December 31, 2004 and 2003 because interest rates on theseinstruments approximate market interest rates.

 

*Recently Issued Accounting Pronouncements*

* *

In December 2004, the FASB issued SFAS 123R “Share-Based Payment,” a revision to FASB No. 123, SFAS 123R replaces existing requirements under SFAS No. 123 and APB Opinion NO. 25, and requires public companies to recognize a compensation expense an amount equal to the fair value of share-based payments granted, such as employee stock options. This is based on the grant-date fair value of those instruments. SFAS 123R also affects the pattern in which compensation cost is recognized, the accounting for employee share purchase plans, and the accounting for income tax effects of share-based payment transactions. For small-business filers such as us, SFAS 123R will be effective for interim periods beginning after December 15, 2005. The Company is currently determining what impact the proposed statement would have on its results of operations and financial position. The impact will largely be due to the selection of either the Black-Scholes or the binominal lattice model for valuing options. The adoption of this standard, in the first quarter of 2006, will have no impact on the Company’s cash flows. 

 

*Use of Estimates*

* *

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

12

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*Basic Loss Per Share*

 

The Company applies the provisions of Statement of Financial AccountingStandard No. 128, “Earnings Per Share”(FAS 128). For the years ended December 31, 2004 and December 31,2003, total stock options, stock warrants, preferred stock and convertible debtof 4,923,251 and 1,073,255 respectively were not included in the computation ofloss per share because their effect was antidilutive; however, if the Companywere to achieve profitable operations in the future, they could potentiallydilute such earnings.  The Company’sbasic and diluted loss per share is equivalent and accordingly only basic lossper share has been presented. 

 

*Reclassifications*

* *

Certain amounts in the 2003 financial statements have been reclassifiedto conform to the 2004 presentation.

 

**HYPERSPACE COMMUNICATIONS, INC.**

**Notes to Financial Statements**

** **

***Note 2—Propertyand Equipment***

 

Property and equipment consist of the following:

 
| ** **                        | ** ** | **December 31,** | ** **   | **December 31,** | ** ** |
|-----------------------------------|------------|-----------------------|--------------|-----------------------|------------|
| ** **                        | ** ** | **2004**              | ** **   | **2003**              | ** ** |
| **Computer Equipment**            | ** ** | **$**                 | **218,985**  | ** **            | **$**      | **218,985** | ** ** |
| **Office Equipment**              | ** ** | **$**                 | **167,202**  | ** **            | **$**      | **115,076** | ** ** |
| **Software**                      | ** ** | **$**                 | **26,051**   | ** **            | **$**      | **26,051** | ** ** |
| ** **                        | ** ** | **$**                 | **412,238**  | ** **            | **$**      | **360,112** | ** ** |
| **Less Accumulated Depreciation** | ** ** | **$**                 | **(301,456** | **)**                 | **$**      | **(232,306** | **)** |
| ** **                        | ** ** | **$**                 | **110,782**  | ** **            | **$**      | **127,806** | ** ** |

 

Depreciation expense for the years ended December 31, 2004 and2003 was $ 69,150 and $90,177, respectively.

 

***Note 3—NotesPayable and Debt***

 
| ** **                                         | ** ** | **December 31,** | ** **    | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|---------------|-----------------------|------------|
| ** **                                         | ** ** | **2004**              | ** **    | **2003**              | ** ** |
|                                               |       |                  |          |                  |       |
| **Convertible Bridge Loans**                       | ** ** | **$**                 | **1,089,627** | ** **            | **$**      | **577,149** | ** ** |
| **Line-of-Credit**                                 | ** ** | **$**                 | **—**    | ** **            | **$**      | **95,500** | ** ** |
| **Amounts due to RCI**                             | ** ** | **$**                 | **—**    | ** **            | **$**      | **483,499** | ** ** |
| **Debt Issuance Costs**                            | ** ** | **$**                 | **—**    | ** **            | **$**      | **(28,578** | **)** |
| ** **                                         | ** ** | **$**                 | **1,089,627** | ** **            | **$**      | **1,127,570** | ** ** |
| **Long-term Portion of Convertible Bridge  Loans** | ** ** | **$**                 | **425,000**   | ** **            | **$**      | **—** | ** ** |
| ** **                                         | ** ** | **$**                 | **664,627**   | ** **            | **$**      | **1,127,570** | ** ** |

 

All amounts are inclusive of accrued interest.

 

The Bridge Loans and NotesPayable have been issued at various interest rates between 9% and 12% perannum. On September 30, 2004 prior to the IPO: certain Bridge Loans, andaccrued interest, were automatically converted to equity and certain otherBridge Loans, and accrued interest, voluntarily

 

13

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convertedto equity. All Bridge Loans were issued in conjunction with warrants topurchase common stock. Our founder also converted $75,000 of his Note to commonstock in September 2004, immediately prior to the IPO.

 

With respect to the Founder’sNote; he has the right, at any time prior to payment (or pre-payment), toconvert all or any part of the then outstanding balance of principal andinterest under this Note into shares of common stock at the conversion priceof  $3.50 per share.  The note is repayable in September 2005.Interest is accrued at 9% on this note.

 

With respect to the ConvertibleBridge Loans, $620,000 is due September 2005 and $425,000 due April 2006plus accrued interest. The Holder shall have the right, at any time prior topayment (or pre-payment), to convert all or any part of the then outstandingbalance of principal and interest under this Note into shares of common stockat the conversion price of $4.375 and $3.50 per share, respectively. The noteshave detachable warrants for purchase of common stock. The value of the warrantswas recorded as interest expense. Debt issue costs of $104,500 were recorded onthe note and are being amortized to interest expense over the life of the note.All assets of the Company collateralize the notes. A beneficial conversionfeature of $233,662 is recorded on the notes, which was recorded as interestexpense when the debt was issued. These notes have registration rights. 

 

In March 2001, the Company purchased the assets of RCI with anoutstanding note of $353,403 at 0% interest and due on March 5, 2004. As aconsequence of the acquisition of the assets from RCI, certain RCI principalsbecame employees of the Company. Within a few months of the acquisition in March 2001,the RCI principals left the Company. In January 2004, the Company filedcertain claims against RCI claiming a breach of the terms of the sale of theassets. In March 2004, the Company settled all aspects of this claim, infull, for $42,500. In 2004, the Company has recorded a gain on this settlementin the amount of $440,999.

 

The Bridge Notes Received fromDirectors in August 2004 had 200,000 detachable warrants to purchasecommon stock. The value of these warrants of $208,148 was booked as interestexpense during the quarter ended September 30, 2004. These Bridge Notesreceived from Directors were repaid in October 2004. 

 

In October 2004, the bank Line-of-Credit was repaid.

** **

***Note 4—Shareholders’Equity***

 

*2003 Stock Issuances*

* *

During 2003, the Company issued16,326 shares of common stock at an average price of $2.63 per share or $43,000of services, of which $35,000 was to an entity controlled by a formerdirector.   During 2003, ConvertibleNotes Payable in the amount of $275,000 was converted into 78,571 shares ofcommon stock and $375,000 converted into 85,713 Preferred Shares. Also in 2003,the Company closed its private placement offering of shares of Preferred Stockat $4.38 per share. 80,286 shares of Preferred Stock were issued for $351,250during 2003 for new cash investments into the Company, of which 11,429 shareswas to an entity controlled by a current company director under same terms asother participants. Additionally, the majority shareholder converted $200,000in a short-term loan to 45,715 shares of Preferred Stock during 2003.

 

*2004 Stock Issuances*

* *

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

 

On October 1, 2004 theCompany’s Registration Statement on Form SB-2 was declared effective bythe

 

14

----

 

US Securities and ExchangeCommission and the Company sold its units to the underwriters on a firmcommitment basis and listed its units on the American Stock Exchange under thesymbol HCO.U. In the initial public offering the Company sold 1.8 million unitsto underwriters at $5.0325 per unit, which is net after the underwriter’sdiscount of 8.5% ($5.50 per unit prior to the discount). The net proceeds tothe Company, after deducting the offering costs and expenses were approximately$7.1 million. The underwriters paid for the units on October 6, 2004. 

 

In 2004, the Company also had the following issuances of Common Stock:$164,813 received from the exercise of warrants into 48,451 shares, $728,202 fromthe conversion of debt into 208,054 shares, $75,000 from the conversionof a portion of the Founder’s loan into 21,429 shares, $1,057,993 from theconversion of all Preferred Stock and accumulated Preferred Dividends into241,827 shares prior to the IPO, $62,500 from the exercise of 19,540 stockoptions, 1,786 shares for $8,125 in IPO costs and 12,801 shares issuedfor $55,700 in services received by the Company. 

 

*Preferred Stock*

* *

Between April 2003 and January 2004,the Company issued 221,714 Series A preferredshares at $4.38 per share for a total of $970,000. Holders of Series Apreferred stock were entitled to receive cumulative annual dividends, at therate of 10% of the original issue amount. These shares had a mandatoryconversion feature if the Company consummates a public offering of the Company’scommon stock for total proceeds of at least $3 million. As the Companycompleted an IPO in October 2004, in excess of $3 million, these shares,and accrued preferred dividends to September 30, 2004, in the amount of$87,993, have been converted into 241,827 ordinary shares of the Company at September 30,2004.

 

As of September 30, 2004 and December 31, 2003, the Companyaccrued dividends $87,993 and $15,503 on Preferred Stock.  These amounts were converted into CommonStock as described above.

 

*Stock Options*

* *

In September 2001, the Company established an Incentive StockOption Plan (the 2001 Option Plan). The options that were granted vest over aperiod of time ranging from one to two years with a term of not more than10 years and exercise price was equal to the fair market value of thestock at date of grant. A total of 1,428,571 shares of common stock areauthorized for issuance under the 2001 Option Plan. Generally options have beengranted to employees, third party consultants and members of the Board ofDirectors. 

 

In July 2004, the Company’s Board and shareholders voted toprovide that not more than 871,619 options be issued under the 2001 Option Planand also voted to create the 2004 Equity Incentive Plan (the 2004 Option Plan)which reserves an additional 700,000 shares of common stock for issuance asoptions or restricted stock. As of December 31, 2004, no issuances havetaken place under the 2004 Option Plan. 

 

For the employee options of 183,572 and 132,678 granted in 2004 and2003, respectively, the Company has recorded an expense in the amount of$27,332 and $139,313 based upon an estimated fair market value of the Company’sstock on the date of issuance. During 2003 the Founder granted the new CEO anoption to purchase 107,143 of his shares of Company stock over a three-yearperiod. The Company recorded a compensation amount of $112,500 for thetransaction based on their intrinsic value in accordance with APB 25. Theintrinsic value was based upon the difference between an estimated fair marketvalue (prior to the IPO) and the closing market price (post IPO) of the Companystock and the exercise price of the options.

 

For third party consultant options, the Company has recorded an expensein 2004 in the amount of $39,406 based on the fair value of options using theBlack-Scholes pricing model based upon a fair market value of the Companycommon stock at the date of grant. In 2003, the Company recorded an expense of$18,812 for the options granted, based on the fair value of options usingBlack-Scholes pricing model.

 

The following table presents the activity for options outstanding underthe 2001 Option Plan:

 

15

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| ** **                               | ** ** | ** **          | ** ** | ** **          | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|------------------------------------------|------------|---------------------|------------|---------------------|------------|-----------------|------------|--------------|------------|
| ** **                               | ** ** | **Employee**        | ** ** | **Employee Non-**   | ** ** | **Third Party** | ** ** | **Average**  | ** ** |
| ** **                               | ** ** | **Incentive Stock** | ** ** | **Qualified Stock** | ** ** | **Consultant**  | ** ** | **Exercise** | ** ** |
| ** **                               | ** ** | **Options**         | ** ** | **Options**         | ** ** | **Options**     | ** ** | **price**    | ** ** |
| **Outstanding - December 31, 2002** | ** ** | **317,857**         | ** ** | **204,285**         | ** ** | **108,072**     | ** ** | **$**        | **3.50**   | ** ** |
| **Granted**                              | ** ** | **120,535**         | ** ** | **12,143**          | ** ** | **29,821**      | ** ** | **$**        | **3.50**   | ** ** |
| **Forfeited/Cancelled**                  | ** ** | **(89,286**         | **)**      | **(61,429**         | **)**      | **(30,714**     | **)**      | **$**        | **3.50**   | ** ** |
| **Exercised**                            | ** ** | **—**          | ** ** | **—**          | ** ** | **—**      | ** ** | **$**        | **—** | ** ** |
| **Outstanding - December 31, 2003** | ** ** | **349,106**         | ** ** | **154,999**         | ** ** | **107,179**     | ** ** | **$**        | **3.50**   | ** ** |
| **Granted**                              | ** ** | **93,143**          | ** ** | **90,429**          | ** ** | **47,263**      | ** ** | **$**        | **4.41**   | ** ** |
| **Forfeited/Cancelled**                  | ** ** | **(43,570**         | **)**      | **(85,000**         | **)**      | **(8,300**      | **)**      | **$**        | **3.50**   | ** ** |
| **Exercised**                            | ** ** | **(7,143**          | **)**      | **—**          | ** ** | **(39,285**     | **)**      | **$**        | **3.50**   | ** ** |
| **Outstanding - December 31, 2004** | ** ** | **391,536**         | ** ** | **160,428**         | ** ** | **106,857**     | ** ** | **$**        | **3.82**   | ** ** |

 

The following table presents the composition of options outstanding andexercisable:

 
| ** **                                   | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **Range  of Exercise Prices**                | ** ** | **Number**              | ** ** | **Price**               | ** ** | **Life** | ** ** | **Number** | ** ** | **Price** | ** ** |
| **At December 31, 2003 - all at $3.50** | ** ** | **611,284**             | ** ** | **$**                   | **3.50**   | ** ** | **8.02** | ** ** | **192,857** | ** ** | **$** | **3.50** | ** ** |
| ** **                                   | ** ** | ** **              | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **At December 31, 2004**                | ** ** | ** **              | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **$2.42 to $3.50**                           | ** ** | **471,428**             | ** ** | **$**                   | **3.48**   | ** ** | **5.72** | ** ** | **377,142** | ** ** | **$** | **3.50** | ** ** |
| **$4.38 to $5.50**                           | ** ** | **187,393**             | ** ** | **$**                   | **4.68**   | ** ** | **7.13** | ** ** | **33,035** | ** ** | **$** | **5.11** | ** ** |
| ** **                                   | ** ** | **658,821**             | ** ** | **$**                   | **3.82**   | ** ** | **6.12** | ** ** | **410,177** | ** ** | **$** | **3.63** | ** ** |

 

----

*              Price and Lifereflect the weighted average exercise price and weighted average remainingcontractual life, respectively.

 

*Warrants – Common Stock*

* *

The Company has issued warrantsin connection with the issuance of certain notes payable.  

 

In 2003, the Company used the Black-Scholes method to compute the valueof 7,143 warrants issued to Note holders ($3.85 exercise price and a five-yearexercise period) and 31,357 warrants issued to financing entities ($3.50exercise price and exercise lives between 5 and 6.25 years). This hasresulted in the Company booking a charge to Interest Expense of $9,163 for thewarrants issued to Note holders and a debt issue cost of $57,156 for thewarrants issued to financing entities.

 

During 2004, the Company used the Black-Scholes method to compute thevalue of the 271,286 non-IPO warrants issued to Note holders ($3.50 to $4.46exercise prices and a five-year exercise period). This has resulted in theCompany booking a charge to Interest Expense of $318,883 for the warrantsissued to Note holders and an Interest Expense charge of $233,662 recorded forthe inducement to convert the notes and extend the debt maturity. In addition,90,000 warrants ($5.50 to $9.08 exercise prices and a five-year exerciseperiod) were issued to certain individuals with respect to financial consultingrelating to fundraising. This resulted in a charge of $44,245 to Interest Expense.

 

No Black-Scholes valuation is necessary on the 3.6 million IPO warrantsas they were issued for consideration as part of the Unit sale price in theIPO. 

 

The following table presents the activity for warrants outstanding onour Common Stock:

 

16

----

 
| ** **                                  | ** ** | ** **    | ** ** | **Weighted** | ** ** |
|---------------------------------------------|------------|---------------|------------|--------------|------------|
| ** **                                  | ** ** | ** **    | ** ** | **Average**  | ** ** |
| ** **                                  | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| ** **                                  | ** ** | **Warrants**  | ** ** | **Price**    | ** ** |
| **Outstanding—December 31, 2002** | ** ** | **51,429**    | ** ** | **$**        | **3.69**   | ** ** |
| **Issued**                                  | ** ** | **38,500**    | ** ** | **$**        | **3.62**   | ** ** |
| **Forfeited/canceled**                      | ** ** | **0**         | ** ** | **$**        | **—** | ** ** |
| **Exercised**                               | ** ** | **0**         | ** ** | **$**        | **—** | ** ** |
| **Outstanding—December 31, 2003** | ** ** | **89,929**    | ** ** | **$**        | **3.73**   | ** ** |
| **Issued**                                  | ** ** | **361,286**   | ** ** | **$**        | **5.04**   | ** ** |
| **Issued as part of the IPO**               | ** ** | **3,600,000** | ** ** | **$**        | **5.50**   | ** ** |
| **Forfeited/canceled**                      | ** ** | **0**         | ** ** | **$**        | **—** | ** ** |
| **Exercised**                               | ** ** | **(61,607)**  | ** ** | **$**        | **3.81**   | ** ** |
| **Outstanding—December 31, 2004** | ** ** | **3,989,608** | ** ** | **$**        | **5.44**   | ** ** |

 

All of the outstanding warrants are exercisable and have a weightedaverage remaining contractual life of 4.73 years as of December 31,2004.

 

*Inducements on Warrants:*During2004 the Company offered inducements to convertible debt holders to convertdebt to equity and extend maturity dates by reducing conversion rates on$580,000 of debt from $4.38 to $3.50. Interest of $150,800 was recorded for theinducements.

 

*Warrants - Units*

* *

As part of our IPO, we issued 90,000 warrants to purchase units (oneshare and two ordinary share warrants) to underwriters. Such warrants areexercisable at 165% of the IPO price of the units i.e. at $9.08 per unit. Theunderwriters must also pay $0.001 per unit for the warrants. These warrants areexercisable for four years from October 1, 2005. These warrants on unitsare not included in the above table.  

 

***Note 5—Related PartyTransactions***

 

Related party transactions consist of the following:

 

Note payable to founder and Chairman of the Board as set out in Note 3above. 

 

During 2003, the founder converted $200,000 of the note payable to45,714 shares of preferred stock at the same price and on the same terms as allother Series A participants.

 

During 2003, the Company sold $50,000 of convertible notes to adirector under the same terms as other participants and included 1,786 options.During 2004, a director converted $50,000 note payable plus accrued interestinto 15,417 shares of common stock. During 2004, the director purchased $55,000of convertible notes and warrants in the bridge note and warrant offering atthe same terms as other participants and included warrants of 2,357. Thisdirector converted all of his notes outstanding and accrued interest intoCommon Stock immediately prior to the IPO.

 

The Company paid fees directly to an entity controlled by a formerdirector with respect to debt and equity offerings and investment bankingservices of: 2003—$8,000 in cash, 25,643 warrants and $35,000 by issuing stock;and in 2004—$102,000 in cash and 15,702 warrants. The investment banking agreementwith this organization also provides for a contingent fee if we consummate atransaction in which they participated either during the term of theiragreement or for a period of 18 months after the termination of theiragreement. The consummated transaction, a business combination as defined inthe agreement, calls for a contingent fee of up to 6% of the purchase priceplus 5% in warrants. The minimum fee up under any business combination would be$100,000. The initial term of the investment banking agreement ends on March 19,2005.  

 

Included in accrued liabilities are salaries of $36,164 due to theChief Executive Officer at December 31, 2003.

 

17

----

 

During the year ended December 31, 2003, the founder granted theChief Executive Officer options to purchase 107,143 of his shares.  The transaction was deemed beneficial to theCompany, which recorded an expense in the amount of $112,500.

 

***Note 6—IncomeTaxes***

*** ***

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

 

The significant components ofthe net deferred tax asset at December 31, 2004 consist of the following:

 
| ** **                           | ** ** | **31-Dec**     | ** ** | **31-Dec**     | ** ** |
|--------------------------------------|------------|----------------|------------|----------------|------------|
| ** **                           | ** ** | **2004**       | ** ** | **2003**       | ** ** |
| **Deferred Tax Assets:**             | ** ** | ** **     | ** ** | ** **     | ** ** |
| **Net operating loss carryforwards** | ** ** | **2,306,824**  | ** ** | **1,263,161**  | ** ** |
| **Fixed Assets**                     | ** ** | **59,532**     | ** ** | **33,050**     | ** ** |
| **Other Items**                      | ** ** | **34,416**     | ** ** | **26,713**     | ** ** |
| **Total deferred tax assets**        | ** ** | **2,400,772**  | ** ** | **1,322,924**  | ** ** |
| ** **                           | ** ** | ** **     | ** ** | ** **     | ** ** |
| **Deferred Tax Liabilities**         | ** ** | **(4,340**     | **)**      | **(3,157**     | **)**      |
| ** **                           | ** ** | ** **     | ** ** | ** **     | ** ** |
| **Net Deferred Tax Assets**          | ** ** | **2,396,432**  | ** ** | **1,319,767**  | ** ** |
| ** **                           | ** ** | ** **     | ** ** | ** **     | ** ** |
| **Valuation allowance**              | ** ** | **(2,396,432** | **)**      | **(1,319,767** | **)**      |
| ** **                           | ** ** | ** **     | ** ** | ** **     | ** ** |
| **Net Asset**                        | ** ** | **$**          | **—** | ** **     | **$**      | **—** | ** ** |
|                                      |            |                |            |                |            |  |  |

 

Income tax expenses differedfrom the amounts computed by applying the U.S. Federal and State income taxrates to loss before income taxes as a result of the following:

 
| ** **                                   | ** ** | **2004**       | ** ** | **2003**   | ** ** |
|----------------------------------------------|------------|----------------|------------|------------|------------|
| **Rate Reconciliation:**                     | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Book Income Before Taxes**                 | ** ** | **(3,193,341** | **)**      | ** ** | ** ** | **(1,854,414** | **)** | ** ** | ** ** |
| ** **                                   | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Federal Tax “expected” benefit** | ** ** | **(1,085,736** | **)**      | **-34.00** | **%**      | **(630,501** | **)** | **-34.00** | **%** |
| **State Tax “expected” benefit**   | ** ** | **(97,589**    | **)**      | **-3.06**  | **%**      | **(56,671** | **)** | **-3.06** | **%** |
| **Options**                                  | ** ** | **6,040**      | ** ** | **0.19**   | **%**      | **88,586** | ** ** | **4.78** | **%** |
| **Nondeductible Interest**                   | ** ** | **94,060**     | ** ** | **2.95**   | **%**      | **59,388** | ** ** | **3.20** | **%** |
| **Other permanent items**                    | ** ** | **30,034**     | ** ** | **0.94**   | **%**      | **7,760** | ** ** | **0.42** | **%** |
| **True-up NOL for Perm Items**               | ** ** | **(23,480**    | **)**      | **-0.74**  | **%**      | **0** | ** ** | **0.00** | **%** |
| **Valuation Allowance**                      | ** ** | **1,076,665**  | ** ** | **33.72**  | **%**      | **531,433** | ** ** | **28.66** | **%** |
| **Income Tax Benefit**                       | ** ** | **(6**         | **)**      | **0.00**   | **%**      | **(4** | **)** | **0.00** | **%** |

 

The benefits of the Company’snet operating loss carryforwards as of December 31, 2004 and 2003, do notsatisfy the realization criteria set forth in SFAS109 and accordingly, theCompany has recorded a valuation allowance for the entire net deferred taxasset. The valuation allowance increased by $531,433 in 2003 and increased by$1,076,665 in 2004, due primarily to changes in the net operating losscarryforward.

 

18

----

 

As of December 31, 2004and December 31, 2003, the Company had approximately $6.2 million and $3.4million respectively, of net operating loss carryforwards that will begin toexpire in 2022. Because the Company may have experienced a significant changein ownership during the year ended December 31, 2004, the Company’s use ofits net operating loss carryforwards may be limited under the current rules ofInternal Revenue Code Section 382.

 

***Note 7—Commitmentsand Contingencies***

*** ***

*Operating Leases*

The Company leases facilitiesand equipment under non-cancelable operating leases. Rent expense for the yearsended December 31, 2004 and 2003 was $93,016 and $92,616 respectively.

 

Future minimum lease payments under these leases are approximately asfollows:

 

**Year Ending December 31,**

 
| **2005**       | ** ** | **$** | **98,633**  | ** ** |
|----------------|------------|-------|-------------|------------|
| **2006**       | ** ** | **$** | **7,751**   | ** ** |
| **Thereafter** | ** ** | **$** | **—**  | ** ** |
| ** **     | ** ** | **$** | **106,384** | ** ** |

 

*Litigation*

In the normal course of business, the Company is party to litigationfrom time to time. The Company maintains insurance to cover certain actions andbelieves that resolution of such litigation will not have a material adverse effecton the Company.

 

*Product and Service Warranty Reserve*

The Company does not have a reserve for any warranty costs due to thefact that: (i) historically there have been no such material claims, (ii) certainminor claims have been settled by providing new copies of the software that wasdefective and (iii) the Company offers a free 30-day trial before anypurchases are consummated. There have been no claims for installation problemsdue to the ease and self-install nature of our products. Should these circumstanceschange, the Company will record a reserve equal to the costs to repair orotherwise satisfy the claim.

 

*Operations*

The following is a summary of sales by geographic region for theCompany:

 
| ** **             | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **             | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| United States          |       | 54                          | %          | 64                          | %          |
| Europe                 |       | 30                          | %          | 33                          | %          |
| Asia/Pacific and other |       | 16                          | %          | 3                           | %          |

 

*Foreign Sales Licenses*

The Company has determined thatcertain of its export sales are subject to export restrictions as a result ofincluding open source and encryption technology in its software.  The Company may have had exported softwareprior to it obtaining the appropriate licenses which were obtained in2004.  The Company believes that it willnot incur significant financial penalties as a result of having possiblyinadvertently not complied with all aspects of applicable export laws.

 

*Employment Agreements*

The Company has entered intoemployment agreements with certain members of its senior management team. Theseagreements bear standard employment terms and conditions. The CEO’s contract isa three-year contract commencing on October 1, 2004 and calls for aminimum bonus based on satisfactory performance and continued employment. All2004 earned bonuses have been paid as of December 31, 2004.

 

19

----

 

*SeveranceAgreements*

The Company has agreed withcertain employees who do not have Employment Agreements, that, under certaincircumstances, they may receive a severance payment if the Company terminatestheir employment. Should the Company be liable to all such employees, themaximum amount due is approximately $250,000.  

 

*InvestmentBanking Agreement*

As discussed under Note 5, wehave entered into an investment banking agreement with a related party. Thisagreement provides for contingent fees due to the related party if weconsummate certain transactions. No amounts are due under the contingent feearrangement as of December 31, 2004. 

 

*Indemnities*

During its normal course of business, theCompany has made certain indemnities, commitments and guarantees under which itmay be required to make payments in relation to certain transactions. Theseinclude (i) intellectual property indemnities to the Company’s customersand licensees in connection with the use, sale and/or license of Companyproducts, (ii) indemnities to the lessor in connection with our facilitylease for certain claims arising from such facility or lease, (iii) indemnitiesto vendors and service providers pertaining to claims based on the negligenceor willful misconduct of the Company, and (iv) indemnities involving theaccuracy of representations in certain contracts. The duration of theseindemnities and commitments, and in certain cases, may be indefinite. Themajority of these indemnities and commitments do not provide for any limitationof the maximum potential for future payments the Company could be obligated tomake. The Company has not recorded any liability for these indemnities as itdoes not currently believe that any will result in a financial obligation.

 

*Registration Rights*

With respect to certain debt and warrants issued, the Company hasundertaken to provide registration rights in the event that those recipientselect to convert their debt to equity or exercise warrants.

 

***Note 8—Settlements***

In March 2001, the Companypurchased the assets of RCI with an outstanding note of $353,403 at 0% interestand due on March 5, 2004. In January 2004, the Company filed certainclaims against RCI claiming a breach of the terms of the sale of the assets. InMarch 2004, the Company settled all aspects of this claim, in full, for$42,500 and recorded a gain on this settlement in the amount of $440,999.

 

***Note 9—SubsequentEvents (Unaudited)***

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

 

On March 21, 2005 theCompany, along with Gores Technology Group, LLC (“Gores”) and MPC Computers,LLC (“MPC”) announced the execution of an Agreement and Plan of Merger dated asof March 21, 2005 (the “Agreement”) by and among the Company, SpudAcquisition Corp., a Delaware corporation and a wholly owned subsidiary of theCompany (“Merger Sub”), GTG PC Holdings, LLC, a Delaware limited liabilitycompany (“Holdings”) and GTG-Micron Holding Company, LLC (“Member”).  MPC is the wholly owned subsidiary ofHoldings.  

 

Under the terms of the Agreement,which has been approved by the Company’s Board of Directors, Merger Sub willmerge with and into Holdings (the “Merger”), with Holdings surviving the Mergerand becoming a wholly owned subsidiary of ours. 

 

As consideration, the Companywill issue an aggregate of 4.3 million shares of its no par value common stockplus warrants to purchase 5 million shares of common stock at an exercise priceof $3.00 per share and warrants to purchase 1.5 million shares of common stockat an exercise price of $5.50 per share. 15% of these shares and warrants willbe retained by the Company and reserved for future distribution by us to MPCmanagement as part of an overall incentive plan. After the consummation of thetransaction, the Company’s existing shareholders will own approximately 51% ofoutstanding common stock of the combined entity.

 

20

----

 

Consummationof the transactions contemplated by the Agreement is conditioned upon (1) approvalby our shareholders and the members of the Member, (2) the receipt of allrequired regulatory approvals and (3) various other conditions set forthin the Agreement.  While it isanticipated that the transaction will be completed in May or June 2005,the Agreement terminates if the Merger is not completed by September 30,2005. In the event of a termination of the Merger Agreement under certaincircumstances, we or Holdings may be required to pay the other a terminationfee as set forth in the Agreement. 

 

**EXHIBIT INDEX**

 
| **Exhibit   No.** | ** ** | **Document Description**                                                                                                                                                                                                                                                        |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **        | ** ** | ** **                                                                                                                                                                                                                                                                      |
| 2.1               |       | Agreement  and Plan of Merger, dated as of March 20, 2005 by and among the  Registrant, Spud Acquisition Corp., GTG PC Holdings, LLC and GTG-Micron  Holding Company, LLC (1)                                                                                              |
|              |       |                                                                                                                                                                                                                                                                            |
| 3.1               |       | Amended  and Restated Articles of Incorporation of the Registrant (2)                                                                                                                                                                                                           |
|              |       |                                                                                                                                                                                                                                                                            |
| 3.2               |       | Bylaws  of the Registrant (3)                                                                                                                                                                                                                                                   |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.1               |       | Specimen  unit certificate (4)                                                                                                                                                                                                                                                  |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.2               |       | Specimen  common stock certificate(3)                                                                                                                                                                                                                                           |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.3               |       | 2001  Equity Incentive Plan(3)                                                                                                                                                                                                                                                  |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.4               |       | 2004  Equity Incentive Plan (5)                                                                                                                                                                                                                                                 |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.5               |       | Form  of Lock-up Agreement for officers and directors (5)                                                                                                                                                                                                                       |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.6               |       | Form  of Lock-up Agreement for certain shareholders (5)                                                                                                                                                                                                                         |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.7               |       | Form  of representatives’ option for purchase of units (6)                                                                                                                                                                                                                 |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.8               |       | Form  of Warrant Agreement (6)                                                                                                                                                                                                                                                  |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.9               |       | Form  of Warrant (4)                                                                                                                                                                                                                                                            |
|              |       |                                                                                                                                                                                                                                                                            |
| 4.10              |       | Irrevocable  Proxy and Voting Agreement, dated as of March 20, 2005, by and among GTG PC  Holdings, LLC, GTG-Micron Holding Company, LLC and each of John P. Yeros,  Mark J. Endry, Mark A. Pougnet, David E. Girard, James M. Gumina, Kent  Swanson and BlueStreak 4, LLC. (1) |
|              |       |                                                                                                                                                                                                                                                                            |
| 10.1              |       | Form  of Software License Agreement (3)                                                                                                                                                                                                                                         |
|              |       |                                                                                                                                                                                                                                                                            |
| 10.2              |       | Form  of Software License Agreement—HyperTunnel Subscription (3)                                                                                                                                                                                                           |
|              |       |                                                                                                                                                                                                                                                                            |
| 10.3              |       | Form  of Software License Agreement—HyperWeb Subscription (3)                                                                                                                                                                                                              |

 

21

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| 10.4   |   | Founders  Employment Agreement with John P. Yeros (3)                                                                  |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                        |
| 10.5   |   | Executive  Employment Agreement with Mark J. Endry (3)                                                                 |
|   |   |                                                                                                                        |
| 10.6   |   | Amended  and Restated Employment Agreement with David J. Bauch (3)                                                     |
|   |   |                                                                                                                        |
| 10.7   |   | Overture  (Yahoo!) Click Through Agreement (3)                                                                              |
|   |   |                                                                                                                        |
| 10.8   |   | Google  Click Through Agreement (3)                                                                                         |
|   |   |                                                                                                                        |
| 10.9   |   | Form  Bridge Note and Warrant Purchase Agreement (2002-2003) (3)                                                            |
|   |   |                                                                                                                        |
| 10.10  |   | Form  Bridge Note 2004 (3)                                                                                                  |
|   |   |                                                                                                                        |
| 10.11  |   | Form  Bridge Warrant 2004 (3)                                                                                               |
|   |   |                                                                                                                        |
| 10.12  |   | Form  Peats Note and Warrant 2004 (3)                                                                                       |
|   |   |                                                                                                                        |
| 10.13  |   | Form  Yeros Note (3)                                                                                                        |
|   |   |                                                                                                                        |
| 10.14  |   | Amended  and Restated Founders Employment Agreement with John P. Yeros (7)                                             |
|   |   |                                                                                                                        |
| 10.15  |   | Form  of 2003 (Yeros) Line of Credit (3)                                                                                    |
|   |   |                                                                                                                        |
| 10.16  |   | Letter  Amendment to Founders Employment Agreement (3)                                                                      |
|   |   |                                                                                                                        |
| 10.17  |   | Sales  Agent Agreement with Simentra Limited (2)                                                                            |
|   |   |                                                                                                                        |
| 10.18  |   | Reseller  Agreement, dated effective as of March 20, 2005, between the Registrant and  MPC Computers, LLC. (1)              |
|   |   |                                                                                                                        |
| 31.1*  |   | Certification  of Chief Executive Officer of the Registrant pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                        |
| 31.2*  |   | Certification  of Chief Financial Officer of the Registrant pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                        |
| 31.3*  |   | Certification  of Chairman of the Registrant pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                |
|   |   |                                                                                                                        |
| 32.1*  | *      | Certification  of Chief Executive Officer of the Registrant pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 |

 

22

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| 32.2*  |   | Certification  of Chief Financial Officer of the Registrant pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                        |
| 32.3*  |   | Certification  of Chairman of the Registrant pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                |

 

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*              Filedherewith

 

(1)           Incorporated by reference to ExhibitNos. 2.1, 99.1 and 99.2, respectively, to the Registrant’s Current Report onForm 8-K/A, filed with the Securities and Exchange Commission on March 20,2005.

 

(2)           Incorporated by reference to ExhibitNos. 3.1 and 10.17, respectively, to Amendment No. 4 to the Registrant’sRegistration Statement on Form SB-2, filed with the Securities and ExchangeCommission on August 6, 2004.

 

(3)           Incorporated by reference to ExhibitNos. 3.2, 4.2, 4.3, 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 10.9,10.10, 10.11, 10.12, 10.13, 10.15 and 10.16, respectively, to Amendment No. 1to the Registrant’s Registration Statement on Form SB-2, filed with theSecurities and Exchange Commission on July 2, 2004.

 

(4)           Incorporated by reference to ExhibitNos. 4.1 and 4.9, respectively, to Amendment No. 7 to the Registrant’sRegistration Statement on Form SB-2, filed with the Securities and ExchangeCommission on September 24, 2004.

 

(5)           Incorporated by reference to ExhibitNos. 4.4, 4.5, and 4.6, respectively, to Amendment No. 3 to the Registrant’sRegistration Statement on Form SB-2, filed with the Securities and ExchangeCommission on July 23, 2004.

 

(6)           Incorporated by reference to ExhibitNos. 4.7 and 4.8, respectively, to Post-Effective Amendment No. 1 to theRegistrant’s Registration Statement on Form SB-2, filed with the Securities andExchange Commission on October 1, 2004.

 

(7)           Incorporated by reference to ExhibitNo. 10.14 to Post-Effective Amendment No. 2 to the Registrant’s RegistrationStatement on Form SB-2, filed with the Securities and Exchange Commission onDecember 28, 2004.

 

23

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