As filed with the Securities and Exchange Commission on September 17, 2004. Registration Statement No. 333-116766 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------- Post Effective Amendment No. 1 to FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------- SPACEDEV, INC. (Exact name of registrant as specified in its charter) COLORADO 3761 84-1374613 ------------------------------- ------ ---------------------- (State or other (Primary standard Industrial (I.R.S. Employer jurisdiction of Classification Code Number) Identification Number) incorporation or organization) 13855 STOWE DRIVE POWAY, CALIFORNIA 92064 (858) 375-2000 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ------------------------- JAMES W. BENSON CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER SPACEDEV, INC. 13855 STOWE DRIVE POWAY, CALIFORNIA 92064 (858) 375-2020 (Name, address, including zip code, and telephone number, including area code, of agent for service) ------------------------- Copies to: GRETCHEN COWEN, ESQ. WEINTRAUB DILLON PC 12520 HIGH BLUFF DRIVE, SUITE 260 SAN DIEGO, CALIFORNIA 92130 (858) 259-2529 Approximate date of commencement of proposed sale to public: FROM TIME TO TIME AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT. PAGE If the only securities being registered on this form are being offered pursuant to dividend or interest reinvestment plans, please check the following box: | | If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, please check the following box: |X| If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: | | If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: | | If delivery of the prospectus is expected to be made pursuant to Rule 434 under the Securities Act, please check the following box: | | CALCULATION OF REGISTRATION FEE ------------------------------- PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF. . . . . AMOUNT TO OFFERING PRICE AGGREGA REGISTRATION SECURITIES TO BE REGISTERED . . BE REGISTERED (1) PER SHARE OFFERING PRICE FEE ------------------------------- ----------------- ----------------- --------------- -------------- Common Stock, $0.001 par value, underlying Convertible Note . . 588,235(2) $0.8500(3) 500,000 $63.35(4) Common Stock, $0.001 par value, underlying Warrants . . . . . . 337,838 $0.3700(3) 125,000 $15.84(4) Common Stock, $0.001 par value, underlying Warrants . . . . . . 128,205 $0.3900(3) 50,000 $6.33(4) Common Stock, $0.001 par value, underlying Warrants . . . . . . 148,810 $0.4200(3) 62,500 $7.92(4) Common Stock, $0.001 par value, underlying Warrants . . . . . . 50,000 $1.0625(3) 53,125 $6.73(4) Common Stock, $0.0001 par value, underlying Preferred Stock & Dividends 1,845,779 1.5400(5) 2,842,500 $360.14(9) Common Stock, $0.0001 par value, underlying Warrants. . . . . . . . . . 487,000 1.7700(6) 861,990 $109.21(9) Common Stock, $0.0001 par value, underlying Convertible Note. . . . . . 1,000,000 1.0000(7) 1,000,000 $126.70(9) Common Stock, $0.0001 par value, underlying Warrants. . . . . . . . . . 50,000 1.9250(8) 96,250 $12.19(9) ------------------------------- ----------------- ----------------- --------------- ---------------- Total. . . . . . . . . . . . . . . . . 4,635,867 5,591,365 $708.43 ------------------------------- ----------------- ----------------- --------------- ---------------- ------------------------------- ----------------- ----------------- --------------- ---------------- (1) In the event of a stock split, stock dividend, or similar transaction involving common stock of the registrant, in order to prevent dilution, the number of shares registered shall be automatically increased to cover the additional shares in accordance with Rule 416(a) under the Securities Act. This registration statement covers an aggregate of 4,635,867 shares. (2) Represents 100% of the good faith estimate of the number of shares that are issuable to the selling security holders following the conversion of interest on and/or principal of a convertible note held by the selling ii PAGE security holder. If our good faith estimate is incorrect and we determine that additional common stock will be required to cover all principal and interest payments, we will be required to file a new registration statement to register any such additional shares. (3) Exercise prices fixed in each warrant agreement. (4) The amount of the registration fee for these securities was paid with the initial filing of this Form SB-2 Registration Statement on June 23, 2004. (5) On August 25, 2004, we entered into a Securities Purchase Agreement with the Laurus Master Fund, Ltd. whereby SpaceDev issued 250,000 shares of its Series C Convertible Preferred Stock (the "Preferred Stock"), par value $0.001 per share, to Laurus for an aggregate purchase price of $2,500,000 or $10.00 per share. The Preferred Shares are convertible into the $0.0001 par value Common Stock of the Company at a rate of $1.54 per share (or 1,623,377 shares) at any time after the date of issuance, and pay quarterly, cumulative dividends at a rate of 6.85% with the first payment due on January 1, 2005. Dividends are payable in cash or shares of Common Stock at the holder's option with the exception that dividends must be paid in shares of Common Stock for up to 25% of the aggregate dollar trading volume if the fair market value of the Common Stock for the 20-days preceding the conversion date exceeds 120% of the Conversion Rate. The 1,845,779 shares represents 100% of the good faith estimate of the number of shares that are issuable to the selling preferred security holder following the payment of stock dividends (222,402) on and/or conversion of the preferred stock (1,623,377 shares) held by the selling preferred security holder. If our good faith estimate is incorrect and we determine that additional common stock will be required to cover all principal and dividend payments, we will be required to file a new registration statement or a post-effective amendment to register any such additional shares. (6) In conjunction with the Preferred Shares, we issued a five-year common stock purchase warrant to Laurus for the purchase of 487,000 shares of Common Stock at an exercise price of $1.77. (7) Also in conjunction with the preferred stock financing, Laurus has agreed to extend our current revolving credit facility reported on Form 8-K filed June 18, 2003 from $1.0 million to $1.5 million. The first $1,000,000 converted under the revolving credit facility was converted last year and earlier this year at a rate of $0.55 per share. On March 31, 2004, the conversion price for the next $500,000 under the revolving credit facility was set at $0.85 per share and is represented by the 588,235 shares listed above. The next $1 million under the revolving credit facility will be convertible by Laurus at a rate of $1.00 per share. (8) In conjunction with the Laurus revolving credit facility, we are required to register a final warrant of 50,000 shares at an exercise price of $1.925 per share. (9) The amount of the registration fee for these securities with this Post Effective Amendment No. 1 on September 17, 2004 is $608.24. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING UNDER SECTION 8(a), MAY DETERMINE. iii PAGE SUBJECT TO COMPLETION, DATED SEPTEMBER 17, 2004. PROSPECTUS SPACEDEV, INC. 4,635,867 SHARES OF COMMON STOCK This prospectus relates to the resale by security holders of up to 4,635,867 shares of our common stock underlying (1) common stock purchase warrants for up to 614,853 shares issued to accredited investors in relation to Convertible Notes, (2) a three-year secured convertible note, or the Convertible Note, issued to Laurus Master Fund, Ltd. ("Laurus") in the principal amount of $500,000 representing 588,235 shares, (3) a common stock purchase warrant for up to 50,000 shares issued to Laurus on June 22, 2004, (4) convertible preferred stock and estimated accrued dividends thereon for up to 1,845,779 shares, (5) a common stock purchase warrant for up to 487,000 shares issued to Laurus on August 25, 2004, (6) a three-year secured convertible note, or the Convertible Note, issued to Laurus in the principal amount of $1,000,000 representing 1,000,000 shares, and (7) a common stock purchase warrant for up to 50,000 shares issued to Laurus on August 25, 2004. We will not receive any of the proceeds from the sale of the shares by the selling security holders. We have not retained any underwriter in connection with the sale of the securities. We have paid, on behalf of the selling security holders, the expenses of the offering estimated to be approximately $32,000 . Our common stock trades on The Over-the-Counter Bulletin Board under the symbol "SPDV." The last reported sale price of our common stock on September 16, 2004, was $1.95 per share. Our principal offices are located at 13855 Stowe Drive, Poway, California 92064, and our telephone number is (858) 375-2030. ------------------------- INVESTING IN OUR COMMON STOCK INVOLVES RISKS. AS YOU REVIEW THE PROSPECTUS, YOU SHOULD CAREFULLY CONSIDER THE MATTERS DESCRIBED UNDER "RISK FACTORS" BEGINNING ON PAGE 7. ------------------------- You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. The date of this prospectus is September 17 , 2004. PAGE 1 TABLE OF CONTENTS Page ------ PROSPECTUS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 ------------------------------------------------------------------------------------- TABLE OF CONTENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 ------------------------------------------------------------------------------------- PROSPECTUS SUMMARY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 ------------------------------------------------------------------------------------- Our Company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 ------------------------------------------------------------------------------------- The Offering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 ------------------------------------------------------------------------------------- Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . 6 ------------------------------------------------------------------------------------- RISK FACTORS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 ------------------------------------------------------------------------------------- SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS . . . . . . . . . . . . . . . . . . 16 ------------------------------------------------------------------------------------- SELLING SECURITY HOLDERS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 ------------------------------------------------------------------------------------- PLAN OF DISTRIBUTION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 ------------------------------------------------------------------------------------- USE OF PROCEEDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 ------------------------------------------------------------------------------------- DESCRIPTION OF BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 ------------------------------------------------------------------------------------- Forward Looking Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 ------------------------------------------------------------------------------------- General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 ------------------------------------------------------------------------------------- Business Strategy . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . 27 ------------------------------------------------------------------------------------- Products and Services; Market. . . . . . . . . . . . . . . . . . . . . . . . . . 28 ------------------------------------------------------------------------------------- Components and Raw Materials.. . . . . . . . . . . . . . . . . . . . . . . . . . 31 ------------------------------------------------------------------------------------- Competition . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . 31 ------------------------------------------------------------------------------------- The Laurus Master Fund, Ltd. Revolving Credit Facility . . . . . . . . . . . . . 32 ------------------------------------------------------------------------------------- Regulation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 ------------------------------------------------------------------------------------- Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 ------------------------------------------------------------------------------------- Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 ------------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 36 ------------------------------------------------------------------------------------- Results Of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 ------------------------------------------------------------------------------------- Liquidity And Capital Resources. . . . . . . . . . . . . . . . . . . . . . . . . 47 ------------------------------------------------------------------------------------- Critical Accounting Standards. . . . . . . . . . . . . . . . . . . . . . . . . . 51 ------------------------------------------------------------------------------------- Recent Accounting Pronouncements . . . . . . . . . . . . . . . . . . . . . . . . 51 ------------------------------------------------------------------------------------- Forward-Looking Statements And Risk Analysis . . . . . . . . . . . . . . . . . . 51 ------------------------------------------------------------------------------------- DESCRIPTION OF PROPERTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 ------------------------------------------------------------------------------------- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . . . . . . . . . . . . . . . 54 ------------------------------------------------------------------------------------- MARKET FOR COMMON EQUITY & RELATED STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . 55 ------------------------------------------------------------------------------------- Market Information. .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 ------------------------------------------------------------------------------------- Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 ------------------------------------------------------------------------------------- Dividends . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 56 ------------------------------------------------------------------------------------- PAGE 2 DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS & CONTROL PERSONS. . . . . . . . . . . . . . 57 ------------------------------------------------------------------------------------- EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 ------------------------------------------------------------------------------------- Remuneration Paid To Executives .. . . . . . . . . . . . . . . . . . . . . . . . 62 ------------------------------------------------------------------------------------- Remuneration Paid To Directors. .. . . . . . . . . . . . . . . . . . . . . . . . 63 ------------------------------------------------------------------------------------- Director Committees . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 64 ------------------------------------------------------------------------------------- Employment Agreements . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 64 ------------------------------------------------------------------------------------- Employee Benefits . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 65 ------------------------------------------------------------------------------------- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. . . . . . . . . . . . 67 ------------------------------------------------------------------------------------- DESCRIPTION OF SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 ------------------------------------------------------------------------------------- Common Stock. . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 69 ------------------------------------------------------------------------------------- Warrants. . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 70 ------------------------------------------------------------------------------------- Transfer Agent and Registrar. . .. . . . . . . . . . . . . . . . . . . . . . . . 71 ------------------------------------------------------------------------------------- DISCLOSURE OF COMMISSION POSITION OF INDEMNIFICATION FOR SECURITIES ACT LIABILITIES . 71 ------------------------------------------------------------------------------------- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS . . . . . . . . . . . . . . . . . . . . 71 ------------------------------------------------------------------------------------- EXPERTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 ------------------------------------------------------------------------------------- LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 ------------------------------------------------------------------------------------- WHERE YOU CAN FIND MORE INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . 74 ------------------------------------------------------------------------------------- FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F1-F44 PAGE 3 PROSPECTUS SUMMARY This summary highlights some information from this prospectus. Because it is a summary, it necessarily does not contain all of the information necessary to your investment decision. To understand this offering fully, you should read carefully the entire prospectus, especially the risks of investing in our common stock discussed under "Risk Factors." In connection with a strategic financing with Laurus Master Fund, Ltd., or simply Laurus, this prospectus covers the resale of up to : 1) 588,235 shares of our common stock that are issuable upon conversion of a three-year Secured Convertible Note (the "Convertible Note"), in the principal amount of $500,000; 2) 1,845,779 shares of our common stock that are issuable upon conversion of convertible preferred stock and accrued dividends thereon; and 3) 1,000,000 shares of our common stock that are issuable upon conversion of a three-year Secured Convertible Note, in the principal amount of $1,000,000. In addition, this prospectus covers the resale of up to: (1) 587,000 shares of common stock issuable upon exercise of outstanding warrants to Laurus (collectively referred to as the "Laurus Warrants") and (2) 614,853 shares of common stock issuable upon exercise of outstanding warrants issued to officers, directors and a former officer of the Company in an additional convertible note program November 2002 to June 2003 (collectively referred to herein as the "Warrants"). OUR COMPANY We are engaged in the conception, design, development, manufacture, integration and operations of space technology systems, products and services. We are currently focused on the commercial development of low-cost microsatellites, nanosatellites and related subsystems, and hybrid rocket propulsion as well as the associated engineering technical services to government, aerospace and other commercial enterprises. Our products and solutions are sold directly to these customers and include sophisticated micro- and nanosatellites, hybrid rocket-based orbital Maneuvering and orbital Transfer Vehicles as well as safe sub-orbital and orbital hybrid rocket-based propulsion systems. We are also developing commercial hybrid rocket motors and small high performance space vehicles and subsystems. See "Description of Business" for more information. THE OFFERING Common stock underlying the interest and/or principal of the Convertible Note 1,588,235 shares Common stock underlying the LaurusWarrant 587,000 shares Common stock underlying the Warrants 614,853 shares Common stock underlying the dividend and/or principal of the Preferred Stock 1,845,779 shares Common Stock Outstanding after Exercise of outstanding Warrants, the Laurus Warrant , the Preferred Stock and the Convertible Note 23,782,527 shares PAGE 4 Termination of the Offering The offering will conclude upon the earlier of the sale of all 4,635,867 shares of common stock registered, the date the shares no longer need to be registered to be sold or the three- year anniversary of the effective date of the registration statement of which this prospectus is a part. Use of Proceeds All proceeds from the sale of shares underlying the Warrants, the Convertible Note and the Laurus Warrant will be received by the selling security holders for their own accounts. See "Use of Proceeds." Risk Factors You should read the "Risk Factors" beginning on page 7, as well as other cautionary statements throughout this prospectus, before investing in shares of our common stock. PAGE 5 SELECTED CONSOLIDATED FINANCIAL DATA The following financial data is provided as of and for the fiscal years ended December 31, 2003 and 2002 and as of and for the six-months ending June 30, 2004 and 2003 . The financial data as of and for the fiscal years ending December 31, 2003 and 2002 is derived from, and is qualified by reference to, the audited consolidated financial statements and the notes to those consolidated financial statements which are a part of this prospectus. The financial data as of and for the six-months ending June 30, 2004 and 2003 is derived from, and is qualified by reference to, unaudited consolidated financial statements, which are a part of this prospectus. In the opinion of our management, those unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial data as of and for the six-months ending June 30, 2004 and 2003 . Our historical results are not necessarily indicative of results to be expected for any future periods. SELECTED CONSOLIDATED STATEMENTS OF OPERATIONS DATA: YEARS ENDING SIX MONTHS ENDING DECEMBER 31, JUNE 30, (Audited) (Unaudited) 2003 2002 2004 2003 -------------- ------------------- ------------ ------------ Net revenues . . . . . . . . . . . . . . . . . . . . $ 2,956,322 $ 3,370,118 $ 2,215,443 $ 1,286,795 Profit (Loss) from operations. . . . . . . . . . . . $ (890,092) $ 13,920 $ 44,785 $ (728,641) Net loss . . . . . . . . . . . . . . . . . . . . . . $ (1,246,067) $ (376,160) $(1,729,416) $ (917,840) Basic loss per share . . . . . . . . . . . . . . . . $ (0.08) $ (0.03) $ (0.09) ($0.06) Weighted average shares outstanding, basic . . . . . 16,092,292 14,744,423 17,410,651 15,092,489 -------------- ------------------- ------------ ------------ SELECTED CONSOLIDATED BALANCE SHEET DATA: AT DECEMBER 31, AT JUNE 30, (Audited) (Unaudited) 2003 2002 2004 2003 -------------- ------------- ---------- ----------- Cash and cash equivalents. . . . . . . . . $ 592,006 $ 27,648 $1,226,529 $80,734 Working capital amount/(deficit) . . . . . ($630,805) ($197,381) $685,834 ($736,234) Total assets . . . . . . . . . . . . . . . $ 1,084,819 $ 3,811,957 $2,054,566 $418,684 Long-term debt, net of current portion . . $ 556,902 $ 661,314 $147,911 $589,448 Stockholders' Deficit. . . . . . . . . . . ($2,072,628) ($1,767,459) ($258,092) ($2,259,358) -------------- ------------- ----------- ------------ PAGE 6 RISK FACTORS AN INVESTMENT IN SHARES OF OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS BEFORE DECIDING TO INVEST OR MAINTAIN AN INVESTMENT IN SHARES OF OUR COMMON STOCK. THIS PROSPECTUS CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN THE FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, IT IS LIKELY THAT OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS WOULD BE HARMED. AS A RESULT, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU COULD LOSE PART OR ALL OF YOUR INVESTMENT. OUR PLAN TO REMAIN CASH FLOW POSITIVE AND BECOME PROFITABLE DEPENDS ON OUR ABILITY TO INCREASE REVENUES, WHILE CONTROLLING COSTS IN A VARIETY OF AREAS, AS WELL AS, IMPROVE OUR PROJECT MANAGEMENT EXPERTISE. Our auditors, PKF, expressed in their formal auditors' opinion dated February 11, 2004 (except for Note 11 as to which the date is April 2, 2004) that in their opinion, based on their audit, our consolidated financial statements referred to herein present fairly, in all material respects, the consolidated financial position of SpaceDev, Inc. and its subsidiary as of December 31, 2003, and the consolidated results of our operations and our cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. In addition, we have recorded three consecutive quarters of positive cash flow and two consecutive quarters of operating profit. However, in previous years, including the opinion of Nation Smith dated February 13, 2003 herein, our auditors expressed an opinion that our financial position raised substantial doubt about our ability to continue as a going concern. After an analysis of our newly awarded $43,362,271 contract from the Missile Defense Agency, our projections (including revenue projections) for the next several quarters and other relevant factors, our auditors concluded there is no longer substantial doubt as to the Company's ability to continue as a going concern, and has, therefore, not included the going concern language in its report dated February 11, 2004 (except for Note 11 as to which the date is April 2, 2004) for the year ended December 31, 2003. We believe that this was appropriate and reflects our improved financial condition, our ability to forecast more accurately and further validation of customer demand for our technology, products and services. However, our ability to continue as a going concern depends upon our ability to ultimately implement our plans, which includes (but is not limited to) generating substantial new revenue from the Missile Defense Agency by successfully performing under the newly awarded contract and continuing to attract and successfully complete other government and commercial contracts, development of a project management expertise to profitably execute on new business contracts and reduce the working capital deficit by raising additional capital. PAGE 7 We recently concluded a preferred stock financing and expanded credit facility with Laurus in order to raise additional capital to further support operations as new contracts and business opportunities materialize. Our new business opportunities, can come from a variety of sources, including state and federal grants and government and commercial customer programs. However, if we are in need of further funding, there can be no assurance that we will be able to obtain such funding or contracts as needed or, if such funding or contracts are available, that we can obtain then on terms favorable to the Company. The likelihood of our success must be considered in light of the expenses, difficulties and delays frequently encountered in connection with the developing businesses, those historically encountered by us, and the competitive environment in which we operate. IF WE ARE UNABLE TO RAISE CAPITAL IN THE FUTURE, WE MAY BE UNABLE TO FUND OPERATING CASH SHORTFALLS. Our future capital requirements will depend upon many factors, including but not limited to sales and marketing efforts, the development of new products and services, the successful completion of existing projects, possible future strategic acquisitions, the progress of our research and development efforts, and the status of competitive products and services. As of June 30, 2004, December 31, 2003 and 2002, we had working capital of $685,834,and a working capital deficit of $630,805 and $197,381, respectively, and an accumulated deficit of $13,547,192, $11,817,776, and $10,571,709, respectively. As of those dates, we had $1,226,529, $592,006 and $27,648, respectively, in cash and cash equivalents and $602,151, $187,062 and $82,325, respectively, of accounts receivable, net of allowance for doubtful accounts. We believe that current and future available capital resources will be adequate to fund our operations for the next twelve (12) months. However, historically we have not been able to generate sufficient cash from our operating activities and have relied upon cash from financing activities to fund part of the cash requirements of our operating and investing activities. To the extent we are in need of any additional financing, it may not be available to us on acceptable terms, or at all. Our inability to obtain any needed financing could result in a significant loss of ownership and/or control of our proprietary technology and other important assets and could also hinder our ability to fund our continued operations and our product development efforts that historically have contributed significantly to our competitiveness. Any financing may cause significant dilution to existing stockholders. Any debt financing or other financing of securities senior to common stock likely will include financial and other covenants that will restrict our flexibility. At a minimum, we expect these covenants to include restrictions on our ability to pay dividends on our common stock. SOME OF OUR GOVERNMENT CONTRACTS ARE STAGED AND WE CANNOT GUARANTEE THAT ALL STAGES OF THE CONTRACTS WILL BE AWARDED TO US OR AT ALL. Some of our government contracts, including the $43,362,271 MDA contract awarded on March 31, 2004 , are phased contracts, in which the customer may determine to terminate the contract between phases for any reason. We can give no assurance that, as to any such agreement, the entire contract will be realized by us. In the event that subsequent phases of some of our government contracts, including but not limited to the MDA contract, are not awarded to us, it would have a material adverse effect on our business operations and financial condition, unless equivalent contracts were simultaneously awarded to us. PAGE 8 IF A SIGNIFICANT PORTION OF THE CONVERTIBLE NOTE OR THE PREFERRED STOCK OR THE WARRANTS WERE CONVERTED INTO SHARES OF OUR COMMON STOCK, THE VOTING POWER OF YOUR INVESTMENT AND OUR EARNINGS PER SHARE COULD BE DILUTED. The Convertible Note in the amount of $1,000,000, that we issued to Laurus, on June 3, 2003 and subsequently increased to $1,500,000 on August 25, 2004, was converted by Laurus into 1,818,182 shares of our common stock at an initial fixed conversion price of $0.55 per share. The next $500,000 of the Convertible Note may be converted into up to 588,235 shares of our common stock at a fixed conversion price of $0.85 per share, to the extent that we draw funds on the credit facility and have not repaid those funds. Thereafter, the next $1,000,000 of the Convertible Note may be converted into up to 1,000,000 shares of our common stock at a fixed conversion price of $1.00 per share, to the extent that we draw funds on the credit facility and have not repaid those funds. Finally, the $2,500,000 of the Preferred Stock and accrued dividends may be converted into up to 1,845,779 shares of our common stock at a fixed conversion price of $1.54 per share. The 588,235 shares represent approximately 3% of the 19,146,660 shares of our common stock outstanding on September 1, 2004, the 1,000,000 shares represent approximately 5% of the 19,146,660 shares of our common stock outstanding on Septmber 1, 2004 and 1,845,779 shares represent approximately 9% of the 19,146,660 shares of our common stock outstanding on Septmber 1, 2004. As a result, if the 1,588,235 shares underlying the Convertible Note and 1,845,779 shares underlying the Preferred Stock were converted at the fixed conversion prices stated above, dilution of the voting power of your investment and of our earnings per share could continue to occur. Furthermore, after the conversion by Laurus of the $500,000, or 588,235 shares, plus $1,000,000, or 1,000,000 shares, Laurus has a continuing right to convert, to the extent that we draw funds on the credit facility and have not repaid those funds, at a fixed conversion price based on a fair market value formula specified in the agreement. In addition, the Laurus Warrant and the Warrants each may be exercised for a per share price that is lower than the current fair market value of our common stock as traded on the Over-The-Counter Bulletin Board. Although the exercise of those warrants will result in proceeds to the Company, significant dilution of the voting power of your investment and of our earnings per share could occur. THE MARKET PRICE OF OUR COMMON STOCK AND THE VALUE OF YOUR INVESTMENT COULD SUBSTANTIALLY DECLINE IF ALL OR A SIGNIFICANT PORTION OF THE CONVERTIBLE NOTE WERE CONVERTED INTO COMMON SHARES WHICH WERE RESOLD INTO THE MARKET, OR IF A PERCEPTION EXISTS THAT SUCH SALES COULD OCCUR. If the conversion prices at which the Convertible Note or Preferred Stock, including stock dividends, is converted, or the exercise prices on the Laurus Warrant and the Warrants are exercised, are lower than the price at which you made your investment, immediate dilution of the value of your investment will occur. In addition, sales of a substantial number of shares of common stock issued upon conversion of the Convertible Note or exercise of the warrants, or the Preferred Stock or even the perception that such sales could occur, could adversely affect the market price of our common stock. You could, therefore, experience a decline in the value of your investment as a result of both the actual and potential conversion of Convertible Note and/or the exercise of the Laurus Warrants or the Warrants. NO ASSURANCE OF SUCCESSFUL OR TIMELY DEVELOPMENT OF PRODUCTS. Despite our success in designing, launching and monitoring our first microsatellite and the initial flight of SpaceShipOne, our products and technologies (including our hybrid rocket technology)_are currently under various stages of development. Further development and testing will be required to prove additional performance capability beyond current tests and commercial viability. Additionally, the final cost of development cannot be PAGE 9 determined until development is complete. The success, if any, will depend on the ability to timely complete our projects within estimated cost parameters and ultimately deploy the product in a cost-effective manner. THE MARKETPLACE FOR OUR TECHNOLOGY AND PRODUCTS IS UNCERTAIN. There can be no assurance that there will be a demand for our technology, products and services or that we will be successful in obtaining a sufficient market share to sustain our business or to achieve profitable operations. Our business plan is based on the assumption that significant revenues will be generated in connection with the government being early adopters and deploying microsatellites in the near-term with a long-term commercial market developing for private manned and unmanned space exploration. Because microsatellites and commercial space exploration are still relatively new concepts, it is difficult to accurately predict the ultimate size of the market. We have a limited prior operating history, and there can be no assurance that we will increase our revenues and become profitable. Additionally, if either the demand for our products produced or services rendered or if general economic conditions deteriorate significantly, our business could be impacted to a substantial degree resulting in lower profitability or losses as a direct result. Many of our products and services are new and unproven, and the true level of consumer demand is uncertain. Lack of significant market acceptance of our products and services, delays in such acceptance, or failure of markets to develop could negatively affect our business, financial condition, and results of operations. Many of the factors, which affect us, and our business, are dictated by the marketplace and are beyond our control. CONTRACTUAL LIMITATIONS THAT RESTRICT LAURUS' ABILITY TO CONVERT THE CONVERTIBLE NOTE AND/OR PREFERRED STOCK MAY NOT NECESSARILY PREVENT SUBSTANTIAL DILUTION OF THE VOTING POWER AND VALUE OF YOUR INVESTMENT. Laurus may convert the Convertible Note into shares of our common stock to the extent that a balance exists on the revolving credit facility. Currently, there is no balance on the revolving credit facility and we have sufficient cash to fund operations; however, the contractual limitations that restrict Laurus' ability to convert the Convertible Note into shares of our common stock are limited in their application and effect and may not prevent dilution of your investment and we cannot be assured that additional draws on the revolving credit facility will not be required in the future. Laurus is subject to a contractual 4.99% beneficial ownership limitation that prohibits Laurus from converting the Note if and to the extent that the conversion would result in Laurus, together with its affiliates, beneficially owning more than 4.99% of our outstanding common stock. However, this 4.99% limitation automatically becomes void upon an event of default under the Note and can be waived at any time by Laurus upon 75 days' advance notice to us. In addition, this 4.99% limitation does not prevent Laurus from converting the Note into shares of common stock and then reselling those shares in stages over time where Laurus and its affiliates do not, at any given time, beneficially own shares in excess of the 4.99% limitation. The 4.99% limitation with respect to the Preferred Stock will be waived if we request redemption of the Preferred Stock and Laurus chooses to convert the remaining balance of Preferred Stock. Consequently, these limitations will not necessarily prevent dilution of the voting power and value of your investment. BECAUSE OUR STOCK IS SUBJECT TO THE SEC'S PENNY STOCK RULES, BROKER-DEALERS MAY EXPERIENCE DIFFICULTY IN COMPLETING CUSTOMER TRANSACTIONS AND TRADING ACTIVITY IN OUR SECURITIES MAY BE ADVERSELY AFFECTED. Because we currently have less than $5,000,000 in net tangible assets and the market price of our common stock is less than $5.00 per share, transactions in our common stock are subject to the "penny stock" rules promulgated under the Securities Exchange Act of 1934. Under these rules, broker-dealers who recommend our securities to persons other than institutional accredited investors: PAGE 10 - must make a special written suitability determination for the purchaser; - receive the purchaser's written agreement to a transaction prior to sale; - provide the purchaser with risk disclosure documents which identify certain risks associated with investing in "penny stocks" and which describe the market for these "penny stocks" as well as a purchaser's legal remedies; and - obtain a signed and dated acknowledgment from the purchaser demonstrating that the purchaser has actually received the required risk disclosure document before a transaction in a "penny stock" can be completed. As a result of these rules, broker-dealers may find it difficult to effectuate customer transactions and trading activity in our securities may be adversely affected. As a result, the market price of our securities may be depressed, and you may find it more difficult to sell our securities. IF WE ARE UNSUCCESSFUL IN ACHIEVING AND MAINTAINING COMPLIANCE WITH OUR REGISTRATION OBLIGATIONS WITH REGARD TO THE CONVERTIBLE NOTE , PREFERRED STOCK AND LAURUS WARRANT, WE MAY INCUR SUBSTANTIAL MONETARY PENALTIES. The agreements we entered into in connection with our issuance of the Convertible Note, Preferred Stock and the Laurus Warrant require us to, among other things, register for resale the shares of common stock issued or issuable under the note, preferred stock and the accompanying warrant and maintain the effectiveness of the registration statement for an extended period of time. We are subject to liquidated damage assessment of 2% of the outstanding principal amount of the Convertible Note and 1.5% of the stated value of the outstanding Preferred Stock for each thirty (30) days of non-compliance thereafter, subject to pro ration for partial months. If we are unable to obtain and maintain effectiveness of the required registration statement, then we may be required to pay additional liquidated damages, to the extent that any amounts are drawn under the Convertible Note, which could adversely affect our business, operating results, financial condition, and ability to service our other indebtedness by negatively impacting our cash flows. OUR LIMITED OPERATING HISTORY AND LACK OF EXPERIENCE IN OUR NEW OR PROPOSED LINES OF BUSINESS MAKES IT DIFFICULT TO PREDICT OUR FUTURE SUCCESS. We launched our first microsatellite, CHIPSat, in January 2003 and , on June 21, 2004, our hybrid rocket technology was used to propel SpaceShipOne to over 50 miles above the earth. We continue to develop other applications for our other technologies and products. We intend to provide microsatellites to early adopters, primarily the U.S. military (e.g., the Missile Defense Agency), and hybrid rocket motors to government and commercial customers (e.g., the Air Force Research Laboratory and Scaled Composites). However , we have limited or no operating histories in each of these new or proposed lines of business. Therefore, our historical financial information is of limited value in projecting our future success in these markets. OUR PRODUCTS AND SERVICES ARE TECHNOLOGICALLY ADVANCED AND MAY NOT FUNCTION UNDER CERTAIN CONDITIONS. Most of our products are technologically advanced and sometimes novel systems that must function under demanding operating conditions. Even though we believe that we employ sophisticated design, manufacturing, and testing practices, there can be no assurance that our products will be successfully launched or operated or that they will be developed or will perform as intended. Like most organizations that have launched satellite programs, we will likely experience some product and service failures, schedule delays, and other PAGE 11 problems in connection with our products in the future. Our products and services are and will continue to be subject to significant technological change and innovation. Our success will generally depend on our ability to penetrate and retain markets for our existing products and services and to continue to conceive, design, manufacture and market new products and services on a cost-effective and timely basis. We anticipate that we will incur significant expenses in the design and initial manufacture and marketing of new products and services. There can be no assurance that we will be able to achieve the technological advances necessary to remain competitive and profitable, that new products and services will be developed and manufactured on schedule and on a cost-effective basis, that anticipated markets will exist or develop for new products or services, or that our existing products and services will not become technologically obsolete. OUR FAILURE TO LAUNCH COULD CAUSE SERIOUS ADVERSE AFFECTS. Although our current $43 million contract to provide up to six microsatellites to the Missile Defense Agency is a cost-plus agreement, which shifts the risk of failure to the buyer, a launch failure could adversely affect our cash flow in other instances, since a large portion of customer payments may sometimes be contingent upon a successful launch. Microsatellite launches are subject to significant risks, including causing disabling damage to or loss of a microsatellite. Delays in the launch could also adversely affect our revenues as the customer may have timing requirements for milestone payments or we may have guarantee requirements. Delays could be caused by a number of factors, including designing, constructing, integrating, or testing the microsatellite, microsatellite components, or related ground systems; delays in receiving the license necessary to operate the microsatellite systems; delays in obtaining the customer's payload; delays related to the launch vehicle; weather; and other events beyond our control. Delays and the perception of potential delay could negatively affect our marketing efforts. There is no assurance that we will be able to launch microsatellites on a timely basis and any delays in the launch could have a material adverse effect on our financial position. OUR EXPANSION INTO OTHER NEW LINES OF BUSINESS MAY DIVERT MANAGEMENT'S ATTENTION FROM OUR EXISTING OPERATIONS AND PROVE TO BE TOO COSTLY. We will migrate our technology from projects into products for microsatellites and hybrid rocket motors over the next several years. In the meantime, we are investigating other applications of our technology and other markets for our technologies and prospective products. Our expansion into new lines of business may be difficult for us to manage because they may involve different disciplines and require different expertise than our core businesses. Consequently, this expansion may detract management's time and attention away from our core business, and we may need to incur significant expenses in order to develop the expertise , including hiring of additional personnel, and reputation we desire, which could prevent us from generating revenues from these lines of business in amounts sufficient to justify the expenses we incur in operating them. OUR SUCCESS DEPENDS ON OUR ABILITY TO RETAIN OUR KEY PERSONNEL. Our success is dependent upon the efforts of certain key members of our management and engineering team, including our chief executive officer, James W. Benson, our chief financial officer, Richard B. Slansky, our vice president of engineering, Frank Macklin and our vice president of business development, Randall K. Simpson. Each of these individuals has substantial prior business experience and we have added other experienced key personnel to our staff. The loss of any of these persons could have a material adverse effect on us if suitable replacements are not found. Our future success is likely to depend substantially on our continued ability to attract and retain highly qualified personnel. The competition for such personnel is intense, and our inability to attract and retain such personnel could have a material adverse effect on us. We do not have current key man life insurance on any of our key personnel. PAGE 12 THE U.S. FEDERAL GOVERNMENT MAY INCREASE REGULATION, WHICH COULD CAUSE OUR BUSINESS TO HAVE SERIOUS ADVERSE EFFECTS. Our business activities are regulated by various agencies and departments of the U.S. federal government and, in certain circumstances, the governments of other countries. Several government agencies, including NASA and the U.S. Air Force, maintain Export Control Offices to ensure that any disclosure of scientific and technical information complies with the Export Administration Regulations and the International Traffic in Arms Regulations ("ITAR"). Exports of our products, services and technical information require either Technical Assistance Agreements or licenses from the U.S. Department of State depending on the level of technology being transferred. This includes recently published regulations restricting the ability of U.S. based companies to complete offshore launches, or to export certain satellite components and technical data to any country outside the United States. The export of information with respect to ground-based sensors, detectors, high-speed computers, and national security and missile technology items are controlled by the Department of Commerce. The government is very strict with respect to compliance and has served notice that failure to comply with the ITAR and/or the Commerce Department regulations may subject guilty parties to fines of up to US$1 million and/or up to 10 years imprisonment per violation. Failure to comply with any of the above mentioned regulations could have serious adverse effects as dictated by the rules associated with compliance to the ITAR regulations. Our conservative position is to consider any material beyond standard marketing material to be regulated by ITAR regulations. In addition to the standard local, state and national government regulations that all businesses must adhere to, the space industry has specific regulations. Command and telemetry frequency assignments for space missions are regulated internationally by the International Telecommunications Union ("ITU"). In the United States, the Federal Communications Commission ("FCC") and the National Telecommunications Information Agency ("NTIA") regulate command and telemetry frequency assignments. All launch vehicles that are launched from a launch site in the United States must pass certain launch range safety regulations that are administered by the U.S. Air Force. In addition, all commercial space launches that we would perform require a license from the Department of Transportation. Satellites that are launched must obtain approvals for command and frequency assignments. For international approvals, the FCC and NTIA obtain these approvals from the ITU. These regulations have been in place for a number of years to cover the large number of non-government commercial space missions that have been launched and put into orbit in the last 15 to 20 years. Any commercial deep space mission that we would perform would be subject to these regulations. At the present time, we are not aware of any additional or unique government regulations related to commercial space missions. We are required to obtain permits, licenses, and other authorizations under federal, state, local and foreign statutes, laws or regulations or other governmental restrictions relating to the environment or to emissions, discharges or releases of pollutants, contaminants, petroleum or petroleum products, chemicals or industrial, toxic or hazardous substances or wastes into the environment including, without limitation, ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, petroleum or petroleum products, chemicals or industrial, toxic or hazardous substances or wastes or the clean-up or other remediation thereof. At the present time, we do not have a requirement to obtain any special environmental licenses or permits. Our failure to comply with any of the above-mentioned regulations could have serious adverse effects. PAGE 13 OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK. The market prices of securities of technology-based companies like ours are highly volatile. The market price of our common stock has fluctuated significantly in the past. In fact, during the 52-week period ended September 1, 2004, the high and low closing price of a share of our common stock was $2.01 and $0.75, respectively. Our market price may continue to exhibit significant fluctuations in response to a variety of factors, many of which are beyond our control. These factors include, among others, deviations in our results of operations from estimates, changes in estimates of our financial performance, changes in market valuations of similar companies and stock market price and volume fluctuations generally. Additionally, until the full effects of our cost reduction efforts become clear, including whether those cuts have a long-term negative impact on revenues, it is likely that our quarter-to-quarter performance will be unpredictable and our stock price particularly volatile. OUR NET OPERATING LOSS CARRYFORWARDS MAY BE SUBJECT TO AN ANNUAL LIMITATION ON THEIR UTILIZATION, WHICH MAY INCREASE OUR TAXES AND DECREASE AFTER-TAX INCOME AND CASH FLOWS. Deferred income taxes are provided for temporary differences in recognizing certain income and expense items for financial and tax reporting purposes. The deferred tax asset of approximately $2,855,000 and $2,190,000 as of June 30, 2004 and December 31, 2003, respectively, consisted primarily of the income tax benefits from net operating loss and capital loss carryforwards, amortization of goodwill and research and development credits. A valuation allowance has been recorded to fully offset the deferred tax asset as it is more likely than not that the assets will not be utilized. The valuation allowance increased approximately $665,000 in 2004 from $2,190,000 at December 31, 2003 to approximately $2,855,000,000 at June 30, 2004. At December 31, 2003 and June 30, 2004, the Company has federal and state tax net operating loss and capital loss carryforwards of approximately $4,230,000 and $5,973,000, respectively. The federal and state tax loss carryforwards will expire in 2023 and 2013, respectively, unless previously utilized. The State of California suspended the utilization of net operating loss for 2002 and 2003. THE CONCENTRATION OF OWNERSHIP OF OUR COMMON STOCK GIVES A FEW INDIVIDUALS SIGNIFICANT CONTROL OVER IMPORTANT POLICY DECISIONS AND COULD DELAY OR PREVENT CHANGES IN CONTROL. As of September 1, 2004, our executive officers and directors and their family members together beneficially owned approximately 56.7% of the issued and outstanding shares of our common stock. As a result, these persons could have the ability to exert significant influential control over matters that could include the election of directors, changes in the size and composition of the board of directors, and mergers and other business combinations involving us. In addition, through control of the board of directors and voting power, they may be able to control certain decisions, including decisions regarding the qualification and appointment of officers, dividend policy, access to capital (including borrowing from third-party lenders and the issuance of additional equity securities), and the acquisition or disposition of our assets. In addition, the concentration of voting power in the hands of those individuals could have the effect of delaying or preventing a change in control of our company, even if the change in control would benefit our stockholders. A perception in the investment community of an anti-takeover environment at our company could cause investors to value our stock lower than in the absence of such a perception. PAGE 14 OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY IS ESSENTIAL TO THE GROWTH AND DEVELOPMENT OF OUR PRODUCTS AND SERVICES. We rely, in part, on patents, trade secrets and know-how to develop and maintain our competitive position and technological advantage. We have a program and plan to protect our intellectual property through a combination of license agreements, patents, trademarks, service marks, copyrights, trade secrets and other methods of restricting disclosure and transferring title. There is no guarantee that such applications will be granted. We have and intend to continue entering into confidentiality agreements with our employees, consultants and vendors; entering into license agreements with third parties; and generally seeking to control access to and distribution of our intellectual property. OUR ABILITY TO SOURCE AND OBTAIN COMPONENTS AND RAW MATERIALS COULD AFFECT OUR ABILITY TO SATISFY CUSTOMER ORDERS OR CONTRACTS. We purchase a significant percentage of our components, including structural assemblies, electronic equipment, and computer chips, from third parties. We also occasionally obtain from the U.S. Government parts and equipment that are used in our projects or in the provision of our services. To date, we have not experienced material difficulty in obtaining product components or necessary parts and equipment. While we believe that alternative sources of supply would be available, we may experience increased costs and possible delays in securing alternative sources of supply. We cannot guarantee that alternative sources of supply would be available if and when required by us. OUR ABILITY TO OBTAIN ONLY LIMITED INSURANCE MAY NOT COVER ALL RISKS. We may find it difficult to insure certain risks involved in our operations. Insurance market conditions or factors outside of our control at the time the insurance is purchased could cause premiums to be significantly higher than current estimates. Additionally, the U.S. Department of State has published regulations which could significantly affect the ability of brokers and underwriters to place insurance for certain launches. These factors could cause other terms to be significantly less favorable than those currently available, may result in limits on amounts of coverage that we can obtain, or may prevent us from obtaining insurance at all. Furthermore, there is no assurance that proceeds from insurance that we are able to purchase will be sufficient to cover losses. OUR GROWTH MAY NOT BE MANAGEABLE. Even if we are successful in obtaining new business, failure to manage the growth could adversely affect our condition. We may experience extended periods of very rapid growth. This growth could place a significant strain on our management, operating, financial and other resources. Our future performance will depend in part on our ability to manage growth effectively. We must develop management information systems, including operating, financial, and accounting systems and expand, train, and manage employees to keep pace with growth. Our inability to manage growth effectively could negatively affect results of operations and the ability to meet obligations as they come due. OUR BUSINESS COULD BE ADVERSELY AFFECTED BY TERRORIST ATTACKS. Our business partially depends on activities regulated by various agencies and departments of the U.S. government and other companies that rely on the government. In the recent past, in response to terrorists' activities and threats aimed at the United States, transportation, mail, financial, and other services have been slowed or stopped altogether. Further delays or stoppages in transportation, mail, financial, or other services could have a material adverse effect on our business, results of operations, and financial condition. Furthermore, we may experience a small increase in operating costs, such as PAGE 15 costs for transportation, insurance, and security as a result of the activities and potential activities. The U.S. economy in general has been adversely affected by the terrorist activities and potential activities, and any economic downturn could adversely impact our results of operations, impair our ability to raise capital, or otherwise adversely affect our ability to grow our business. Conversely, because of the nature of our products and services, there may be opportunities for us to offer solutions to the government that may address some of the problems that the country faces at this time. OUR COMMON STOCK INVESTORS MAY NOT RECEIVE DIVIDENDS. We have not paid common stock dividends since our inception and do not anticipate issuing them in the foreseeable future. There can be no guarantee or assurance that common stock dividends will ever be paid. In fact, our goal is to reinvest earnings in an effort to complete development of our technologies and products, and to increase sales and long-term profitability and value. In addition, the revolving credit facility with Laurus, our newly issued Preferred Stock or other bank lines of credit, which we may establish in the future or other credit or borrowing arrangements may significantly impact our ability to pay common stock dividends to our shareholders. OUR COMMON STOCKHOLDERS MAY EXPERIENCE DILUTION IF OUR PREFERRED STOCK IS CONVERTED OR OUR OUTSTANDING WARRANTS AND OPTIONS ARE EXERCISED As of September 1, 2004, we are obligated to issue 1,776,827 shares of our common stock if all of our outstanding warrants, outside of the shares underlying our preferred stock and warrants in this offering, are exercised. In addition, as of September 1, 2004, we have outstanding stock options to purchase an aggregate of 6,351,266 shares of our common stock, including 2,000,000 unvested options issued to our Chief Executive Officer. The total number of shares, which could be issued upon the exercise of currently vested warrants, options and preferred stock (5,764,607 shares) represents approximately 29% of our issued and outstanding shares of common stock as of September 1, 2004. Shares of common stock issued as a result of the exercise of stock options will have a dilutive effect, which could be substantial, on the currently and then outstanding shares of common stock. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. We intend that those forward-looking statements be subject to the safe harbors created by those sections. These forward-looking statements generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance, and can generally be identified by the use of the words "believe," "intend," "plan," "expect," "forecast," "project," "may," "should," "could," "seek," "pro forma," "estimates," "continues," "anticipate" and similar words. The forward-looking statements and associated risks may include, relate to, or be qualified by other important factors, including, without limitation: our ability to be profitable and obtain additional working capital, if required; our ability to successfully implement our future business plans; our ability to attract strategic partners, alliances and advertisers; our ability to hire and retain qualified personnel; the risks of uncertainty of trademark protection; risks associated with existing and future governmental regulation to which we are subject; and, PAGE 16 uncertainties relating to economic conditions in the markets in which we currently operate and in which we intend to operate in the future. These forward-looking statements necessarily depend upon assumptions and estimates that may prove to be incorrect. Although we believe that the assumptions and estimates reflected in the forward-looking statements are reasonable, we cannot guarantee that we will achieve our plans, intentions or expectations. The forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ in significant ways from any future results expressed or implied by the forward-looking statements. We do not undertake to update, revise or correct any forward-looking statements. Any of the factors described above or in the "Risk Factors" section above could cause our financial results, including our net income (loss) or growth in net income (loss) to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. SELLING SECURITY HOLDERS Laurus may sell, from time to time, under this prospectus, 1,588,235 shares of our common stock, representing 100% of the shares that may become issuable upon conversion of the principal of and interest on the Convertible Note at the fixed conversion price of $0.85 per share for the first 588,235 shares and $1.00 per share for the remaining 1,000,000 shares. Laurus may sell, from time to time, under this prospectus, up to 1,845,779 shares of our common stock at a fixed conversion price of $1.54 per share upon conversion of the $2,500,000 in Preferred Stock and accrued dividends. Laurus may also exercise and sell, from time to time, under this prospectus, warrants on 587,000 shares of our common stock underlying the Laurus Warrant . Laurus may also convert principal and interest on the Convertible Note into our common stock only to the extent that there are amounts outstanding under the revolving credit facility described under "Description of Business - The Laurus Master Fund Ltd. Revolving Credit Facility" below and only if we have not repaid the outstanding amounts before Laurus exercises its conversion rights ; however, Laurus has committed to convert up to $1,500,000, representing 1,588,235 shares, on or before December 31, 2004. The following table sets forth, to our knowledge, certain information about Laurus as of September 1, 2004 . Beneficial ownership is determined in accordance with the rules of the Commission, and includes voting or investment power with respect to the securities. In computing the number of shares beneficially owned by a holder and the percentage ownership of that holder, shares of common stock subject to options or warrants or underlying convertible notes held by that holder that are currently exercisable or convertible or are exercisable or convertible within 60 days after the date of the table are deemed outstanding. To our knowledge, Laurus has sole voting and investment power with respect to all shares of common stock shown as beneficially owned by it, except that Laurus Capital Management, LLC, a Delaware limited liability company, may be deemed a control person of the shares owned by Laurus. David Grin and Eugene Grin are the principals of Laurus Capital Management, LLC. The address for Messrs. David Grin and Eugene Grin is 152 West 57th Street, New York, NY 10019. PAGE 17 Percentage of beneficial ownership is based on presumed ownership of 19,146,660 shares of common stock outstanding as of September 1, 2004 . Actual ownership of the shares is subject to conversion of the Convertible Note and exercise of the Warrants. SHARES OF COMMON SHARES OF COMMON STOCK BENEFICIALLY SHARES OF STOCK BENEFICIALLY OWNED PRIOR COMMON STOCK OWNED AFTER TO OFFERING BEING OFFERING (1) ------------------ ------------------ ------------------- SELLING SECURITY HOLDER. NUMBER PERCENTAGE REGISTERED NUMBER PERCENTAGE ------------------------ ------------- ------------ ------------------- --------- ------------ LAURUS MASTER FUND, LTD. 787,000(2) 3.94% 4,021,014 787,000 3.30% (1) The amount assumes the sale of all shares being offered under this prospectus. (2) The number and percentage of shares beneficially owned is determined in accordance with Rule 13d-3 of the Securities Exchange Act of 1934, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rule, beneficial ownership includes any shares as to which the selling security holder has sole or shared voting power or investment power and also any shares, which the selling stockholder has the right to acquire within 60 days. The actual number of shares of common stock issuable upon the conversion or payment of the Convertible Note is subject to the amount drawn under the note. Furthermore, the selling stockholder has contractually agreed, absent an event of default under the revolving credit facility, to restrict its ability to convert the convertible note or exercise its warrants and receive shares of our common stock if the number of shares of common stock held by it and its affiliates after such conversion or exercise does not exceed 4.99% of the then issued and outstanding shares of common stock. Laurus may void this restriction upon seventy-five days prior written notice to us. All other selling security holders named in this prospectus are offering up to 614,853 shares of common stock through this prospectus, subject to exercise of warrants issued to them in a convertible debt offering following the conversion of interest on and/or principal of the convertible note held by the selling security holders. These security holders consist of our CEO and CFO, Mr. Schaffer, who currently sits on our Board of Directors, and Emery Skarupa, our former Vice President of Operations. Our CEO, CFO and Mr. Schaffer have already exercised their warrants and received registered stock under this registration statement. Each of these selling shareholders, aside from Mr. Skarupa, is subject to insider trading restrictions set forth in the Securities Exchange Act of 1934, the SEC rules and regulations promulgated thereunder and our internal insider trading policy. PAGE 18 The following table sets forth, as of the date of this prospectus, the name of each selling security holder, the number of selling security holders (excluding Laurus), the aggregate number of shares owned by each selling security holder, and the number of shares each selling security holder will own after the completion of the offering made pursuant to this prospectus. For purposes of establishing ownership and shares offered, we have assumed the exercise of all of the outstanding Warrants under this offering: Total Number Of Shares To Total Shares Percentage of Be Offered For to Be Owned Shares Owned Name Of Shares Owned Selling Upon Upon Selling Prior To This Shareholders Completion of Completion of Stockholder Offering Account This Offering This Offering(4) James W. Benson. . (1) 9,241,707 486,647 8,755,060 36.81% Stuart Schaffer. . (2) 128,206 64,103 64,103 0.27% Emery Skarupa. . . 51,282 25,641 25,641 0.10% Richard B. Slansky (3) 81,934 38,462 43,472 0.18% (1) Mr. Benson is our Founding Chairman and Chief Executive Officer. Mr. Benson owns 8,257,647 shares held directly by Mr. Benson and his wife, Susan Benson, (including 486,647 shares as part of the Company's convertible debt repayment when he converted $187,500 of his debt into shares in 2003); 497,413 shares transferred from SD Holdings, LLC to Space Development Institute, a 501(c)(3) corporation; vested options on 510,000 shares; and warrants that were registered hereunder on 486,647 shares and later exercised (Mr. Benson forgave half of his warrants on 973,294 shares as part of the convertible debt repayment). In addition, Mr. Benson has unvested options on 2,000,000 shares. In 2003, 8,245,000 shares were transferred from SD Holdings, LLC, an entity previously controlled by Mr. Benson, directly to Mr. Benson and his children. Mr. Benson's children now hold 1,312,000 shares. Mr. Benson disclaims ownership of shares held by his children. (2) Mr. Schaffer is a current member of our Board of Directors, is our former Vice President of Marketing and Product Development and a loyal stockholder. In addition to the Warrants, Mr. Schaffer holds options to purchase an additional 90,000 shares of our common stock. (3) Mr. Slansky is our Chief Financial Officer and Corporate Secretary. In addition to the Warrants, Mr. Slansky holds 43,472 shares of which 38,462 shares were purchased for cash in a private transaction with Mr. Skarupa, our former Vice President of Operations; 38,462 shares underlying warrants which were also purchased from Mr. Skarupa and were registered and exercised; and, vested options on 276,250 shares. Mr. Slansky also holds 473,750 unvested options. (4) For purposes of calculating percentage of ownership, we assumed the exercise of all of the Convertible Note , Preferred Stock and the Laurus Warrants. We did not assume exercise of all other outstanding derivative securities. Ownership is based on the total outstanding shares of common stock on September 1, 2004 plus shares issuable upon exercise of the Warrants, the Convertible Note, the Preferred Stock and the Laurus Warrants, or 23,782,527 shares. All costs, expenses and fees incurred in connection with the registration of the selling security holders' shares will be borne by us. All brokerage commissions, if any, attributable to the sale of shares by selling security holders will be borne by selling security holders. PAGE 19 PLAN OF DISTRIBUTION The selling security holders, and any of their donees, pledgees, assignees and other successors-in-interest, may, from time to time, sell any or all of their shares of common stock being offered under this prospectus on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales, which may include block transactions, may be at fixed or negotiated prices. The selling security holders may use any one or more of the following methods when selling shares: - ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers; - block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; - purchases by a broker-dealer as principal and resales by the broker-dealer for its own account; - an exchange distribution in accordance with the rules of the applicable exchange; - privately negotiated transactions; - broker-dealers may agree with the selling security holder to sell a specified number of shares at a stipulated price per share; - a combination of any of these methods of sale; or - any other method permitted by applicable law, except (a) that Laurus has agreed that it has not engaged and will not engage or cause, advise, ask or assist any person or entity, directly or indirectly, or engage, in short sales or our common stock, which are contracts for the sale of shares of stock that the seller does not own, or certificates which are not within the seller's control, so as to be available for delivery at the time when, under applicable rules, delivery must be made, and (b) that selling shareholders who also qualify as insiders of the Company are restricted from engaging in short sales and other trading transactions specified in our internal insider trading policy. The sale price to the public may be: - the market price prevailing at the time of sale; - a price related to the prevailing market price; - at negotiated prices; or - a price the selling security holder determines from time to time. Laurus has agreed, with respect to both the Convertible Note and the Preferred Stock, pursuant to the Securities Purchase Agreement, that it has not engaged and will not engage or cause, advise, ask or assist any person or entity, directly or indirectly, to engage, in short sales of our common stock. Broker-dealers engaged by the selling security holders may arrange for other broker-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the selling security holder (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated. The selling security holder does not expect these commissions and discounts to exceed what is customary in the types of transactions involved. PAGE 20 The selling security holders and any broker-dealers or agents that are involved in selling the shares may be deemed to be "underwriters" within the meaning of the Securities Act in connection with these sales. Commissions received by these broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. Any broker-dealers or agents that are not deemed to be underwriters may not sell shares offered under this prospectus unless and until we set forth the names of the underwriters and the material details of their underwriting arrangements in a supplement to this prospectus or, if required, in a replacement prospectus included in a post-effective amendment to the registration statement of which this prospectus is a part. In the event sales are made to broker-dealers as principals, we would be required to file a post-effective amendment to the registration statement of which the prospectus forms a part. In such post-effective amendment, we would be required to disclose the names of any participating broker-dealers and the compensation arrangements relating to such sales. In addition, if any shares of common stock or warrants offered for sale pursuant to this prospectus are transferred, subsequent holders could not use this prospectus until a post-effective amendment is filed, naming such holder. The selling security holders, alternatively, may sell all or any part of the shares offered under this prospectus through an underwriter. To our knowledge, the selling security holders have not entered into any agreement with a prospective underwriter, and we cannot assure you as to whether any such agreement will be entered into. If any selling security holder informs us that it has entered into such an agreement or agreements, any material details will be set forth in a supplement to this prospectus or, if required, in a replacement prospectus included in a post -effective amendment to the registration statement of which this prospectus is a part. This prospectus does not cover the sale or other transfer of the Convertible Note, the Preferred Stock, the Laurus Warrants or the Warrants. If the selling security holders transfer any such securities prior to conversion or exercise, the transferee of those derivative securities may not sell the shares of common stock issuable upon conversion or exercise of those derivative securities under the terms of this prospectus unless we amend or supplement this prospectus to cover such sales. For the period a holder holds the Convertible Note , Preferred Stock and/or the Laurus Warrants , with respect to Laurus, or the Warrants, with respect to all other selling security holders, the holder has the opportunity to profit from a rise in the market price of our common stock. The terms on which we could obtain additional capital during the period in which those derivative securities remain outstanding may be adversely affected. The holders of the derivative securities are most likely to voluntarily convert or exercise those derivative securities when the conversion price or exercise price is less than the market price for our common stock. However, we cannot assure you as to whether any of those derivative securities will be converted or exercised. We have agreed with Laurus to keep the registration statement of which this prospectus constitutes a part effective until the earlier of three years or the termination of the Securities Purchase Agreement for the Convertible Note, as amended, and the earlier of (i) the sale of all registered shares underlying the Preferred Stock, dividends and Laurus Warrant for 487,000 shares or (ii) the date when all such securities may be sold immediately without registration under the Securities Act and without volume restrictions pursuant to Rule 144(k). PAGE 21 USE OF PROCEEDS We will not receive any proceeds from the sale of the shares of our common stock offered by Laurus and other selling security holders under this prospectus. Upon exercise of the Laurus Warrants and the Warrants, we will receive proceeds from the Warrant holder; however, upon selling the common stock underlying the Secured Convertible Note and/or the Preferred Stock and/or the Laurus Warrant and the Warrants, the selling security holder will receive all proceeds directly. DESCRIPTION OF BUSINESS FORWARD LOOKING STATEMENTS The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto and the other financial information appearing elsewhere in this document. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," in our General Registration Statement on Form 10SB12G/A filed January 28, 2000 and in our other periodic reports (e.g., Form 10-KSB, Form 10-QSB and Form 8-K). In addition to historical information, the following discussion and other parts of this document may contain forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," or "continue," the negative of such terms or other comparable terminology. These statements are only predictions. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to publicly update any of the forward-looking statements after the date of this prospectus to conform such statements to actual results or to changes in our expectations. Actual results could differ materially from those anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, the level of sales to key customers; the economic conditions affecting our industry; actions by competitors; fluctuations in the price of raw materials; the availability of outside contractors at prices favorable to us; our dependence on single-source or a limited number of suppliers; our ability to protect our proprietary technology; market conditions influencing prices or pricing; an adverse outcome in potential litigation, claims and other actions by or against us, technological changes and introductions of new competing products; fluctuations in economic conditions; terrorist attacks or acts of war, particularly given the acts of terrorism against the United States on September 11, 2001 and subsequent military responses by the United States in Afghanistan and Iraq; mission disasters such as the loss of the space shuttle Columbia on February 1, 2003 during its re-entry into earth's atmosphere; ability to retain key personnel; changes in market demand; exchange rates; productivity; weather; and market and economic conditions in the areas of the world in which we operate and market our products. These are factors that we think could cause our actual results to differ materially from expected and historical events. PAGE 22 GENERAL SpaceDev, Inc. (the "Company," "SpaceDev," "we," "us" or "our") is engaged in the conception, design, development, manufacture, integration and operations of space technology subsystems, systems, products and services. We are currently focused on the commercial and military development of low-cost microsatellites, nanosatellites and related subsystems, hybrid rocket propulsion for space and launch vehicles, as well as the associated engineering technical services to government, aerospace and other commercial enterprises. Our products and solutions are sold directly to these customers and include sophisticated micro- and nanosatellites, hybrid rocket-based launch vehicles, orbital Maneuvering and orbital Transfer Vehicles as well as safe sub-orbital and orbital hybrid rocket-based propulsion systems. We are also developing commercial hybrid rocket motors for possible use in small launch vehicles, targets and sounding rockets, and small high performance space vehicles and subsystems. Our approach is to provide smaller spacecraft - generally 250 kg (550 pounds) mass and less - and cleaner, safer hybrid propulsion systems to commercial, international and government customers. We are developing smaller spacecraft and miniaturized subsystems using proven, lower cost, high-quality off-the-shelf components. Our space products are modular and reproducible, which allows us to create affordable space solutions for our customers. By utilizing our innovative technology and experience, and space-qualifying commercial industry-standard hardware, software and interfaces, we provide increased reliability with reduced costs and risks. We have been awarded, have successfully concluded or are successfully concluding contracts from such esteemed government, university and commercial customers as the Air Force Research Laboratory, Boeing, the California Space Authority, the Defense Advanced Research Projects Agency, National Aeronautics and Space Administration's Jet Propulsion Laboratory, Lockheed Martin, the Lunar Enterprise Corporation, Malin Space Science Systems, the Missile Defense Agency (formerly the Ballistic Missile Defense Organization), the National Reconnaissance Office, Scaled Composites and the University of California at Berkeley via NASA. We were incorporated under the laws of the State of Colorado on December 23, 1996 as Pegasus Development Group, Inc. ("PDGI"). SpaceDev, LLC of Colorado was originally formed in 1997 for commercial space exploration and was the sole owner of shares of common stock of SpaceDev (a Nevada corporation) ("SpaceDev"), formed on August 22, 1997. On October 22, 1997, PDGI issued 8,245,000 of its $.0001 par value common stock for 100 percent (1,000,000 shares) of SpaceDev's common stock owned by SpaceDev, LLC. Upon the acquisition of the SpaceDev stock, SpaceDev was merged into PDGI and, on December 17, 1997, PDGI changed its name to SPACEDEV, INC. After the merger, SpaceDev, LLC, changed its name to SD Holdings, LLC on December 17, 1997. We became a publicly traded company in October 1997 and are trading on the Nasdaq Over-the-Counter Bulletin Board ("OTCBB") under the symbol of "SPDV." In February 1998, we acquired Integrated Space Systems, in San Diego. Integrated Space Systems was fully integrated into SpaceDev. Most of the Integrated Space Systems employees were former commercial Atlas launch vehicle engineers and managers who worked for General Dynamics in San Diego. As SpaceDev employees, they primarily develop systems and products based on hybrid rocket motor technology and launch vehicle systems. PAGE 23 In August 1998, we acquired a license to the patents and intellectual property produced by American Rocket Company ("AMROC"). The license provided us access to a large cache of hybrid rocket documents, designs and test results. AMROC specialized in the design, development and testing of hybrid rocket technology (solid fuel plus liquid oxidizer) for small sounding rockets and launch vehicles. In late 1998, we bid and won a government-sponsored research and development contract, which was directly related to our strategic commercial space interests. We competed with seven other industry teams and we were one of five firms selected by Jet Propulsion Laboratory to perform a mission and spacecraft feasibility assessment study for the proposed 200-kg Mars MicroMissions. The final report was delivered to Jet Propulsion Laboratory in March 1999 and, as a result, we now offer lunar and Mars commercial deep-space missions based on this and subsequent innovative space system designs. In mid-1999, we won an R&D contract from the National Reconnaissance Office to study small hybrid-based "micro" kick-motors for small-satellite orbital transfer applications. During the contract, we successfully developed three Secondary Payload Orbital Transfer Vehicle ("SPOTV") design concepts. We subsequently created a prototype, which led to the development of our capability to apply the SPOTV concept to our subsequent Maneuvering and orbit Transfer Vehicles development programs. In November 1999, we won a $4.9 million mission contract by the Space Sciences Laboratory ("SSL") at the University of California at Berkeley. We were competitively selected to design, build, integrate, test and operate, for one year, a small NASA-sponsored scientific, Earth-orbiting spacecraft called CHIPSat. CHIPSat is the first and only successful mission of NASA's low-cost University-Class Explorer ("UNEX") series to date. Due to additional NASA and customer reviews, additional work and schedule extensions, the CHIPSat contract award was increased by $600,000 on June 15, 2001 and again by $1.2 million on November 28, 2001, bringing the total contract value for design and build to approximately $6.8 million. An extension of the original contract based on our successful launch and orbit status in the amount of approximately $400,000 was awarded to us for one year of satellite operations. CHIPSat launched as a secondary payload on a Delta-II rocket on January 12, 2003. The satellite, the world's first orbiting Internet node, achieved 3-axis stabilization, meaning it was pointing and tracking properly, with all individual components and systems successfully operating, and is continuing to work well in orbit after more than a year. The CHIPSat program generated approximately $2.1 million, $3.2 million, $1.7 million and $0.4 million of revenue in 2000, 2001, 2002 and 2003, respectively. On March 22, 2000, the California Spaceport Authority and the California Space and Technology Alliance ("CSTA") awarded us a grant of approximately $100,000 to be used for test firing our hybrid rocket motors. California's Western Commercial Space Center also awarded us approximately $200,000 to help build and equip its satellite and space vehicle manufacturing facilities. These capabilities are being used to expand our current project and technology base. In July 2000, the National Reconnaissance Office granted us two separate follow-on competitive awards of approximately $400,000 each for further hybrid rocket engine design, test, evaluation, and development. Our work for the National Reconnaissance Office has helped fund two innovative hybrid rocket motor products: - a family of small versatile orbital Maneuver and orbit Transfer Vehicles using clean, safe hybrid rocket propulsion technology; and, - a protoflight hybrid propulsion module for a 50-kg class microsatellite. Both of those contracts were successfully completed. PAGE 24 In September 2001, Scaled Composites awarded us a contract for a proprietary hybrid propulsion development program for Scaled's "SpaceShipOne," valued in excess of $1 million. As a part of that program, we competed with another party to design a space propulsion system. The entire contract, awarded upon the submitted designs, was valued at approximately $2.2 million. The contract was indicative of an increased demand for our hybrid motor technology and expertise in the space industry. Work on this project generated approximately $1.2 million and $397,000 of revenue in 2002 and 2003, respectively. In September of 2003, SpaceDev was selected by Scaled Composites as the sole supplier of hybrid propulsions systems, and was awarded the follow-on SpaceShipOne propulsion contract. We generated approximately $115,000 of revenue in 2003 from this new contract and related engineering change orders. On December 17, 2003, which corresponded with the 100th anniversary of the Wright Brothers flight, our hybrid propulsion system, which we believe is the world's largest of its kind, aboard SpaceShipOne, successfully powered a pilot toward space on its historic first powered supersonic flight. After being released by the White Knight, a carrier aircraft, the SpaceShipOne Test Pilot flew the ship to a stable 0.55 mach gliding flight condition, started a pull-up and fired our hybrid rocket motor. Nine seconds later, SpaceShipOne broke the sound barrier and continued its steep powered ascent. The climb was very aggressive, accelerating forward at more than 3-g while pulling upward at more than 2.5-g. At motor shutdown, 15 seconds after ignition, SpaceShipOne was climbing at a 60-degree angle and flying near 1.2 Mach (930 mph). The test pilot then continued the maneuver to a vertical climb, achieving zero speed at an altitude of 68,000 feet. This is important because we are showing that the private sector can perform human space flight in a rapid, safe and inexpensive manner. In addition, our rocket motor technology successfully propelled SpaceShipOne on its second historic manned powered flight on April 8, 2004, achieving a speed of 1.6 Mach and altitude of 105,000 feet, in Scaled Composites' goal to win the $10 million X-Prize for stimulating the development of a private sector human space flight industry. On May 13, 2004, our hybrid rocket motor technology successfully propelled SpaceShipOne on its third manned flight accelerating to 2.5 Mach and setting an altitude record of 211,400 feet. Finally, on June 21, 2004, our hybrid rocket motor technology successfully powered SpaceShipOne on its fourth manned flight propelling Mike Melvill to over 328,000 feet and created the world's first private sector astronaut. These historic flights are the first human flights ever powered by hybrid rocket technology, and we provided the critical hybrid motor components and technology to make it happen. On April 4, 2002, SpaceDev, Inc., an Oklahoma corporation, was formed for the purpose of investigating and developing commercial space products in the state of Oklahoma. We currently have no plans to develop this business in Oklahoma. On April 30, 2002, we were awarded Phase I of a contract to develop a Shuttle-compatible propulsion module for AFRL. We received an award for Phase II of the contract on March 28, 2003. We are using the project to further expand our Maneuvering and orbital Transfer Vehicles technology and product line to satisfy government space transportation requirements. The first two phases of the contract have an estimated value of approximately $2.5 million, of which $100,000 was awarded for Phase I. Phase II was expanded on May 3, 2004 with the exercise of an option, which was at the discretion of AFRL, for an additional $1 million. On July 9, 2003, we were awarded a Phase I contract to develop micro- and nano satellite bus and subsystem designs. This AFRL SBIR contract, valued at approximately $100,000, will enable us to explore the further miniaturization of our unique and innovative microsat subsystems. It will also enable us to explore ways to reduce the time and cost to build small satellites through further standardization in order to help define de facto standards for payload hardware PAGE 25 and software interfaces. The contract is fixed price, milestone-based and should be completed within one year. On August 23, 2004, this SBIR moved into Phase II valued at approximately $750,000 of carry-forward work for us and is expected to be completed by May 2006. On July 9, 2003, we were awarded a Phase I Small Business Innovation Research ("SBIR") contract by Air Force Research Lab ("AFRL") to design and begin the development of the SpaceDev Streaker(TM) small launch vehicle ("SLV"). SpaceDev Streaker(TM) will be designed to responsively and affordably lift up to 1,000 pounds to Low Earth Orbit ("LEO"). The SpaceDev Streaker(TM) SLV concept is based on a proprietary combination of technologies to increase the performance of hybrid rocket motor technology. Hybrid rocket motors are a combination of solid fuel and liquid oxidizer, and can be relatively safe, clean, non-explosive, and storable, and can be throttled, shut down and restarted. This contract is valued at approximately $100,000, is a fixed price, milestone-based agreement . We believe that this SBIR will move into Phase II valued at approximately $740,000 of carry-forward work for us, plus approximately #800,000 of funds provided by Congress. This money will be used to develop and test fire our large Common Core Booster for the SpaceDev Streaker(TM) launch vehicle. On August 5, 2004, we were informed that we received a Congressional budget award for approximately $3 million to expand and accelerate the scope of the work on our SLV program. Also on July 9, 2003, we were awarded a second contract by the Missile Defense Agency ("MDA") to explore the use of micro-satellites ("microsats") in national missile defense. Our microsats are operated over the Internet and are capable of pointing and tracking targets in space or on the ground. This study explored fast response microsat launch and commissioning; small, low-power passive sensors; target acquisition and tracking; formation flying and local area networking within a cluster of microsats; and an extension of our proven use of the Internet for on-orbit command, control and data handling. The contract was successfully concluded on February 27, 2004. The total contract value was $800,000 with approximately $481,000 of revenue realized in the year ending December 31, 2003 and approximately $319,000 of revenue realized in the first quarter of 2004. The total value of our microsatellite studies for MDA was over $1 million in 2003. On July 24, 2003, we were awarded a contract by Lunar Enterprise of California ("LEC") for a first phase project to begin developing a conceptual mission and spacecraft design for a lunar lander program. The unmanned mission will be designed to put a small dish antenna near the south pole of the Moon. From that location it will be in near-constant sunlight for solar power generation, and should be able to perform multi-wavelength astronomy while communicating with ground stations on Earth. The contract value was $100,000 and was completed by November 2003. We were awarded a follow-on phase to further analyze launch opportunities, spacecraft design, trajectory possibilities, potential landing areas, available technologies for a small radio astronomy system, and communications and data handling requirements on July 20, 2004 in the amount of $150,000. Although this project is currently unfunded, if the project were to proceed past the analysis stage, the total mission cost could exceed $50-$75 million. Again, we can give no assurance that any additional contracts will be awarded to us from this contract . Revenues for the year ending December 31, 2003 were approximately $70,000. On October 2, 2003, we were awarded an exclusive, follow-on contract to provide the hybrid rocket motor systems and components for SpaceShipOne. We provide our facilities, resources and a team of launch vehicle and hybrid propulsion engineers & technical personnel in continued support of the SpaceShipOne program. The contract calls for us to use our best efforts to satisfy the requirements of the SpaceShipOne program, based on our experience with the prior phases. We are to provide two sets of re-usable flight test hardware, including a bulkhead, commonly known as the SpaceDev bulkhead, machined in the flight configuration, a main oxidizer valve of the current design and associated interfaces and plumbing to the SpaceDev bulkhead, a motor control system, igniter housings, pressure transducers, and thermocouples as PAGE 26 required for input to the motor control system. In addition, we are to produce and assemble test motors, including but not limited to, all expendable or semi-reusable materials as defined by our baseline design motor. We are also to provide on-site engineering test support and post-test analysis. Provisions are made in the contract for minimum monthly payments in the event of customer schedule slippage as well as additional levels of support via engineering change orders, if required. The total contract value is estimated at $429,000. On March 31, 2004, we were awarded a $43,362,271, five-year, cost-plus-fixed fee indefinite delivery/indefinite quantity contract to conduct a microsatellite distributed sensing experiment, an option for a laser communications experiment, and other micro satellite studies and experiments as required in support of the Advanced Systems Deputate of the Missile Defense Agency. This effort will be accomplished in a phased approach. The total five-year contract has a ceiling amount of $43,362,271. The principal place of performance will be Poway, California. We expect to complete the work under the contract before February 2009. Government contract funds will not expire at the end of the current government fiscal year. The microsatellite distributed sensing experiment is intended to design and build up to six responsive, affordable, high performance microsatellites to support national missile defense. The milestone-based, multiyear, multiphase contract has an effective start date of March 1, 2004. The first phase is expected to be completed this year and will result in detailed mission and microsat designs. The estimated first phase revenue is $1.1 million. The overall contract calls for us to analyze, design, develop, fabricate, integrate, test, operate and support a networked cluster of three formation-flying boost phase and midcourse tracking microsatellites, with an option to design, develop, fabricate, integrate, test, operate and support a second cluster of three formation flying microsats to be networked on-orbit with high speed laser communications technology. The second phase is anticipated to begin October 1, 2004 and run through 2005. BUSINESS STRATEGY Our strategy is based on the belief that innovative advancements in technology and the application of standard business processes and practices will make access to space much more practical and affordable. We believe these factors will cause growth in certain areas of space commerce and will create new space markets and increased demand for our proprietary products. Our business strategy is to: - Introduce commercial business practices into the space arena, use off-the-shelf technology in innovative ways and standardize hardware and software to reduce costs and to increase reliability and profits; - Start with small, practical and profitable projects, and leverage credibility and profits into larger and ever more bold initiatives - utilizing partnerships where appropriate; - Bid, win and leverage government programs to fund our research and development ("R&D") and product development efforts; - Integrate our smaller, low cost commercial spacecraft and hybrid space transportation systems to provide one-stop turnkey payload and/or data delivery services to target customers; - Apply our low cost space products to new applications and to create new users, new markets and new revenue streams; - Produce and fly commercial missions, in conjunction with partners and PAGE 27 investors, throughout the inner solar system in the commercial beyond earth orbit "space"; and - Join or establish a team to build a safe, affordable sub-orbital, passenger space plane to help initiate the space tourism business. We believe that our business model, emphasizing smaller satellites, commercial approaches, technological simplicity, architectural and interface standardization and horizontal integration (i.e., "whole product"), provides the following advantages: - Enables small-space customers to contract for end-to-end mission solutions, reducing the need for and complexity of finding other contractors for different project tasks; - Decreases schedule time and lowers total project costs, thereby providing greater value and increases return on investment for us and our customers; and - Creates barriers to entry by and competition from competitors. PRODUCTS AND SERVICES; MARKET We currently have three primary lines of space products and services on which we believe a sound foundation and profitable, cash generating business can be built: - Our Products - Microsatellites & Nanosatellites, BD-II Spacecraft Bus, Maneuvering and orbital Transfer Vehicle and Hybrid Propulsion and Launch Vehicle Systems; - Our Subsystem Products - Miniature Flight Computer, Micro-Space Vehicle Operating System (micro space vehicle operating system), PC-DS (power conditioning and distribution system) and Miniature S-Band Transmitter; and, - Our Services - Mission Analysis and Design, Spacecraft and Subsystem Design, Microsatellite and Nanosatellite Launches and Mission Control and Operations. These products and services are being marketed and sold directly into primarily domestic government, university, military and commercial markets. Our business is not seasonal to any significant extent; however, our business follows normal industry trends such as increased demand during bullish economic periods, or slow-downs in demand during periods of recession. In addition, we are working with partners to create new markets that can generate new space-related service, media, tourism and commercial revenue streams. While we believe that certain space market opportunities are still several years away, we are currently working with industry-leading partners to develop unique enabling technology for the potentially very large sub-orbital manned space plane tourism market; and, creating a new unmanned Beyond Earth Orbit commercial market with spacecraft derived from our NASA Jet Propulsion Laboratory Mars MicroMission and Boeing Lunar Orbiter mission design contracts. Our Products ------------- Microsatellites & Nanosatellites - We design and build small, light, high-performance, reliable and affordable micro- and nanosatellites. The primary benefit of micro- and nanosatellites is lower cost and weight. Since we can dramatically reduce manufacturing costs and the costs to launch the satellites to earth-orbit and deep space, we can pass those cost savings on to PAGE 28 our customers. Small, inexpensive satellites were once the exclusive domain of scientific and amateur groups; however, smaller satellites are now a viable alternative to larger, more expensive ones, as they provide cost-effective solutions to traditional problems. We design and build low cost, high performance space-mission solutions involving microsatellites (generally less than 100 kg) and even smaller satellites (less than 50 kg). Our approach is to provide smaller spacecraft and compatible low cost, safe hybrid propulsion space systems to a growing market of commercial, government and potentially international customers. BD-II (Boeing Delta-II compatible) spacecraft bus - We have a qualified microsatellite bus available to sell as a standard, fixed-price product to government and commercial customers needing an affordable satellite for small payloads. We began developing this product in 1999, when we were selected as the mission designer, spacecraft bus provider, integrator and mission operator of CHIPSat. CHIPSat was launched at 4:45 PM PST on January 12, 2003 from Vandenberg Air Force Base in California. Maneuvering and orbital Transfer Vehicle - Our Maneuvering and orbital Transfer Vehicles system is a family of small, affordable, elegantly simple, throttleable, and restartable propulsion and integrated satellite products. Our Maneuvering and orbital Transfer Vehicles can be used as a standard propulsion module to transport a customer's payload to different orbits. The Maneuvering and orbital Transfer Vehicles provide the change in velocity and maneuvering capabilities to support a wide variety of applications for on-orbit maneuvering, proximity operations, rendezvous, inspection, docking, surveillance, protection, inclination changes and orbital transfers. Hybrid Rocket Propulsion and Launch Vehicle System - We provide a wide variety of safe, clean, simple, reliable, cost-effective hybrid propulsion systems to safely and inexpensively enable satellites and on-orbit delivery systems to rendezvous and maneuver on-orbit and deliver payloads to sub-orbital altitudes. Hybrid rocket propulsion is a safe and low-cost technology that has tremendous benefits for current and future space missions. Our hybrid rocket propulsion technology features a simple design, is restartable, is throttleable and is easy to transport, handle and store. We acquired some of our expertise in hybrid propulsion technology from AMROC. We are using this base technology, as modified by SpaceDev, to develop the responsive, affordable SpaceDev Streaker(TM) small launch vehicle under an Air Force contract. Our Subsystem Products ------------------------ Miniature Flight Computer - Our Miniature Flight Computer is a high performance 300 million instructions per second general-purpose space-qualified flight computer for a wide variety of space vehicles. It is cost-effective, has about ten times the performance-to-power ratio of current flight computers and only uses 0.5 to 6 watts of power, depending on its tasks. Our Miniature Flight Computer has successfully passed manufacturing and environmental testing and over 14 months of reliable operations in low earth orbit ("LEO"), and is ready for civil, military and commercial spacecraft and launch vehicle applications. Micro Space Vehicle Operating System - Our Micro-Space Vehicle Operating System is a small, fast, modular and layered operating system, similar to the operating systems of microcomputers. The modular nature of our Micro-Space Vehicle Operating System and our other space products allow us to design and build affordable space solutions for our customers. We use industry-standard interfaces to increase reliability while reducing cost. Our Micro-Space Vehicle Operating System combines standard protocols like TCP/IP, software components like VxWorks(R) and application software to effect real time command and control, scriptable autonomous vehicle control, scriptable data acquisition and telemetry. PAGE 29 Mission Control and Operations Software ("MC-OS") - Our MC-OS performs satellite command and control and data acquisition. This general purpose software permits direct command, control and data operations from any laptop computer anywhere in the world. The MC-OS satellite command and control is managed via user commands, batched command scripts and timed command scripts. MC-OS components include direct, real-time interactive Telnet communications with the satellite, file transfer protocol ("FTP") for file transfer between the ground station and satellite, a system security module which assigns users a password, command level and logs all user commands to disk, and a status window for monitoring MC-OS status. Power Conditioning and Distribution System ("PC-DS") - Our PC-DS controls critical failsafe spacecraft functions, including battery charge control, bus voltage regulation, load power switching, current monitoring & limiting for the spacecraft and individual loads, and hardware load-shedding protection for spacecraft contingency management, and allows direct ground control of power switches. Our PC-DS is capable of keeping the spacecraft alive independent of any other spacecraft computers. Our Miniature S-Band Transmitter and Miniature S-Band Receiver are cost-effective solutions for low cost and low mass spacecraft. The Miniature S-Band Transmitter and the Miniature S-Band Receiver feature lightweight state-of-the-art electronic circuitry designed to meet today's requirements for power efficient space-based communications hardware. The weight of the transmitter and receiver are 2.5-oz and 32-oz, respectively. These units leverage years of communications design heritage and have been operating on-orbit since the January 12, 2003 launch of CHIPSat, the first mission to be funded through NASA's University Explorer Program and the first and only successful University Explorer mission to date. The Miniature S-Band Transmitter and the Miniature S-Band Receiver designs provide flexibility to meet customer requirements and options. Both units are designed to operate in most present day thermal, launch, and on-station LEO spacecraft environments. Our Services ------------- Mission Analysis and Design - We can provide end-to-end mission design and analysis, including the design of the mission and its science, commerce or technology demonstration goals, the design of an appropriate space vehicle (satellite or spacecraft), prototype development, construction and testing of the spacecraft, integration of one or more payloads (instruments, experiments or technologies) into the spacecraft, integration of the spacecraft onto the launch vehicle (rocket), the launch and the mission control and operations during the life of the mission. Spacecraft and Subsystem Design - We also provide reliable, affordable access to space through innovative solutions currently lacking in the marketplace. Our approach is to provide smaller spacecraft - generally 250 kg mass and less - and compatible hybrid propulsion space systems to commercial, university and government customers. The small spacecraft market is supported by the evolution and enabling of microelectronics, common hardware & software interface standards, and smaller launch vehicles. Reduction of the size and mass of traditional spacecraft electronics has reduced the overall spacecraft size, mass, and volume over the past 10 to 15 years. For example, our Miniature Flight Computer is only 24 cubic inches and provides 300 million instructions per second of processing power versus a competitor's more "traditional" solution that requires about 63 cubic inches and only provides 10 million instructions per second. Microsatellite & Nanosatellite Launches - To support the growth in customer demand within the small satellite market, we work with launch providers to identify and market affordable launch opportunities and to provide customers with a complete on-orbit data delivery service that combines our spacecraft and hybrid propulsion products. These innovative, low-cost, turnkey launch solutions will allow us to provide one-stop shopping for launch services, spacecraft, PAGE 30 payload accommodation, total flight system integration and test and mission operations. The customer only needs to provide the payload, and we are capable to perform all the tasks required for the customer to get to orbit and to begin collecting their data. Mission Control and Operations - Our mission control and operations center, located in our headquarters building near San Diego, coupled with our mission control and operations package, is uniquely Internet-based and allows for the operation and control of missions from anywhere in the world that has access to the Internet. CHIPSat is the first U.S. mission to use end-to-end satellite operations with TCP/IP and FTP. While this concept has been analyzed and demonstrated by the NASA OMNI team, CHIPSat is the first to implement the concept as the only means of satellite communication. A formation flying cluster or constellation of TCP/IP-based microsatellites, can be designed to communicate directly with each other, as in a wide area network in space. Providing any one satellite/node in this network is in line-of-sight with any ground station at any given time, the entire constellation could always maintain ground station connectivity, thus creating a network on-orbit and on the web, a direct extension of CHIPSat's elegantly simple TCP/IP mission operations architecture. COMPONENTS AND RAW MATERIALS Although we may experience a shortage of certain parts and components related to our products, we have many alternative suppliers and distributors and are not dependent on any individual supplier or distributor. We have not experienced difficulty in our ability to obtain our parts or component materials to date, and do not currently expect this to be an issue in the future; however, we can provide no assurances that alternative sources would be available on terms favorable to us or at the time we would require them. COMPETITION We compete for sales of our products and services based on price, performance, technical features, contracting approach, reliability, availability, customization, and, in some situations, geography. Our primary competition for low-cost propulsion systems using clean, safe, commercially available hybrid rocket motor technology comes from Cesaroni Technology Incorporated in Canada and their affiliates. While Lockheed Martin has demonstrated large-scale hybrid rocket capability, and there are a number of smaller enterprises, especially academic-based organizations, in the domestic market currently investigating various aspects of hybrid rocket technology, to-date we have seen limited competitive pressures arising from these organizations. The primary domestic competition for unmanned earth-orbiting microsatellites, unmanned deep space micro-spacecraft and microsatellite subsystems as well as software systems comes from other small companies such as AeroAstro, Orbital Sciences and Spectrum Astro. The most established international competitors are Surrey Satellite Technology Limited ("SSTL") in the United Kingdom, OHB Systems in Germany, an OHB Technology AG Company, and EADS Astrium with locations throughout Western Europe. Swedish Space Corporation is also able to compete in the small-satellite arena, particularly in the European market. In addition to private companies, there are a limited number of universities in the United States that have the capability to produce reasonably simple microsatellites; these include, Weber State in Ogden, Utah and Colorado University in Boulder, Colorado. While we believe that our product and service offerings provide a wide breadth of solutions for our customers and prospective customers, some of our competitors compete across many of our product lines. Several of our current and potential competitors have greater resources, including technical and engineering resources. We are not aware of any established large companies (e.g., Northrop Grumman, Lockheed Martin, Boeing), which have expressed PAGE 31 corporate goals to design and build inexpensive micro-spacecraft for a mission, which would be our direct competition. THE LAURUS MASTER FUND, LTD. REVOLVING CREDIT FACILITY On June 3, 2003, we entered into a Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant, with Laurus Master Fund, Ltd. ("Laurus"), which were filed on Form 8-K dated June 18, 2003. Pursuant to the agreements, we received a $1 million revolving credit facility in the form of a three-year Convertible Note secured by its assets. The net proceeds from the Convertible Note are used for general working capital needs. Advances on the Convertible Note may be repaid at the our option, in cash or through the issuance of our shares of common stock. The Convertible Note carries an interest rate of WSJ Prime plus 0.75% on any outstanding balance. In addition, we are required to pay a collateral management payment of 0.55% of the average aggregate outstanding balance during the month plus an unused line payment of 0.20% per annum. Approximately $1,700 in interest and $2,100 in fees were accrued under the revolving credit facility in the 83098478first quarter of 2004. The outstanding balance on the revolving credit facility at June 30, 2004 was $408,003. We filed a prior Form SB-2 on July 25, 2003 in connection with this transaction. The shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. Once the market price exceeded 118% of the fixed conversion price, which occurred on or about July 21, 2003, we obtained the ability to pay amounts outstanding under the revolving credit facility in cash or shares of our common stock at the fixed conversion price of $0.55 per share on the first $1 million of principal. The Convertible Note includes a right of conversion in favor of Laurus. If Laurus exercises its conversion right at any time or from time to time at or prior to maturity, on any outstanding balance at the time, the Convertible Note is convertible into shares of our common stock at a fixed conversion price, subject to adjustments for stock splits, combinations and dividends and for shares of common stock issued for less than the fixed conversion price (unless exempted pursuant to the agreements). The agreement was modified on March 31, 2004 to provide for a six-month waiver to us and a fixed conversion price to Laurus of $0.85 per share on the first $500,000 after the first $1 million. The agreement was modified again as part of the Preferred Stock transaction to increase the Convertible Note from $1.0 million to $1.5 million and set the fixed conversion price on the next $1 million at $1.00 per share and thereafter, the fixed conversion price will be adjusted to 103% of the then fair market value of our common stock ("Adjusted Fixed Conversion Price"). Laurus converted 1,403,182 shares to reduce the debt we owed by $771,750 for the six-months ending June 30, 2004. Laurus converted a total of 1,818,182 shares to reduce the debt by $1,000,000 since the inception of the revolving credit facility. For the six-months ending June 30, 2004, we expensed $1,177,846 for the non-cash loan fee expense based on the fair market value of the stock when Laurus converted and approximately $1,304,000 for the non-cash loan fee expense since the inception of the revolving credit facility. The fair market value used in 2003 was established using a 20% discount to the closing price on the date of conversion based on the restricted and thinly-traded nature of the stock in 2003 and the fair market value used in 2004 was established using the closing price on the date of conversion with no discount taken due to the increased volume of the stock. Availability of funds under the revolving credit facility is based on our accounts receivables, except as waivers are provided by Laurus. An initial three (3) month waiver was offered by Laurus, under which Laurus permitted a credit advance up to $300,000, which amount would otherwise have exceeded eligible accounts receivable during the period. Laurus subsequently extended PAGE 32 the waiver for two additional six (6) month periods, under which Laurus permitted a credit advance up to $1 million, which amount would otherwise have exceeded eligible accounts receivable during the period. The credit facility was modified again in March 31, 2004, to provide additional waivers in exchange for a fixed conversion rate of $0.85 per share on the next $500,000 converted under the Convertible Note. The revolving credit facility is secured by all of our assets. In conjunction with this transaction, Laurus was paid a fee of $20,000 for the first year which was expensed as additional interest expense in 2003. We were required to pay a continuation fee of $10,000 in June 2004 and each year thereafter. In addition, Laurus received a warrant to purchase 200,000 shares of our common stock and two subsequent warrants to purchase 50,000 shares each, as stated herein. The warrant exercise price is computed as follows: $0.63 per share for the purchase of up to 125,000 shares; $0.69 per share for the purchase of an additional 50,000 shares; and $0.80 per share for the purchase of an additional 25,000 shares. The two additional 50,000 share warrants carry an exercise price of $1.0625 per share and $1.9250 per share, respectively. The warrant exercise price may be paid in cash, in shares of our common stock, or by a combination of both. The warrant expiration dates for these warrants are June 3, 2008, June 18, 2009 and August 25, 2009, respectively. The warrant exercise prices and the number of shares underlying the warrants are subject to adjustments for stock splits, combinations and dividends. We may terminate our agreements with Laurus before the end of the initial three-year term and Laurus will release its security interests upon payment to Laurus of all obligations, if we have: (i) provided Laurus with an executed release of all claims which we may have under the agreements; and, (ii) paid to Laurus an early payment fee in an amount equal to (x) four percent (4%) of the capital availability amount if such payment occurs prior to the first anniversary of the Initial Term (i.e., June 3, 2004); (y) three percent ( 3%) of the capital availability amount if such payment occurs after the first anniversary and prior to the second anniversary of the Initial Term; and, (z) two percent (2%) of the capital availability amount if such payment occurs after the second anniversary and prior to the end of the Initial Term. The early payment fee is also due and payable by us to Laurus if we terminate our Agreement after the occurrence of an Event of Default, as define in the agreements. On March 31, 2004, we agreed to amend our Security Agreement and Secured Convertible Note with the Laurus Master Fund, Ltd. to change certain terms of the conversion price to allow for the next Five Hundred Thousand Dollars ($500,000) converted under the Convertible Note to be converted at eighty-five cents ($0.85) per share of common stock. As part of our Preferred Stock transaction, we agreed to amend our Laurus agreements again to extend the revolving credit facility to $1.5 million and fix the conversion price on the next $1 million converted at $1.00 per share of common stock. Thereafter, the fixed conversion price shall be reset to equal 103% of the volume weighted average closing price of the common stock for the ten (10) trading days prior to the last day on which such five hundred thousand dollars ($500,000) has been converted. In exchange, Laurus agreed to waive certain over advance compliance provisions for six (6) months. THE LAURUS MASTER FUND, LTD. PREFERRED STOCK TRANSACTION On August 25, 2004, we entered into a Securities Purchase Agreement with the Laurus Master Fund, Ltd., whereby we issued 250,000 shares of our Series C Convertible Preferred Stock, par value $0.001 per share (the "Preferred Stock"), to Laurus for an aggregate purchase price of $2,500,000 or $10.00 per share (the "Stated Value"). The preferred shares are convertible into shares of our $0.0001 par value common stock at a rate of $1.54 per share at any time after the date of issuance, and pay quarterly, cumulative dividends at a rate of 6.85% with the first payment due on January 1, 2005. Dividends are payable in cash or shares of our common stock at the holder's option with the exception that dividends must be paid in shares of our common stock for up to 25% of the aggregate dollar trading volume if the fair market value of our common stock for the 20-days preceding the conversion date exceeds 120% of the conversion rate. PAGE 33 The preferred shares are redeemable by us in whole or in part at any time after issuance for (a) 115% of the Stated Value if the average closing price of the common stock for the 22 days immediately preceding the date of conversion does not exceed the conversion rate or (b) the Stated Value if the average closing price of our common stock for the 22 days immediately preceding the date of conversion exceeds the Stated Value. The preferred shares have a liquidation right equal to the Stated Value upon our dissolution, liquidation or winding-up. The preferred shares have no voting rights. In conjunction with the Preferred Shares, we issued a five-year common stock purchase warrant to Laurus for the purchase of 487,000 shares of our common stock at an exercise price of $1.77 per share. We committed to register all of the shares of our common stock underlying the Preferred Shares and the warrant, as well as shares payable as dividends on the Preferred Shares, for resale. Also in conjunction with the Preferred Stock financing, Laurus agreed to extend our current revolving credit facility reported on Form 8-K filed June 18, 2003 from $1.0 million to $1.5 million. The first $1,000,000 converted under the revolving credit facility was converted last year and earlier this year at a rate of $0.55 per share. On March 31, 2004, the conversion price for the next $500,000 under the revolving credit facility was set at $0.85 per share. The next $1 million under the revolving credit facility will be convertible by Laurus at a rate of $1.00 per share. Laurus has committed to convert a full $1,500,000 drawn on the Convertible Note into our common stock on or prior to December 31, 2004. REGULATION Our business activities are regulated by various agencies and departments of the U.S. government and, in certain circumstances, the governments of other countries. Several government agencies, including NASA and the U.S. Air Force, maintain Export Control Offices to ensure that any disclosure of scientific and technical information complies with the Export Administration Regulations and the International Traffic in Arms Regulations ("ITAR"). Exports of our products, services and technical data require either Technical Assistance Agreements ("TAAs") or licenses from the U.S. Department of State, depending on the level of technology being transferred. This includes recently published regulations restricting the ability of U.S.-based companies to complete offshore launches, or to export certain satellite components and technical data to any country outside the United States. The export of information with respect to ground-based sensors, detectors, high-speed computers, and national security and missile technology items are controlled by the Department of Commerce. The government is very strict with respect to compliance and has served notice that failure to comply with the ITAR and/or the Commerce Department regulations may subject guilty parties to fines of up to $1 million and/or up to 10 years imprisonment per violation. Our failure to comply with any of the foregoing regulations could have serious adverse effects as dictated by the rules associated with compliance to the ITAR regulations. Also, our ability to successfully market and sell into international markets may be severely hampered due to ITAR regulation requirements. Our conservative position is to consider any material beyond standard marketing material to be regulated by ITAR regulations. This year we began an active and comprehensive internal and external ITAR training program provided by our regulatory consulting firm, Q International Group, and the Society for International Affairs, both for our employees and our Empowered Official, Mr. Slansky. We also introduced in 2003 an Internal Export Compliance Control Program for defense articles and defense services controlled by the U.S. Department of State under ITAR. In addition to the standard local, state and national government regulations that all businesses must adhere to, the space industry has specific regulations. In the U.S., command and telemetry frequency assignments for space missions are primarily regulated by the Federal Communications Commission for our domestic commercial products. Our products geared toward domestic government customers are regulated by the National Telecommunications Information Agency and any of our products sold internationally, if any, are regulated by the International Telecommunications Union. All launch vehicles PAGE 34 that are launched from a launch site in the United States must pass certain launch range safety regulations that are administered by the U.S. Air Force. In addition, all commercial space launches that we might perform require a license from DOT. Satellites that are launched must obtain approvals for command and frequency assignments. For international approvals, the FCC and NTIA obtain these approvals from the ITU. These regulations have been in place for a number of years to cover the large number of non-government commercial space missions that have been launched and put into orbit in the last 15 to 20 years. Any commercial deep space mission that we might perform would be subject to these regulations. Presently, we are not aware of any additional or unique government regulations related to commercial space missions. We are also required to obtain permits, licenses, and other authorizations under federal, state, local and foreign statutes, laws or regulations or other governmental restrictions relating to the environment or to emissions, discharges or releases of pollutants, contaminants, petroleum or petroleum products, chemicals or industrial, toxic or hazardous substances or wastes into the environment including, without limitation, ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, petroleum or petroleum products, chemicals or industrial, toxic or hazardous substances or wastes or the clean-up or other remediation thereof. Presently, we do not have a requirement to obtain any special environmental licenses or permits. We may need to utilize the Deep Space Network on some of our missions. The DSN is a U.S. funded network of large antennas that supports interplanetary spacecraft missions and radio and radar astronomy observations for the exploration of the solar system and the universe. The network also supports selected Earth-orbiting missions. The network is a facility of NASA, and is managed and operated for NASA by the Jet Propulsion Laboratory. The Telecommunications and Mission Operations Directorate manages the program within Jet Propulsion Laboratory. Coordination for the use of this facility is arranged with the Telecommunications and Mission Operations Command. EMPLOYEES At December 31, 2003, we employed approximately thirty (30) persons full and part-time, most of whom are aerospace, mechanical and electrical engineers. We expect to hire other personnel as necessary for completion of projects, product development, quality assurance, sales and marketing, finance and administration. In addition, due to the nature of our business, we anticipate that it may become necessary to lay off employees whose work is no longer required to maintain operations in order to prevent cost overruns. We do not have any collective bargaining agreements with our employees, and we believe our employee-relations are good. INTELLECTUAL PROPERTY We rely, in part, on licenses, patents, trade secrets and know-how to develop and maintain our competitive position and technological advantage. We intend to protect our intellectual property through a combination of patents, license agreements, trademarks, service marks, copyrights, trade secrets and other methods of restricting disclosure and transferring title. There can be no assurance that such applications will be granted. We have and intend to continue entering into confidentiality agreements with our employees, consultants and vendors; enter into license agreements with third parties; and, generally, seek to control access to and distribution of our intellectual property. In August 1998, we acquired a license to intellectual property (including two patents and trade secrets) from an individual who had acquired them from the former AMROC, which specialized in hybrid rocket technology. We are obligated to issue warrants to this individual to purchase a minimum of 100,000 and a PAGE 35 maximum of 3,000,000 shares of our common stock over ten years beginning at the inception of the agreement, depending on our annual revenues directly related to sales of hybrid technology-based products from the original technology acquisition. To date, we have issued warrants to purchase a total of 100,000 shares of our common stock under the agreement. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto and the other financial information appearing elsewhere in this document. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation our General Registration Statement on Form 10SB12G/A filed January 28, 2000 as well as any or all of our recent filings including prior year 10-KSB and quarterly 10-QSB filings. In addition to historical information, the following discussion and other parts of this document may contain forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," or "continue," the negative of such terms or other comparable terminology. These statements are only predictions. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to publicly update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations. Actual results could differ materially from those anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, the level of sales to key customers; the economic conditions affecting our industry; actions by competitors; fluctuations in the price of raw materials; the availability of outside contractors at prices favorable to us; our dependence on single-source or a limited number of suppliers; our ability to protect our proprietary technology; market conditions influencing prices or pricing; an adverse outcome in potential litigation, claims and other actions by or against us; technological changes and introductions of new competing products; the current recession; terrorist attacks or acts of war, particularly given the acts of terrorism against the United States on September 11, 2001 and subsequent military responses by the United States and coalition forces; mission disasters such as the loss of the space shuttle Columbia on February 1, 2003 during its re-entry into earth's atmosphere; ability to retain key personnel; changes in market demand; exchange rates; productivity; weather; and market and economic conditions in the areas of the world in which we operate and market our products. These are factors that we think could cause our actual results to differ materially from expected and historical events. OVERVIEW We are engaged in the conception, design, development, manufacture, integration and operation of space technology systems, products and services. We are currently focused on the commercial and military development of low cost microsatellites, nanosatellites and related subsystems, and hybrid rocket propulsion for space, launch and human flight vehicles as well as associated PAGE 36 engineering and technical services primarily to government agencies, and specifically the Department of Defense. Our products and solutions are sold, mainly on a project-basis, directly to these customers and include sophisticated micro- and nanosatellites, hybrid rocket-based launch vehicles, Maneuvering and orbital Transfer Vehicles as well as safe sub-orbital and orbital hybrid rocket-based propulsion systems. Although we believe there will be a commercial market for our microsatellite and nanosatellite products and services in the long-term, the early adopters of this technology appears to be government military agencies and our "products" are considered to be the outcome of specific "projects." We are also developing commercial hybrid rocket motors for possible use in small launch vehicles, targets and sounding rockets and small high performance space vehicles and subsystems for commercial customers. We were incorporated under the laws of the State of Colorado on December 23, 1996 as Pegasus Development Group, Inc. ("PDGI"). SpaceDev, LLC of Colorado was originally formed in 1997 for commercial space exploration and was the sole owner of shares of common stock of SpaceDev (a Nevada corporation) ("SpaceDev"), formed on August 22, 1997. On October 22, 1997, PDGI issued 8,245,000 of its $.0001 par value common stock for 100 percent (1,000,000 shares) of SpaceDev's common stock owned by SpaceDev, LLC. Upon the acquisition of the SpaceDev stock, SpaceDev was merged into PDGI and, on December 17, 1997, PDGI changed its name to SPACEDEV, INC. After the merger, SpaceDev, LLC, changed its name to SD Holdings, LLC on December 17, 1997. We became a publicly traded company in October 1997 and are trading on the Nasdaq Over-the-Counter Bulletin Board ("OTCBB") under the symbol of "SPDV." SELECTION OF SIGNIFICANT CONTRACTS On March 31, 2004, we were awarded a five-year, cost-plus-fixed fee indefinite delivery/indefinite quantity contract for up to $43,362,271 to conduct a microsatellite distributed sensing experiment, an option for a laser communications experiment, and other micro satellite studies and experiments as required in support of the Advanced Systems Deputate of the Missile Defense Agency. This effort will be accomplished in a phased approach , with the first task order awarded April 1, 2004. The total five-year contract has a ceiling amount of $43,362,271. The principal place of performance will be Poway, California. We expect to complete the work under the contract before March 2009. Government contract funds will not expire at the end of the current government fiscal year. The microsatellite distributed sensing experiment is intended to design and build up to six responsive, affordable, high performance microsatellites to support national missile defense. The milestone-based, multiyear, multiphase contract has an effective start date of March 1, 2004. Approximately $557,000 of revenue has been generated since the beginning of this contract through June 30, 2004, of which $62,000 was accrued for work preformed in March 2004 but not invoiced until April 2004 due to the late execution date of the contract. The first phase is expected to be completed this year and will result in detailed mission and microsat designs. The estimated first phase revenue is $1.1 million. The overall contract calls for us to analyze, design, develop, fabricate, integrate, test, operate and support a networked cluster of three formation-flying boost phase and midcourse tracking microsatellites, with an option to design, develop, fabricate, integrate, test, operate and support a second cluster of three formation flying microsats to be networked on-orbit with high speed laser communications technology. The second phase is anticipated to begin on or before October 1, 2004 and run through 2005. On October 2, 2003, we were awarded an exclusive, follow-on contract to provide the hybrid rocket motor systems and components for SpaceShipOne. We provide our facilities, resources and a team of launch vehicle and hybrid propulsion engineers and technical personnel in continued support of the SpaceShipOne program. The contract called for us to use our best efforts to satisfy the requirements of the SpaceShipOne program, based on our experience with the prior phases. We are to provide two sets of re-usable flight test hardware, including a bulkhead, commonly known as the SpaceDev bulkhead, machined in the flight configuration, a main oxidizer valve of the current design and associated interfaces and plumbing to the SpaceDev bulkhead, a motor control system, igniter housings, pressure transducers, and thermocouples as required for input to the motor control system. In addition, we will produce and assemble test motors, including but not limited to, all expendable or PAGE 37 semi-reusable materials as defined by our baseline design motor. We are also required to provide on-site engineering test support and post-test analysis. Provisions are made in the contract for minimum monthly payments in the event of customer schedule slippage as well as additional levels of support via engineering change orders, if required. The total contract value is estimated at $429,000. Approximately $115,000 of revenue was realized in the year ending December 31, 2003, with approximately $35,000 from engineering change orders and the remaining $80,000 from the contract. Approximately $394,000 of revenue was realized in the six-months ending June 30, 2004, with approximately $98,000 from engineering change orders and the remaining $296,000 from the contract. On July 24, 2003, we were awarded a contract by Lunar Enterprise of California ("LEC") for a first phase project to begin developing a conceptual mission and spacecraft design for a lunar lander program. The unmanned mission will be designed to put a small dish antenna near the south pole of the Moon. From that location it will be in near-constant sunlight for solar power generation, and should be able to perform multi-wavelength astronomy while communicating with ground stations on Earth. The contract value was $100,000 and was completed by November 2003. We were awarded a follow-on phase of $140,000 to further analyze launch opportunities, spacecraft design, trajectory possibilities, potential landing areas, available technologies for a small radio astronomy system, and communications and data handling requirements on July 20, 2004 in the amount of $150,000. This phase is targeted for a late-2004 completion. Although this project is currently unfunded, if the project were to proceed past the analysis stage, the total mission cost could exceed $50-$75 million. Again, we can give no assurance that any additional contracts will be awarded to us. Revenues for the year ending December 31, 2003 were approximately $70,000. On July 9, 2003, we were awarded a contract by the Missile Defense Agency ("MDA") to explore the use of microsatellites in national missile defense. It was a precursor contract to the approximately $43 million contract mentioned above. Our microsatellites are operated over the Internet and are capable of pointing and tracking targets in space or on the ground. This study explored fast response micro satellite launch and commissioning; small, low-power passive sensors; target acquisition and tracking; formation flying and local area networking within a cluster of micro satellites ; and an extension of our proven use of the Internet for on-orbit command, control and data handling. The contract was successfully concluded on February 27, 2004. The total contract value was $800,000 with approximately $481,000 and $319,000 of revenue realized in the twelve-months ending December 31, 2003 and the six-month period ending June 30, 2004, respectively. The total value of our micro satellite studies for MDA was over $1 million in 2003. This second contract was considered an investigatory phase by MDA. Also on July 9, 2003, we were awarded a Phase I Small Business Innovation Research ("SBIR") contract by Air Force Research Lab ("AFRL") to design and begin the development of the SpaceDev Streaker(TM) small launch vehicle ("SLV"). SpaceDev Streaker(TM) will be designed to responsively and affordably lift up to 1,000 pounds to Low Earth Orbit ("LEO"). The SpaceDev Streaker(TM) SLV concept is based on a proprietary combination of technologies to increase the performance of hybrid rocket motor technology. Hybrid rocket motors are a combination of solid fuel and liquid oxidizer, and can be relatively safe, clean, non-explosive, and storable, and can be throttled, shut down and restarted. This contract is valued at approximately $100,000, is a fixed price, milestone-based agreement, which should be completed within one year. We believe that this SBIR will move into Phase II valued at approximately $750,000 of carry-forward work for us, plus an additional $750,000 of funds provided by Congress based on discussions with the Air Force Research Laboratory technical personnel. This money will be used to develop and test fire our large Common Core Booster for the SpaceDev Streaker(TM) launch vehicle. We believe that there may be some interest by Congress in providing additional matching funding to expand and accelerate the scope of the work; however, there can be no assurance that such work will be awarded to us. Revenues for the year ending December 31, 2003 were approximately $50,000. Revenues for the six-month period ending June 30, 2004 were approximately $48,000. PAGE 38 Finally, on July 9, 2003, we were awarded a Phase I contract to develop micro- and nanosatellite bus and subsystem designs. This AFRL SBIR contract, valued at approximately $100,000, will enable us to explore the further miniaturization of our unique and innovative microsatellite subsystems. It will also enable us to explore ways to reduce the time and cost to build small satellites through further standardization in order to help define de facto standards for payload hardware and software interfaces. The contract is fixed price, milestone-based and should be completed within one year. On August 23, 2004 we were awarded a Phase II contract valued at approximately $740,000 of carry-forward work . Revenues for the year ending December 31, 2003 were approximately $40,000. Revenues for the six-month period ending June 30, 2004 were approximately $32,000. On December 18, 2003, we were awarded a contract by the Defense Advanced Research Projects Agency ("DARPA") for the study of Novel Satcom Microsat Constellation Deployment. The contract is a milestone-based, fixed price contract with total consideration of approximately $200,000. There were no revenues for the year ending December 31, 2003. Revenues for the six-month period ending June 30, 2004 were approximately $136,000. We were awarded approximately an additional $40,000 on this program on August 6, 2004 bringing the contract total to approximately $240,000. On April 30, 2002, we were awarded Phase I of a contract to develop a Shuttle-compatible propulsion module for the AFRL. We received an award for Phase II of the contract on March 28, 2003, and will use the project to further expand our product line to satisfy commercial and government space transportation requirements. The first two phases of the contract (including an additional add-on option) are worth up to approximately $2.5 million, of which $100,000 was awarded for Phase I, and approximately $1.4 million was awarded for Phase II. AFRL Phase II is a cost-plus fixed fee contract. In order to complete AFRL Phase II, we requested and were granted approximately four months of additional time and approximately $240,000 of additional funding, memorialized by a contract amendment executed on July 7, 2004. In addition to the Phase I and Phase II awards, there is an option worth approximately $800,000, which was initiated on May 3, 2004. The additional funding to complete AFRL Phase II came in part from the original $1 million option; thereby reducing the option to approximately $800,000. Revenues for the twelve-months ending December 31, 2003 and the six-month period ending June 30, 2004 were approximately $997,000 and $663,000 for AFRL Phase II, including the exercised option. In November 1999, we won a $4.9 million turnkey mission contract by the Space Sciences Laboratory ("SSL") at UCB . We were competitively selected by UCB /SSL to design, build, integrate, test and operate, for one year, a small NASA-sponsored scientific, Earth-orbiting spacecraft called CHIPSat. CHIPSat is the first and only successful mission of NASA's low-cost University-Class Explorer ("UNEX") series to date. CHIPSat launched as a secondary payload on a Delta-II rocket on January 12, 2003. The satellite achieved 3-axis stabilization, meaning it was pointing and tracking properly, with all individual components and systems successfully operating, and is continuing to work well in orbit after one year. In 2000, we reviewed the contract status at year-end and determined that the total estimated costs at the end of the program would exceed the likely revenue. As a result, we accrued a loss of approximately $860,000 based on the expected contract modification of $600,000, which was approved on June 15, 2001. On November 28, 2001, a second contract modification was signed with UCB , which added approximately $1.2 million to the contract as well as an increase in contract scope. This increased the total contract revenue to approximately $6.8 million and reduced the total expected loss on the contract to approximately $460,000. During 2002, an additional contract modification for approximately $400,000 was signed, which also increased the contract value and increased the scope of the contract to the current value of the CHIPSat project of approximately $7.4 million, thereby increasing the total expected loss to approximately $514,000. In retrospect, some of the CHIPSat expenses creating the loss could have been recorded as research and development costs associated with our ongoing satellite design and development programs. As of December 31, 2003, the total contract costs were PAGE 39 expended, mainly as cost of goods sold. The original support contract expired on December 31, 2003. CHIPSat is still operating successfully and providing UCB with new and interesting data. UCB requested to extend the program and we negotiated a new time and materials contract in the first quarter of 2004 in the form of a purchase order with UCB for continuing support of this project. The contract will continue until UCB decides that no further relevant information is forthcoming or funding is terminated, at which time the use of the mirco satellite will revert to NASA and then to us. Revenue for the year ending December 31, 2003 was approximately $356,000. Revenue for the six-month periods ending June 30, 2004 and 2003 were approximately $22,000 and $331,000, respectively. On June 18, 2001, we entered into a relationship with two individuals (doing business as EMC Holdings Corporation ("EMC")) whereby EMC was to provide certain consulting and advisory services to us. EMC received the first installment of 500,000 shares of our common stock on June 26, 2001. Total expense for the initial stock issuance through September 30, 2001 was approximately $455,000. Pursuant to a demand for arbitration filed by us on November 7, 2001, we sought the return of all or a portion of the shares issued to EMC. Following a three-day arbitration in May and June 2002, on July 17, 2002, an interim award was issued in favor of us against EMC, ordering the return of the initial installment of our 500,000 shares and denying EMC's own claim for $118,000. On October 22, 2002, a tentative final award was issued in our favor including an award of approximately $83,000 in attorney and arbitration fees to us. The tentative final ruling became effective on October 29, 2002, and has been submitted to the Superior Court of California, Orange County, for entry of judgment. Because collection of the attorney and arbitration fees award is not assured, we expensed all of our fees related to this matter. Any recovery of the fees will be recorded as income in the period they are received; however, at this time, we do not expect any recovery and in June 2003, we ceased efforts to recover the awarded fees, as it was determined that the cost to pursue collection exceeded the likelihood of collection. The return of our 500,000 shares, as provided in the interim award issued on July 17, 2002, was recorded in the third quarter of 2002 as a reversal of the original expense recorded. Because the original expense was not recorded as an extraordinary item, the reversal of the expense did not qualify as an extraordinary item. RESULTS OF OPERATIONS Please refer to the consolidated financial statements, which are a part of this prospectus for further information regarding the results of operations. YEAR ENDED DECEMBER 31, 2003 -VS.- YEAR ENDED DECEMBER 31, 2002 During the year ending December 31, 2003, we had net sales of approximately $2,960,000 as compared to net sales of approximately $3,370,000 for the same period in 2002. Sales declined primarily due to government delays in finalizing the follow-on contracts for AFRL and MDA and to customer delays on SpaceShipOne. Sales in 2003 reflected the substantial completion of CHIPSat and the completion of the original SpaceShipOne contract, AFRL Phase I and MDA Phase I, while a new exclusive proprietary propulsion contract (SpaceShipOne), began on October 2, 2003, a new contract with MDA began on July 9, 2003, a new contract with AFRL began on July 9, 2003 and a new contract with Lunar Enterprises began on July 24, 2003. The total value of the MDA, AFRL and Lunar Enterprises contracts were $800,000, $1.4 million and $100,000, respectively. Revenues for the year ending December 31, 2003 were comprised of approximately $29,600 and $997,000 from AFRL Phase I and II, respectively, $397,000 and $115,000 from the original and new exclusive proprietary propulsion contracts (SpaceShipOne), respectively, $250,000 and $481,000 from MDA Phase I and II, respectively, $356,000 from the CHIPSat program, $100,000 from the contract by Lunar Enterprises of California and approximately $220,400 from all other programs. During the same period of 2002, sales were comprised of approximately $1.7 million from the CHIPSat program, approximately $1.2 million from the original SpaceShipOne propulsion development program, approximately $300,000 from the completion of our PAGE 40 outstanding government grants, approximately $70,000 from Phase I of the AFRL project and approximately $130,000 from all other programs. For the year ending December 31, 2003, we had costs of sales (direct and allocated costs associated with individual contracts) of approximately $2,415,000, or 82% of net sales, as compared to approximately $3,348,000 or 99% of net sales, during the same period in 2002. The decrease in cost of sales was primarily due to a lower overall cost structure, combined with the implementation of stronger cost controls and project monitoring. Also, we altered our cost allocation method in the second quarter of 2003 as we completed CHIPSat, our main fixed price contract at the time, and began work on our new AFRL and MDA cost plus contracts. We continue to focus efforts on developing project management skills and reports to assist in the efficient and effective management of our projects. The gross margin percentage for the year ending December 31, 2003 was 18% of net sales, an increase of 16% of net sales, as compared to 2% of net sales for the period in 2002. We experienced an increase of approximately $1,364,000 in operating expenses from approximately $66,000, or 2% of net sales, in the year ending December 31, 2002 to approximately $1,430,000, or 48% of net sales, for the year ending December 31, 2003. Operating expenses include general and administrative expenses ("G&A"), marketing and sales expenses and research and development expenses as well as stock and stock option based compensation expenses. In 2002, we experienced a one-time reversal for the EMC transaction (see EMC Holdings Corporation transaction in MD&A Overview Section above). The increase in operating expenses for the year ending would have been approximately $905,000, rather than the stated $1,360,000 increase, without the one-time EMC reversal. The following comparisons are based on total operating expenses excluding the effects of the one-time EMC reversal. - Marketing and sales expenses accounted for approximately 15% of the increase in operating expenses, from approximately $258,000, or 8% of net sales, for the year ending December 31, 2002, to approximately $395,000, or 13% of net sales, during the same period in 2003, mainly due to our decision to expand our marketing and sales department and add a Vice President of Marketing and Product Development. Although our Vice President of Marketing and Product Development is no longer with us, our CEO, Mr. Benson is leading our marketing & sales efforts and most of his related expenses are being charged to this department. - Research and development ("R&D") expenses accounted for approximately 31% of the increase in operating expenses. We began incurring R&D expenses of approximately $281,000, or 10% of net sales, during the year ending December 31, 2003. Approximately $192,000 of R&D was in connection with our hybrid rocket propulsion design system and technologies and the remaining $89,000 was part of our satellite bus design and development. Approximately 1% of the increase in operating expenses came from stock and stock option-based compensation expense. During the year ending December 31, 2003, we had an increase in stock and stock option based compensation expense from approximately ($452,000), or 14% of net sales, in 2002 to approximately $9,000 or 0% of net sales during the same period in 2003. This increase was mainly due to the reversal of stock compensation from the EMC arbitration ruling as noted above. - G&A expenses accounted for approximately 53% of the increase in operating expenses. The increase in G&A expenses from approximately $261,000 for the year ending December 31, 2002 to approximately $746,000 for the same period in 2003 was primarily due to new rent charges of approximately $291,000 (we owned the building in 2002 and incurred interest expense on loans but not rental payments) plus one-time revolving credit facility expenses of approximately $42,000 and an increase in G&A labor expense with the hiring of our Chief Financial Officer, PAGE 41 offset by a reduction in G&A labor expense of $92,000 primarily due to the loss of our Vice President of Operations. Non-operating expense/(income) consists of interest expense, non-cash debt discount expense and deferred gain on the sale of our building, as well as other loan fees and expenses. - Interest expense for the year ending December 31, 2003 and 2002 was approximately $91,000, or 3% of net sales, and $263,000, or 8% of net sales, respectively. The decrease was due to the building sale on January 31, 2003, which eliminated building debt and reduced overall interest on the notes associated with the building. We continue to pay interest expense on certain capital leases and settlement notes. In addition, we accrued interest expense related to our related party note, convertible debentures and our revolving credit facility. In the years ending December 31, 2003 and 2002, the accrued interest on our related party note was approximately $47,000 and $45,000 respectively. We also accrued and paid approximately $18,000 of interest on our convertible notes and accrued approximately $14,000 of interest, $42,000 of fees and $126,000 of non-cash loan fees on our revolving credit facility with Laurus for the year ending December 31, 2003. - In conjunction with our convertible notes, we recorded a convertible note debt discount of $475,000 related to warrants that accompanied the convertible debt issue in 2002; however, since we made a partial repayment and the note holders converted the remaining balance and forfeited half of their warrants, the debt discount amount was reduced from $475,000 to $237,500. The reduction is exclusively attributable to forfeiture of half of the original warrants. During the year ending December 31, 2003, the convertible debt was eliminated. A debt discount adjustment of approximately $234,000 was made and the ending balance of $112,500 was recorded on the statement of operations for the year. - We recognized approximately $107,500 of the deferred gain on the sale of the building during the year ending December 31, 2003 and we will continue to amortize the remaining deferred gain of approximately $1,065,000 into non-operating income over the remainder of the lease. In relation to the gain we received on the building, we also accrued an income tax payable expense of $40,000 at March 31, 2003 of which none remained at December 31, 2003. The reduction of the income tax payable was due to a change in estimate based on the loss we experienced during the year. - We realized loan fees related to our revolving credit facility and expenses related to the conversion of notes to common stock below fair market value of approximately $258,000 for the year ending December 31, 2003. We anticipate additional expenses related to similar note to equity conversions in the quarters ahead. During the year ending December 31, 2003, we incurred a net loss of approximately $1,246,000, or 42% of net sales, compared to a net loss of approximately $376,000, or 11% of net sales, for the same period in 2002. During the year ending December 31, 2003, we incurred an EBITDA (earnings before interest taxes depreciation and amortization) of approximately <$723,000>, or <24 %> of net sales, compared to an EBITDA of approximately $372,000, or 10 % of net sales, for the year ending in 2002. PAGE 42 The following table reconciles EBITDA to net loss for the twelve-months ending December 31, 2003 and 2002, respectively: FOR THE YEAR ENDING. . . . . . . . . . DECEMBER 31, 2003 December 31, 2002 (UNAUDITED) (Unaudited) ------------------- ------------------- NET LOSS . . . . . . . . . . . . . . . $ (1,246,067) $ (376,160) -------------------------------------- ------------------- ------------------- Interest Expense . . . . . . . . . . . 91,493 263,480 Non-Cash Interest exp. (Debt Discount) 112,500 125,000 Gain on Building Sale. . . . . . . . . (107,498) 0 Loan Fee - Equity Compensation. . . . 257,882 0 Provision for income taxes . . . . . . 1,600 1,600 Depreciation and Amortization. . . . . 166,971 357,692 -------------------------------------- ------------------- ------------------- EBITDA . . . . . . . . . . . . . . . . $ (723,119) $ 371,612 -------------------------------------- ------------------- ------------------- PAGE 43 EBITDA should not be considered as an alternative to net income (as an indicator of operating performance) or as an alternative to cash flow (as a measure of liquidity or ability to service debt obligations). We believe that EBITDA provides an important additional perspective on our operating results, our ability to service our long-term obligations, our ability to fund continuing growth, and our ability to continue as a going concern. The increase in the net loss was mainly due to our quarterly losses in the first and second quarters of 2003 and less depreciation on our building, which we sold in January 2003. The first two quarterly losses were spurred by reductions in revenues due to the substantial completion of CHIPSat and the delay in starting our new AFRL and MDA projects; however, revenues for the four quarters in 2003 showed continued progress, as did the loss by quarter. SIX MONTHS ENDING JUNE 30, 2004 -VS- SIX-MONTHS ENDING JUNE 30, 2003 During the six-months ending June 30, 2004, we had net sales of approximately $2,215,000 as compared to net sales of approximately $1,287,000 for the same six-month period in 2003, an increase of over 65%. Sales increased primarily due to the addition and expansion of government contacts, e.g., AFRL and MDA, which created new revenue opportunities for us. Revenues in the six-month period ending June 30, 2004 were comprised of approximately $663,000 from AFRL Phase II, $557,000 from MDA Phase I, $318,000 from the MDA Phase 0, $394,000 from SpaceShipOne, $136,000 from our DARPA contract, $80,000 from the two SBIR contracts listed above and $66,000 from all other programs. During the same period of 2003, sales were comprised of approximately $397,000 from SpaceShipOne, $250,000 from the MDA projects, $331,000 from the CHIPSat program, $242,000 from Phase I and Phase II of the AFRL project and approximately $67,000 from all other programs. For the six-month period ending June 30, 2004, we had costs of sales (direct and allocated costs associated with individual contracts) of approximately $1,749,000, or 79.0% of net sales, as compared to approximately $1,039,000, or 80.8% of net sales, during the same period in 2003. The increase in cost of sales was primarily due to higher revenues since the majority of our current contracts are cost plus fixed fee contracts. We continue to focus efforts on developing project management skills and reports to assist in the efficient and effective management of our projects. The gross margin percentage for the six-month period ending June 30, 2004 was 21.0% of net sales, an increase of 1.8% of net sales, as compared to 19.2% of net sales for the same six-month period in 2003. We experienced a decrease of approximately $555,000 in operating expenses from approximately $976,000, or 75.8% of net sales, for the six-month period ending June 30, 2003 to approximately $421,000 or 19.0% of net sales, for the six-month period ending June 30, 2004. Operating expenses include general and administrative expenses ("G&A"), marketing and sales expenses and research and development expenses as well as stock and stock option-based compensation expenses. Fluctuations in operating expenses for 2004 from 2003 are primarily attributable to the following: - Marketing and sales expenses increased during the first six-months of 2004 compared to the same period in 2003. The increase in marketing and sales expense, from approximately $199,000, or 15.5% of net sales, for the six-month period ending June 30, 2003, to approximately $215,000, or 9.7% of net sales, during the same period in 2004, are mainly due to personnel expenses related to our decision to expand the marketing and sales department. - Research and development ("R&D") expenses decreased during the first six-months of 2004 from approximately $252,000 or 19.6% of net sales in 2003 to approximately $35,000 or 1.6% of net sales for the six-month period ending June 30, 2004, mainly due to our decision to focus our limited resources on billable projects and develop new technologies under existing contracts. PAGE 44 - The decrease of approximately $354,000 in G&A expenses from approximately $525,000 for the six-month period ending June 30, 2003 to approximately $171,000 for the same six-month period in 2004 was primarily due to software amortization expense of $69,000, which is no longer present in 2004 as well as refinement of our allocation model to appropriately classify certain expenses as cost of goods sold rather than G&A. Non-operating expense (income) consists of interest expense, non-cash debt discount expense and deferred gain on the sale of our building, as well as, other loan fees and expenses. - Interest expense for the six-month period ending June 30, 2004 and 2003 was approximately $39,500, or 1.8% of net sales, and $34,600, or 2.7% of net sales, respectively. The slight increase was due to accrued interest on our revolving credit facility. Interest expense is comprised of interest on our note to our CEO, interest on our revolving credit facility/convertible debt and interest on our settlement notes/capital leases. For the six-month period ending June 30, 2004 and 2003, interest expense on our note to our CEO was approximately $25,900 and $24,000, respectively. For the six-month period ending June 30, 2004 and 2003, interest expense on our revolving credit facility/convertible debt was $11,900 and $4,900, respectively. And interest expense on our settlement notes/capital leases for the six-month period ending June 30, 2004 and 2003 were approximately $1,800 and $2,700, respectively. - We recognized approximately $58,600 and $48,900 of the deferred gain on the sale of the building during the six-month periods ending June 30, 2004 and 2003, respectively, and we will continue to amortize the remaining deferred gain of approximately $1,006,600 into non-operating income over the remainder of the lease. In relation to the gain we received on the building, we also accrued an income tax payable expense of $2,526 at June 30, 2003 of which none remained at December 31, 2003. The reduction of the income tax payable was due to a change in estimate based on the loss we experienced during the year. - During the six-month period ending June 30, 2003, we expensed in conjunction with our convertible notes, part of the existing convertible debt discount related to warrants that accompanied the convertible debt issue in 2002 of approximately $475,000, of which approximately $201,000 was expensed during the six-months ended June 30, 2003 and paid or converted in September 2003. There was no debt discount for the first six-months of 2004. - We realized $1,793,000 in loan fees of which approximately $1,178,000 was related to our revolving credit facility and approximately $615,000 was related to the conversion of notes to common stock below fair market value for the six-month period ending June 30, 2004. We accrued approximately $11,900 of interest for the six-month period ending June 30, 2004. We anticipate additional expenses related to similar note to equity conversions in the future. During the six-month period ending June 30, 2004, we incurred a net loss of approximately $1,729,000, or 78.1% of net sales, compared to a net loss of approximately $918,000, or 71.3% of net sales, for the same six-month period in 2003. During the six-month period ending June 30, 2004, we incurred an EBITDA (earnings before interest taxes depreciation and amortization) of approximately $77,000, or 3.5% of net sales, compared to an EBITDA loss of approximately <$622,000>, or <48.4> % of net sales, for the six-month period ending June 30, 2003. PAGE 45 The following table reconciles EBITDA to net loss for the six-month period ending June 30, 2004 and 2003, respectively: FOR THE SIX-MONTHS ENDING. . . . . . . JUNE 30, 2004 June 30, 2003 (UNAUDITED) (Unaudited) NET LOSS . . . . . . . . . . . . . . . ($1,729,416) ($917,840) -------------------------------------- --------------- -------------- Interest Expense . . . . . . . . . . . 39,524 34,628 Non-Cash Interest exp. (Debt Discount) - 200,908 Gain on Building Sale. . . . . . . . . (58,636) (48,863) Loan Fee - Equity Conversion. . . . . 1,793,313 0 Provision for income taxes . . . . . . - 2,526 Depreciation and Amortization. . . . . 32,487 106,201 -------------------------------------- --------------- -------------- EBITDA . . . . . . . . . . . . . . . . $ 77,272 ($622,440) -------------------------------------- --------------- -------------- EBITDA should not be considered as an alternative to net income or loss (as an indicator of operating performance) or as an alternative to cash flow (as a measure of liquidity or ability to service debt obligations). We believe that EBITDA provides an important additional perspective on our operating results, our ability to service our long-term obligations, our ability to fund continuing growth, and our ability to continue as a going concern. PAGE 46 LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2004, we believe that the opinion our auditors expressed in their formal auditors' opinion dated February 11, 2004 (except for Note 11 as to which the date is April 2 , 2004) is still accurate. PKF stated, that in their opinion, based on their audit, our consolidated financial statements referred to herein present fairly, in all material respects, the consolidated financial position of the Company and its subsidiary as of December 31, 2003, and our consolidated results of operations and cash flows for the year then ended are in conformity with accounting principles generally accepted in the United States of America. Our ability to continue as a going concern depends upon our ability to ultimately implement our plan, which includes (but is not limited to) generation of substantial new revenue from MDA by successfully performing under the newly awarded contract and continuing to attract and successfully complete other government and commercial contracts, development of a project management expertise to profitably execute on new business contracts and reduction of the working capital deficit by raising additional capital. We are working with Laurus on our revolving credit facility to further support operations as new contracts and business opportunities materialize. The prospective funding, as well as new business opportunities, can come from a variety of sources, including public or private equity markets, state and federal grants and government and commercial customer program funding. However, there can be no assurance that we will be able to obtain such funding or contracts as needed or, if such funding or contracts are available, that we can obtain them on terms favorable to us. The likelihood of our success must be considered in light of the expenses, difficulties and delays frequently encountered in connection with the developing businesses, those historically encountered by us, and the competitive environment and industry in which we operate. On January 31, 2003, we closed escrow on the sale of our facility in Poway, California and entered into a ten-year leaseback. The selling price of the facility was $3.2 million. The total debt repayment from the transaction was approximately $2.4 million. The net proceeds to us for working capital purposes was approximately $636,000. At the end of 2002, we raised $475,000 from certain of our directors and officers by issuing 2.03% convertible debentures. The convertible debentures entitled the holder to convert the principal and unpaid accrued interest into our common stock when the note matured. The original maturity on the notes was six (6) months from issue date; however, on March 19, 2003, the maturity date was extended to twelve (12) months from issue date. The convertible debentures were exercisable into common shares at a conversion price that equals the 20-day average asking price less 10%, which was established when the debentures were issued, or the initial conversion price. Concurrent with the issuance of the convertible debentures, we issued warrants to purchase up to 1,229,705 shares of our common stock to the subscribers. These warrants are exercisable for three (3) years from the date of issuance at the initial exercise price, or the initial conversion price on the debentures. On September 5, 2003, we repaid one-half of the convertible notes, with the condition that the note holders would convert the other half. Also, as a condition of the partial repayment, the note holders were required to relinquish one-half of the 1,229,705 warrants previously issued. As additional consideration for the transaction, the note holders were offered 5% interest on their notes, rather than the stated 2.03%. All the note holders accepted the offer and the convertible notes were retired in 2003. Each of the note holders is a selling security holder under this prospectus. During the six-month period ending June 30,, 2003, we raised approximately $426,000 from accredited investors by selling 861,267 units of our common stock and common stock purchase warrants under a private placement offering ("PPO") made under Section 4(2) of the Securities Act of 1933, and Rule 506, to accredited investors only. We subsequently closed the PPO. PAGE 47 We have sustained ourselves over the last few years with a mixture of government and commercial contracts and capital raised in the private market. In particular, we anticipated and received awards for AFRL Phase II on March 28, 2003 and MDA on March 31, 2004. The AFRL and MDA contracts are cost-plus contracts, which have required us to incur certain costs in advance of regular contract reimbursements from our customers. Although we have needed a certain amount of cash to fund advance payments on the contract, we have been entitled, as a small business concern, to recover our costs on a weekly basis and we established the Laurus Master Fund revolving credit facility at the end of the second quarter of 2003, in part, to support our advance payment needs. On March 31, 2004, we negotiated an amendment to our Secured Convertible Note dated June 3, 2003 with the Laurus Master Fund to add a fixed conversion price at $0.85 per share for the next $500,000 converted under the revolving credit facility, after the initial $1 million conversion. In exchange for the amendment, Laurus granted us a six-month waiver to utilize the full revolving credit facility in advance of eligible accounts. At June 30, 2004, Laurus had converted 1,403,182 shares under the revolving credit facility, which represented approximately $772,000 of debt converted to equity. The agreement was modified again as part of the Preferred Stock transaction to increase the revolving credit facility from $1.0 million to $1.5 million and set the fixed conversion price on the next $1 million at $1.00 per share and, thereafter, the fixed conversion price will be adjusted to 103% of the then fair market value of our common stock. We recorded our third consecutive quarter of positive cash flow. We realized a small positive cash flow from operations during the fourth quarter of 2003 and first and second quarters of 2004. Our improving EBITDA is an indicator of our financial performance. We expect to continue realizing positive cash flow as well as net losses in 2004. The continued net losses are primarily due to non-cash interest expense and other fees related to our revolving credit facility and debt related warrant conversion. While EBITDA should not be considered as an alternative to net income (as an indicator of operating performance) or as an alternative to cash flow (as a measure of liquidity or ability to service debt obligations), we believe that by using EBITDA as a measure of performance, we can illustrate the improving results of our core business, despite the net losses derived from financing activities. Our EBITDA was approximately $77,000 for the six-month period ending June 30, 2004, compared to a negative EBITDA of $622,000 for the same period in 2003, an improvement of approximately $699,000. We recored our second consecutive quarter of profit from operation, which is a significant indicator of our improving financial performance. Operating results are an important measure of the performance of our core business. We recorded a profit from operations of approximately $12,000 in the first quarter of 2004, compared to a loss from operations of $364,000 in the first quarter of 2003. We recorded a profit from operations of approximately $33,000 in the second quarter of 2004, compared to a loss from operations of $365,000 in the second quarter of 2003. Profits or losses from operations are derived from all expenses excluding interest, taxes, non-cash expenses related to our revolving credit facility and other non-cash financing activities. We expect to continue showing a positive trend in cash flow and operating profits in 2004. We anticipate that with the projected increase in revenue and backorders from near term contracts, combined with our fiscally responsible budget and project controls and borrowings under our revolving credit facility, that net positive cash flow from operations will be sufficient to fund both operations and capital expenditures in 2004. There is no assurance, however, that we will achieve or sustain any positive cash flow or profitability now or thereafter. PAGE 48 CASH POSITION FOR YEAR ENDED DECEMBER 31, 2003 -VS.- YEAR ENDED DECEMBER 31, 2002 Net increase in cash during the year ending December 31, 2003 was approximately $565,000, compared to a net decrease of approximately $184,000 for the same period in 2002. Net cash used in operating activities totaled approximately $1,029,000 for the year ending December 31, 2003, an increase of approximately $323,000 as compared to approximately $707,000 used in operating activities during the same period in 2002, mainly due to the increase in our net loss. Net cash provided by investing activities totaled approximately $3,111,000 for the year ending December 31, 2003, compared to $48,000 provided by investing activities during the same period in 2002. The increase in cash provided by investing activities is attributable to the sale of the building on January 31, 2003. Net cash used in financing activities totaled approximately $1,517,000 for the year ending December 31, 2003, which is a decrease of approximately $1,992,000 from the approximately $475,000 provided by financing activities during the same period in 2002. This is primarily attributable to the repayment of notes payable associated with the building sale and advances on our new revolving credit facility. At December 31, 2003, our cash, which includes cash reserves and cash available for investment, was approximately $592,000, as compared to approximately $28,000 at December 31, 2002, an increase of approximately $564,000, mainly due to advances on our revolving credit facility. As of December 31, 2003, our backlog of funded and non-funded business was approximately $2.0 million, as opposed to approximately $4.0 million as of December 31, 2002. As of March 31, 2004, our backlog of funded and non-funded business grew to approximately $45 million due to the follow-on, five-year contract from MDA for up to $43,362,271. We expect approximately $2 million in revenue from the MDA program in 2004. Although the MDA contract was awarded to us, there can be no assurance that the contract will be continued through all phases, and/or, if continued, that it will generate the amounts anticipated. During the year ending December 31, 2003, we won the AFRL Phase II contract worth approximately $1.4 million, negotiated increases of approximately $1.0 million to the AFRL Phase II Contract as a deferred option still open, completed our first proprietary propulsion contract (SpaceShipOne) and was awarded a new exclusive proprietary propulsion contract for SpaceShipOne, completed significant milestones on CHIPSat, completed MDA's Phase I project and obtained a new contract for a new $800,000 project, obtained two AFRL SBIR Phase I grants and were awarded a $100,000 contract by Lunar Enterprises. Deferred income taxes are provided for temporary differences in recognizing certain income and expense items for financial and tax reporting purposes. The deferred tax asset of $2,190,000 and $1,372,000 as of December 31, 2003 and 2002, respectively, consisted primarily of the income tax benefits from net operating loss and capital loss carryforwards, amortization of goodwill and research and development credits. A valuation allowance has been recorded to fully offset the deferred tax asset as it is more likely than not that the assets will not be utilized. The valuation allowance increased approximately $818,000 in 2003 from $1,372,000 at December 31, 2002 to $2,190,000 at December 31, 2003. At December 31, 2003, we had federal and state tax net operating loss and capital loss carryforwards of approximately $4,230,000 and $1,847,000, respectively. The federal and state tax loss carryforwards will expire in 2023 and 2013, respectively, unless previously utilized. The State of California has suspended the utilization of net operating loss for 2002 and 2003. PAGE 49 CASH POSITION FOR SIX-MONTHS ENDING JUNE 30, 2004 -VS.- SIX-MONTHS ENDING JUNE 30, 2003 Net cash increased during the six-months ending June 30, 2004 by approximately $634,500 to $1,226,500, compared to an increase of approximately $53,000 to $80,700 for the same six-month period in 2003. Net cash used in operating activities totaled approximately $237,000 for the six-months ending June 30, 2004, a decrease of approximately $582,000 as compared to approximately $819,000 used in operating activities during the same six-month period in 2003, mainly due to the decrease in operating expenses for the first six-months of 2004 compared to the same period in 2003. Net cash used in investing activities totaled approximately $80,000 for the six-months ending June 30, 2004, compared to $3,147,000 provided by investing activities during the same six-month period in 2003. The decrease in cash provided by investing activities is attributable to the sale of the building on January 31, 2003 and no comparable transaction in 2004. During the first six-month period in 2004, we invested approximately $80,000 in specialized software and certain upgrades to computer hardware for our engineering team. Net cash provided by financing activities totaled approximately $951,000 for the six-month period ending June 30, 2004, which is an increase of approximately $3,226,000 from the approximately $2,275,000 used in financing activities during the same period in 2003. This is primarily attributable to the repayment of notes payable associated with the building sale in 2003, payments on related party notes in 2004, conversions under our revolving credit facility in 2004, as well as an increase in issuance of common stock from the exercise of stock options and warrants. At June 30, 2004, our cash was approximately $1,227,000, as compared to approximately $81,000 at June 30, 2003, an increase of approximately $1,146,000, mainly due to conversions under our revolving credit facility and the exercise of stock options and warrants. As of June 30, 2004, our backlog of funded and non-funded business was approximately $44 million due to the follow-on, five-year contract from MDA for up to $43,362,271. We expect approximately $2 million in revenue from the MDA program in 2004. Although the MDA contract was awarded to us and the first task order was issued to us on April 1, 2004, there can be no assurance that the contract will be continued through all phases, and if continued, that it will generate the amounts anticipated. Backlog as of June 30, 2003 was $3.2 million. Deferred income taxes are provided for temporary differences in recognizing certain income and expense items for financial and tax reporting purposes. The deferred tax asset of approximately $2,808,000 and $2,190,000 as of June 30, 2004 and December 31, 2003, respectively, consisted primarily of the income tax benefits from net operating loss and capital loss carryforwards, amortization of goodwill and research and development credits. A valuation allowance has been recorded to fully offset the deferred tax asset as it is more likely than not that the assets will not be utilized. The valuation allowance increased approximately $665,000 in 2004 from $2,190,000 at December 31, 2003 to $2,855,000 at June 30, 2004. At June 30, 2004, we had federal and state tax net operating loss and capital loss carryforwards of approximately $5,973,000 and $3,651,000, respectively. The federal and state tax loss carryforwards will expire in 2023 and 2013, respectively, unless previously utilized. The State of California has suspended the utilization of net operating loss for 2002 and 2003. PAGE 50 CRITICAL ACCOUNTING STANDARDS Our revenues transitioned in 2003 and early 2004 from being based primarily from fixed-price contracts, where revenues are recognized using the percentage-of-completion method of contract accounting based on the ratio of total costs incurred to total estimated costs, to primarily cost-plus fixed fee contracts, where revenues are recognized as costs are incurred and services are performed. Losses on contracts are recognized when they become known and reasonably estimable (see Notes to the Consolidated Financial Statements). Actual results of contracts may differ from management's estimates and such differences could be material to the consolidated financial statements. Professional fees are billed to customers on a time-and-materials basis, a fixed-price basis or a per-transaction basis. Time-and-materials revenues are recognized as services are performed. Deferred revenue represents amounts collected from customers for services to be provided at a future date. Research and development costs are expensed as incurred. In October 1995, the Financial Accounting Standards Board (FASB) issued SFAS No. 123, "Accounting for Stock-Based Compensation." We adopted SFAS No. 123 in 1997. We have elected to measure compensation expense for our stock-based employee compensation plans using the intrinsic value method prescribed by APB Opinion 25, "Accounting for Stock Issued to Employees," and have provided pro forma disclosures as if the fair value based method prescribed in SFAS No. 123 has been utilized. (See Notes to the Consolidated Financial Statements.) We have valued our stock, stock options and warrants issued to non-employees at fair value in accordance with the accounting prescribed in SFAS No. 123, which states that all transactions in which goods or services are received for the issuance of equity instruments shall be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, which amends SFAS No. 123, Accounting for Stock-Based Compensation, was published by Financial Accounting Standards Board on December 31, 2002. The effective date of FASB No. 148 is December 15, 2002. SFAS No. 123 prescribes a "fair value" methodology to measure the cost of stock options and other equity awards. Companies may elect either to recognize fair value stock-based compensation costs in their financial statements or to disclose the pro forma impact of those costs in the footnotes. We have chosen the latter approach. The immediate impact of SFAS No. 148 is more frequent and prominent disclosure of stock-based compensation costs, starting with financial statements for the year ended December 31, 2002 for companies whose fiscal year is the calendar year. SFAS No. 148 also provides some flexibility for the transition, if a company chooses the fair-value cost recognition of employee stock options. RECENT ACCOUNTING PRONOUNCEMENTS There were no recent Accounting Pronouncements that affected us during the second quarter of 2004. For past pronouncements please refer our 10-KSB filed on April 6, 2004. FORWARD-LOOKING STATEMENTS AND RISK ANALYSIS During the first six-months of 2004, we submitted two bids for government programs, continued our work with the US Congress to identify directed funding for our programs and are actively working to win several significant commercial programs. We believe that we will win some of these programs, which would enable us to continue to grow and broaden our business base, although there can be no assurance that these contracts will be awarded to us. PAGE 51 To date, we have maintained a mix of government and commercial business. In 2003, we had about 82% government or government-related work. In 2002, we had about 64% government and government-related work. In 2004, we expect the ratio to be about 90% government or government-related work. We will continue to do both government and commercial business and anticipate the mix of government revenues to continue to be above 70% for the next several years as we increase our government and commercial marketing efforts for both of our product lines. Currently, we are focusing on the domestic U.S. government market, which we believe is only about one-half of the global government market for our technology, products and services. Although we are interested in exploring international revenue and contract opportunities, we are restricted by export control regulations, e.g., International Traffic in Arms Regulations ("ITAR"), which may limit our ability to develop market opportunities outside the United States. While we do not expect a reduction of government sales, a majority of our government work is contract related and could be affected by political and budget changes . We are beginning to develop commercial products with the long-term idea and vision of becoming a product-oriented company; however, in the short-term, a majority of our revenue is expected to come from government cost plus fixed fee and firm fixed price contracts. Our definition of short-term is the next three to five years and long-term is five to ten years and beyond. We anticipate winning contracts in both the government and commercial market segments, although there can be no assurance that the contracts will be awarded to us. If they are not awarded to us, based on current trends and proposals, we believe that we can offset fluctuations in one market segment with contracts from the other; however, our inability to win business in both markets would have a negative effect on our business operations and financial condition. We believe that we will experience an accelerated growth in sales over the next few years. At this time, over 90% of the forecasted sales for 2004 are under contract or near contract award. There is no guarantee and there can be no assurance that we will win enough new business to achieve our targeted growth projection or to maintain our positive cash flow position. Additionally, there is no guarantee that awarded contracts will not be altered or terminated prior to us recognizing our projected revenue from them. Many contracts have "exit ramps," i.e., provides the customer the right to terminate the contract for any of a variety of reasons, including but not limited to non-performance by us. We do not believe that any of our contracts will be terminated early; however, there can be no assurance that they will not be terminated early in the future. Finally, we do not believe that significant capital expenditures will be required to achieve this increase in sales; however, additional capital will be required to support and sustain our growth. During the six month period ending June 30, 2004, we raised approximately $1,751,000 through a combination of conversions on our revolving credit facility (approximately $772,000), exercises of warrants previously issued (approximately $276,000), from participants in our employee stock purchase plan (approximately $6,000) and from exercises of employee stock options, mainly from Mr. Lloyd, our former Chief Financial Officer (approximately $697,000). During the year ended December 31, 2003, we raised approximately $654,000 through a combination of private sales of our stock (approximately $426,000) and conversions on our revolving credit facility (approximately $228,000). During the year ended December 31, 2002, we raised approximately $475,000 from our convertible debt offering, of which $237,500 plus interest was repaid in 2003. To execute our strategy of growing our Company with small, capable, low-cost micro and nanosatellites, hybrid propulsion products and new commercial revenue sources, we require additional funding and/or the win of both significant government and commercial programs. We believe investor or customer funding of $5 to $15 million may be required, which could come from a combination of private and/or public equity placements or government and commercial customers. The amount of capital we need to raise is dependent upon many factors. The need for additional capital will be greater if (i) we do not enter into PAGE 52 agreements with our customers on the terms we anticipate; (ii) our net operating deficit increases because we incur significant unanticipated expenses; or (iii) we incur additional costs from modifying our microsatellite products or our hybrid-related propulsion systems to meet changed or unanticipated market, regulatory, or technical requirements. If these or other events occur, there is no assurance that we could raise additional capital on favorable terms, on a timely basis or at all. If additional capital is not raised, it could have a significant negative effect on our business operations and financial condition. Our ability to execute a public offering or otherwise obtain funds is subject to numerous factors beyond our control, including, without limitation, a receptive securities market and appropriate governmental clearances. No assurances can be given that we will maintain operating profitability and positive cash flow, or that any additional public offering will occur, that we will be successful in obtaining additional funds from any source or be successful in implementing an acceptable exit strategy on behalf of our investors. Moreover, additional funds, if obtainable at all, may not be available on terms acceptable to us when such funds are needed or may be on terms which are significantly adverse to our current shareholders. Our business partially depends on activities regulated by various agencies and departments of the U.S. government and other companies and agencies that rely on the federal government. Recently, in response to terrorists' activities and threats aimed at the United States, transportation, mail, financial, and other services have been slowed or stopped altogether. Further delays or stoppages in transportation, mail, financial, or other services could have a material adverse effect on our business, results of operations, and financial condition. Furthermore, we may experience a small increase in operating costs, such as costs for transportation, insurance, and security as a result of the activities and potential activities. The U.S. economy in general is being adversely affected by the terrorist activities and potential activities, and any economic downturn could adversely impact our results of operations, impair our ability to raise capital, or otherwise adversely affect our ability to grow our business. Conversely, because of the nature of our products, there may be opportunities for us to offer solutions to the government that may address some of the problems that the country faces at this time. DESCRIPTION OF PROPERTY In January 2003, we entered into a sale and leaseback of our 25,000 square foot facility in Poway, California. Our facility includes a small Spacecraft Assembly and Test facility ("SAT") with an 1,800 square foot Class 100,000 clean room, avionics development lab, machine shop with rocket motor casting capability, mechanical assembly lab, and mission control and operations center. Key uses of our California facility are program and project conferences and meetings, engineering design, engineering analysis, spacecraft assembly, avionics labs and software labs and media outreach. We also have an Internet-based Mission Control and Operations Center in our building. Our facility allows for efficient design, assembly and test of our products and technologies. We originally purchased our headquarter facility in December 1998, and as noted above we sold the facility and entered into a sale-leaseback in January 2003. The rent is approximately $25,700 per month with a 3.5% COLA increase annually. We are responsible for property tax and liability insurance on the facility. We were required to make an advance payment in the form of a security deposit of approximately $25,700, which we carry as an asset on our balance sheet. Our Chief Executive Officer, Mr. Benson, provided a guarantee for the leaseback. [See Notes 2 and 9(c) to our consolidated financial statements for additional information , and "Certain Relationships And Related Transactions" below .] The original purchase price of the facility was $1.1 million, and the selling price of the facility was $3.2 million. The total debt repayment from the transaction was approximately $2,407,000. The approximate net proceeds to us for working capital purposes was $636,000. PAGE 53 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS James W. Benson, our Chief Executive Officer and Chairman of the Board of Directors, and Susan Benson, our former Corporate Secretary, are husband and wife. Mr. Benson has personally guaranteed the building lease on our facility. One of our independent directors, Robert S. Walker, is a principal of Wexler & Walker Public Policy Associates, a Washington-based, full-service government relations firm founded in 1981. Wexler & Walker principals have served in Congress, in the White House and federal agencies, as congressional staff, in state and local governments and in political campaigns. Wexler & Walker is a leader on the technology issues of the twenty-first century. During 2003 and 2002, we incurred consulting fees with Hill and Knowlton, Inc., an affiliate of Wexler & Walker, in an aggregate amount of approximately $0 and $56,000, respectively. In December 2001, we entered into a consulting agreement with one of our independent directors, Curt D. Blake, pursuant to which Mr. Blake agreed to perform certain services for us and identify and qualify significant investors and potential acquisition targets for us. Under the agreement, Mr. Blake was to receive compensation, in cash and non-statutory stock options, for his services. In addition, Mr. Blake was to receive a cash finder's fee plus a common stock grant for all monies raised as a result of introductions made by him. However, as a result of the independence rules imposed by the Sarbanes-Oxley Act of 2002, Mr. Blake voluntarily terminated his agreement with us on November 25, 2002. We made no payments to Mr. Blake in 2003 and 2002, other than reimbursement of Board-related travel expenses. In September and October 2002, certain of our officers provided personal interest-free short-term loans to support our working capital needs. The officer loans were paid with the proceeds from imminently pending contract payments and the proceeds of the convertible note program sales. From October 14, 2002 through November 14, 2002, we sold an aggregate of $475,000 of 2.03% convertible debentures to two of our directors, officers and Mr. Skarupa, a former officer. Mr. Benson purchased $375,000 of Series A Subordinated Convertible Notes and Mr. Shaffer purchased $50,000. The total funding was completed on November 14, 2002. The convertible debentures entitled the holder to convert the principal and unpaid accrued interest into our common stock when the note matured. The notes originally were set to mature six (6) months from issue date and were subsequently extended to twelve (12) months from issue date on March 19, 2003. Unless paid, extended or re-negotiated, the convertible debentures were exercisable into a number of our common shares at a conversion price that equals the 20-day average asking price less 10%, which was established when the note was issued, or the initial conversion price. Concurrent with the issuance of the convertible debentures, we issued to the subscribers, warrants to purchase up to 1,229,705 shares of our common stock. These warrants are exercisable for three (3) years from the date of issuance at the initial exercise price, which equals to the 20-day average asking price less 10% which was established when the note was issued, or the initial conversion price. Upon issuance, the warrants were valued using the Black-Scholes pricing model based on the expected fair value at issuance and the estimated fair value was recorded as debt discount. See Note 8(c) to our Consolidated Financial Statements for discussion of the terms of the warrants. The debt discount was being amortized as additional interest expense over the term of the convertible debentures. On September 5, 2003, we repaid one-half of the convertible notes, with the condition that the note holders would convert the other half. Also, as a condition of the partial repayment, the note holders were required to relinquish one-half of the previously issued warrants. Finally, as additional consideration for the transaction, the note holders were offered 5% interest on PAGE 54 their notes, rather than the stated 2.03% for a total of $18,161 of interest expense. All the note holders accepted the offer and the convertible notes were retired. In order for Mr. Skarupa, our former Vice President of Operations, to accept the offer, he entered into a private transaction with Mr. Slansky, our Chief Financial Officer. Mr. Slansky purchased 60% of Mr. Skarupa's note conversion for $15,000 in cash and received 38,462 shares of SpaceDev common stock and warrants on 38,462 shares of SpaceDev common stock. As of December 31, 2003, we recorded a credit of $88,408, as debt discount recovery; therefore, for the year ending December 31, 2003, the debt discount expense was $112,500. We also expensed $131,411 for non-cash loan fee expense related to the convertible note. Fair market value of the stock was determined by discounting the closing market price on the date of the transaction by 20%, based on the nature of the restricted securities. MARKET FOR COMMON EQUITY & RELATED STOCKHOLDER MATTERS (a) (b) (c) --------------------------- ------------------- -------------------------- Plan category. . . Number of securities Weighted-average Number of securities to be issued upon exercise price of remaining available for exercise of outstanding outstanding future issuance under issuance options, warrants options, warrants equity compensation plans and rights and rights (excluding securities reflected in column (a)) Equity compensation plans 3,184,231 $ 0.89 2,263,432 approved by security holders Equity . . . . . . 2,500,000 $ 2.00 0 compensation plans not approved by security holders ------------------ --------------------------- ------------------- -------------------------- Total. . . . . . . 5,684,231 $ 1.45 2,263,432 ------------------ --------------------------- ------------------- -------------------------- MARKET INFORMATION Our common stock has been traded on the Over-the-Counter Bulletin Board ("OTCBB") since August 1998 under the symbol "SPDV" or "SPDV.OB." The following table sets forth the trading history of our common stock on the OTCBB for each quarter as reported by Yahoo Finance Historical Prices (www.finance.yahoo.com). The quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not represent actual transactions. PAGE 55 QUARTERLY QUARTERLY QUARTER ENDING HIGH LOW -------------- ---------- ---------- 3/31/2002. . . $ 0.65 $ 0.48 -------------- ---------- ---------- 6/30/2002. . . $ 0.64 $ 0.43 9/30/2002. . . $ 0.52 $ 0.30 12/31/2002 . . $ 0.50 $ 0.29 3/31/2003. . . $ 0.55 $ 0.41 6/30/2003. . . $ 0.75 $ 0.33 9/30/2003. . . $ 1.80 $ 0.55 12/31/2003 . . $ 1.15 $ 0.81 3/31/2004. . . $ 1.85 $ 0.92 6/30/2004 . $ 2.01 $ 1.04 9/1/2004*. . . $ 1.78 $ 1.46 * Represents partial period. HOLDERS As of September 1, 2004, there were over 600 holders of record of our common stock. We estimate the total number of beneficial owners of our common stock to be in excess of 4,500 holders. We believe that the number of beneficial owners is substantially greater than the number of record holders because a significant portion of our outstanding common stock is held in broker "street names" for the benefit of individual investors. DIVIDENDS We have never paid a cash dividend on our Common Stock. Payment of dividends is at the discretion of the Board of Directors. The Board of Directors plans to retain earnings, if any, for operations and does not intend to pay dividends on Common Stock in the foreseeable future. PAGE 56 DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS & CONTROL PERSONS Our management and directors' business activities are under the control of our Board of Directors. Our Chief Executive Officer, James W. Benson, Chief Financial Officer, Richard B. Slansky, Vice President of Engineering , Frank Macklin and Vice President of New Business Development, Randall K. Simpson, manage our daily operations. Our Board currently consists of seven directors. Stuart Schaffer and Scott McClendon were added to the Board of Directors in 2002. J. Mark Grosvenor was added and resigned from the Board of Directors in 2003. Below are our current executive officers and directors. NAME POSITION HELD ---- -------------- James W. Benson Chief Executive Officer, 13855 Stowe Drive Director, Chairman of the Board Poway, California 92064 Richard B. Slansky Corporate Secretary, Chief Financial 13855 Stowe Drive Officer Poway, CA 92064 Frank Macklin Vice President, Engineering 13855 Stowe Drive Poway, CA 92064 Randall K. Simpson Vice President, New Business 13855 Stowe Drive Development Poway, California 92064 Stuart Schaffer Director 13855 Stowe Drive Poway, CA 92064 Wesley T. Huntress* Director 13855 Stowe Drive Poway, California 92064 Curt Dean Blake* Director 13855 Stowe Drive Poway, California 92064 General Howell M. Estes, III (USAF Retired)* Director 13855 Stowe Drive Poway, California 92064 Robert S. Walker* Director 13855 Stowe Drive Poway, California 92064 PAGE 57 Scott McClendon * Director 13855 Stowe Drive Poway, California 92064 * Denotes Independent Director The following is a summary of the business experience of our officers and directors. James W. Benson, age 59, is our founder and has served as our Chief Executive Officer and Chairman of the Board since inception, and started the trend of successful computer entrepreneurs moving into the entrepreneurial space arena. In 1984, Mr. Benson founded Compusearch Corporation (later renamed Compusearch Software Systems), in McLean, Virginia. Compusearch was based on the first development of software algorithms and applications for personal computers and networked servers to create full text indexes of massive government procurement regulations and to provide instant full text searches for any word or phrase; the first instance of large scale, commercial implementation of PC-based full text searching, which later grew to encompass such systems as worldwide web search engines. Seeing related opportunities in document and image management, Mr. Benson started the award-winning ImageFast Software Systems in 1989, which later merged with Compusearch. In 1995, Mr. Benson sold Compusearch and ImageFast, and retired at age fifty. After months of research, Mr. Benson started SpaceDev, Inc., a Nevada corporation, which was acquired by us in October 1997. Mr. Benson holds a Bachelor of Science degree in Geology from the University of Missouri. He founded the non-profit Space Development Institute, and introduced the $5,000 Benson Prize for Amateur Discovery of Near Earth Objects. He is also Vice-Chairman and private sector representative on NASA's national Space Grant Review Panel, and is a member of the American Society of Civil Engineers subcommittee on Near Earth Object Impact Prevention and Mitigation. Richard B. Slansky, age 47, is our Chief Financial Officer and Corporate Secretary and joined us on February 10, 2003. Mr. Slansky served as interim Chief Executive Officer and Chief Financial Officer of Quick Strike Resources, Inc., an IT training, services and consulting firm, from July 2002 to February 2003. Previously, Mr. Slansky served as Chief Financial Officer, Vice President of Finance, Administration and Operations and Corporate Secretary for Path 1 Network Technologies, Inc., a company focused on merging broadcast and cable quality video transport with IP networks from May 2000 to July 2002. Before his tenure at Path 1, Mr. Slansky served as President, Chief Financial Officer and member of the Board of Directors of Nautronix, Inc., a marine electronics/engineering services company, from January 1999 to May 2000. Prior to Nautronix, Mr. Slansky served as Chief Financial Officer of Alexis Corporation, an international pharmaceutical research products technology company, from August 1995 to January 1999. He also served as President and Chief Financial Officer of C-N Biosciences, formerly Calbiochem, from July 1989 to July 1995. Mr. Slansky is currently serving on the Board of Directors of two privately held high technology companies and one closely held, private real estate company. Mr. Slansky earned a bachelor's degree in economics and science from the University of Pennsylvania's Wharton School of Business and a master's degree in business administration in finance and accounting from the University of Arizona. Frank Macklin, age 47, was appointed as our Vice President of Engineering on September 17, 2004. Mr. Macklin has been our chief engineer of hybrid propulsion systems and the technical leader for our NRO funded SPOTV Hybrid System Definition study, and is acting chief engineer for our orbital Maneuvering and Transfer Vehicle Hybrid Technology Development and X-Motor Development. Mr. Macklin was a founder of Integrated Space Systems, Inc., which was acquired by SpaceDev in 1998. Prior to his work at ISS, Mr. Macklin worked at the General Dynamics Space Systems Division in San Diego from January 1987 to December 1994. During his tenure at General Dynamics, Mr. Macklin integrated a new guidance system onto the new generation of Atlas launch vehicles and became PAGE 58 intimately familiar with all aspects of vehicle flight software and hardware. He also designed and implemented diverse ground guidance performance and analysis software systems, became a complete end-to-end systems expert, and served as the guidance system expert on the elite "tiger team" sent to support all launches. Prior to General Dynamics, Mr. Macklin served as a member of the Peacekeeper developmental launch team at Vandenberg Air Force Base from March 1984 to December 1986, where he was responsible for the $30M guidance and control system, led a group of 30 industry engineers and gave the final guidance system go/no-go for launch. Mr. Macklin is a California State registered professional electrical engineer with more than 20 years of experience with launch vehicles, ground launch control systems, launch sites and launch teams. Mr. Macklin received his BSEE from San Diego State Univeristy and is a California Board Certified Professional Engineer. Randall K. Simpson, age 57, is our Vice President of Engineering and New Business Development and joined us in January 2004. Mr. Simpson has over 30 years of diversified experience in business development, product definition, engineering development and support for aerospace, commercial and international customers. From October 2000 to January 2004, Mr. Simpson served as AVP of Program Management for Alvarion, Inc., a high technology commercial communications firm. From March 1997 to September 2000, Mr. Simpson was Vice President of Engineering for Cubic Defense Systems, an engineering and production company providing military training ranges, laser instrumentation products, space avionics and battlefield communications equipment. From November 1992 to February 1997, Mr. Simpson was Program Director for Advanced Test Systems and Engineering Director for GDE Systems, which develops, integrates and produces test equipment for advanced electronic aircraft, munitions, space launch, satellite and telecommunications systems. Mr. Simpson began his career at General Dynamics/Convair where he held various positions. Mr. Simpson received both his BSEE and MSEE from San Diego State University. Stuart Schaffer, age 44, was appointed to our Board of Directors on May 17, 2002. Mr. Schaffer is currently VP of Marketing, for Overture Performance Marketing -- a business unit of Overture Services, which is a subsidiary of Yahoo! Mr. Schaffer was our vice president of product development and marketing from May 2002 to August 2003. From 1998 to 2001, Mr. Schaffer acted as vice president of marketing for Infocus Corporation, a fully reporting company, where he managed all aspects of the marketing mix for market-share leading digital projection business throughout the Americas region. In that position, Mr. Schaffer revitalized the Proxima brand, managed a multi-million dollar annual advertising, communications and program budget, directed multiple outside and in-house agencies, led product marketing teams in defining and delivering both mobile and conference room digital projector product lines, developed channel strategies and programs for both value-added and volume channels, served as primary company press spokesperson, established a market intelligence structure focused on developing customer and industry knowledge and spearheaded merger teams to ensure the smooth transition of the merger between the Infocus and Proxima marketing organizations. Prior to Infocus, Mr. Schaffer worked for the Hewlett-Packard Company from 1985 to 1998, where he held various positions in Business Development, Marketing and Business Planning. Mr. Schaffer has worked with the Leukemia & Lymphoma Society, on a volunteer basis, as an Assistant Coach and Mentor. Mr. Schaffer has an MBA from Harvard University and a BS degree in physics from Harvey Mudd College. Wesley T. Huntress, age 62, was elected to our Board of Directors as an independent director at our annual shareholder meeting held June 30, 1999. Dr. Huntress is currently Director of the Geophysical Laboratory at the Carnegie Institution of Washington in Washington, DC, where he leads an interdisciplinary group of scientists in the fields of high-pressure science, astrobiology, petrology and biogeochemistry. Prior to his appointment at Carnegie, Dr. Huntress served the Nation's space program as the Associate Administrator for Space Science at NASA from October 1993 through September 1998, where he was responsible for NASA's programs in astrophysics, planetary exploration, and space physics. During his tenure, NASA space science produced numerous major discoveries, and greatly increased the launch rate of missions. These discoveries include the discovery of possible ancient microbial life in a Mars meteorite; a possible subsurface ocean on Jupiter's moon Europa; the finding PAGE 59 that gamma ray bursts originate at vast distances from the Milky Way and are extraordinarily powerful; discovery of massive rivers of plasma inside the Sun; and a wealth of announcements and images from the Hubble Space Telescope, which have revolutionized astronomy as well as increased public interest in the cosmos. Dr. Huntress also served as a Director of NASA's Solar System Exploration Division from 1990 to 1993, and as special assistant to NASA's Director of the Earth Science and Applications from 1988 to 1990. Dr. Huntress came to NASA Headquarters from Caltech's Jet Propulsion Laboratory. Dr. Huntress joined the Jet Propulsion Laboratory as a National Research Council resident associate after receiving is B.S. in Chemistry from Brown University in 1964 and his Ph.D. in Chemical Physics from Stanford in 1968. He became a permanent research scientist at the Jet Propulsion Laboratory in 1969. He and his Jet Propulsion Laboratory team gained an international reputation for their pioneering studies of chemical evolution in interstellar clouds, comets and planetary atmospheres. At the Jet Propulsion Laboratory, Dr. Huntress served as co-investigator for the ion mass spectrometer experiment in the Giotto Halley's Comet mission, and as an interdisciplinary scientist for the Upper Atmosphere Research Satellite and Cassini missions. He also assumed a number of line and research program management assignments while at the Jet Propulsion Laboratory, and spent a year as a visiting professor in the Department of Planetary Science and Geophysics at Caltech. Curt Dean Blake, age 47, was appointed to our Board of Directors as an independent director on September 5, 2000. Mr. Blake is CEO of GotVoice, Inc., a startup company in the voicemail consolidation and messaging business. From 1999 to 2002, Mr. Blake provided consulting services to various technology companies, including Apex Digital, Inc. and SceneIt.com. Mr. Blake acted as the Chief Operating Officer of the Starwave Corporation from 1993 until 1999, where he managed business development, finance, legal and business affairs, and operations for the world's most successful collection of content sites on the Internet. During that time, he developed business strategies, financial models, and structured and negotiated venture agreements for Starwave's flagship site, ESPN Sportszone, at that time the highest traffic destination site on the Internet. He also developed and negotiated venture agreements with the NBA, NFL, Outside Magazine and NASCAR to create sites around these brands. Mr. Blake negotiated sale of controlling interest in Starwave Corporation to Disney/ABC. Prior to Starwave, Mr. Blake worked at Corbis from 1992 to 1993, where he led the acquisitions and licensing effort to fulfill Bill Gates' vision of creating the largest taxonomic database of digital images in the world. Mr. Blake acted as General Counsel to Aldus Corporation from 1989 to 1992, where he was responsible for all legal matters of the $125 million public corporation and its subsidiaries. Prior to that, Mr. Blake was an attorney at Shidler, McBroom, Gates and Lucas, during which time he was assigned as onsite counsel to the Microsoft Corporation, where he was primarily responsible for the domestic OEM/Product Support and Systems Software divisions. Mr. Blake has an MBA and JD from the University of Washington. General Howell M. Estes, III (USAF Retired), age 63, was appointed to our Board of Directors as an independent director on April 2, 2001. General Estes retired from the United States Air Force in 1998 after serving for 33 years. At that time he was the Commander-in-Chief of the North American Aerospace Defense Command ("CINCNORAD") and the United States Space Command ("CINCSPACE"), and the Commander of the Air Force Space Command ("COMAFSPC") headquartered at Peterson AFB, Colorado. In addition to a Bachelor of Science Degree from the Air Force Academy, he holds a Master of Arts Degree in Public Administration from Auburn University and is a graduate of the Program for Senior Managers in Government at Harvard's JFK School of Government. Gen. Howell Estes is the President of Howell Estes & Associates, Inc., a wholly owned consulting firm to CEOs, Presidents and General Managers of aerospace and telecommunications companies worldwide. He serves as Vice Chairman of the Board of Trustees at The Aerospace Corporation. He served as a consultant to the Defense Science Board Task Force on SPACE SUPERIORITY and more recently as a commissioner on the U.S. Congressional Commission to Assess United States National Security Space Management and Organization (the "Rumsfeld Commission"). PAGE 60 Robert S. Walker, age 62, was appointed to our Board of Directors as an independent director on April 2, 2001. Mr. Walker has acted as Chairman of Wexler & Walker Public Policy Associates in Washington, D.C. since January 1997. As a former Congressman (1977-1997), Chairman of the House Science Committee, Vice Chairman of the Budget Committee, and a long-time member of the House Republican leadership, Walker became a leader in advancing the nation's space program, especially the arena of commercial space, for which he was the first sitting House Member to be awarded NASA's highest honor, the Distinguished Service Medal. Bob Walker is a frequent speaker at conferences and forums. His main issues include the breadth and scope of space regulation today, and how deregulation could unleash the telecommunications, space tourism, broadcast and Internet industries. Mr. Walker currently sits on the boards of directors of Aerospace Corporation, a position he has held since March 1997. Wexler & Walker is a Washington-based, full-service government relations firm founded in 1981. Wexler & Walker principals have served in Congress, in the White House and federal agencies, as congressional staff, in state and local governments and in political campaigns. Wexler & Walker is a leader on the technology issues of the twenty-first century. During 2002, we incurred consulting fees with Hill and Knowlton, Inc., an affiliate of Wexler & Walker, in an aggregate amount of approximately $56,000. No fees were paid to Hill and Knowlton in 2003. Scott McClendon, age 65, was appointed to our Board of Directors as an independent director on July 19, 2002. McClendon currently sits on the Board of Directors for Overland Storage, Inc., a public company, where he acts as chairman of the Board. He became the chairman after serving as president and chief executive officer from October 1991 to March 2001. Prior to joining Overland Storage, Inc., Mr. McClendon was employed by Hewlett-Packard Company for over 32 years in various positions of engineering, manufacturing, sales and marketing. In addition to SpaceDev and Overland Storage, Mr. McClendon is currently serving on the Board of Directors of Procera Networks, Inc., a public company, and Sicommnet, Inc., privately held high technology company. Mr. McClendon received a Bachelor of Science degree in electrical engineering in June 1960, and a Master of Science degree in electrical engineering in June 1962 from Stanford University School of Engineering. One of our independent directors currently sits on the board of directors of another Reporting Company. "Reporting Companies" include companies with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the "1934 Act") or subject to the requirements of Section 15(d) of the 1934 Act, or any company registered as an investment company under the Investment Company Act of 1940, as amended (the "1940 Act"). PAGE 61 EXECUTIVE COMPENSATION REMUNERATION PAID TO EXECUTIVES The following table sets forth the remuneration to our executive officers for the past three fiscal years: SUMMARY COMPENSATION TABLE Annual Compensation Awards Payouts Long Term Compensation ---------------------- ---------- --------- ---------------------- Name and Principal Position(1) Restricted Stock Award(s) ($) Name and Principal Position(1) Year Salary Bonus Other Annual Restricted Securities LTIP Payouts All Other ($) ($) Compensation Stock Award(s) Underlying ($) Compensation ($) ($) Options/ SARs # ($) ------------------------------ ---- ------- ----- ------------- -------------- ------------ ------------ ------------ James W. Benson, CEO (2) . . . 2001 147,923 - - - - - - .. . . . . . . . . . . . . . . 2002 141,325 - - - 10,000(2) - - .. . . . . . . . . . . . . . . 2003 150,000 - - - - - - Richard B. Slansky, CFO. . . . 2001 - - - - - - - .. . . . . . . . . . . . . . . 2002 - - - - - - - .. . . . . . . . . . . . . . . 2003 94,625 - 1,183 - 355,000(3) - - ------------------------------ ---- ------- ----- ------------- -------------- ------------ ------------ ------------ ------------------------------ ---- ------- ----- ------------- -------------- ------------ ------------ ------------ (1) The table includes information as to the Chief Executive Officer and our highest paid officers for the last fiscal year, including persons whose information would have been required but for the fact that they were not serving as our officers at its fiscal year end. For purposes of the table, only persons whose total annual salary and bonus exceeded $100,000 have been included. (2) Mr. Benson was awarded 10,000 options in 2001 as a part of an annual award of options to our employees. (3) Mr. Slansky was awarded up to 385,000 options in 2003 as part of his employment agreement, with 25,000 vested immediately, 180,000 vesting in six-month increments over five years and the remaining based on performance criteria established by the CEO. The timeframe for certain performance criteria lapsed in 2003 and 30,000 options not earned were forfeited; thereby, reducing Mr. Slansky's potential securities underlying options to a maximum of 355,000, as illustrated above. During the last fiscal year and as of December 31, 2003, we granted stock options to executive officers as set forth in the following table: OPTION/SAR GRANTS IN LAST FISCAL YEAR Individual Grants ------------------ Name . . . . . . . Number of Securities % of Total Options/SARs Exercise of Base Expiration Underlying Granted to Employees in Price ($/Sh) Date Options/SARs Fiscal Year Granted (#) ------------------ -------------------- ----------------------- ---------------- ------------ James W. Benson 0 0 0 0 Richard B. Slansky 355,000 29% 0.51 2/10/2009 PAGE 62 As of December 31, 2003, we had vested and unvested securities underlying stock options to executive officers as set forth in the following table: Option/SAR Grants Ended December 31, 2003 Number of Securities Underlying Value of Unexercised In-the-Money Unexercised Options/SARs at FY-End (#) Options/SARs at FY- End ($) -------------------------------------- --------------------------------- Exercisable/ Exercisable/ Name . . . . . . . Shares Acquired on Value Realized Unexercisable Unexercisable(1) Exercise (#) ($) ------------------ ------------------ -------------- -------------------------------------- --------------------------------- James W. Benson. . 0 0 506,666/ 506,312/ ------------------ ------------------ -------------- -------------------------------------- --------------------------------- 2,003,334 3,157 ------------------ ------------------ -------------- -------------------------------------- --------------------------------- Richard B. Slansky 0 0 83,000/ 42,330/ ------------------ ------------------ -------------- -------------------------------------- --------------------------------- 272,000 138,720 ------------------ ------------------ -------------- -------------------------------------- --------------------------------- (1) For purposes of determining whether options are "in-the-money," we defined fair market value as the five-day weighted average of the closing price of our common stock on the Over-The-Counter Bulletin Board as of March 4, 2004, or $1.05 per share. All the options listed on the table are "in-the-money," except unvested options on 2,000,000 of Mr. Benson's shares. REMUNERATION PAID TO DIRECTORS At our annual meeting on July 16, 2000, our Board of Directors adopted a compensation plan for independent directors whereby they received options for attending meetings of the Board as follows: each such director received an option to purchase 5,000 shares for each of two telephonic meetings attended per year, and an option to purchase 10,000 shares for each of two meetings attended in person per year. These directors did not receive additional compensation for attending meetings in excess of those described above. In addition to the above, independent directors received $5,000 in options on the date of election or appointment. All such options were issued pursuant to our 1999 Incentive Stock Option Plan at fair market value as of the date of the meeting attended, were set up to vest 50% on the first anniversary date of the date of grant and 50% on the second anniversary date of the date of grant and expire on the five-year anniversary of the grant date. The following table sets forth the remuneration paid to our directors during the fiscal year ended December 31, 2003 under this compensation plan. We do not pay directors, who are also our officers, additional compensation for their service as directors. Cash Compensation Security Grants --------------------------------- --------------- Annual Meeting Consulting Number of Number of Retainer Fees Fees/Other Shares Securities Fees Fees Underlying Options/SARs ----------------------------- -------- ------- ---------- --------- ------------ Name ----------------------------- -------- ------- ---------- --------- ------------ James W. Benson . . . . . . . - - - - - ----------------------------- -------- ------- ---------- --------- ------------ J. Mark Grosvenor (1) . . . . - - - - - ----------------------------- -------- ------- ---------- --------- ------------ Stuart Schaffer . . . . . . . - - - - - ----------------------------- -------- ------- ---------- --------- ------------ Wesley T. Huntress. . . . . . - - - - 30,000 ----------------------------- -------- ------- ---------- --------- ------------ Curt Dean Blake . . . . . . . - - - - 20,000 ----------------------------- -------- ------- ---------- --------- ------------ General Howell M. Estes, III. - - - - 30,000 ----------------------------- -------- ------- ---------- --------- ------------ Robert S. Walker. . . . . . . - - - - 30,000 ----------------------------- -------- ------- ---------- --------- ------------ Scott McClendon . . . . . . . - - - - 30,000 ----------------------------- -------- ------- ---------- --------- ------------ PAGE 63 (1) Mr. Grosvenor was issued options to purchase 19,615 shares of our common stock upon joining the Board of Directors on May 6, 2003. Mr. Grosvenor forfeited the right to those options when he resigned from the Board on September 15, 2003. Mr. Grosvenor continues to be one of our investors with ownership of 665,188 shares and warrants to purchase 665,188 shares. On March 25, 2004, our Board of Directors modified our compensation plan for independent directors. Under the modified plan, independent directors will receive options for attending meetings of the Board as follows: each director shall receive an option to purchase 6,000 shares for each telephonic meeting attended and an option to purchase 12,000 shares for each meeting attended in person, with a cap of options on 36,000 shares per year. Our directors will also receive compensation for attending committee meetings as follows: each director shall receive an option to purchase 5,000 shares for each Audit Committee meeting attended, each director shall receive an option to purchase 2,500 shares for each Compensation Committee meeting attended and each director shall receive an option to purchase 2,500 shares for each Nominating/Governance Committee meeting attended, which options shall not be subject to a cap. In addition to the above, independent directors will receive 5,000 options on the date of election or appointment. All such options will be issued pursuant to the Plan at fair market value as of the date of the meeting attended, will vest 50% on the first anniversary date of the date of grant and 50% on the second anniversary date of the date of grant and will expire on the three-year anniversary of the grant date. DIRECTOR COMMITTEES We have a standing audit committee comprised of Messrs. Blake, McClendon and Dr. Huntress. In 2004, we established a nominating and governance committee comprised of Messrs. Estes, Walker and Dr. Huntress and a compensation committee comprised of Messrs. Blake, Estes and McClendon. The Company does not maintain any pension, retirement or other arrangements other than as disclosed in the following table for compensating its Directors. Our Board of Directors took action eight (8) times during the last fiscal year: seven (7) times at regular or special meetings attended by all of the members of the Board either personally or telephonically, and one (1) time by unanimous written consent. Our Audit Committee took separate action four (4) times during the last fiscal year, each time at a regular or special meeting attended by all of the members of the committee either personally or telephonically. On March 25, 2004, the Board established two new committees of the Board of Directors: the Compensation Committee and the Nominating and Governance Committee. Mr. McClendon chairs the Compensation Committee with General Estes and Mr. Blake as members. General Estes chairs the Nominating and Governance Committee with Dr. Huntress and Mr. Walker as members. EMPLOYMENT AGREEMENTS On November 21, 1997, we entered into a five-year employment agreement with our CEO, Mr. Benson. This agreement provides for compensation of salary and stock as well as stock options. This agreement also prohibits Mr. Benson from competing with us, disclosing any confidential information, or soliciting any of our employees or customers for one year after termination of employment. Our Board of Directors revised Mr. Benson's employment agreement at its meeting on July 16, 2000. This employment contract supercedes the previous agreement. The term of this revised employment contract is for a period of five (5) years from July 16, 2000. The revised agreement provides for the grant of options to purchase up to 4,000,000 shares of our common stock upon the occurrence of certain events, of which options to purchase 500,000 shares are currently vested. PAGE 64 On May 17, 2002, we entered into an "at-will" employment agreement with Mr. Schaffer. The agreement provided for Mr. Schaffer's compensation of salary, benefits and options to purchase up to 450,000 shares of our common stock. On July 2, 2003, we entered into a Confidential Separation Agreement and General Release with Mr. Schaffer. The agreement provided for Mr. Schaffer to receive salary and benefits until August 8, 2003 and for the resignation of Mr. Schaffer as an officer, but not as a director. In exchange for a release of claims and other promises set forth in the agreement, Mr. Schaffer retained certain exercise rights on his vested options of 90,000 shares until the earlier of (i) eighteen (18) months from his resignation as a member of our Board of Directors or other subsequent consulting relationship with us, or (ii) July 19, 2008. On May 31, 2002, we entered into a Confidential Separation Agreement and General Release of Claims with Mr. Lloyd, our former Chief Operating Officer and Chief Financial Officer. The agreement provided for the resignation of Mr. Lloyd as an officer and director of SpaceDev, Inc. and Integrated Space Systems, Inc., effective June 14, 2002. In exchange for a release of claims and other promises set forth in the agreement, Mr. Lloyd received $36,000 and an extension of the exercise period of each of his non-statutory stock options for a five-year period from the original date of grant. Until May 31, 2003, the agreement also prohibits Mr. Lloyd from soliciting our employees, inducing any customer away from us or representing himself on our behalf. On February 14, 2003, we entered into an "at-will" employment agreement with Mr. Slansky. The agreement provided for Mr. Slansky's compensation of salary, benefits and options to purchase up to 385,000 shares of our common stock. The agreement also provided for severance under certain termination provisions and prohibits Mr. Slansky from soliciting our employees or competing with us, if he were to leave us. On November 17, 2003, we entered into an "at-will" employment relationship with Mr. Dario ("Dan") DaPra to become our Vice President of Engineering. Our offer letter provided for Mr. DaPra's compensation of salary, benefits and options to purchase up to 250,000 shares of our common stock. The offer letter also provided for severance under certain termination provisions and prohibits Mr. DaPra from soliciting our employees or competing with us. Mr. DaPra resigned on March 5, 2004 and subsequently entered into a Confidential Separation Agreement and General Release with us. The Agreement provides for Mr. DaPra to receive one-half pay through April 30, 2004 in lieu of severance, and to retain options on 40,000 shares of our stock with the ability to exercise those options until October 31, 2004. EMPLOYEE BENEFITS At our 1999 Annual Stockholder Meeting, the shareholders adopted an Incentive Employee Stock Option Plan under which its Board of Directors may grant our employees, directors and affiliates Incentive Stock Options, Supplemental Stock Options and other forms of stock-based compensation, including bonuses or stock purchase rights. Incentive Stock Options, which provide for preferential tax treatment, are only available to employees, including officers and affiliates, and may not be issued to non-employee directors. The exercise price of the Incentive Stock Options must be 100% of the fair market value of the stock on the date the option is granted. Pursuant to our plan, the exercise price for the Supplemental Stock Options will not be less than 85% of the fair market value of the stock on the date the option is granted. We are required to reserve an amount of common shares equal to the number of shares, which may be purchased as a result of awards made under the Plan at any time. At the 2000 Annual Stockholder Meeting, the shareholders approved an amendment to the Stock Option Plan of 1999, increasing the number of shares eligible for issuance under the Plan to 30% of the then outstanding common stock PAGE 65 and allowing the Board of Directors to make annual adjustments to the Plan to maintain a 30% ratio to outstanding common stock at each annual meeting of the Board of Directors. The Board, at its annual meetings in 2001 and 2002, made no adjustment, as a determination was made that the number of shares then available under the Plan was sufficient to meet our needs. As of December 31, 2003, 4,184,698 shares were authorized for issuance under the Plan, 3,124,807 of which are currently subject to outstanding options and awards and options on 37,000 shares were exercised in 2003. The Stock Option Plan of 1999 was registered with the U.S. Securities & Exchange Commission on Form S-8. During 2003, we issued non-statutory options to purchase 140,000 shares to our independent directors for attendance at our 2003 Board of Directors meetings. In addition to the Stock Option Plan of 1999, our shareholders adopted the 1999 Employee Stock Purchase Plan, which authorized our Board of Directors to make twelve consecutive offerings of our common stock to our employees. The 1999 Employee Stock Purchase Plan has been instituted and the first employees enrolled in the plan in August 2003. The first shares of common stock were issued under the Plan in February 2004. We also offer a variety of health, dental, vision, 401(k) and life insurance benefits to our employees in conjunction with our co-employment partner, Administaff. At the 2004 Annual Stockholders Meeting, the shareholders approved our 2004 Equity Incentive Plan, which incentive plan authorized and reserved for issuance under the Plan 2,000,000 shares of our common stock. We have used our 1999 plan to provide employees, directors and consultants an incentive for continued and future service. The 2004 Equity Incentive Plan is an important part of our total compensation program as competitive benefit programs are a critical component of our efforts to attract and retain qualified employees, directors and consultants. The purpose of our 2004 Equity Incentive Plan is to provide selected eligible employees, directors and certain types of consultants an opportunity to participate in our future by offering them an opportunity to acquire our stock so as to retain, attract and motivate them. Options granted under the Plan may be Incentive Stock Options or Non-statutory Stock Options, as determined by our Board of Directors or a committee appointed by our Board of Directors at the time of grant. Limited rights and stock awards may also be granted under the Plan. On September 1, 2004, we had 333,432 options available under our 1999 Stock Option Plan and 2,000,000 options available under our 2004 Equity Incentive Plan. PAGE 66 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table provides information as of September 1, 2004 concerning the beneficial ownership of our common stock by (i) each director, (ii) each named executive officer, (iii) each shareholder known by us to be the beneficial owner of more than 5% of our outstanding Common Stock, and (iv) the directors and officers as a group. Except as otherwise indicated, the persons named in the table have sole voting and investing power with respect to all shares of Common Stock owned by them. Title of Name and Address of Amount and Percent of Class Beneficial Owner Nature of Class(1) Beneficial Ownership(1) ---------- ---------------------- ---------------- ----------- ..0001 par James W. Benson, CEO 9,751,707(2) 49.61% value and Chairman common 13855 Stowe Drive stock Poway, California 92064 ..0001 par Richard B. Slansky 358,184(3) 1.84% value 13855 Stowe Drive common Poway, California 92064 stock ..0001 par Frank Macklin 230,073(4) 1.20% value 13855 Stowe Drive common Poway, California 92064 stock ..0001 par Randall K. Simpson 12,500(5) 0.07% value 13855 Stowe Drive common Poway, California 92064 stock ..0001 par J. Mark Grosvenor 1,330,376(6) 6.72% value 13855 Stowe Drive common Poway, California 92064 stock ..0001 par Curt Dean Blake 135,930(7) 0.71% value Director common 13855 Stowe Drive stock Poway, California 92064 ..0001 par Wesley T. Huntress Jr. 90,515(8) 0.47% value Director common 13855 Stowe Drive stock Poway, California 92064 PAGE 67 ..0001 par General Howell M. 69,167(9) 0.36% value Estes III, Director common 13855 Stowe Drive stock Poway, California 92064 ..0001 par Robert S. Walker 61,667(10) 0.32% value Director common 13855 Stowe Drive stock Poway, California 92064 PAGE 69 ..0001 par Stuart Schaffer, Director 218,206(11) 1.13% value 13855 Stowe Drive common Poway, California 92064 stock ..0001 par Scott McClendon 27,960(12) 0.15% value Director common 13855 Stowe Drive stock Poway, California 92064 ---------- ---------------------- ---------------- ----------- ..0001 par Officers and Directors as 10,955,909(13) 53.73%(1) value a group (10 Persons) common stock ---------- ---------------------- ---------------- ----------- ---------- ---------------------- ---------------- ----------- (1) Where persons listed on this table have the right to obtain additional shares of our common stock through the exercise of outstanding options or warrants or the conversion of convertible securities within 60 days from September 1, 2004 , these additional shares are deemed to be beneficially owned for the purpose of computing the amount and percentage of common stock owned by such persons. Percentages are based on total outstanding shares on September 1, 2004 plus options and warrants that will become exercisable for that individual within 60 days of September 1, 2004 . (2) Represents 8,257,647 shares held directly by Mr. Benson and his wife, Susan Benson, (including 486,647 shares as part of our convertible debt repayment when he converted $187,500 of his debt into shares in 2003); 497,413 shares transferred from SD Holdings, LLC to Space Development Institute, a 501(c)(3) corporation; plus vested options on 510,000 shares; and, warrants on 486,647 shares, which were exercised on June 22, 2004 (Mr. Benson forgave half of his warrants on 973,294 shares as part of the convertible debt repayment). In addition, Mr. Benson has unvested options on 2,000,000 shares. In 2003, 8,245,000 shares were transferred from SD Holdings, LLC, an entity previously controlled by Mr. Benson, directly to Mr. Benson and his children. Mr. Benson's children now hold 1,312,000 shares. Mr. Benson disclaims ownership of shares held by his children. (3) Mr. Slansky owns 43,472 shares of which 38,462 shares he purchased for cash in a private transaction with Mr. Skarupa, our former Vice President of Operations; 38,462 warrants which were also purchased from Mr. Skarupa and were registered and exercised; and, vested options on 276,250 shares. Mr. Slansky also holds 473,750 unvested options. (4) Mr. Macklin owns 222,073 shares of our common stock plus 8,000 vested options. Mr. Macklin also owns 45,000 unvested options. (5) Mr. Simpson owns 12,500 vested options and 237,500 unvested options. PAGE 68 (6) Mr. Grosvenor owns 665,188 shares of our common stock plus 665,188 vested warrants that he purchased in our private placement. On May 6, 2003, Mr. Grosvenor was granted options on 19,615 shares, which he forfeited upon his resignation from the Board on September 15, 2003, and as a result, is not included in the calculation of officer and directors above. (7) Mr. Blake owns 30,612 shares of our common stock plus 30,612 vested warrants that he purchased in our private placement. Mr. Blake also owns 74,706 vested options, which he received as compensation for his participation on our Board of Directors. In addition, Mr. Blake has unvested options on 84,000 shares. (8) Mr. Huntress owns 8,868 shares of our common stock. Mr. Huntress also owns 81,647 vested options, which he received as compensation for his participation on our Board of Directors. In addition, Mr. Huntress has unvested options on 90,000 shares. (9) General Estes III owns 69,167 vested options, which he received as compensation for his participation on our Board of Directors. In addition, General Estes III has unvested options on 47,500 shares. (10) Mr. Walker owns 61,667 vested options, which he received as compensation for his participation on our Board of Directors. In addition, Mr. Walker has unvested options on 38,000 shares. (11) Mr. Schaffer owns 128,206 shares of our common stock. Mr. Schaffer also owns 90,000 vested options, which he received as part of his compensation package as Vice President of Product Development and Marketing. (12) Mr. McClendon owns 27,960 vested options, which he received as compensation for his participation on our Board of Directors. In addition, Mr. McClendon has unvested options on 92,500 shares. (13) Officers and directors as a group include our seven Board members, one of whom is also an officer of the Company, Messrs. Grosvenor, Slansky, Macklin and Simpson. DESCRIPTION OF SECURITIES COMMON STOCK We are authorized to issue up to 50,000,000 shares of our $.0001 par value common stock, of which 19,146,660 shares are issued and outstanding as of September 1, 2004 . The Board of Directors may issue additional shares of Common Stock without the consent of the holders of Common Stock. VOTING RIGHTS Each outstanding share of Common Stock is entitled to one vote. The holders of Common Stock do not have cumulative voting rights, which means that the holders of more than 50% of such outstanding shares voting for the election of directors can elect all of our directors, if they so choose. NO PREEMPTIVE RIGHTS Holders of Common Stock are not entitled to any preemptive rights. DIVIDENDS AND DISTRIBUTIONS Holders of Common Stock are entitled to receive such dividends as may be declared by the directors out of funds legally available therefore and to share pro rata in any distributions to holders of Common Stock upon liquidation or otherwise. However, we have not paid cash dividends on our Common Stock, and do not expect to pay such dividends in the foreseeable future. No dividends may PAGE 69 be paid on our Common Stock unless all dividends due on our outstanding Series C Convertible Cumulative Preferred Stock (described below) have been paid. PREFERRED STOCK We are authorized to issue up to 10,000,000 shares of our $0.001 par value preferred stock, of which 250,000 shares have been designated Series C Convertible Cumulative Preferred Shares (referred to in this section as the "Series C Shares") issued to Laurus on August 25, 2004 at a stated value of $10 per share, for an aggregate purchase price of $2,500,000 and are currently outstanding. No other series of preferred shares is currently outstanding. The Board of Directors may designate additional series of preferred stock ranking on parity with or subordinate to the Series C Shares. VOTING RIGHTS The Series C Shares have no voting rights. LIQUIDATION RIGHTS The Series C Shares carry a liquidation preference equal to the then stated value ($10.00 per share) of the then outstanding Series C Shares. As a result, the holders of the Series C Shares will receive a distribution out of the assets of the Company upon liquidation equal to the number of Series C Shares then outstanding multiplied by $10.00 before the holders of our Common Stock will be entitled to any distribution. DIVIDENDS The Series C Shares pay quarterly, cumulative dividends at a rate of 6.85% with the first payment due on January 1, 2005. Dividends are payable in cash or shares of Common Stock at the holder's option with the exception that dividends must be paid in shares of Common Stock for up to 25% of the aggregate dollar trading volume if the fair market value of the Common Stock for the 20-days preceding the conversion date exceeds 120% of the Conversion Rate. CONVERSION The Series C Shares are convertible into the $0.0001 par value Common Stock of the Company at a rate of $1.54 per share (the "Conversion Rate") at any time after the date of issuance, subject to adjustments for stock splits, combinations and dividends and for shares of common stock issued for less than the fixed conversion price (unless exempted pursuant to the agreements). REDEMPTION We may redeem the Series C Shares in whole or in part at any time after issuance for (a) 115% of the stated value if the average closing price of the Common Stock for the 22 days immediately preceding the date of conversion does not exceed the Conversion Rate or (b) the stated value if the average closing price of the Common Stock for the 22 days immediately preceding the date of conversion exceeds the stated value. WARRANTS The Warrants, excluding the Laurus Warrant, are exercisable immediately upon issuance for the purchase of one additional share of Common Stock at an exercise price equal to the price paid for the Common Stock, and expire on the PAGE 70 third anniversary date of the date of issuance. In conjunction with the sale of the Series C Shares, on August 25, 2004, we issued a five-year warrant to Laurus for the purchase of 487,000 shares of our Common Stock at an exercise price equal to $1.77 per share. In addition, Laurus holds a warrant to purchase 50,000 shares of our Common Stock at an exercise price of $1.925 per share which expires on August 25, 2009, a warrant to purchase 50,000 shares of our Common Stock at an exercise price of $1.0625 per share which expires on June 18, 2009, and a warrant to purchase shares of our Common Stock as follows, which expires on June 3, 2008 $0.63 per share for the purchase of up to 125,000 shares, $0.69 per share for the purchase of an additional 50,000 shares, and $0.80 per share for the purchase of an additional 25,000 shares. The exercise price on all warrants is subject to adjustments for stock splits, combinations and dividends and for shares of common stock issued for less than the fixed conversion price (unless exempted pursuant to the warrant agreements). TRANSFER AGENT AND REGISTRAR We use Continental Stock Transfer and Trust, 17 Battery Place, 8th Floor, New York, NY 10004, as our transfer agent for our Common Stock. Corporate Stock Transfer can be contacted via telephone at (212) 845-3215. DISCLOSURE OF COMMISSION POSITION OF INDEMNIFICATION FOR SECURITIES ACT LIABILITIES Our Articles of Incorporation provide that our directors, officers, employees or agents shall be indemnified as to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, as long as the director, officer, employee or agent acted in good faith and in a manner reasonably believed to be in the best interests of the corporation. No indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his/her duty. In addition, our Articles of Incorporation and Bylaws obligate us to indemnify our directors and officers against expenses and other amounts reasonably incurred in connection with any proceeding arising from the fact that such person is or was an agent of ours. Our Articles of Incorporation and Bylaws also authorize us to purchase and maintain insurance on behalf of any of our directors or officers against any liability asserted against that person in that capacity, whether or not we would have the power to indemnify that person. We have been advised that in the opinion of the Securities and Exchange Commission indemnification for liabilities arising under the Securities Act is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities is asserted by one of our directors, officers, or controlling persons in connection with the securities being registered, we will, unless in the opinion of our legal counsel the matter has been settled by controlling precedent, submit the question of whether such indemnification is against public policy to court of appropriate jurisdiction. We will then be governed by the court's decision. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS The Sarbanes-Oxley Act of 2002 ("Act") established the Public Company Accounting Oversight Board ("PCAOB") and charged it with the responsibility of overseeing the audits of public companies that are subject to the federal securities laws. Under the Act, the PCAOB's duties included the establishment of a registration system for public accounting firms. The PCAOB has proposed rules for the registration process, which would require approval of the U.S. Securities Commission ("SEC") prior to enforcement. Within 180 days after SEC PAGE 71 approval, all public accounting firms would be required to register with the PCAOB if they wished to prepare or issue audit reports on U.S. public companies, or to play a substantial role in the preparation or issuance of such reports. Once registered, public accounting firms are required to file periodic reports with the PCAOB. Prior to adoption of the registration process, the cost of compliance with these new rules could not be determined, and, as a result of the legislation, it appeared that the cost of professional liability insurance for public accounting firms would be dramatically increased. We were informed by our independent auditor, Nation Smith Hermes Diamond, Accountants and Consultants, P.C. ("Nation Smith"), that it did not intend register with the PCAOB at that time, and, as a result, would not be able to continue to act as our independent auditor once the rules were in effect. Nation Smith did not resign its position as a result of any disagreements with us on accounting or financial disclosure issues. Effective June 2, 2003, we confirmed with our auditors, Nation Smith Hermes Diamond, P.C., "Nation Smith"), that Nation Smith would no longer be representing us as our accountants, except to provide consent herein. As of that date, we informed Nation Smith that we were engaging a new audit firm as our accountants. Nation Smith last reported on Registrant's financial statements as of February 13, 2003. The report, which covered the two fiscal years ended December 31, 2002, was an unqualified report modified for going concern. While Nation Smith expressed concern as to the Registrant's ability to remain a going concern, neither the report nor the financial statements for the periods contained any other adverse opinion or disclaimer of opinion, nor were they modified as to audit scope or accounting principles. Our Board of Directors ratified the change of independent accountants on June 3, 2003. During our fiscal year 2002 and the subsequent interim period through July 25, 2003, there were no disagreements with Nation Smith on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not resolved, to Nation Smith's satisfaction, would have caused it to make reference to the subject matter of the disagreement in connection with its report. During fiscal year 2002 and the subsequent interim period through July 25, 2003, there have been no reportable events (as defined in Regulation S-B Item 304(a)(1)(v)). During fiscal year 2002 and the subsequent interim period through July 25, 2003, Nation Smith did not advise us that the internal controls necessary for us to develop reliable financial statements do not exist. During fiscal year 2002 and the subsequent interim period through July 25, 2003, Nation Smith did not advise us that any information had come to their attention which had led them to no longer be able to rely on management's representation, or that had made Nation Smith unwilling to be associated with the financial statements prepared by management. During fiscal year 2002 and the subsequent interim period through July 25, 2003, Nation Smith did not advise us that the scope of any audit needed to be expanded significantly or that more investigation was necessary. During fiscal year 2002 and the subsequent interim period through July 25, 2003, Nation Smith did not advise us that there was any information which the accountants concluded would materially impact the fairness and reliability of either (i) a previously issued audit report or the underlying financial statements, or (ii) the financial statements issued or to be issued covering the fiscal period(s) subsequent to the date of the most recent financial PAGE 72 statements covered by an audit report (including information that, unless resolved to the accountant's satisfaction, would prevent it from rendering an unqualified audit report on those financial statements. We requested that Nation Smith furnish us with a letter addressed to the SEC stating whether or not it agrees with the above statements. A copy of such letter, dated June 4, 2003, was filed as Exhibit 16.1 to our Form 8-K filing of the same date. We engaged PKF, Certified Public Accountants, A Professional Corporation ("PKF"), as our new independent accountants on June 2, 2003 for the fiscal year ending December 31, 2003, and to review our quarterly financial statements for the periods ending June 30, 2003 and September 30, 2003. Prior to June 2, 2003, we had not consulted with PKF regarding (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on our financial statements, and no written report or oral advice was provided to us by PKF concluding there was an important factor to be considered by us in reaching a decision as to an accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a disagreement, as that term is defined in Item 304(a)(1)(iv) of Regulation S-B and the related instructions to Item 304 of Regulation S-B, or a reportable event, as that term is defined in Item 304(a)(1)(iv) of Regulation S-B. EXPERTS The financial statements included in this prospectus have been audited by PKF, certified public accountants, a professional corporation for the year ending December 31, 2003 and Nation Smith Hermes Diamond, P.C., independent certified public accountants for the year ending December 31, 2002, to the extent and for the periods set forth in their report (which contains an explanatory paragraph regarding our ability to continue as a going concern) appearing elsewhere herein and are included in reliance upon such report given upon the authority of said firm as experts in auditing and accounting. Weintraub Dillon PC, our independent legal counsel, has provided an opinion on the validity of our common stock underlying the Convertible Note, Preferred Stock, Laurus Warrants and Warrants. LEGAL PROCEEDINGS On June 18, 2001, we entered into a relationship with two individuals (doing business as EMC Holdings Corporation ("EMC")), whereby EMC was to provide certain consulting and advisory services to us in exchange for our common stock. EMC received the first installment of 500,000 shares of our common stock on June 26, 2001. Total expense for the initial stock issuance through September 30, 2001 was valued at approximately $455,000. Pursuant to a demand for arbitration filed by us on November 7, 2001, we sought the return of all or a portion of the shares issued to EMC. EMC filed its own claim with the American Arbitration Association on November 13, 2001, alleging that we owed EMC $118,000 in fees, plus damages. PAGE 73 A three-day arbitration hearing was held in May and June 2002 with respect to claims arising out of consulting and advisory service agreements between EMC and us. On July 17, 2002, an interim award was issued in favor of us against EMC, ordering the return of the initial installment of 500,000 shares and denying EMC's claim for $118,000. On October 22, 2002, a status conference was held and a tentative final award was issued again in the favor of us. Included in this tentative final ruling was an award of approximately $83,000 in attorney and arbitration fees to us. The tentative final ruling became effective on October 29, 2002, and was submitted to the Superior Court of California, Orange County, for entry of judgment. Because collection of the attorney and arbitration fees award is not assured, we expensed all of our fees related to this matter. Any recovery of fees will be recorded as income in the period they are received. The return of the 500,000 shares, as provided in the interim award issued on July 17, 2002, was recorded in the third quarter of 2002 as a reversal of the original expense recorded. See "Results of Operations" below. In June 2003, we ceased efforts to recover the awarded fees, as it was determined that the cost to pursue collection exceeded the likelihood of collection. WHERE YOU CAN FIND MORE INFORMATION We file annual, quarterly and special reports, proxy statements and other information with the Commission. You may read and copy any document we file at the Commission's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for information on the operation of the Public Reference Room. Our filings with the Commission are also available to the public at the Commission's Web site at http://www.sec.gov. Our common stock is quoted on The Over-the-Counter Bulletin Board (OTCBB). Our reports, proxy statements and other information are also available to the public on the OTCBB's Web site at http://www.otcbb.com. This prospectus is part of a post-effective amendment to registration statement on Form SB-2 (File No. 333-116766) filed with the Commission under the Securities Act. This prospectus may omit some of the information contained in the registration statement. You should refer to the registration statement for further information with respect to our company and the securities offered under this prospectus. Any statement contained in this prospectus concerning the provisions of any document filed as an exhibit to the registration statement or otherwise filed with the Commission is not necessarily complete, and in each case you should refer to the copy of the document filed for more complete information. PAGE 74 SPACEDEV, INC. AND SUBSIDIARIES CONTENTS REPORT OF INDEPENDENT AUDITORS . . . . . . . . . . . . . . . . . . . F-2 to F-3 FINANCIAL STATEMENTS Consolidated Balance Sheets at December 31, 2003 and 2002. . . . . F-4 to F-5 Consolidated Statements of Operations for the Years Ending December 31, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . F-6 Consolidated Statements of Stockholders' Deficit for the Years Ending December 31, 2003 and 2002. . . . . . . . . . . . . . . . . F-7 to F-9 Consolidated Statements of Cash Flows for the Years Ending December 31, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . F-10 to F-11 Notes to Consolidated Financial Statements for the Years Ending December 31, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . F-12 to F-31 Unaudited Consolidated Balance Sheets at June 30 , 2004 and 2003 . . . . . . . . . . . F-32 to F-33 Unaudited Consolidated Statements of Operations for the Quarters Ending June 30 , 2004 and 2003. . . . . . . . . . . . . . . F-34 Unaudited Consolidated Statements of Cash Flows for the Quarters Ending June 30 , 2004 and 2003 . . . . . . . . . . . . . . . F-35 to F-36 Notes to Consolidated Financial Statements for the Six-Month Periods ending June 30 , 2004 and 2003. . . . . . . . . . . . . F-37 to F-44 PAGE F-1 Report of Independent Auditors Board of Directors and Stockholders SPACEDEV, INC. We have audited the accompanying consolidated balance sheet of SPACEDEV, INC. AND SUBSIDIARIES (see Note 1(c) to the consolidated financial statements) as of December 31, 2003, and the related consolidated statements of operations, stockholders' deficit and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SPACEDEV, INC. AND SUBSIDIARIES as of December 31, 2003, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ PKF San Diego, California February 11, 2004 (except for Note 11 for which the date is April 2, 2004) PAGE F-2 Report of Independent Auditors Board of Directors and Stockholders SPACEDEV, INC. We have audited the accompanying consolidated balance sheet of SPACEDEV, INC. AND SUBSIDIARIES (see Note 1(c) to the consolidated financial statements) as of December 31, 2002, and the related consolidated statements of operations, stockholders' deficit and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, based on our audit the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SPACEDEV, INC. AND SUBSIDIARIES as of December 31, 2002, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1(b) to the consolidated financial statements, the Company incurred a net loss of $376,160 for the year ended December 31, 2002, and had a working capital deficit of $197,381 as of December 31, 2002. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1(b). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Nation Smith Hermes Diamond P.C. /s/ Nation Smith Hermes Diamond San Diego, California February 13, 2003 PAGE F-3 SPACEDEV, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, . . . . . . . . . . . . . . . . . . . . . 2003 2002 ------------------------------------------------------- ---------------------------- ---------- ASSETS ------------------------------------------------------- ---------------------------- ---------- CURRENT ASSETS Cash (Note 10(a)) . . . . . . . . . . . . . . . . . $ 592,006 $ 27,648 Accounts receivable (Note 10(b)). . . . . . . . . . 187,062 82,325 Inventory . . . . . . . . . . . . . . . . . . . . . 9,961 1,729 Receivable for assets held for sale (Note 2). . . . - 3,150,124 Costs in excess of billings and estimated earnings. - 281,175 Work in Progress. . . . . . . . . . . . . . . . . . 110,490 - ------------------------------------------------------- ---------------------------- ---------- Total current assets . . . . . . . . . . . . . . . . . 899,519 3,543,001 ------------------------------------------------------- ---------------------------- ---------- FIXED ASSETs - Net (Notes 1(g) and 2). . . . . . . . . 137,532 141,488 CAPITALIZED SOFTWARE COSTS. . . . . . . . . . . . . . - 103,508 OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . 47,768 23,960 TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . $ 1,084,819 $3,811,957 ------------------------------------------------------- ---------------------------- ---------- ------------------------------------------------------- ---------------------------- ---------- The accompanying notes are an integral part of these consolidated financial Statements PAGE F-4 SPACEDEV, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2003 2002 --------------------------------------------------------------------- ---------------------- ------------- LIABILITIES AND STOCKHOLDERSDEFICIT CURRENT LIABILITIES Current portion of notes payable (Note 4(a)). . . . . . . . . . . $ 41,464 $ 2,431,134 Current portion of capitalized lease obligations (Note 9(a)). . . 10,332 32,783 Notes payable - related party (Note 4(b)) . . . . . . . . . . . . 80,000 174,665 Convertible debt notes payable (Note 5) . . . . . . . . . . . . . - 127,075 Accounts payable and accrued expenses . . . . . . . . . . . . . . 311,606 598,480 Accrued payroll, vacation and related taxes . . . . . . . . . . . 84,001 174,188 Customer deposits and deferred revenue (Note 1(f)). . . . . . . . - 69,402 Revolving line of credit (Note 4(c)). . . . . . . . . . . . . . . 748,893 Provision for anticipated loss (Note 10(c)) . . . . . . . . . . . - 11,044 Employee Stock Purchase Plan (Note (7(b)) . . . . . . . . . . . . 5,498 - Other accrued liabilities (Note 9(b)) . . . . . . . . . . . . . . 248,530 121,611 --------------------------------------------------------------------- ---------------------- ------------- TOTAL CURRENT LIABILITIES. . . . . . . . . . . . . . . . . . . . . . 1,530,324 3,740,382 --------------------------------------------------------------------- ---------------------- ------------- NOTES PAYABLE, LESS CURRENT MATURITIES (NOTE 4(A)) . . . . . . . . . 46,127 89,052 CAPITALIZED LEASE OBLIGATIONS, LESS CURRENT MATURITIES (NOTE 9(A)) . 5,253 8,431 NOTES PAYABLE - RELATED PARTY, LESS CURRENT MATURITIES (NOTE 4(B)) . 505,522 563,831 DEFERRED GAIN - ASSETS HELD FOR SALE (NOTE 2). . . . . . . . . . . . 1,065,221 1,172,720 DEFERRED REVENUE (NOTE 1(F)) . . . . . . . . . . . . . . . . . . . . 5,000 5,000 --------------------------------------------------------------------- ---------------------- ------------- TOTAL LIABILITIES. . . . . . . . . . . . . . . . . . . . . . . . . . 3,157,447 5,579,416 --------------------------------------------------------------------- ---------------------- ------------- COMMITMENTS AND CONTINGENCIES (NOTES 9) --------------------------------------------------------------------- ---------------------- ------------- STOCKHOLDERSDEFICIT Convertible preferred stock, $.001 par value, 10,000,000 shares authorized, no shares issued or outstanding (Note 8(a)). . . . . - - Common stock, $.0001 par value; 50,000,000 shares authorized, and 16,413,260 and 14,447,640 shares issued and outstanding, respectively (Note 8(b)) . . . . . . . . . . . . . . . . . . . . 1,641 1,447 Additional paid-in capital . . . . . . . . . . . . . . . . . . . . 9,243,507 8,302,803 Additional paid-in capital - stock options (Note 8(d)) . . . . . . 750,000 750,000 Deferred compensation (Note 8(d)). . . . . . . . . . . . . . . . . (250,000) (250,000) Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . (11,817,776) (10,571,709) --------------------------------------------------------------------- ---------------------- ------------- TOTAL STOCKHOLDERSDEFICIT. . . . . . . . . . . . . . . . . . . . . . (2,072,628) (1,767,459) --------------------------------------------------------------------- ---------------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT. . . . . . . . . . . . . $ 1,084,819 $ 3,811,957 --------------------------------------------------------------------- ---------------------- ------------- --------------------------------------------------------------------- ---------------------- ------------- The accompanying notes are an integral part of these consolidated financial Statements PAGE F-5 SPACEDEV, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31,. . . . . . . . . . . . . . . 2003 2002 ------------------------------------------------------ -------------- ------------ ----------- ------------ NET SALES . . . . . . . . . . . . . . . . . . . . . . $ 2,956,322 100% $3,370,118 100% ------------------------------------------------------ -------------- ------------ ----------- ------------ Cost of sales . . . . . . . . . . . . . . . . . . . . 2,414,997 82% 3,348,671 99% Anticipated loss on uncompleted contract (Note 10(c)) - - (58,941) -2% ------------------------------------------------------ -------------- ------------ ----------- ------------ TOTAL COST OF SALES . . . . . . . . . . . . . . . . . ,414,997 82% 3,289,730 98% ------------------------------------------------------ -------------- ------------ ----------- ------------ GROSS MARGIN. . . . . . . . . . . . . . . . . . . . 541,325 18% 80,388 2% ------------------------------------------------------ -------------- ------------ ----------- ------------ OPERATING EXPENSES Marketing and sales expense. . . . . . . . . . . . 394,974 13% 257,648 8% Research and development . . . . . . . . . . . . . 281,280 10% - 0% Stock and stock option based compensation. . . . . 9,170 0% 2,938 0% General and administrative . . . . . . . . . . . . 745,993 25% 260,882 8% EMC - stock based compensation (Note 8(b)) . . . . - 0% (455,000) -14% ------------------------------------------------------ -------------- ------------ ----------- ------------ TOTAL OPERATING EXPENSES. . . . . . . . . . . . . . . 1,431,417 48% 66,468 2% ------------------------------------------------------ -------------- ------------ ----------- ------------ INCOME/(LOSS) FROM OPERATIONS . . . . . . . . . . . . (890,092) -30% 13,920 0% ------------------------------------------------------ -------------- ------------ ----------- ------------ NON-OPERATING EXPENSE/(INCOME) Interest expense . . . . . . . . . . . . . . . . . 91,492 3% 263,480 8% Non-cash interest expense debt discount (Note 5) . 112,500 4% 125,000 4% Gain on Building Sale (Note 4(a)). . . . . . . . . (107,499) -4% - 0% Loan Fee - Equity Compensation (Note 4(c) & 5) . . 257,882 9% - 0% ------------------------------------------------------ -------------- ------------ ----------- ------------ TOTAL NON-OPERATING EXPENSE/(INCOME). . . . . . . . . 354,375 12% 388,480 12% ------------------------------------------------------ -------------- ------------ ----------- ------------ LOSS BEFORE INCOME TAXES. . . . . . . . . . . . . . . (1,244,467) -42% (374,560) -11% Income tax provision (Notes 1(j) and 6) . . . . . . . 1,600 0% 1,600 0% ------------------------------------------------------ -------------- ------------ ----------- ------------ NET LOSS. . . . . . . . . . . . . . . . . . . . . . . $ (1,246,067) -42% $ (376,160) -11% ------------------------------------------------------ -------------- ------------ ----------- ------------ NET LOSS PER SHARE: Net loss. . . . . . . . . . . . . . . . . . . . . . . $ (0.08) $ (0.03) ------------------------------------------------------ -------------- ------------ ----------- ------------ Weighted-Average Shares Outstanding . . . . . . . . . 16,092,292 14,744,423 ------------------------------------------------------ -------------- ------------ ----------- ------------ ------------------------------------------------------ -------------- ------------ ----------- ------------ The accompanying notes are an integral part of these consolidated financial Statements PAGE F-6 SPACEDEV, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT Common Stock ------------------------------------------------- Shares Amount ----------------------------------------------------------------------- ---------------------------- ----------------- BALANCE AT JANUARY 1, 2002. . . . . . . . . . . . . . . . . . . . . . . 14,817,580 $ 1,481 Common stock issued for cash (Note 8(b)). . . . . . . . . . . . . . . . 153,060 15 Reversal of common stock issued for services (Note 8 (b)) . . . . . . . (493,000) (49) Warrants issued for convertible debt program (Note 5 and 8(c)). . . . . - - Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - ----------------------------------------------------------------------- ---------------------------- ----------------- BALANCE AT DECEMBER 31, 2002. . . . . . . . . . . . . . . . . . . . . . 14,477,640 1,447 Common stock issued for cash (Note 8(b)). . . . . . . . . . . . . . . . 861,267 86 Common stock issued from notes on revolving credit facility (Note 4(c)) 415,000 42 Common stock issued for services (Note 8 (b)) . . . . . . . . . . . . . 7,500 1 Common stock issued from convertible debt program (Note 5 and 8(c)) . . 614,853 61 Common stock issued from employee stock options (Note 7(b)) . . . . . . 37,000 4 Warrants issued for convertible debt program (Note 5 and 8(c)). . . . . - - Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - ----------------------------------------------------------------------- ---------------------------- ----------------- BALANCE AT DECEMBER 31, 2003. . . . . . . . . . . . . . . . . . . . . . $ 16,413,260 $ 1,641 ----------------------------------------------------------------------- ---------------------------- ----------------- ----------------------------------------------------------------------- ---------------------------- ----------------- The accompanying notes are an integral part of these consolidated financial Statements PAGE F-7 SPACEDEV, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT Additional Additional Paid-In Paid-in Capital - Deferred Capital Stock Options Compensation ------------------------------------------------------------------------ ------------ ------------- -------------- BALANCE AT JANUARY 1, 2002 . . . . . . . . . . . . . . . . . . . . . . . $ 8,204,831 750,000 $ (250,000) Common stock issued for cash (Note 8(b)) . . . . . . . . . . . . . . . . 74,985 - - Reversal of common stock issued for services (Note 8 (b)). . . . . . . . (452,013) - - Warrants issued for convertible debt program (Note 5 and 8(c)) . . . . . 475,000 - - Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - - ------------------------------------------------------------------------ ------------ ------------- -------------- BALANCE AT DECEMBER 31, 2002 . . . . . . . . . . . . . . . . . . . . . . 8,302,803 750,000 (250,000) ------------------------------------------------------------------------ ------------ ------------- -------------- Common stock issued for cash (Note 8(b)) . . . . . . . . . . . . . . . . 425,856 - - Common stock issued from notes on revolving credit facility (Note 4( c)) 354,679 - - Common stock issued for services (Note 8 (b)). . . . . . . . . . . . . . 9,169 - - Common stock issued from convertible debt program (Note 5 and 8(c)). . . 368,850 - - Common stock issued from employee stock options (Note 7(b)). . . . . . . 19,650 - - Warrants issued for convertible debt program (Note 5 and 8(c)) . . . . . (237,500) - - Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - ------------------------------------------------------------------------ ------------ ------------- -------------- BALANCE AT DECEMBER 31, 2003 . . . . . . . . . . . . . . . . . . . . . . $ 9,243,507 750,000 (250,000) ------------------------------------------------------------------------ ------------ ------------- -------------- ------------------------------------------------------------------------ ------------ ------------- -------------- The accompanying notes are an integral part of these consolidated financial Statements PAGE F-8 SPACEDEV, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT Accumulated Deficit Total ----------------------------------------------------------------------- ---------------------------- ----------------- BALANCE AT JANUARY 1, 2002. . . . . . . . . . . . . . . . . . . . . . . $ (10,195,549) $ (1,489,237) Common stock issued for cash (Note 8(b)). . . . . . . . . . . . . . . . - 75,000 Reversal of common stock issued for services (Note 8 (b)) . . . . . . . - (452,062) Warrants issued for convertible debt program (Note 5 and 8(c)). . . . . - 475,000 Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (376,160) (376,160) ----------------------------------------------------------------------- ---------------------------- ----------------- BALANCE AT DECEMBER 31, 2002. . . . . . . . . . . . . . . . . . . . . . (10,571,709) (1,767,459) Common stock issued for cash (Note 8(b)). . . . . . . . . . . . . . . . - 425,942 Common stock issued from notes on revolving credit facility (Note 4(c)) - 354,721 Common stock issued for services (Note 8 (b)) . . . . . . . . . . . . . - 9,170 Common stock issued from convertible debt program (Note 5 and 8(c)) . . - 61 Common stock issued from employee stock options (Note 7(b)) . . . . . . - 368,911 Warrants issued for convertible debt program (Note 5 and 8(c)). . . . . - 19,654 Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,246,067) (1,246,067) ----------------------------------------------------------------------- ---------------------------- ----------------- BALANCE AT DECEMBER 31, 2003. . . . . . . . . . . . . . . . . . . . . . $ (11,817,776) $ (2,072,628) ----------------------------------------------------------------------- ---------------------------- ----------------- ----------------------------------------------------------------------- ---------------------------- ----------------- The accompanying notes are an integral part of these consolidated financial Statements PAGE F-9 SPACEDEV, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31,. . . . . . . . . . . . . . . . . . . . . . 2003 2002 -------------------------------------------------------------------- --------------------------------------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (1,246,067) $(376,160) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization . . . . . . . . . . . . . . . . 166,971 357,692 Contributed assets. . . . . . . . . . . . . . . . . . . . . . - (16,251) (Gain) loss on disposal of assets . . . . . . . . . . . . . . (107,499) 7,410 Non-cash interest expense - convertible debt program. . . . . 131,411 125,000 Non-cash loan fees. . . . . . . . . . . . . . . . . . . . . . 126,471 Common stock issued for compensation and services . . . . . . 9,170 (452,062) Change in operating assets and liabilities: . . . . . . . . . -------------------------------------------------------------------- --------------------------------------- ---------- Accounts receivable . . . . . . . . . . . . . . . . . . . . (104,737) 208,290 Work in Progress. . . . . . . . . . . . . . . . . . . . . . (110,490) - Prepaid and other current assets. . . . . . . . . . . . . . (33,888) 10,168 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . (8,232) (1,729) Convertible debt notes payable. . . . . . . . . . . . . . . 130,661 - Costs in excess of billings and estimated earnings. . . . . 281,175 (281,175) Accrued interest revolving line of credit . . . . . . . . . 13,601 - Accounts payable and accrued expenses . . . . . . . . . . . (286,874) 202,641 Accrued payroll, vacation and related taxes . . . . . . . . (90,187) 15,936 Customer deposits and deferred revenue. . . . . . . . . . . (69,402) (158,319) Employee Stock Purchase Plan. . . . . . . . . . . . . . . . 5,498 - Billings in excess of costs incurred and estimated earnings - (302,553) Provision for anticipated loss. . . . . . . . . . . . . . . (11,044) (91,241) Accrued interest - related party. . . . . . . . . . . . . . 47,023 45,265 Other accrued liabilities . . . . . . . . . . . . . . . . . 126,919 115 -------------------------------------------------------------------- --------------------------------------- ---------- NET CASH (USED IN) OPERATING ACTIVITIES . . . . . . . . . . . . . . (1,029,520) (706,973) CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from the sale of building. . . . . . . . . . . . . . . . . 3,150,124 50,000 Purchases of fixed assets. . . . . . . . . . . . . . . . . . . . (39,292) (1,900) -------------------------------------------------------------------- --------------------------------------- ---------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES. . . . . . . . . 3,110,832 48,100 -------------------------------------------------------------------- --------------------------------------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds (payments) from convertible debt program. . . . . . . (257,736) 475,000 Principle payments on notes payable. . . . . . . . . . . . . . (2,432,595) (65,785) Principal payments on capitalized lease obligations. . . . . . (35,764) (37,330) Payments on notes payable - related party. . . . . . . . . . . (199,997) (66,667) Proceeds from revolving credit facility. . . . . . . . . . . . 963,542 - Proceeds on notes payable - related party. . . . . . . . . . . - 94,666 Proceeds from issuance of common stock . . . . . . . . . . . . 445,596 75,000 NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES . . . . . . . . (1,516,954) 474,884 -------------------------------------------------------------------- --------------------------------------- ---------- Net increase/(decrease) in cash . . . . . . . . . . . . . . . . . . 564,358 (183,989) CASH AT BEGINNING OF YEAR . . . . . . . . . . . . . . . . . . . . . 27,648 211,637 -------------------------------------------------------------------- --------------------------------------- ---------- CASH AT END OF YEAR . . . . . . . . . . . . . . . . . . . . . . . . $ 592,006 $ 27,648 -------------------------------------------------------------------- --------------------------------------- ---------- -------------------------------------------------------------------- --------------------------------------- ---------- The accompanying notes are an integral part of these consolidated financial Statements PAGE F-10 SPACEDEV, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, . . . . . . . . . . . . . 2003 2002 --------------------------------------------------- -------------------------------------- -------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest . . . . . . . . . . . . . . . . . . . $ 41,726 $310,821 Income Taxes . . . . . . . . . . . . . . . . . $ 1,600 $ 1,600 NONCASH INVESTING AND FINANCING ACTIVITIES: During 2003 and 2002, the Company issued 7,500 and 7,000 shares of restricted shares of stock for employee awards and services and for summer & student interns and recorded expenses of $9,170 and $2,900, respectively. During 2003 and 2002, the Company issued 861,267 and 153,060 shares of restricted shares of stock under the Company's Private Placement Memorandum for cash of $425,942 and $75,000, respectively. During 2003, the Company eliminated its convertible debt by repaying half of the notes in cash ($237,500) and having the note holders convert the other half into 614,853 shares of the Company's common stock. The Company recorded additional loan fees of $131,411 and charged these fees to equity. During 2003, the Company issued 415,000 shares of its common stock to the Laurus Master Fund from conversions of its convertible debt notes under its revolving credit facility with Laurus; thereby realizing a corresponding reduction in debt of $228,250. The Company recorded additional loan fees of $126,471 and charged these fees to equity. During 2003, the Company issued 37,000 shares of stock converted from employee stock options for $19,654 in cash. During 2002, the Company recovered 500,000 shares of stock for a credit of $455,000 upon final judgment of the outstanding litigation against EMC Holdings, Inc. The expense for this matter was recorded during 2001. During 2003 and 2002, the Company financed $10,135 and $20,472, respectively, in fixed assets through various capital lease obligations. The accompanying notes are an integral part of these consolidated financial Statements PAGE F-11 SPACEDEV, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the Company's significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows. (a) Nature of operations SPACEDEV, INC. (the "Company") is engaged in the conception, design, development, manufacture, integration and operations of SPACE TECHNOLOGY SYSTEMS, products and services. The Company is currently focused on the development of low-cost microsatellites, nanosatellites and related subsystems, hybrid rocket propulsion as well as associated engineering and technical services, primarily to government agencies, and specifically to the United States Department of Defense. The Company's products and solutions are sold, mainly on a project-basis, directly to these customers and include sophisticated micro- and nanosatellites, hybrid rocket-based orbital Maneuvering and orbital Transfer Vehicles as well as safe sub-orbital and orbital hybrid rocket-based propulsion systems. The Company believes there will be an evolving and developing commercial market for its space technology systems (e.g., its microsatellite and nanosatellite products and services) in the long-term. In the short-term, the early adopters of this technology appear to be in the United States Department of Defense and the Company's "products" are considered to be the outcome of specific projects. The Company is also designing and developing commercial hybrid rocket motors and small high performance space vehicles and subsystems for commercial customers (e.g., Scaled Composites' SpaceShipOne) and military customers (e.g., the Air Force Research Laboratory. The Company was incorporated under the laws of the State of Colorado on December 23, 1996 as Pegasus Development Group, Inc. ("PDGI"). SpaceDev, LLC of Colorado was originally formed in 1997 for commercial space exploration and was the sole owner of shares of common stock of SpaceDev (a Nevada corporation) ("SpaceDev"), formed on August 22, 1997. On October 22, 1997, PDGI issued 8,245,000 of its $.0001 par value common stock for 100 percent (1,000,000 shares) of SpaceDev's common stock owned by SpaceDev, LLC. Upon the acquisition of the SpaceDev stock, SpaceDev was merged into PDGI and, on December 17, 1997, PDGI changed its name to SPACEDEV, INC. After the merger, SpaceDev, LLC, changed its name to SD Holdings, LLC on December 17, 1997. (See Notes 8(a) and 8(b).) For accounting purposes, the transaction was accounted for as a reverse merger with the Company as the acquirer. Since SpaceDev had minimal assets prior to the merger, the transaction was accounted for as the sale of the Company's common stock for net assets of $1,232. The Company became publicly traded in October 1997 and is currently trading on the Over-the-Counter Bulletin Board ("OTCBB") under the symbol of "SPDV." In February 1998, the Company's operations were expanded with the acquisition of Integrated Space Systems, Inc., a California corporation founded for the purpose of providing engineering and technical services related to space-based systems. The Integrated Space Systems employee base, acquired upon acquisition, largely consisted of former Atlas and General Dynamics personnel and enlarged its then current employee base to 20 employees. Integrated Space Systems was purchased PAGE F-12 for approximately $3.6 million, paid in Rule 144 restricted common shares of SpaceDev. Goodwill of approximately $3.5 million was capitalized and was to be amortized over a period of sixty (60) months, based on the purchase price exceeding the net asset value of approximately $164,000. As a result of a change in corporate focus, on November 15, 2001, the Company determined that the unamortized balance of goodwill from Integrated Space Systems, which was approximately $923,000, had become impaired and it was written-off. While the Integrated Space Systems segment did provide small hybrid propulsion space systems and engineering services on separate contracts (mainly with government agencies), the engineering service contracts had expired and, therefore, would not be producing revenue or cash flow to support future operations. The Company determined that all future business, contracts and proposals would be sought after only in the SpaceDev name, making it a more efficient way for it to manage and track multiple contracts and work on many different business ventures at the same time within the same operating segment. The Company filed for dissolution of Integrated Space Systems in December 2003, since all activities have been integrated into SpaceDev, Inc. (b) Prior year going concern The Company's auditors, PKF, expressed in their formal auditors' opinion dated February 11, 2004 (except for Note 11 as to which the date is April 2, 2004), that in their opinion, based on their audit, the Company's consolidated financial statements referred to herein present fairly, in all material respects, the consolidated financial position of SPACEDEV, INC. AND SUBSIDIARIES as of December 31, 2003, and the consolidated results of our operations and our cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. In previous years, including the opinion issued by the Company's previous auditors, Nation Smith, dated February 13, 2003, they expressed an opinion that our financial position raised substantial doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements as of December 31, 2003 have been prepared assuming the Company will continue as a going concern. However, in 2002, the Company had a working capital deficit of $197,381 and incurred a net loss of $376,160 for the year ended December 31, 2002. The working capital deficit, together with the total net loss, raised, at that time, substantial doubt about the Company's ability to continue as a going concern. Subsequent to December 2003, the Company was awarded a $43,362,271 contract from MDA and after analysis of the Company's projections (including revenue projections) for the next several quarters and other relevant factors, the Company's current auditors, PKF, concluded there is no longer substantial doubt as to the Company's ability to continue as a gong concern, and has, therefore, not included the going concern language in its report dated February 11, 2004 (except for Note 11 as to which the date is April 2, 2004) for the year ended December 31, 2003. Management believes that this was appropriate and reflects the Company's improved financial condition, its ability to forecast more accurately and further validate customer demand for the Company's technology, products and services. Management still intends to obtain new commercial and government contracts, continue to utilize (and possibly expand) its revolving credit facility and possibly raise some additional equity capital in a public or private offering or fund-raising effort. Regardless, management may seek additional capital through a combination of public and private debt or equity placements in the future. There can be no assurance that existing contracts will be completed successfully or that new contracts or additional debt or equity financing that may be needed to fund operations will be available or, if available, obtained in sufficient amounts necessary to meet the Company's needs. Management does believe that current contracts will be sufficient to fund the Company through 2004. The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern. PAGE F-13 (c) Principles of consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned inactive subsidiary SpaceDev Oklahoma and former wholly-owned inactive subsidiary Integrated Space Systems, Inc., a California corporation. The Company filed for dissolution of Integrated Space Systems in December 2003, since all activities have been integrated into SpaceDev, Inc. (d) Use of estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions, including estimates of anticipated contract costs and revenues utilized in the earnings recognition process, that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. (e) Software Development Costs In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," the Company capitalizes the direct costs and allocated overhead associated with the development of software products. Initial costs are capitalized as development costs prior to the design of a detailed program or working model. Costs incurred subsequent to the product release and development costs performed under contract are charged to operations. Beginning in the second quarter 2002, and completing in 2003, capitalized software costs were being amortized over their estimated useful life of eighteen months using the straight-line method. Periodically and at least annually, management performs a review for impairment in accordance with SFAS No. 144. As of December 31, 2003, the Company had fully amortized the capitalized software costs. (f) Revenue recognition The Company's revenues in 2003 were derived primarily from United States government cost plus fixed fee (CPFF) contracts compared to a predominance of fixed price contracts in 2002. Revenues from the CPFF contracts during 2003 are recognized as expenses are incurred compared to revenues from fixed price contracts in 2002, which were recognized using the percentage-of-completion method. Estimated contract profits are taken into earnings in proportion to revenues recorded. Revenues under certain long-term fixed price contracts, which provide for the delivery of minimal quantities or require significant amounts of development effort in relation to total contract value, are recorded upon achievement of performance milestones or using the cost-to-cost method of accounting where revenues and profits are recorded based on the ratio of costs incurred to estimated total costs at completion. Losses on contracts are recognized when estimated costs are reasonably determined. Actual results of contracts may differ from management's estimates and such differences could be material to the consolidated financial statements. Professional fees are billed to customers on a time and materials basis, a fixed price basis or a per-transaction basis depending on the terms and conditions of the specific contract. Time and material revenues are recognized as services are performed and costs incurred. In 2002, billings in excess of costs incurred and estimated earnings represent the excess of amounts billed in accordance with the contractual billing terms. Costs in excess of billings represent the excess of actual costs incurred to the amount that is billed to date. Deferred revenue represents amounts collected from customers for projects, products or services to be provided at a future date. PAGE F-14 (g) Depreciation and amortization Fixed assets are depreciated over their estimated useful lives of three-to-five years using the straight-line method of accounting. In December 2002, the Company entered an agreement to sell its interest in its only facility, which closed in January 2003. The escrow transaction included the sale of the land and building at 13855 Stowe Drive, Poway, CA 92064. In conjunction with the sale of its only facility in December 2002, the Company entered into a non-cancelable operating lease with the buyer to lease-back its facilities for ten years (see Note 2). The base rent shall increase by 3.5% per year (see Notes 2 and 9(c)). (h) Research and development The Company is actively engaged in design and development activities with its commercial propulsion systems as well as its new projects with the Missile Defense Agency and the Air Force Research Laboratory. The Company has several SBIR (Small Business Innovation Research) grants from the government and continues to seek new SBIR opportunities. Cost incurred under SBIR grants are charged against revenues received under SBIR grants. Non-reimbursable research and development expenditures relating to possible future products are expensed as incurred. The Company incurred $281,280 in non-reimbursable research and development costs during 2003 as compared to no recorded research and development costs during 2002. (i) Advertising The Company follows the policy of charging the costs of advertising to expense as incurred. Advertising expense was approximately $1,460 and $900 in 2003 and 2002, respectively. (j) Income taxes Deferred income taxes are recognized for the tax consequences in future years of the differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the years in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the combination of the tax payable for the year and the change during the year in deferred tax assets and liabilities. PAGE F-15 (k) Stock-based compensation In October 1995, the FASB (Financial Accounting Standards Board) issued SFAS (Statements of Financial Accounting Standards) No. 123, "Accounting for Stock-Based Compensation." The Company adopted SFAS No. 123 in 1997. The Company has elected to measure compensation expense for its stock-based employee compensation plans using the intrinsic value method prescribed by APB (Accounting Principles Board) Opinion No. 25, "Accounting for Stock Issued to Employees," and has provided pro forma disclosures as if the fair value based method prescribed in SFAS No. 123 has been utilized. See Note 8(d). During December 2002, FASB issued SFAS No. 148 "Accounting for Stock Based Compensation - Transition and Disclosure", which amends SFAS No. 123 to require companies to elect to recognize fair value stock based compensation costs in their financial statements or to disclose the pro forma impact of those costs in the footnotes. If the Company had accounted for these options in accordance with SFAS No. 123, the total value of options granted during 2003 and 2002 would be amortized on a pro forma basis over the vesting period of the options. Thus, the Company's consolidated net loss would have been as follows: Years Ended December 31, 2003 2002 ------------------------ ------------ ---------- Net loss: As reported. . . . . . . $(1,246,067) ($376,160) Pro forma. . . . . . . . $(1,480,592) ($604,395) ------------------------ ------------ ---------- Loss per Share: As reported. . . . . . . $ (0.08) ($0.03) Pro forma. . . . . . . . $ (0.09) ($0.04) ------------------------ ------------ ---------- (l) Common stock, stock options and warrants to non-employees The Company has valued its stock, stock options and warrants issued to non-employees at fair value in accordance with the accounting prescribed in SFAS No. 123, which states that all transactions in which goods or services are received for the issuance of equity instruments shall be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. (m) Net loss per common share Net loss per common share has been computed on the basis of the weighted average number of shares outstanding, according to the rules of SFAS No. 128, "Earnings per Share." Diluted net loss per share has not been presented, as the computation would result in anti-dilution. (n) Financial instruments The Company's financial instruments consist primarily of cash, accounts receivable, capital leases and notes payable. These financial instruments are stated at their respective carrying values, which approximate their fair values. (o) Segment reporting The Company merged its Space Missions Division business segment and Integrated Space Systems business segment in 2002. The Company has one other inactive PAGE F-16 subsidiary, SpaceDev Oklahoma. The Company follows the requirement of SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information" ("SFAS No. 131"). (p) New accounting standards In April 2002, FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that SFAS, SFAS No. 64, "Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements." SFAS No. 145 also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers." Further, SFAS No. 145 amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or described their applicability under changed conditions. This pronouncement requires gains and losses from extinguishment of debt to be classified as an extraordinary item only if the criteria in Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," have been met. Further, lease modifications with economic effects similar to sale-leaseback transactions must be accounted for in the same manner as sale-leaseback transactions. The provisions of SFAS No. 145 related to the rescission of SFAS No. 4 shall be applied in fiscal years beginning after May 15, 2002. The provisions of SFAS No. 145 related to Statement 13 shall be effective for transactions occurring after May 15, 2002, with early application encouraged. The adoption of SFAS No. 145 did not have a material impact on our consolidated financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 did not have a material impact on our consolidated financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No. 123." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The adoption of this Statement did not have a material effect on the consolidated financial statements of the Company. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 requires that contracts with comparable characteristics be accounted for similarly. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this Statement did not have a material effect on the consolidated financial statements of the Company. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 PAGE F-17 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this Statement did not have a material effect on the consolidated financial statements of the Company. 2. FIXED ASSETS In December 2002, the Company entered an agreement to sell its interest in its only facility. As of December 31, 2002 the Company listed a receivable held for sale of $3,150,124 which was realized when the transaction closed in January 2003. The escrow transaction included the sale of the land and building at 13855 Stowe Drive, Poway, CA 92064. In conjunction with the sale, the Company entered into a lease agreement with the buyer to lease-back its facilities (see Note 9(c)). The gain on the sale of the facility was deferred and will be amortized in proportion to the gross rental charged to expense over the lease term. Deferred gain of $1,172,720 will be amortized over ten (10) years beginning February 2003 and ending in February 2013. This amortization will be included in the Company's non-operating income and expense. Fixed assets consisted of the following: December 31, . . . . . . . . . . . . . . 2003 2002 ---------------------------------------- ---------- ---------- Capital leases . . . . . . . . . . . . . $ 155,802 $ 145,365 Computer equipment . . . . . . . . . . . 163,721 124,429 Building improvements. . . . . . . . . . 9,488 9,488 Furniture and fixtures . . . . . . . . . 5,271 5,271 ---------------------------------------- ---------- ---------- 334,282 284,553 Less accumulated depreciation and amortization. . . . . . . . . . . (196,750) (143,065) ---------------------------------------- ---------- ---------- $ 137,532 $ 141,488 ---------- ---------- Depreciation and amortization expense for fixed assets was approximately $53,000 and $164,000 for the years ending December 31, 2003 and 2002, respectively. Depreciation and amortization expense was significantly less during 2003 due to the sale of our facility in January 2003 and the full amortization of the AMROC technology. (See Note 3(a).) 3. ACQUISITIONS All acquisitions have been accounted for using the purchase method of accounting and intangible assets were amortized using the straight-line method. Initial purchase price included stock issued at the date of acquisition, direct acquisition costs and any guaranteed future consideration. (a) AMROC On August 14, 1998, the Company entered an Agreement for License and Purchase of Technology from American Rocket Company (AMROC) with an unrelated individual who had obtained ownership of such technology from AMROC. The intellectual property acquired was hybrid rocket technology that may be modified and used in the future operations of the Company. Upon execution of the Agreement, the Company issued the seller a warrant to purchase 25,000 shares of restricted common stock at a strike price equal to 50% of the market price of the common stock on the issuance date. This warrant expired in 2003 having been unexercised. PAGE F-18 For each of the three years following the Agreement date, the licensor received warrants to purchase 25,000 shares of restricted common stock. In the fourth through tenth year following the Agreement date, the licensor will receive a warrant to purchase a number of shares based on the amount of revenue generated from the acquired technology. All revenue based warrants are earned at a rate of one share per $125 of revenue generated from the technology acquired. Under the terms of the Agreement, the minimum number of shares to be issued is 100,000 and the maximum consideration shall not exceed warrants to purchase 3,000,000 shares of common stock or $6,000,000 in recognized value. Recognized value is the sum of (a) the cumulative difference between the market price of the common stock and the strike price and (b) the cumulative difference between the market price on the date of exercise and the strike price for each warrant previously exercised. To date, no revenue has been generated from the acquired technology. The Company valued the warrants using the fair value method as prescribed by SFAS No. 123. Under this method, the Company used the risk-free interest rate at the date of grant, the expected volatility of the stock, the expected dividend yield on the stock and the expected life of the warrants to determine the fair value of the warrants. The risk-free rate of interest used to value the initial issuance was 5.4 percent, a zero percent dividend yield was assumed and the expected life of the warrants was five years from the date of issuance. This calculation resulted in a fair value of $24,500 and was used as the value of the intangible assets acquired. All warrants are immediately exercisable after issuance and expire on the fifth anniversary of their issuance. Other intangible assets consisted of the following: December 31,. . . . . . . . . . . . . . . . . . . . 2003 2002 --------------------------------------------------- ---------- ---------- Other intangibles . . . . . . . . . . . . . . . . . $ 116,292 $ 116,292 Less accumulated amortization . . . . . . . . . . . (116,292) (105,736) --------------------------------------------------- ---------- ---------- $ 0 $ 10,556 ---------- ---------- The Company's intangible assets were fully amortized in 2003. Amortization expense was approximately $11,000 and $40,000 for 2003 and 2002, respectively. 4. NOTES PAYABLE (a) Building and settlement notes In December 2002, the Company entered into an agreement to sell its interest in its only facility. The transaction closed in January 2003. The escrow transaction included the sale of the land and building at 13855 Stowe Drive, Poway, CA 92064. Net fixed assets were reduced by approximately $1.9 million and notes payable were reduced by approximately $2.4 million while a deferred gain was recorded. In conjunction with the sale, the Company entered into a lease agreement with the buyer to leaseback its facilities. The Company's Chief Executive Officer provided a guarantee for the leaseback. The gain on the sale of the facility was deferred and amortized on a straight-line basis over the ten (10) year term of the lease. Deferred gain of $1,172,720 is being amortized at the rate of $117,272 per year for ten (10) years ending in January 2013. As of December 31, 2003, the deferred gain was $1,065,221. This amortization will be included in the Company's non-operating income and expense and totaled $107,499 in 2003. PAGE F-19 Deferred Gain consisted of the following: December 31,. . . . . . . 2003 2002 ------------------------- ----------- ----- Deferred Gain . . . . . . $1,172,720 $ - Less Amortization to date (107,499) - ------------------------- ----------- ----- $1,065,221 $ - ----------- ----- In 2001, the Company entered into three settlement loan agreements with various vendors. The total of $171,402 for all three loans called for payment between 24 and 50 months with interest that ranged from 0% to 8%. At December 31, 2003 and 2002, the outstanding balances on these notes were $87,591 and $146,527, with interest expense of $4,956 and $4,782, respectively. Future minimum principal payments on notes payable are as follows: Year Ending December 31, 2004 . . . . . . . . . . $41,464 2005 . . . . . . . . . . 36,670 2006 . . . . . . . . . . 9,457 ------- Total Settlement Notes . $87,591 ------------------------ ------- (b) Related parties The Company has a note payable to its CEO. At December 31, 2003 and 2002, the balances were $585,522 and $738,496, respectively, with accrued interest of 10%. The note was amended on March 20, 2000 to call for annual payments of not less than $80,000 per year with interest at 10%. Future minimum principal payments on notes payable, related parties are as follows: Year Ended December 31, ----------------------- 2004. . . . . . . . . . 80,000 2005. . . . . . . . . . 80,000 2006. . . . . . . . . . 80,000 2007. . . . . . . . . . 80,000 2008. . . . . . . . . . 80,000 Thereafter. . . . . . . $185,522 ----------------------- -------- $585,522 ----------------------- Accrued interest expense on this note was $47,023 and $45,265 for 2003 and 2002, respectively. (c) Revolving Credit Facility. On June 3, 2003, the Company entered into a Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant, with Laurus Master Fund, Ltd. ("Laurus"), which were filed on Form 8-K dated June 18, 2003. Pursuant to the agreements, the Company received a $1 million revolving credit facility in the form of a three-year Convertible Note secured by its assets. The net proceeds from the Convertible Note are for general working capital needs. Advances on the Convertible Note may be repaid PAGE F-20 at the Company's option, in cash or through the issuance of the Company's shares of common stock. The Convertible Note carries an interest rate of WSJ Prime plus 0.75% on any outstanding balance. In addition, the Company is required to pay a collateral management payment of 0.55% of the average aggregate outstanding balance during the month plus an unused line payment of 0.20% per annum. The outstanding balance on the revolving credit facility at December 31, 2003 was $748,893, of which approximately $13,600 had been accrued for interest. The Company filed a registration statement on Form SB-2 on July 25, 2003 in connection with this transaction. The Form SB-2 was declared effective on August 6, 2003. With the securities registered for public resale, the Company has an option to pay amounts outstanding under the revolving credit facility by converting shares of its common stock at the fixed conversion price of $0.55 per share on the first $1 million of principal, as long as the then current market price is more than 118% of the fixed conversion price. The Convertible Note includes a right of conversion in favor of Laurus. If Laurus exercises its conversion right at any time or from time to time at or prior to maturity, on any outstanding balance at the time, the Convertible Note will be convertible into shares of the Company's common stock at a fixed conversion price, subject to adjustments for stock splits, combinations and dividends and for shares of common stock issued for less than the fixed conversion price (unless exempted pursuant to the agreements). The fixed conversion price will be adjusted after conversion of the first $1 million to 103% of the then fair market value of our common stock ("Adjusted Fixed Conversion Price"). As of December 31, 2003, Laurus had converted 415,000 shares to reduce the amount borrowed under the revolving credit facility by $228,250. The Company expensed approximately $126,500 for non-cash loan fee expenses in 2003. Fair market value of the stock was determined by discounting the closing market price on the date of the conversion by 20%. Availability of funds under the revolving credit facility will be based on our accounts receivables, except as waivers are provided by Laurus. An initial three (3) month waiver was offered by Laurus, under which Laurus permitted a credit advance up to $300,000, which amount might otherwise exceed eligible accounts receivable during the period. Laurus subsequently extended the waiver for an additional six (6) months, under which Laurus permitted a credit advance up to $1 million, which amount might otherwise exceed eligible accounts receivable during the period. The revolving credit facility is secured by all of the assets of the Company. In conjunction with this transaction, Laurus was paid a fee of $20,000 for the first year (and the Company will be required to pay a continuation fee of $10,000 for each year thereafter), which fee was expensed as additional interest expense. In addition, Laurus received a warrant to purchase 200,000 shares of the Company's common stock, as stated herein. The warrant exercise price is computed as follows: $0.63 per share for the purchase of up to 125,000 shares; $0.69 per share for the purchase of an additional 50,000 shares; and $0.80 per share for the purchase of an additional 25,000 shares. The warrant exercise price may be paid in cash, in shares of the Company's common stock, or by a combination of both. The warrant expiration date is June 3, 2008. The warrant exercise price and the number of shares underlying the warrant are subject to adjustments for stock splits, combinations and dividends. In addition to the initial warrant, the Company is obligated to issue an additional five-year warrant to Laurus to purchase one share of common stock at an exercise price equal to 125% of the Adjusted Fixed Conversion Price for every ten dollars ($10) in principal of the Convertible Note converted into common stock, if and when over $1 million is converted under the revolving credit facility. The value of the warrant will be determined, if and when issued, and will be treated as additional interest expense and will be amortized over the remaining term of the Convertible Note, unless sooner terminated. No more than PAGE F-21 an aggregate of 100,000 shares of the Company's common stock may be purchased by Laurus under such additional warrants. 5. CONVERTIBLE DEBENTURES From October 14, 2002 through November 14, 2002, the Company sold an aggregate of $475,000 of 2.03% convertible debentures to various directors and officers of the Company. The total funding was completed on November 14, 2002. The convertible debentures entitled the holder to convert the principal and unpaid accrued interest into the Company's common stock when the note matures. The maturity on the notes was six (6) months from issue date. On March 25, 2003, an amendment was executed which extended these notes an additional six (6) months. The convertible debentures were exercisable into a number of the Company's common shares at a conversion price that equals the 20-day average ask price less 10%, which was, established when the note was issued, or the initial conversion price. Concurrent with the issuance of the convertible debentures, the Company issued warrants to purchase up to 1,229,705 shares of the Company's common stock to the subscribers. These warrants are exercisable for three (3) years from the date of issuance at the initial exercise price which is equal to the 20-day average ask price less 10%, which was established when the note was issued, or the initial conversion price of the notes. Upon issuance, the issued warrants were valued using the Black-Scholes pricing model based on the expected fair value at issuance and the estimated fair value was recorded as debt discount. As a result of the change to the maturity date of the convertible debt, the amortization period for the debt discounts was also extended during the first quarter in 2003. On September 5, 2003, the Company repaid one-half of the convertible notes, with the condition that the note holders convert the other half. Also, as a condition of the partial repayment, the note holders were required to relinquish one-half of the previously issued warrants. Finally, as additional consideration for the transaction, the note holders were offered 5% interest on their notes, rather than the stated 2.03%. All the note holders accepted the offer and the convertible notes were retired. As of December 31, 2003, the Company recorded a credit of $88,408, as debt discount recovery; therefore, for the year ending December 31, 2003, the debt discount expense was $112,500. The Company also expensed $131,411 for non-cash loan fee expense. Fair market value of the stock was determined by discounting the closing market price on the date of the transaction by 20%, based on the nature of the restricted securities. PAGE F-22 Convertible debentures - beginning balance . $ 475,000 Total interest expense incurred . . . . $ 20,236 Accrued interest paid - current year. . $ (18,161) Accrued interest paid - prior year. . . $ (2,075) Convertible debtures paid . . . . . . . $(237,500) Convertible debtures converted. . . . . $(237,500) $(475,000) Convertible debentures - ending balance. . . $ 0 -------------------------------------------- ---------- Debt discount (Warrants) - beginning balance $ 475,000 Amount forfeited. . . . . . . . . . . . $(237,500) Amount expensed prior year. . . . . . . $(125,000) Amount expensed current year. . . . . . $(267,879) Current year - adjustment . . . . . . . $ 155,379 $(475,000) Debt discount (Warrants) - ending balance. . $ 0 -------------------------------------------- ---------- 6. INCOME TAXES Deferred income taxes are provided for temporary differences in recognizing certain income and expense items for financial and tax reporting purposes. The deferred tax asset of $2,190,000 and $1,372,000 as of December 31, 2003 and 2002, respectively, consisted primarily of the income tax benefits from net operating loss and capital loss carryforwards, amortization of goodwill and research and development credits. A valuation allowance has been recorded to fully offset the deferred tax asset as it is more likely than not that the assets will not be utilized. The valuation allowance increased approximately $818,000 in 2003 from $1,372,000 at December 31, 2002 to $2,190,000 at December 31, 2003. At December 31, 2003, the Company has federal and state tax net operating loss and capital loss carryforwards of approximately $4,229,589 and $1,846,945, respectively. The federal and state tax loss carryforwards will expire in 2023 and 2013, respectively, unless previously utilized. The State of California has suspended the utilization of net operating loss for 2002 and 2003. A reconciliation of the statutory income tax rates and the Company's effective tax rate is as follows: Years Ended December 31,. . . . . . . . . . 2003 2002 --------------------------------------------- ----- ----- Statutory U.S. federal rate . . . . . . . . 34% 34% --------------------------------------------- ----- ----- State income taxes - net of federal benefit 5% 5% Net operating loss for which no tax Benefit is currently available . . . . . . (39%) (39%) - - ----- ----- PAGE F-23 The tax effects of temporary differences and carryforwards that give rise to -------------------------------------------------------------------------------- deferred tax assets consist of the following: --------------------------------------------------- December 31,. . . . . . . . . . . . . 2003 2002 --------------------------------------- ------------ ------------ Deferred tax assets: --------------------------------------- Loss carryforwards . . . . . . . . . $ 1,588,000 $ 1,262,000 Deferred gain on sale of building 435,000 - Temporary differences. . . . . . . . 127,000 100,000 Research and development credits . . 40,000 10,000 Gross deferred tax assets . . . . . . 2,190,000 1,372,000 --------------------------------------- ------------ ------------ Valuation allowance . . . . . . . . . (2,190,000) (1,372,000) $ - $ - ------------ ------------ 7. EMPLOYEE BENEFIT PLAN (a) Profit sharing 401(k) plan During 1997, the Company adopted a 401(k) retirement savings plan for its employees, which allows each eligible employee to voluntarily make pre-tax salary contributions up to 15% of their compensation. The Company may elect to make a matching contribution. The total Company contribution and participant salary reduction may not exceed 25% of the compensation of eligible participants. During 2003 and 2002, the Company did not contribute to the Plan. (b)Incentive stock option and employee stock purchase plans At its 1999 Annual Stockholder Meeting, the shareholders adopted an Incentive Employee Stock Option Plan under which its Board of Directors may grant its employees, directors and affiliates Incentive Stock Options, Supplemental Stock Options and other forms of stock-based compensation, including bonuses or stock purchase rights. Incentive Stock Options, which provide for preferential tax treatment, are only available to employees, including officers and affiliates, and may not be issued to non-employee directors. The exercise price of the Incentive Stock Options must be 100% of the fair market value of the stock on the date the option is granted. Pursuant to our plan, the exercise price for the Supplemental Stock Options will not be less than 85% of the fair market value of the stock on the date the option is granted. The Company is required to reserve an amount of common shares equal to the number of shares, which may be purchased as a result of awards made under the Plan at any time. At the 2000 Annual Stockholder Meeting, the shareholders approved an amendment to the Stock Option Plan of 1999, increasing the number of shares eligible for issuance under the Plan to 30% of the then outstanding common stock and allowing the Board of Directors to make annual adjustments to the Plan to maintain a 30% ratio to outstanding common stock at each annual meeting of the Board of Directors. The Board, at its annual meetings in 2002 and 2003, made no adjustment, as a determination was made that the number of shares then available under the Plan was sufficient to meet the Company's needs. As of December 31, 2003, 4,184,698 shares were authorized for issuance under the Plan, 3,124,807 of which are currently subject to outstanding options and awards. The Stock Option Plan of 1999 was registered with the U.S. Securities & Exchange Commission on Form S-8. During 2003, the Company issued non-statutory options to purchase 140,000 shares to its independent directors for attendance at its 2003 Board of Directors meetings. In addition to the Stock Option Plan of 1999, its shareholders adopted the 1999 Employee Stock Purchase Plan with 1,000,000 shares reserved PAGE F-24 under the plan and authorized its Board of Directors to make twelve consecutive offerings of our common stock to its employees. The 1999 Employee Stock Purchase Plan has been instituted and the first employees enrolled in the plan in August 2003. The first shares of common stock were issued under the Plan in February 2004. The exercise price for the Stock Purchase Plan will not be less than 85% of the fair market value of the stock on the date the stock is purchased. During 2003 employees contributed $5,498 to the employee stock purchase plan; however, no shares were issued under the plan as of December 31, 2003. 8. STOCKHOLDERS' EQUITY (a) Convertible preferred stock On November 4, 1997, 82,450 shares of $.001 par value convertible preferred stock were issued to SD Holdings, LLC in exchange for 8,245,000 common shares of the Company that were issued on October 22, 1997 (see Notes 1(a) and 8(b)). Each share of convertible preferred stock was convertible, at the option of the holder, into 100 shares of common stock. The conversion ratio was subject to certain anti-dilution adjustments, and the holder of each share of preferred stock was entitled to one vote for each share of common stock into which it would convert. These shares were converted into 8,245,000 shares of the Company's common stock on May 11, 1999. (b) Common stock On October 22, 1997, PDGI issued 8,245,000 of its $.0001 par value common stock for 100 percent (1,000,000 shares) of SpaceDev's common stock owned by SpaceDev, LLC, a Nevada corporation. Upon the acquisition of the SpaceDev stock, SpaceDev was merged into PDGI and, on December 17, 1997, the name of the Company was changed to SPACEDEV, INC. On November 4, 1997, these common shares were exchanged for 82,450 shares of convertible preferred stock. See Note 8(a). On May 11, 1999, the Company issued 8,245,000 shares of common stock upon the conversion of the preferred shares. During 2003 and 2002, the Company issued 7,500 and 7,000, shares of its common stock for employee awards and services and for summer & student interns and recorded expenses of $9,170 and $2,900, respectively. The fair value of the shares issued was calculated using the closing price on the date of issuance. During 2002, the Company recovered 500,000 shares of stock for a credit of $455,000 during 2002 pursuant to an arbitration award issued against EMC Holdings, Inc. The Company recorded the credit during 2002 to offset the expense that was recorded during 2001. On June 18, 2001, SpaceDev entered into a relationship with two individuals (doing business as EMC Holdings Corporation ("EMC")) whereby EMC was to provide certain consulting and advisory services to the Company. EMC received the first installment of 500,000 shares of common stock on June 26, 2001. Total expense for the initial stock issuance through September 30, 2001 was $455,000. Pursuant to a demand for arbitration filed on November 7, 2001, the Company sought the return of all or a portion of the shares issued to EMC. EMC filed its own claim with the American Arbitration Association on November 13, 2001, alleging that the Company owed EMC $118,000 in fees, plus damages to be proven at arbitration. A three-day arbitration hearing was held in May and June 2002 with respect to claims arising out of consulting and advisory service agreements between the Company and EMC. On July 17, 2002, an interim award was issued in favor of the Company against EMC, ordering the return of the initial installment of 500,000 shares and denying EMC's claim for $118,000. On October 22, 2002, a status conference was held and a tentative final award was issued again in the favor of PAGE F-25 the Company. Included in this tentative final ruling was an award of approximately $83,000 in attorney and arbitration fees to the Company. The tentative final ruling became effective on October 29, 2002, and was submitted to the Superior Court of California, Orange County, for entry of judgment. Because collection of the attorney and arbitration fees award is not assured, the Company has expensed all of its fees related to this matter, any recovery of the fees will be recorded as income in the period they are received; however, at this time, the Company does not expect any recovery, and in June 2003, the Company ceased efforts to recover the awarded fees, as it was determined that the cost to pursue collection exceeded the likelihood of collection. The return of the 500,000 shares, as provided in the interim award issued on July 17, 2002, was recorded in the third quarter of 2002 as a reversal of the original expense recorded. Because the original expense was not recorded as an extraordinary item, the reversal of the expense did not qualify as an extraordinary item. In connection with the signing of the agreement, the Company's majority shareholder issued 50,000 shares of common stock to EMC with a fair value of approximately $45,000. The shares were recorded as a contribution of capital and additional expense related to the EMC agreement in accordance with the SEC's Staff Accounting Bulletin number 79. In June 2003, the Company ceased its efforts to recover the awarded fees, as it determined the cost to pursue collection exceeded the likelihood of collection. On November 5, 2000, the Company commenced a private placement offering (PPO) for a maximum of 1,000,000 shares of the Company's $0.0001 par value common stock and warrants to purchase an additional 1,000,000 shares of common stock (the "Units"). The offering price of the Unit(s) was the five-day average of the bid and ask price for the Company's common stock on the date of issuance, with a minimum per Unit price of $1.00. The warrants allowed the holder to acquire additional shares at $0.50 above the offering price of the shares. The Company sold to one related-party investor under these terms. On March 2, 2001, the PPO price was amended to the average of the high bid prices on the date of issuance and four preceding days, with no minimum per share price, and the warrants were amended to allow the holder to acquire additional shares at the Unit price. The Company sold 153,060 Units under the PPO during 2002 for $75,000. On January 16, 2003 and February 14, 2003, pursuant to an extension of the PPO, the Company sold 665,188 and 196,079 Units, respectively. The Company received approximately $326,000 and $100,000, respectively, for the Units sold under the PPO during the first quarter 2003. The PPO was subsequently closed. (c) Warrants Concurrent with the issuance of the convertible debentures from October 2002 through November 2002, the Company issued to subscribers warrants to purchase up to 1,229,705 shares of the Company's common stock. On September 5, 2003, the Company repaid one-half of the convertible notes, with the condition that the note holders would convert the other half. As a condition of the partial repayment, the note holders were required to relinquish one-half of the previously issued warrants reducing the total warrants issued under the convertible debt program to 614,853. These warrants are exercisable for three (3) years from the date of issuance at the initial exercise price, which is equal to the 20-day average asking price less 10% established when the notes were issued. Upon issuance the warrants were valued using the Black-Scholes pricing model based on the expected fair value at issuance and the estimated fair value was also recorded as debt discount. As of December 31, 2003, the Company had other warrants outstanding issued as part of its private placement PAGE F-26 that allow the holders to purchase up to 2,285,931 shares of common stock at prices between $0.37 and $1.05 per share. The warrants may be exercised any time within three (3) and five (5) years of issuance. (d) Stock options On November 21, 1997, the Company entered into a five (5) year employment agreement with its CEO. As part of the employment agreement, the Company granted options to the CEO to purchase up to 2,500,000 shares of the Company's $.0001 par value restricted common stock. The options are subject to the following vesting conditions, which were amended on January 21, 2000, with an option for the board to award an additional 1,500,000 options at a later date, the exercise prices set forth: Exercise Number price per Of shares Vesting Conditions share ---------------- --------- ----------------------------------------------------------- ------------------- Granted Options: 500,000. . . . . Currently vested $ 1.00 500,000. . . . . Obtaining $6,500,000 additional equity capital $ 1.50 500,000. . . . . Financing and executing a definitive space launch agreement $ 2.00 500,000. . . . . Launching of first lunar or deep-space mission $ 2.50 500,000. . . . . Successful completion of first lunar or deep-space mission $ 3.00 Options to be Granted upon the Occurrence of Certain Events: 250,000. . . . . Upon the Companymarket capitalization reading $250 million $ 5.00 500,000. . . . . Upon the Companymarket capitalization reading $500 million $ 10.00 750,000. . . . . Upon the Companymarket capitalization reading $1 billion $ 20.00 ---------------- --------- ----------------------------------------------------------- ------------------- All options expire ten (10) years from date of amendment. In accordance with APB 25, the Company recognized $500,000 of compensation expense and $250,000 of deferred compensation in 1997. The options granted to the CEO are subject to vesting conditions and have exercise prices between $1.00 and $3.00 per share. On August 27, 2001, as part of an annual review process, an additional 10,000 options were granted to the CEO at the exercise price of $0.9469 per share with a set vesting schedule of 3,333 shares per year after issuance with the third year having 3,334 options vest. These options expire five years from grant date. PAGE F-27 The following summarizes stock option activity related to all of the option plan and employee compensation agreements: Weighted Options Average Outstanding Exercise Prices ------------ ---------------- Balance at January 1, 2002 . 4,360,162 1.67 Granted. . . . . . . . . . . 1,386,110 0.50 Exercised. . . . . . . . . . 0 - Expired. . . . . . . . . . . (297,500) 0.88 ---------------------------- ------------ ---------------- Balance at December 31, 2002 5,448,772 0.91 Granted. . . . . . . . . . . 1,219,615 0.76 Exercised. . . . . . . . . . (37,000) (0.53) Expired. . . . . . . . . . . (1,006,580) (0.52) ---------------------------- ------------ ---------------- Balance at December 31, 2003 5,624,807 1.39 ---------------------------- ------------ ---------------- The weighted average fair value of options granted to employees under the plan during 2003 and 2002 was $0.76 and $0.50, respectively. At December 31, 2003 and 2002, there were 2,266,520 and 2,064,716 options exercisable at a weighted average exercise price of $1.05 and $0.42 per share, respectively. The weighted average remaining life of outstanding options under the plan at December 31, 2003 was 4.78 years. Weighted-Average Weighted- Remaining Contractual Averagee Range of Number of Shares Life of Shares Number of Exercisable Exercise Outstanding Outstanding Exercisable Price Price ---------- 0.42-0.99 1,511,954 4.34 552,001 0.61 1.00-1.99. 2,610,631 4.02 1,712,297 1.19 2.00-2.99. 1,002,222 6.54 2,222 2.25 3.00-3.50. 500,000 6.54 - - 5,624,807. 4.78 2,266,520 $ 1.05 ---------- --------------------- ------------------------- ----------------- ----------- The Company has elected to account for its stock-based compensation plans under APB 25. However, the Company has computed, for pro forma disclosure purposes, the value of all options granted during 2003 and 2002 using the minimum value method as prescribed by SFAS No. 123. Under this method, the Company used the risk-free interest rate at date of grant, the expected volatility, the expected dividend yield and the expected life of the options to determine the fair value of options granted. The risk-free interest rates ranged from 6.0% to 6.5%; expected volatility of 117% and the dividend yield was assumed to be zero, and PAGE F-28 the expected life of the options was assumed to be three to five years based on the average vesting period of options granted. 9. COMMITMENTS AND CONTINGENCIES (a) Capital leases The Company leases certain equipment under non-cancelable capital leases, which are included in fixed assets as follows: December 31,. . . . . . . . . 2003 2002 ----------------------------- ---------- --------- Computer equipment. . . . . . $ 155,802 $145,365 Less accumulated depreciation (106,562) (76,161) $ 49,240 $ 69,204 ---------- --------- Future minimum lease payments are as follows: Year Ending December 31, 2003 2004. . . . . . . . . . . . . . . . . . $ 11,665 2005. . . . . . . . . . . . . . . . . . $ 4,425 2006. . . . . . . . . . . . . . . . . . $ 1,526 2007. . . . . . . . . . . . . . . . . . $ - Thereafter. . . . . . . . . . . . . . . $ - --------------------------------------- --------- Total minimum lease payments. . . . . . $ 17,616 Amount representing interest. . . . . . $ 2,031 --------------------------------------- --------- Present value of minimum lease payments $ 15,585 Total obligation. . . . . . . . . . . . $ 15,585 Less current portion. . . . . . . . . . $(10,332) --------------------------------------- --------- Long-term portion . . . . . . . . . . . $ 5,253 --------------------------------------- --------- (b) Other accrued liabilities During 2003, the Company accrued expenses in connection with current projects and commitments. The total of these accruals were $248,530 as of December 31, 2003. In November 2002, the Company entered an agreement to sell its interest in its only facility. The transaction closed in January 2003. The escrow transaction included the sale of the land and building at 13855 Stowe Drive, Poway, CA 92064. The fees that were incurred for the sale of the building were $121,311 and recorded as other accrued liabilities. The fees include broker fees, escrow and title fees and property taxes. (c) Building lease In conjunction with the sale of its only facility, the Company entered into a non-cancelable operating lease with the buyer to lease-back its facilities for ten (10) years (see Note 2). The base rent is $25,678 per month and will increase by 3.5% per year. Mr. Benson provided a guarantee for the leaseback. PAGE F-29 10. CONCENTRATIONS AND CONTINGENCIES (a) Credit risk The Company maintains cash balances at various financial institutions primarily located in San Diego, California and New York, New York. The accounts at these institutions are secured by the Federal Deposit Insurance Corporation up to $100,000. The Company has not experienced any losses in such accounts. (b) Customer During 2002, the Company had a major customer that accounted for sales of approximately $1,727,000 or 51% of consolidated revenue. Sales from this customer were approximately $346,000 and the contract with this customer was successfully completed during 2003. During 2003, the Company had three major customers that accounted for sales of approximately $1,782,600 or 60% of consolidated revenue. At December 31, 2003 and 2002, the amount receivable from these customers was approximately $160,200 and $50,000, respectively. (c) Contract In November 1999, the Space Missions Division was awarded a turnkey mission contract by the Space Sciences Laboratory at the University of California at Berkeley worth as of December 31, 2002 approximately $7.2 million, including two change orders worth approximately $412,000 June 12, 2002 and October 7, 2002. This contract represented 51% of the Company's revenue in 2002. The contract concluded on December 31, 2003. 11. SUBSEQUENT EVENTS On March 31, 2004, the Company was awarded a $43,362,271, five-year, cost-plus-fixed fee indefinite delivery/indefinite quantity contract to conduct a micro satellite distributed sensing experiment, an option for a laser communications experiment, and other micro satellite studies and experiments as required in support of the Advanced Systems Deputate of the Missile Defense Agency. This effort will be accomplished in a phased approach. The total five-year contract has a ceiling amount of $43,362,271. The principal place of performance will be Poway, California. The Company expects to complete the work under the contract before February 2009. Government contract funds will not expire at the end of the current government fiscal year. The micro satellite distributed sensing experiment is intended to design and build up to six responsive, affordable, high performance micro satellites to support national missile defense. The milestone-based, multiyear, multiphase contract has an effective start date of March 1, 2004. The first phase is expected to be completed this year and will result in detailed mission and microsat designs. The estimated first phase revenue is $1.1 million. The overall contract calls for the Company to analyze, design, develop, fabricate, integrate, test, operate and support a networked cluster of three formation-flying boost phase and midcourse tracking microsatellites, with an option to design, develop, fabricate, integrate, test, operate and support a second cluster of three formation flying microsats to be networked on-orbit with high speed laser communications technology. The second phase is anticipated to begin September 1, 2004 and run through 2005. PAGE F-30 On March 31, 2004, the Company negotiated an amendment to its Secured Convertible Note dated June 3, 2003 with the Laurus Master Fund to add a fixed conversion price at $0.85 per share for the next $500,000 converted under the revolving credit facility after the initial $1 million conversion. In exchange for the amendment, Laurus granted the Company a six-month waiver to utilize the full revolving credit facility in advance of eligible accounts. At December 31, 2003, Laurus had converted 415,000 shares under the revolving credit facility, which represented approximately $228,000 of debt converted to equity. PAGE F-31 SPACEDEV, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (UNAUDITED) At June 30,. . . . . . . . . 2004 2003 ---------------------------- ---------- -------- ASSETS CURRENT ASSETS Cash . . . . . . . . . $1,226,529 $ 80,734 Accounts receivable. . 602,151 142,759 Work in Progress . . . 10,316 - ---------------------------- ---------- -------- Total current assets. . . . 1,838,996 223,493 ---------------------------- ---------- -------- FIXED ASSETS - NET. . . . . 184,996 127,314 CAPITALIZED SOFTWARE COSTS - 33,375 OTHER ASSETS. . . . . . . . 30,574 34,502 ---------------------------- ---------- -------- $2,054,566 $418,684 ---------------------------- ---------- -------- ---------------------------- ---------- -------- The accompanying notes are an integral part of these consolidated financial statements. PAGE F-32 SPACEDEV, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (UNAUDITED) At June 30, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2004 2003 ------------------------------------------------------------------------ ------------- ------------- LIABILITIES AND STOCKHOLDERS DEFICIT CURRENT LIABILITIES Current portion of notes payable . . . . . . . . . . . . . . . . . $ 35,778 $ 52,000 Current portion of capitalized lease obligations . . . . . . . . . 4,257 26,629 Note payable - related party (Note 3(b)) . . . . . . . . . . . . . 80,000 80,000 Convertible debt notes payable (Note 4). . . . . . . . . . . . . . - 332,847 Accounts payable and accrued expenses. . . . . . . . . . . . . . . 202,908 338,432 Accrued payroll, vacation and related taxes. . . . . . . . . . . . 252,221 122,129 Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . 28,400 - Provision for anticipated loss (Note 2). . . . . . . . . . . . . . - 5,174 Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . - 2,526 Revolving credit facility (Note 3(c)). . . . . . . . . . . . . . . 408,003 - Other accrued liabilities. . . . . . . . . . . . . . . . . . . . . 141,595 - ------------------------------------------------------------------------ ------------- ------------- TOTAL CURRENT LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . 1,153,162 959,737 ------------------------------------------------------------------------ ------------- ------------- NOTES PAYABLE, LESS CURRENT MATURITIES (NOTE 3(A)). . . . . . . . . . . 28,021 65,260 CAPITALIZED LEASE OBLIGATIONS, LESS CURRENT MATURITIES. . . . . . . . . 3,445 6,558 NOTE PAYABLE - RELATED PARTY, LESS CURRENT MATURITIES . . . . . . . . . 116,445 517,630 DEFERRED GAIN - ON BUILDING SALE (NOTE 3(A)). . . . . . . . . . . . . . 1,006,585 1,123,857 DEFERRED REVENUE. . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 5,000 ------------------------------------------------------------------------ ------------- ------------- TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,312,658 2,678,042 ------------------------------------------------------------------------ ------------- ------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS DEFICIT Convertible preferred stock, $.001 par value, 10,000,000 shares authorized no shares issued or outstanding. . . . . . . . . . - - Common stock, $.0001 par value; 50,000,000 shares authorized, and 18,985,285 and 15,338,907 shares issued and outstanding, respectively. . . . . . . . . . . . . . . . . . . . . . . . . 1,898 1,533 Additional paid-in capital (Note 3(c), 4 & 5). . . . . . . . . . . 12,787,202 8,728,659 Additional paid-in capital - stock options . . . . . . . . . . . . 750,000 750,000 Deferred compensation (Note 5) . . . . . . . . . . . . . . . . . . (250,000) (250,000) Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . (13,547,192) (11,489,550) ------------------------------------------------------------------------ ------------- ------------- TOTAL STOCKHOLDERS DEFICIT . . .. . . . . . . . . . . . . . . . . . . . (258,092) (2,259,358) ------------------------------------------------------------------------ ------------- ------------- $ 2,054,566 $ 418,684 ------------------------------------------------------------------------ ------------- ------------- ------------------------------------------------------------------------ ------------- ------------- The accompanying notes are an integral part of these consolidated financial statements. PAGE F-33 SPACEDEV, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three and Six Months Ending Three-Months Ending Six-Months Ending June 30, 2004 and 2003 2004 % 2003 % 2004 % 2003 % ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- NET SALES . . . . . . . . . . . . . $ 1,200,692 100.0% $ 753,956 100.0% $ 2,215,443 100.0% $ 1,286,795 100.0% TOTAL COST OF SALES . . . . . . . . 942,116 78.5% 577,874 76.6% 1,749,639 79.0% 1,039,484 80.8% GROSS MARGIN. . . . . . . . . . . . 258,576 21.5% 176,082 23.4% 465,804 21.0% 247,311 19.2% ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- OPERATING EXPENSES Marketing and sales expense. . . 116,132 9.7% 134,005 17.8% 215,284 9.7% 199,047 15.5% Research and development . . . . 19,500 1.6% 251,983 33.4% 34,804 1.6% 251,983 19.6% General and administrative . . . 90,079 7.5% 155,006 20.6% 170,931 7.7% 524,922 40.8% ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- TOTAL OPERATING EXPENSES. . . . . . 225,711 18.8% 540,994 71.8% 421,019 19.0% 975,952 75.8% ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- PROFIT (LOSS) FROM OPERATIONS . . . 32,865 2.7% (364,912) -48.4% 44,785 2.0% (728,641) -56.6% ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- NON-OPERATING EXPENSE (INCOME) Interest expense . . . . . . . . 19,736 1.6% 14,179 1.9% 39,524 1.8% 34,628 2.7% Non-cash interest expense debt discount (Note 4) . . . . - 0.0% 100,453 13.3% - 0.0% 200,908 15.6% Gain on Building Sale (Note 3(a)) (29,318) -2.4% (29,318) -3.9% (58,636) -2.6% (48,863) -3.8% Non-Cash Loan Fee - Equity Conversions (Note 3(c)) 1,329,313 110.7% - 0.0% 1,793,313 80.9% - 0.0% ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- TOTAL NON-OPERATING EXPENSE . . . . 1,319,731 109.9% 85,314 11.3% 1,774,201 80.1% 186,673 14.5% ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- LOSS BEFORE TAXES . . . . . . . . . (1,286,866) -107.2% (450,226) -59.7% (1,729,416) -78.1% (915,314) -71.1% INCOME TAX PROVISION. . . . . . . . - 0.0% (37,474) -5.0% - 0.0% 2,526 0.2% NET LOSS. . . . . . . . . . . . . . $ (1,286,866) -107.2% $ (412,752) -54.7% $(1,729,416) -78.1% $ (917,840) -71.3% ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- NET LOSS PER SHARE: Net loss . . . . . . . . . . . $ (0.07) $ (0.03) $ (0.09) $ (0.06) ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- Weighted-Average Shares Outstanding 17,986,803 15,092,489 17,410,651 15,092,489 ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- ------------------------------------- ------------ ------ ----------- ------- ------------ ------ ----------- ------- The accompanying notes are an integral part of these consolidated financial statements. PAGE F-34 SPACEDEV, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months Ending June 30, 2004 and 2003 . . . . . . . 2004 2003 --------------------------------------------------------------- ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net loss. . . . . . . . . . . . . . . . . . . . . . . . . $(1,729,416) $ (917,840) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization. . . . . . . . . . . . 32,487 106,201 Gain on building sale. . . . . . . . . . . . . . . . (58,636) (48,863) Non-cash interest expense - convertible debt program - 200,908 Non-cash loan fees . . . . . . . . . . . . . . . . . 1,793,313 - Change in operating assets and liabilities:. . . . . (274,410) (159,009) --------------------------------------------------------------- ------------ ------------ NET CASH USED IN OPERATING ACTIVITIES. . . . . . . . . . . . . (236,662) (818,603) --------------------------------------------------------------- ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from the sale of building. . . . . . . . . . . . - 3,150,124 Purchases of fixed assets . . . . . . . . . . . . . . . . (79,951) (3,100) --------------------------------------------------------------- ------------ ------------ NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES . . . . . . (79,951) 3,147,024 --------------------------------------------------------------- ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Principle payments on notes payable . . . . . . . . . . . (23,792) (2,524,537) Principal payments on capitalized lease obligations . . . (7,883) (16,741) Payments on notes payable - related party . . . . . . . . (415,000) (159,999) Proceeds from issuance of common stock. . . . . . . . . . 978,889 425,942 Proceeds from revolving credit facility . . . . . . . . . 418,922 - --------------------------------------------------------------- ------------ ------------ NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES. . . . . . 951,136 (2,275,335) --------------------------------------------------------------- ------------ ------------ NET INCREASE IN CASH . . . . . . . . . . . . . . . . . . . . . 634,523 53,086 --------------------------------------------------------------- ------------ ------------ CASH AT BEGINNING OF PERIOD. . . . . . . . . . . . . . . . . . 592,006 27,648 --------------------------------------------------------------- ------------ ------------ CASH AT END OF PERIOD. . . . . . . . . . . . . . . . . . . . . $ 1,226,529 $ 80,734 --------------------------------------------------------------- ------------ ------------ --------------------------------------------------------------- ------------ ------------ The accompanying notes are an integral part of these consolidated financial statements. PAGE F-35 SPACEDEV, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS, CONT'D. (UNAUDITED) For the Six Months Ending June 30, 2004 and 2003 . 2004 2003 --------------------------------------------------- ------- ------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest . . . . . . . . . . . . . . . . $82,614 $15,494 --------------------------------------------------- ------- ------- NONCASH INVESTING AND FINANCING ACTIVITIES: -------------------------------------------------------------------------------- During the six-months ending June 30, 2004 the Company issued 1,403,182 shares of its common stock to the Laurus Master Fund from conversions under its revolving credit facility, thereby realizing a corresponding reduction in current liabilities of approximately $772,000 The Company recorded additional non-cash loan fees of approximately $1,178,000 and charged these fees to expense. -------------------------------------------------------------------------------- The accompanying notes are an integral part of these consolidated financial statements. PAGE F-36 SPACEDEV, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying consolidated financial statements of SpaceDev, Inc. ("the Company") include the accounts of the Company and its inactive subsidiary, SpaceDev Oklahoma. In the opinion of management, the consolidated financial statements reflect all normal and recurring adjustments, which are necessary for a fair presentation of the Company's financial position, results of operations and cash flows as of the dates and for the periods presented. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Consequently, these statements do not include all disclosures normally required by generally accepted accounting principles of the United States of America for annual financial statements nor those normally made in an Annual Report on Form 10-KSB. Accordingly, reference should be made to the Company's Form 10-KSB filed on April 6, 2004 and other reports the Company filed with the U.S. Securities and Exchange Commission for additional disclosures, including a summary of the Company's accounting policies, which have not materially changed. The consolidated results of operations for the six-months ending June 30, 2004 are not necessarily indicative of results that may be expected for the fiscal year ending December 31, 2004 or any future period, and the Company makes no representations related thereto. As of June 30, 2004 , management continues the opinion that the Company's auditors, PKF, expressed in their formal auditors' opinion dated February 11, 2004 (except for Note 11 as to which the date is April 2 , 2004), that in their opinion, based on their audit, the Company's consolidated financial statements referred to herein present fairly, in all material respects, the consolidated financial position of SPACEDEV, INC. AND SUBSIDIARY as of December 31, 2003, and the consolidated results of the Company's operations and cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements as of June 30, 2004 have been prepared assuming the Company will continue as a going concern. During the first six-months of 2004, the Company had a working capital balance of $685,834 and incurred a net loss of $1,729,416 as compared to a working capital deficit of $736,244 and a net loss of $917,840 for the same six-month period in 2003. On March 31, 2004, the Company was awarded a $43,362,271 contract from the Missile Defense Agency. The first task order was awarded on April 1, 2004. Management still intends to obtain new commercial and government contracts, continue to utilize (and possibly expand) its revolving credit facility and possibly raise some additional debt or equity capital in a public or private offering or fund-raising effort. There can be no assurance that existing contracts will be completed successfully or that new contracts or additional debt or equity financing that may be needed to fund operations will be available or, if available, obtained in sufficient amounts necessary to meet the Company's needs. Management does believe that, if current contracts remain on schedule and are funded as expected, they will be sufficient to fund the Company through 2004. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities and the results of PAGE F-37 operations during the reporting period. Actual results could differ materially from those estimates. Beginning in the second quarter of 2002, the Company's capitalized software costs were amortized over their estimated useful lives using the straight-line method. Periodically and at least annually, management performs a review for impairment in accordance with SFAS No. 144. During the six-months ended June 30, 2003, these capitalized software costs were $70,133 leaving a balance of $33,375, which was fully amortized in 2003. 2. REVENUE RECOGNITION The Company's revenues for the six-months ended June 30, 2004 were derived primarily from United States government cost plus fixed fee (CPFF) contracts compared to a predominance of fixed price contracts for the same six-months in 2003. Revenues from the CPFF contracts during the first six-months of 2004 were recognized as expenses were incurred compared to revenues from fixed price contracts for the same period in 2003, which were recognized using the percentage-of-completion method. Estimated contract profits are taken into earnings in proportion to revenues recorded. Revenues under certain long-term fixed price contracts, which provide for the delivery of minimal quantities or require significant amounts of development effort in relation to total contract value, are recorded upon achievement of performance milestones or using the cost-to-cost method of accounting where revenues and profits are recorded based on the ratio of costs incurred to estimated total costs at completion. Time and material revenues are recognized as services are preformed and costs incurred. Losses on contracts are recognized when estimated costs are reasonably determined. Actual results of contracts may differ from management's estimates and such differences could be material to the consolidated financial statements. Professional fees are billed to customers on a time and materials basis, a fixed price basis or a per-transaction basis depending on the terms and conditions of the specific contract. Time and material revenues are recognized as services are performed and costs incurred. Deferred revenue represents amounts collected from customers for projects, products or services to be provided at a future date. Deferred revenue for the six-months ended June 30, 2004 and 2003 was $33,400 and $5,000, respectively. In November 1999, the Company was awarded a turnkey mission contract by the Space Sciences Laboratory at the University of California at Berkeley worth, as of December 31, 2003 , approximately $7.4 million, including change orders worth approximately $514,000. This contract represented 14% of the Company's revenues for the year ending December 31, 2003. The contract concluded on December 31, 2003. The micro satellite developed under this mission, called CHIPSat, continues to operate successfully and UCB decided to extend the mission. On February 25, 2004, a new time and materials purchase order arrangement was initiated , on an as needed basis, between the University of California at Berkeley and the Company. 3. NOTES PAYABLE a) Building and Settlement Notes In December 2002, the Company entered an agreement to sell its interest in its facility. The transaction closed in January 2003. The escrow transaction included the sale of the land and building. Net fixed assets were reduced by approximately $1.9 million and notes payable were reduced by approximately $2.4 million while a deferred gain was recorded. In conjunction with the sale, the Company entered into a lease agreement with the buyer to leaseback its facilities. The Company's Chief Executive Officer provided a guarantee for the leaseback. The gain on the sale of the facility was deferred and amortized in proportion to the gross rental charged to expense over the lease term. Deferred gain of $1,172,720 is being amortized at the rate of $117,272 per year for ten PAGE F-38 (10) years ending in January 2013. As of June 30, 2004, the deferred gain was $1,006,585. This amortization will be included in the Company's occupancy and facility expense and totaled $58,636 and $48,863 for the six-months ending June 30, 2004 and 2003, respectively. Deferred Gain consisted of the following: Six-Months Ending June 30, 2004 Original Deferred Gain $1,172,720 Less Amortization 2003 (107,499) Less Amortization 2004 (58,636) $1,006,585 ---------- In 2001, the Company entered into three settlement loan agreements with various vendors. The total of $171,402 for all three loans called for payment between 24 and 50 months with interest that ranges from 0% to 8%. At June 30, 2004 and 2003, the outstanding balances on these notes were $63,799 and $117,260, respectively, with interest expense for the six-months ending June 30, 2004 and 2003 of $1,847 and $2,685, respectively. Future minimum principal payments on settlement notes are as follows: Period Ended June 30, ---------------------------------- 2004 $35,778 2005 28,021 2006 0 Total Settlement Notes $63,799 ---------------------- ------- b) Related Parties The Company has a note payable to the CEO. At June 30, 2004 and 2003, the balances were $196,445 and $597,630, respectively, with interest accruing at 10%. The note was amended on March 20, 2000 to call for annual payments of not less than $80,000 per year with interest at 10%. The Company is currently making principle and interest payments on the note. Future minimum principal payments on note payable, related parties are as follows: Period Ending June 30, ---------------------------- 2004 $80,000 2005 80,000 2006 36,445 2007 0 $196,445 -------- Interest expense on this note was $25,923 and $23,633 for the six-month periods ending June 30, 2004 and 2003, respectively. PAGE F-39 c) Revolving Credit Facility. On June 3, 2003, the Company entered into a Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant, with Laurus Master Fund, Ltd. ("Laurus"), which were filed on Form 8-K dated June 18, 2003. Pursuant to the agreements, the Company received a $1 million revolving credit facility in the form of a three-year Convertible Note secured by its assets. The net proceeds from the Convertible Note are used for general working capital needs. Advances on the Convertible Note may be repaid at the Company's option, in cash or through the issuance of the Company's shares of common stock. The Convertible Note carries an interest rate of WSJ Prime plus 0.75% on any outstanding balance. In addition, the Company is required to pay a collateral management payment of 0.55% of the average aggregate outstanding balance during the month plus an unused line payment of 0.20% per annum. Approximately $11,900 in interest and $16,255 in fees were accrued under the revolving credit facility in the first six-months of 2004. The outstanding balance on the revolving credit facility at June 30, 2004 was $408,003. The Company filed Form SB-2 on July 25, 2003 in connection with this transaction. The shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. Once the market price exceeded 118% of the fixed conversion price, which occurred on or about July 21, 2003, the Company obtained the ability to pay amounts outstanding under the revolving credit facility in cash or shares of its common stock at the fixed conversion price of $0.55 per share on the first $1 million of principal. The Convertible Note includes a right of conversion in favor of Laurus. If Laurus exercises its conversion right at any time or from time to time at or prior to maturity, on any outstanding balance at the time, the Convertible Note is convertible into shares of the Company's common stock at a fixed conversion price, subject to adjustments for stock splits, combinations and dividends and for shares of common stock issued for less than the fixed conversion price (unless exempted pursuant to the agreements). The agreement was modified on March 31, 2004 to provide for a six-month waiver to us and a fixed conversion price to Laurus of $0.85 per share on the first $500,000 after the first $1 million. Thereafter, the fixed conversion price will be adjusted after conversion of the first $1.5 million to 103% of the then fair market value of our common stock ("Adjusted Fixed Conversion Price"). Laurus converted 1,403,182 shares to reduce the debt we owed by $771,750 for the six-month period ending June 30, 2004. Laurus converted a total of 1,818,182 shares to reduce the debt by $1,000,000 since the inception of the revolving credit facility. For the six-month period ending June 30, 2004, the Company expensed $1,177,846 for the non-cash loan fee expense based on the fair market value of the stock when Laurus converted and approximately $1,304,000 for the non-cash loan fee expense since the inception of the revolving credit facility. The fair market value used in 2003 was established using a 20% discount to the closing price on the date of conversion based on the restricted and thinly-traded nature of the Company stock in 2003 and the fair market value used in 2004 was established using the closing price on the date of conversion with no discount taken due to the increased volume of the Company's stock. Availability of funds under the revolving credit facility will be based on the Company's accounts receivables, except as waivers are provided by Laurus. An initial three (3) month waiver was offered by Laurus, under which Laurus permitted a credit advance up to $300,000, which amount would have otherwise exceeded eligible accounts receivable during the period. Laurus subsequently extended the waiver for two additional six (6) month periods, under which Laurus permitted a credit advance up to $1 million, which amount would have otherwise exceeded eligible accounts receivable during the period. The revolving credit facility is secured by all of the assets of the Company. PAGE F-40 In conjunction with this transaction, Laurus was paid a fee of $20,000 for the first year which was expensed as additional interest expense in 2003. The Company is required to pay a continuation fee of $10,000 each year thereafter. In addition, Laurus received a warrant to purchase 200,000 shares of the Company's common stock, as stated herein. The warrant exercise price is computed as follows: $0.63 per share for the purchase of up to 125,000 shares; $0.69 per share for the purchase of an additional 50,000 shares; and $0.80 per share for the purchase of an additional 25,000 shares. The warrant exercise price may be paid in cash, in shares of the Company's common stock, or by a combination of both. The warrant expiration date is June 3, 2008. The warrant exercise price and the number of shares underlying the warrant are subject to adjustments for stock splits, combinations and dividends. In addition to the initial warrant, the Company is obligated to issue an additional five-year warrant to Laurus to purchase one share of common stock at an exercise price equal to 125% of the Adjusted Fixed Conversion Price for every ten dollars ($10) in principal of the Convertible Note converted into common stock if and when over $1 million is converted under the revolving credit facility. The value of the warrant will be determined if and when issued, and will be treated as additional interest expense and will be amortized over the remaining term of the Convertible Note, unless sooner terminated. No more than an aggregate of 100,000 shares of the Company's common stock may be purchased by Laurus under such additional warrants. The Company may terminate its agreements with Laurus before the end of the initial three year term and Laurus will release its security interests upon payment to Laurus of all obligations, if the Company has: (i) provided Laurus with an executed release of all claims which the Company may have under the agreements; and, (ii) paid to Laurus an early payment fee in an amount equal to (x) four percent (4%) of the Capital Availability Amount if such payment occurs prior to the first anniversary of the Initial Term (i.e., June 3, 2004); (y) three percent ( 3%) of the Capital Availability Amount if such payment occurs after the first anniversary and prior to the second anniversary of the Initial Term; and, (z) two percent (2%) of the Capital Availability Amount if such payment occurs after the second anniversary and prior to the end of the Initial Term. The early payment fee is also due and payable by the Company to Laurus if the Company terminates its Agreement after the occurrence of an Event of Default, as defined in the agreements. 4. CONVERTIBLE DEBT NOTES PAYABLE From October 14, 2002 through November 14, 2002, the Company sold an aggregate of $475,000 of 2.03% convertible debentures to various directors and officers of the Company. The total funding was completed on November 14, 2002. The convertible debentures entitled the holder to convert the principal and unpaid accrued interest into the Company's common stock when the notes matured. The maturity on the notes was six (6) months from issue date. On March 25, 2003, an amendment was executed which extended these notes an additional six (6) months. The convertible debentures were exercisable into a number of the Company's common shares at a conversion price that equals the 20-day average ask price less 10%, which was, established when the note was issued, or the initial conversion price. Concurrent with the issuance of the convertible debentures, the Company issued warrants to purchase up to 1,229,705 shares of the Company's common stock to the subscribers. These warrants are exercisable for three (3) years from the date of issuance at the initial exercise price, which is equal to the 20-day average ask price less 10%, which was established when the notes were issued, or the initial conversion price of the notes. Upon issuance, the issued warrants were valued using the Black-Scholes pricing model based on the expected fair value at issuance and the estimated fair value was recorded as debt discount. As a result of the change to the maturity date of the convertible debt, the amortization period for the debt discounts was also extended during the first quarter in 2003. PAGE F-41 All debt discounts are to be amortized as additional interest expense over the term of the convertible debenture. As of June30, 2003, $475,000 was reflected as debt discount of which $200,908 was amortized to non-cash interest expense for the six-months ending June 30, 2003. Fair market value of the stock was determined by discounting the closing market price on the date of the transaction by 20%, based on the nature of the restricted securities and thinly traded stock. On September 5, 2003, the Company repaid one-half of the convertible notes, with the condition that the note holders convert the other half. Also, as a condition of the partial repayment, the note holders were required to relinquish one-half of the previously issued warrants. Finally, as additional consideration for the transaction, the note holders were offered 5% interest on their notes, rather than the stated 2.03%. All the note holders accepted the offer and the convertible notes were retired. Balances as of June30, 2004 were: Convertible debentures - beginning balance . $ 475,000 Total interest expense incurred . . . . $ 20,236 Accrued interest paid - current year. . $ (18,161) Accrued interest paid - prior year. . . $ (2,075) Convertible debtures paid . . . . . . . $(237,500) Convertible debtures converted. . . . . $(237,500) ---------- $(475,000) ---------- Convertible debentures - ending balance. . . $ 0 -------------------------------------------- ---------- Debt discount (Warrants) - beginning balance $ 475,000 Amount forfeited. . . . . . . . . . . . $(237,500) Amount expensed prior year. . . . . . . $(125,000) Amount expensed current year. . . . . . $(267,879) Current year - adjustment . . . . . . . $ 155,379 ---------- $(475,000) ---------- Debt discount (Warrants) - ending balance. . $ 0 -------------------------------------------- ---------- 5. STOCKHOLDERS' EQUITY - COMMON STOCK AND WARRANTS On November 5, 2000, the Company commenced a private placement offering ("PPO") for a maximum of 1,000,000 shares of the Company's $0.0001 par value common stock and warrants to purchase an additional 1,000,000 shares of common stock (the "Units"). The offering price of the Units was the five-day average of the bid and ask prices for the Company's common stock on the date of issuance, with a minimum per Unit price of $1.00. The warrants allowed the holder to acquire additional shares at $0.50 above the offering price of the shares. The Company sold to one related-party investor under these terms. On March 2, 2001, the PPO offering price was amended to the average of the high bid prices on the date of issuance and four preceding days, with no minimum per share price, and the warrants were amended to allow the holder to acquire additional shares at the Unit price. On January 16, 2003 and February 14, 2003, pursuant to an extension of the PPO, the Company sold 665,188 and 196,079 Units, respectively. The Company received approximately $326,000 and $100,000, respectively, for the Units sold under the PPO during the first quarter 2003. PAGE F-42 The Company has elected to account for its stock-based compensation plans under APB 25. However, the Company has computed, for pro forma disclosure purposes, the value of all options granted during the period ending June 30, 2004 and 2003 using the minimum value method as prescribed by SFAS 123 and amended by SFAS 148. Under this method, the Company used the risk-free interest rate at the date of grant, the expected volatility, the expected dividend yield and the expected life of the options to determine the fair value of options granted. The risk-free interest rates ranged from 6.0% to 6.5%, expected volatility was 117%, the dividend yield was assumed to be zero, and the expected life of the options was assumed to be three to five years based on the average vesting period of options granted. If the Company had accounted for these options in accordance with SFAS 123, the total value of options granted during the six-month period ending June 30, 2004 and 2003 would be amortized on a pro forma basis over the vesting period of the options. Thus, the Company's consolidated net loss would have been as follows: Six-Months Ending June 30, 2004 2003 ----------------------------- -------------- ------------ Net loss: ----------------------------- -------------- ------------ As reported. . . . . . . . . $(1,729,416)9) $ (917,840) Pro forma. . . . . . . . . . $ (1,863,048) $(1,056,426) Loss per Share: ----------------------------- -------------- ------------ As reported. . . . . . . . . $ (.09) $ (.06) Pro forma. . . . . . . . . . $ (.10) $ (.07) ----------------------------- -------------- ------------ ----------------------------- -------------- ------------ On November 21, 1997, the Company entered into a five (5) year employment agreement with its CEO. On July 16, 2000, the Company amended the employment agreement with its CEO extending the term until July 16, 2005. As part of the original employment agreement, the Company granted options to the CEO to purchase up to 2,500,000 shares of the Company's $.0001 par value restricted common stock. PAGE F-43 The options are subject to the following vesting conditions, which were amended on January 21, 2000 and later ratified by the Board on July 16, 2000. The agreement provided an option for the Board to award options on an additional 1,500,000 shares of restricted common stock at a later date. The exercise prices are set forth in the following chart: Exercise Number price per Of shares Vesting Conditions share ---------------- --------- ----------------------------------------------------------- ------------------- Granted Options: 500,000. . . . . Currently vested $ 1.00 500,000. . . . . Obtaining $6,500,000 additional equity capital $ 1.50 500,000. . . . . Financing and executing a definitive space launch agreement $ 2.00 500,000. . . . . Launching of first lunar or deep-space mission $ 2.50 500,000. . . . . Successful completion of first lunar or deep-space mission $ 3.00 Options to be Granted upon the Occurrence of Certain Events: 250,000. . . . . Upon the Companymarket capitalization reading $250 million $ 5.00 500,000. . . . . Upon the Companymarket capitalization reading $500 million $ 10.00 750,000. . . . . Upon the Companymarket capitalization reading $1 billion $ 20.00 ---------------- --------- ----------------------------------------------------------- ------------------- All options expire on July 16, 2010. In accordance with APB 25, the Company recognized $500,000 of compensation expense and $250,000 of deferred compensation in 1997. The options granted to the CEO are subject to vesting conditions and have exercise prices between $1.00 and $3.00 per share. On August 27, 2001, as part of an annual review process, an additional 10,000 options were granted to the CEO at the exercise price of $0.9469 per share with a set vesting schedule of 3,333 shares per year after issuance with the third year having 3,334 options vest. These options expire five years from grant date. 6. NEW ACCOUNTING PRONOUNCEMENTS There were no recent Accounting Pronouncements that affect the Company during the second quarter 2004. For past pronouncements please refer the company's 10-KSB filed on April 6, 2004. PAGE F-44 No dealer, sales person or other SPACEDEV, INC. individual has been authorized to give any information or make any representations other than those contained in this prospectus and, if 4,635,867 SHARES given or made, such information or representations must not be relied OF upon as having been authorized by us. This prospectus does not COMMON STOCK constitute an offer to sell, or a solicitation of an offer to buy, the common stock offered hereby in any jurisdiction where, or to any person to whom, it is unlawful to make an offer or solicitation. Neither the delivery of this prospectus nor any sale made hereunder shall, under any circumstances, create an implication PROSPECTUS that there has been any change in our affairs since the date hereof or that the information contained herein is correct or complete as of any time subsequent to the date hereof. SEPTEMBER 17, 2004 PAGE II-1 [Outside Back Cover of Prospectus] PAGE II-2 PART II INFORMATION NOT REQUIRED IN PROSPECTUS INDEMNIFICATION OF DIRECTORS AND OFFICERS Our Articles of Incorporation provide that our directors, officers, employees or agents shall be indemnified as to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, as long as the director, officer, employee or agent acted in good faith and in a manner reasonably believed to be in the best interests of the corporation. No indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his/her duty. In addition, our Articles of Incorporation and Bylaws obligate us to indemnify our directors and officers against expenses and other amounts reasonably incurred in connection with any proceeding arising from the fact that such person is or was an agent of ours. Our Articles of Incorporation and Bylaws also authorize us to purchase and maintain insurance on behalf of any of our directors or officers against any liability asserted against that person in that capacity, whether or not we would have the power to indemnify that person. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION Expenses payable in connection with the distribution of the securities being registered (estimated except for the registration fee), all of which will be borne by the registrant, are as follows: Securities and Exchange Commission Registration Fee $ 708 Printing Expenses . . . . . . . . . . . . . . . . . $ 1,000 Legal Fees and Expenses . . . . . . . . . . . . . . $20,000 Accounting Fees . . . . . . . . . . . . . . . . . . $10,000 Miscellaneous Expenses. . . . . . . . . . . . . . . $ 292 Total . . . . . . . . . . . . . . . . . . . . . . . $32,000 =================================================== ======= RECENT SALES OF UNREGISTERED SECURITIES On March 2, 2001, we issued 50,000 shares of our common stock to our former president, Mr. Stanley W. Dubyn, according to the terms of his employment agreement with us. The common stock was issued with restrictions pursuant to Section 4(2) of the Securities Act. Mr. Dubyn resigned his positions as our president, chief operating officer and director on July 6, 2001. During the first quarter of 2001, we issued a total of 17,247 shares to consultants in exchange for services rendered to us. The shares were issued with restrictions pursuant to Section 4(2) of the Securities Act. In April 2001, we issued 66,667 shares of common stock and warrants to purchase an additional 66,667 shares of common stock at an exercise price of $0.75 per share to an individual investor in exchange for an investment of $50,000. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. PAGE II-3 During the second quarter of 2001, we issued a total of 500,000 shares to EMC Holdings Corporation pursuant to Section 4(2) of the Securities Act for certain consulting services. Due to teh failure of performance by EMC under the consulting and advisory agreements between EMC and the Company, EMC's engagement was terminated in late 2001, and the shares were recovered by us in arbitration. On June 12, 2001 we issued 33,333 shares of common stock and warrants to purchase an additional 33,333 shares of common stock at an exercise price of $0.75 per share to an individual investor in exchange for an investment of $25,000. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. On June 20, 2001 we issued 33,333 shares of common stock and warrants to purchase an additional 33,333 shares of common stock at an exercise price of $0.75 per share to an individual investor in exchange for an investment of $25,000. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. On August 11, 2001, we issued a warrant to purchase 25,000 shares of restricted common stock pursuant to its agreement to acquire the AMROC hybrid motor technology. The exercise price of the warrant is $.877, based on the five-day average closing price of our common stock on the date of grant. The warrant was issued pursuant to Section 4(2) of the Securities Act of 1933 (the "Act"). On September 18, 2001, we issued 23,419 shares of common stock and warrants to purchase an additional 23,419 shares of common stock at an exercise price of $0.854 per share to an individual investor in exchange for an investment of $20,000. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. During 2001, we issued a total of 105,599 shares to consultants, employees and summer interns in exchange for services rendered to us and awards given by us. The shares were issued with restrictions pursuant to Section 4(2) of the Securities Act. On November 21, 1997, we entered into a five-year employment agreement with its President, James W. Benson. This agreement provides for compensation of salary and stock as well as stock options. Our Board of Directors amended the Employment contract for Mr. Benson at its meeting on July 16, 2000. The amended agreement provides for the grant of options to purchase up to 4,000,000 shares of our common stock upon the occurrence of certain events. Such options would be immediately exercisable upon grant. The options are non-statutory stock options issued outside of our 1999 Incentive Stock Option Plan and were originally granted to Mr. Benson pursuant to Rule 701 of the Securities Act. On March 14, 2002, we issued 40,816 shares of common stock and warrants to purchase an additional 40,816 shares of common stock at an exercise price of $0.49 per share to an individual investor in exchange for an investment of $20,000. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. On August 9, 2002, we issued 30,612 shares of common stock and warrants to purchase an additional 30,612 shares of common stock at an exercise price of $0.49 per share to an individual investor in exchange for an investment of $15,000. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. PAGE II-4 From October 14, 2002 through November 14, 2002, we sold an aggregate of $475,000 of 2.03% convertible debentures to three of our directors and officers pursuant to Section 4(2) of the Securities Act. Mr. Benson purchased $375,000 of Series A Subordinated Convertible Notes and Messrs. Shaffer and Skarupa purchased $50,000 each. The total funding was completed on November 14, 2002. The convertible debentures entitle the holder to convert the principal and unpaid accrued interest into our common stock when the note matures. The notes originally were set to mature six (6) months from issue date and were subsequently extended to twelve (12) months from issue date on March 19, 2003, unless paid, extended or re-negotiated, the convertible debentures are exercisable into a number of our common shares at a conversion price that equals the 20-day average asking price less 10%, which was established when the note was issued, or the initial conversion price. Concurrent with the issuance of the convertible debentures, we issued to the subscribers, warrants to purchase up to 1,229,705 shares of our common stock. These warrants are exercisable for three (3) years from the date of issuance at the initial exercise price, which equals to the 20-day average asking price less 10% which was established when the note was issued, or the initial conversion price. During 2002, we issued a total of 7,000 shares to employees and summer interns in exchange for services rendered to us and awards given by us. The shares were issued with restrictions pursuant to Section 4(2) of the Securities Act. On December 2, 2002, we issued 81,632 shares of common stock and warrants to purchase an additional 81,632 shares of common stock at an exercise price of $0.49 per share to two individual investors in exchange for an investment of $40,000. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. On January 21, 2003, we issued 665,188 shares of common stock and warrants to purchase an additional 665,188 shares of common stock at an exercise price of $0.49 per share to an individual investor in exchange for an investment of $325,942. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. On February 14, 2003, we issued 196,079 shares of common stock and warrants to purchase an additional 196,079 shares of common stock at an exercise price of $0.51 per share to an individual investor in exchange for an investment of $100,000. This purchase was made as a part of an accredited investor only, private placement transaction under Rule 506 of Regulation D of the Securities Act of 1933. On June 3, 2003, we entered into a Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant, with Laurus Master Fund, Ltd., which were filed on Form 8-K dated June 18, 2003. Pursuant to the agreements, we received a $1 million revolving credit facility in the form of a three-year Convertible Note secured by its assets. The net proceeds from the Convertible Note are used for general working capital needs. Advances on the Convertible Note may be repaid at the our option, in cash or through the issuance of our shares of common stock. The Convertible Note carries an interest rate of WSJ Prime plus 0.75% on any outstanding balance. In addition, we are required to pay a collateral management payment of 0.55% of the average aggregate outstanding balance during the month plus an unused line payment of 0.20% per annum. There was no outstanding balance on the revolving credit facility at June 11, 2004. PAGE II-5 On June 3, 2003, we issued warrants to purchase 200,000 shares of common stock to Laurus Master Fund Ltd. The warrants were issued in three tranches: warrants on 125,000 shares of common stock at an exercise price of $0.63 per share; warrants on 50,000 shares of common stock at an exercise price of $0.69 per share; and warrants on 25,000 shares of common stock at an exercise price of $0.80 per share. Also on June 3, 2003, we entered into a $1 million revolving credit facility with the Laurus Master Fund, Ltd. In July 2003, we issued a total of 2,100 shares to employees in exchange for services rendered to us and awards given by us. The shares were issued with restrictions pursuant to Section 4(2) of the Securities Act. On August 8, 2003, we issued 10,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $5,500 reduction in our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On September 1, 2003, we issued warrants to purchase 200,000 shares of common stock to Dian Grisel of the Investor Relations Group ("IRG"), for public and investor relations services. The warrants will vest ratably over one year at an exercise price of $1.05 per share. On September 23, 2003, we issued 50,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $27,500 reduction in our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On October 3, 2003, we issued 55,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $30,250 reduction in our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On October 14, 2003, we issued 100,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $55,000 reduction in our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On December 11, 2003, we issued 100,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $55,000 reduction in our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On December 29, 2003, we issued 100,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $55,000 reduction in our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. PAGE II-6 On January 9, 2004, we issued 300,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $165,000 reduction in our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On March 3, 2004, we issued 200,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $110,000 reduction in our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. Pursuant to our independent director compensation plan, adopted January 16, 2000 and modified March 25, 2004, we granted options to purchase 5,000 shares each to Curt Dean Blake, Wesley T. Huntress and Scott McClendon for their attendance and participation at the Audit Committee Meeting held on March 23, 2004. These options were issued with an exercise price of $0.92 per share, (based on the closing price of our common stock on the date of grant), will vest over two-years and will expire on the three-year anniversary date of the date of grant. On March 31, 2004, we agreed to amend our Security Agreement and Secured Convertible Note with the Laurus Master Fund, Ltd. to change certain terms of the conversion price to allow for the next Five Hundred Thousand Dollars ($500,000) converted under the Note to be converted at eighty-five cents ($0.85) per share of common stock. Thereafter, the fixed conversion price shall be reset to equal 103% of the volume weighted average closing price of the common stock for the ten (10) trading days prior to the last day on which such five hundred thousand dollars ($500,000) has been converted. In exchange, Laurus agreed to waive certain over advance compliance provisions for six (6) months. On April 1, 2004, we issued 250,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $137,500 reduction in debt on our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On April 20, 2004, we issued 300,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $165,000 reduction in debt on our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On May 17, 2004, we issued 353,182 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $194,250 reduction in debt on our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on August 6, 2003. On June 18, 2004, we issued warrants to purchase 50,000 shares of common stock to Laurus Master Fund Ltd. The warrants were issued at an exercise price of $1.0625 per share, were immediately vested and are exercisable over a five (5) year period. The warrants were issued pursuant to Section 4(2) of the Securities Act. As part of this transaction, the underlying shares are being registered with the Securities and Exchange Commission ("SEC") for public resale. PAGE II-7 On July 12, 2004, we issued 41,876 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $35,595 reduction in debt on our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on July 1, 2004. On August 25, 2004, we issued warrants to purchase 487,000 shares of common stock to Laurus Master Fund Ltd. The warrants were issued at an exercise price of $1.77 per share, were immediately vested and are exercisable over a five (5) year period. The warrants were issued pursuant to Section 4(2) of the Securities Act and Rule 506 promulgated thereunder. As part of this transaction, the underlying shares are being registered with the Securities and Exchange Commission ("SEC") for public resale.. Also on June 3, 2003, we entered into a $1 million revolving credit facility with the Laurus Master Fund, Ltd. On August 25, 2004, we issued 250,000 shares of our Series C Convertible Cumulative Preferred Stock, with a stated value of $10.00 per share, to Laurus Master Fund Ltd. for a total purchase price of $2,500,000. The preferred stock was issued pursuant to Section 4(2) of the Securities Act and Rule 506 promulgated thereunder. As part of the transaction, 1,845,779 shares of Common Stock underlying the preferred stock and cumulative dividends are being registered with the Securities and Exchange Commission ("SEC") for resale. On August 25, 2004, we issued warrants to purchase 50,000 shares of common stock to Laurus Master Fund Ltd. The warrants were issued at an exercise price of $1.9250 per share, were immediately vested and are exercisable over a five (5) year period. The warrants were issued pursuant to Section 4(2) of the Securities Act.As part of this transaction, the underlying shares are being registered with the Securities and Exchange Commission ("SEC") for public resale.. Also on June 3, 2003, we entered into a $1 million revolving credit facility with the Laurus Master Fund, Ltd. On September 3, 2004, we issued 100,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $85,000 reduction in debt on our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on July 1, 2004. On September 10, 2004, we issued 150,000 shares of our common stock to Laurus, pursuant to our Security Agreement, Secured Convertible Note, Registration Rights Agreement and Common Stock Purchase Warrant with Laurus dated June 3, 2003, for a corresponding $127,500 reduction in debt on our revolving credit facility. As part of the transaction, the shares were registered with the Securities and Exchange Commission ("SEC") for public resale on July 1, 2004. PAGE II-8 EXHIBITS ITEM EXH. NO. ----------------------------------------------------------------------------------------------------------------- SpaceDev's Articles of Incorporation(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 SpaceDev's Articles of Amendment to Articles of Incorporation dated November 4, 1997 Authorizing Series B Preferred Stock(1). . . . . . . . . . . . . . . . . . . . . 3.2 SpaceDev's Articles of Amendment to Articles of Incorporation dated December 17, 1997 Changing Name to SpaceDev, Inc. (1) . . . . . . . . . . . . . . . . . . . . . . 3.3 SpaceDev's Bylaws(1) . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . 3.4 SpaceDev's Articles of Amendment to Articles of Incorporation dated July 21, 2003 Increasing the Authorized Shares of Common Stock(10) . . . . . . . . . . . . . . . . . . . . . . . . . 3.5 Articles of Amendment to Articles of Incorporation dated August 30, 2004(14) . . . . . . . . . . 3.6 Form of Common Stock Certificate(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Form of Non-Qualified Stock Option(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Form of Incentive Stock Option(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Form of Re-Pricing Warrant(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 Form of Warrant(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5 1999 Stock Option Plan(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.6 First Amendment to 1999 Stock Option Plan(10). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.7 1999 Employee Stock Purchase Plan(10). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.8 Form of Warrant from November 2, 2000 Private Placement (4). . . . . . . . . . . . . . . . . . . . . . 4.9 Common Stock Purchase Warrant-Phillips Aerospace (4) . . . . . . . . . . . . . . . . . . . . . . . . . 4.10 Note Purchase Agreement for Series A Subordinated Convertible Notes (6). . . . . . . . . . . . . . . . 4.11 Form of Series A Subordinated Convertible Note (6) . . . . . . . . . . . . . . . . . . . . . . . . . . 4.12 Form of Warrant for Series A Subordinated Convertible Note Offering (6). .. . . . . . . . . . . . . . . 4.13 Form of Certificate of Series C Preferred Stock (14). . . . . . . . .. . . . . . . . . . . . . . . . 4.14 Form of Warrant, Dated August 25, 2004, by and among SpaceDev and Laurus(14). . . . . . . . . . . . . . 4.15 Opinion of Weintraub Dillon Dated September 17, 2004 . . . . . . . . . . . . . . . . . . . . . . . 5.1 Common Stock Exchange Agreement Between SpaceDev and SIL (1) .. . . . . . . . . . . . . . . . . . . . . 10.1 Mutual Rescission and Release of Share Acquisition Agreement (1). . . . . . . . . . . . . . . . . . . . 10.2 Share Exchange Agreement Between SpaceDev and Integrated Space Systems (1) . . . .. . . . . . . . . . . 10.3 Agreement of License and Purchase of Technology Between SpaceDev and AMROC (1) . .. . . . . . . . . . . 10.4 Firm Fixed Price Agreement Number 108252 Between SpaceDev and Regents of the University of California (1).. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.5 Employment Agreement between Integrated Space Systems and Charles H. Lloyd (1) . . . . . . . . . . . . 10.6 Employment Agreement of James W. Benson (2). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.7 Deed of Counter-Indemnity dated August 28, 1999 (3) . . . . . . . . . . . . . . . . . . . . . . . . . . 10.8 PAGE II-9 Financial Advisory Services Agreement, dated June 18, 2001 (5). . . . . . . . . . . . . . . . . . . . . 10.9 Consultant/Advisory Services Agreement, dated June 18, 2001 (5). . . . . . . . . . . . . . . . . . . . 10.10 Employment Agreement between SpaceDev, Inc. and Stuart Schaffer, dated May 17, 2002(7). . . . . . . . 10.11 First Amendment to Employment Agreement with Stuart Schaffer, dated May 17, 2002(7). . . . . . . . . . 10.12 Employment Agreement between SpaceDev, Inc. and Emery Skarupa, dated May 24, 2002(7). . . . . . . . . . 10.13 Confidential Separation Agreement and General Release of Claims, dated May 31, 2002(7). . . . . . . . . 10.14 Code of Business Conduct and Ethics(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.15 Employment Agreement between SpaceDev and Richard B. Slansky, dated February 10, 2003(7) . . . . . . . 10.16 Second Amendment to Series A Subordinated Convertible Note - Benson1, dated March 25, 2003(7). . . . . 10.17 Second Amendment to Series A Subordinated Convertible Note - Benson2, dated March 25, 2003(7). . . . . 10.18 Second Amendment to Series A Subordinated Convertible Note - Benson3, dated March 25, 2003(7). . . . . 10.19 Second Amendment to Series A Subordinated Convertible Note - Benson4, dated March 25, 2003(7). . . . . 10.20 Second Amendment to Series A Subordinated Convertible Note - Skarupa, dated March 25, 2003(7). . . . . 10.21 Second Amendment to Series A Subordinated Convertible Note - Schaffer, dated March 25, 2003(7). . . . . 10.22 Security Agreement, dated as of June 3, 2003, by and between SpaceDev, Inc. ("SpaceDev") and Laurus Master Fund, Ltd. ("Laurus")(9). . . . . . . . . . . . . . . . . . . . . . 10.23 Secured Convertible Note, dated June 3, 2003, by and among SpaceDev and Laurus(9) . . . . . . . . . . . 10.24 Common Stock Purchase Warrant, dated June 3, 2003, issued by SpaceDev to Laurus(9). . . . . . . . . . . 10.25 Registration Rights Agreement, dated as of June 3, 2003, by and between SpaceDev and Laurus(9). . . . . 10.26 Waiver Letter, dated June 3, 2003, by and between SpaceDev and Laurus(9) . . . . . . . . . . . . . . . 10.27 Separation Agreement and General Release, by and between SpaceDev and Stuart Schaffer dated July 2, 2003(10). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.28 AFRL Small Vehicle Launch Technology SBIR contract(11) . . . . . . . . . . . . . . . . . . . . . . . . 10.29 AFRL Small Satellite Bus Technologies SBIR contract(11) . . . . . . . . . . . . . . . . . . . . . . . . 10.30 AFRL Small Shuttle Compatible Propulsion Module contract(11). . . . . . . . . . . . . . . . . . . . . . 10.31 MDA Advanced Systems Deputate for the Micro Satellite Experiment(11). . . . . . . . . . . . . . . . . . 10.32 PAGE II-10 MDA Advanced Systems Deputate for the Micro Satellite Experiment (Modification) (11). . . . . . . . . . 10.33 Lunar Enterprises of California contract(11). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.34 Hybrid Rocket Motor Systems and Components contract*(11). . . . . . . . . . . . . . . . . . . . . . . . 10.35 Third Amendment to Series A Subordinated Convertible Note - Benson1, dated Sept. 5, 2003(11) . . . . . 10.36 Third Amendment to Series A Subordinated Convertible Note - Benson2, dated Sept. 5, 2003(11) . . . . . 10.37 Third Amendment to Series A Subordinated Convertible Note - Benson3, dated Sept. 5, 2003(11) . . . . . 10.38 Third Amendment to Series A Subordinated Convertible Note - Benson4, dated Sept. 5, 2003(11) . . . . . 10.39 Third Amendment to Series A Subordinated Convertible Note - Skarupa, dated Sept. 5, 2003(11) . . . . . 10.40 Third Amendment to Series A Subordinated Convertible Note - Schaffer, dated Sept. 5, 2003(11) . . . . 10.41 Employment Offer between SpaceDev and Dario Emanuel DaPra, dated November 17, 2003(12). . . . . . . . . 10.42 Employment Offer between SpaceDev and Randall K. Simpson, dated Jan. 16, 2004(12). . . . . . . . . . . 10.43 Confidential Separation Agreement and General Release of Claims with Mr. DaPra, dated March 18, 2004(12). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.47 Missile Defense Agency Contract with SpaceDev, dated March 31, 2004 *(12) . . . . . . . . . . . . 10.48 Amendment No. 1 to Note with the Laurus Master Fund, dated March 31, 2004(12) . . . . . . . . . . . . . 10.49 Waiver Letter from Laurus Master Fund, dated March 31, 2004(12) . . . . . . . . . . . . . . . . . . . . 10.50 First Task Order Under Missile Defense Agency Contract with SpaceDev, dated April 1, 2004. . . . . . . . 10.51 Separation Agreement and General Release, by and between SpaceDev and Jeffrey Janicik dated June 18, 2004 (13). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.52 Modification to Small Shuttle Compatible Propulsion Module contract with AFRL dated July 7, 2004(13) . . 10.53 Lunar Enterprises of California contract with SpaceDev dated July 20, 2004(13). . . . . . . . . . . . . 10.54 Security Purchase Agreement, Dated August 25, 2004, by and among SpaceDev and Laurus(14). . . . . . . 10.55 Registration Rights Agreement, Dated August 25, 2004, by and among SpaceDev and Laurus(14). . . . . . . 10.56 Letter Agreement, Dated August 25, 2004, by and among SpaceDev and Laurus(14). . . . . . . . . . . . . 10.57 PAGE II-11 Air Force Research Laboratories contract with SpaceDev dated as of August 23, 2004(15). . . . . . . . . 10.58 Air Force Research Laboratories Statement of Work*(15). . . . . . . . . . . . . . . . . . . . . . . . . 10.59 List of Subsidiaries of the Company(12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21.1 Letter from Nation Smith dated June 4, 2003 (8) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23.1 SB-2 Consent Letter from Nation Smith dated September 17, 2004. . . . . . . . . . . . . . . . . . . . . 23.2 SB-2 Consent Letter from PKFdated September 17, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . 23.3 Consent of Weintraub Dillon PC (included in Exhibit 5.1 hereto) . . . . . . . . . . . . . . . . . . . . 23.4 PAGE II-12 ____________________ (1) Incorporated by reference to the corresponding Exhibit previously filed as an Exhibit to Registrant's Form 10-SB (File #000-28947). (2) Incorporated by reference to Exhibit 10.1 previously filed as an Exhibit to Registrant's Form 10-QSB filed on August 10, 2000. (3) Incorporated by reference to Exhibit 10.2 previously filed as an Exhibit to Registrant's Form 8-K filed on September 20, 2000. (4) Incorporated by reference to the corresponding Exhibit previously filed as an Exhibit to Registrant's Form 10-KSB filed on April 2, 2001. (5) Incorporated by reference to Exhibits 10.1 and 10.2 previously filed as an Exhibit to Registrant's Form 8-K filed on July 19, 2001. (6) Incorporated by reference to Exhibits 4.1, 4.2 and 4.3 previously filed as an Exhibit to Registrant's Form 10-QSB filed on November 14, 2002. (7) Incorporated by reference to the corresponding Exhibit previously filed as an Exhibit to Registrant's Form 10-KSB filed on March 28, 2003. (8) Incorporated by reference to Exhibits 16.1 previously filed as an Exhibit to Registrant's Form 8-K filed on June 4, 2003. (9) Incorporated by reference to Exhibits 10.1, 10.2, 10.3, 10.4 and 10.5 previously filed as an Exhibit to Registrant's Form 8-K filed on June 18, 2003. (10) Incorporated by reference to Exhibit 10.27 previously filed as an Exhibit to Registrant's Form SB-2 on July 25, 2003. (11) Incorporated by reference to Exhibits 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 10.9, 10.10, 10.11, 10.12 and 10.13 previously filed as an Exhibit to Registrant's Form 10-QSB on November 12, 2003. (12) Incorporated by reference to Exhibits 10.37, 10.38, 10.39, 10.40, 10.41, 10.42, 10.43, and 10.44 previously filed as an Exhibit to Registrant's Form 10-KSB filed on April 6, 2004. (13) Incorporated by reference to Exhibits 10.1, 10.2 and 10.3 previously filed as an Exhibit to Registrant's Form 10-QSB on August 9, 2004. (14) Incorporated by reference to Exhibits 3.1, 4.1, 4.2, 10.1, 10.2 and 10.3 previously filed as an Exhibit to Registrant's Form 8-K filed on August 30, 2004. (15) Incorporated by reference to Exhibits 10.1 and 10.2 previously filed as an Exhibit to Registrant's Form 8-K filed on September 1, 2004. * Registrant requested confidential treatment pursuant to Rule 406 for a portion of the referenced exhibit and has separately filed such exhibit with the Commission. PAGE II-13 UNDERTAKINGS The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) to include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) to reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; and (iii) to include any additional or changed material information on the plan of distribution. Provided however, that paragraphs (1)(i) and (1)(ii) shall not apply if the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed by the registrant pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the registration statement. (2) For determining liability under the Securities Act of 1933, to treat each post-effective amendment as a new registration statement of the securities offered, and the offering of the securities at that time to be the initial bona fide offering. (3) To file a post-effective amendment to remove from registration any of the securities that remain unsold at the end of the offering. (4) That, insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or controlling persons of the registrant pursuant to the foregoing provisions or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. PAGE II-14 SIGNATURES In accordance with the requirements of the Securities Act of 1933, as amended, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 to be signed on its behalf by the undersigned, in the City of San Diego, California, on the 17th day of September 2004 . SpaceDev, Inc. By: /s/ James W. Benson ----------------------------- James W. Benson, Chief Executive Officer By: /s/ Richard B. Slansky ------------------------------- Richard B. Slansky, Chief Financial Officer KNOW ALL MEN BY THESE PRESENTS, that the undersigned officers and directors of SpaceDev, Inc., a Colorado corporation that is filing a registration statement on Form SB-2 POS with the Securities and Exchange Commission under the provisions of the Securities Act of 1933, as amended, hereby constitute and appoint James W. Benson and Richard B. Slansky, and each of them, their true and lawful attorneys-in-fact and agents; with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign such registration statement and any or all amendments to the registration statement, including a prospectus or an amended prospectus therein, and all other documents in connection therewith to be filed with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all interests and purposes as they might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. PAGE II-15 Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed below by the following persons in the following capacities on the dates indicated. Name Title . . . . . . . . . . . . . . . . . . . . . . . . . . . Date -------------------------- -------------------------------------------------------------------------- ------------- /s/ James W. Benson Chairman of the Board, Chief Executive . . .. . . . . . . . . . . . . . . September 17, 2004 -------------------------- Officer and Director (principal executive James W. Benson officer) /s/ Richard B. Slansky Chief Financial Officer and Corporate . . . . . . . . . . . . . . . . . . . September 17, 2004 --------------------------- Secretary Richard B. Slansky /s/ Curt Dean Blake Director . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . September 17, 2004 ------------------------ Curt Dean Blake /s/ Howell M. Estes, III Director . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . September 17, 2004 ------------------------ Howell M. Estes, III /s/ Wesley T. Huntress Director . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .September 17, 2004 ---------------------------- Wesley T. Huntress /s/ Scott McClendon Director . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .September 17, 2004 ------------------------- Scott McClendon /s/ Stuart Schaffer Director . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . September 17, 2004 ---------------------- Stuart Schaffer /s/ Robert S. Walker Director . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . September 17, 2004 ------------------------- Robert S. Walker PAGE II-16 INDEX TO EXHIBITS FILED WITH THIS REGISTRATION STATEMENT ITEM EXH. NO. ----------------------------------------------------------------------------------------------------------------- SpaceDev's Articles of Incorporation(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 SpaceDev's Articles of Amendment to Articles of Incorporation dated November 4, 1997 Authorizing Series B Preferred Stock(1). . . . . . . . . . . . . . . . . . . . . 3.2 SpaceDev's Articles of Amendment to Articles of Incorporation dated December 17, 1997 Changing Name to SpaceDev, Inc. (1) . . . . . . . . . . . . . . . . . . . . . . 3.3 SpaceDev's Bylaws(1) . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . 3.4 SpaceDev's Articles of Amendment to Articles of Incorporation dated July 21, 2003 Increasing the Authorized Shares of Common Stock(10) . . . . . . . . . . . . . . . . . . . . . . . . . 3.5 Articles of Amendment to Articles of Incorporation dated August 30, 2004(14) . . . . . . . . . . 3.6 Form of Common Stock Certificate(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Form of Non-Qualified Stock Option(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Form of Incentive Stock Option(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Form of Re-Pricing Warrant(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 Form of Warrant(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5 1999 Stock Option Plan(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.6 First Amendment to 1999 Stock Option Plan(10). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.7 1999 Employee Stock Purchase Plan(10). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.8 Form of Warrant from November 2, 2000 Private Placement (4). . . . . . . . . . . . . . . . . . . . . . 4.9 Common Stock Purchase Warrant-Phillips Aerospace (4) . . . . . . . . . . . . . . . . . . . . . . . . . 4.10 Note Purchase Agreement for Series A Subordinated Convertible Notes (6). . . . . . . . . . . . . . . . 4.11 Form of Series A Subordinated Convertible Note (6) . . . . . . . . . . . . . . . . . . . . . . . . . . 4.12 Form of Warrant for Series A Subordinated Convertible Note Offering (6). .. . . . . . . . . . . . . . . 4.13 Form of Certificate of Series C Preferred Stock (14). . . . . . . . .. . . . . . . . . . . . . . . . 4.14 Form of Warrant, Dated August 25, 2004, by and among SpaceDev and Laurus(14). . . . . . . . . . . . . . 4.15 Opinion of Weintraub Dillon Dated September 17, 2004 . . . . . . . . . . . . . . . . . . . . . . . 5.1 Common Stock Exchange Agreement Between SpaceDev and SIL (1) .. . . . . . . . . . . . . . . . . . . . . 10.1 Mutual Rescission and Release of Share Acquisition Agreement (1). . . . . . . . . . . . . . . . . . . . 10.2 Share Exchange Agreement Between SpaceDev and Integrated Space Systems (1) . . . .. . . . . . . . . . . 10.3 Agreement of License and Purchase of Technology Between SpaceDev and AMROC (1) . .. . . . . . . . . . . 10.4 Firm Fixed Price Agreement Number 108252 Between SpaceDev and Regents of the University of California (1).. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.5 Employment Agreement between Integrated Space Systems and Charles H. Lloyd (1) . . . . . . . . . . . . 10.6 PAGE II-17 Employment Agreement of James W. Benson (2). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.7 Deed of Counter-Indemnity dated August 28, 1999 (3) . . . . . . . . . . . . . . . . . . . . . . . . . . 10.8 Financial Advisory Services Agreement, dated June 18, 2001 (5). . . . . . . . . . . . . . . . . . . . . 10.9 Consultant/Advisory Services Agreement, dated June 18, 2001 (5). . . . . . . . . . . . . . . . . . . . 10.10 Employment Agreement between SpaceDev, Inc. and Stuart Schaffer, dated May 17, 2002(7). . . . . . . . 10.11 First Amendment to Employment Agreement with Stuart Schaffer, dated May 17, 2002(7). . . . . . . . . . 10.12 Employment Agreement between SpaceDev, Inc. and Emery Skarupa, dated May 24, 2002(7). . . . . . . . . . 10.13 Confidential Separation Agreement and General Release of Claims, dated May 31, 2002(7). . . . . . . . . 10.14 Code of Business Conduct and Ethics(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.15 Employment Agreement between SpaceDev and Richard B. Slansky, dated February 10, 2003(7) . . . . . . . 10.16 Second Amendment to Series A Subordinated Convertible Note - Benson1, dated March 25, 2003(7). . . . . 10.17 Second Amendment to Series A Subordinated Convertible Note - Benson2, dated March 25, 2003(7). . . . . 10.18 Second Amendment to Series A Subordinated Convertible Note - Benson3, dated March 25, 2003(7). . . . . 10.19 Second Amendment to Series A Subordinated Convertible Note - Benson4, dated March 25, 2003(7). . . . . 10.20 Second Amendment to Series A Subordinated Convertible Note - Skarupa, dated March 25, 2003(7). . . . . 10.21 Second Amendment to Series A Subordinated Convertible Note - Schaffer, dated March 25, 2003(7). . . . . 10.22 Security Agreement, dated as of June 3, 2003, by and between SpaceDev, Inc. ("SpaceDev") and Laurus Master Fund, Ltd. ("Laurus")(9). . . . . . . . . . . . . . . . . . . . . . 10.23 Secured Convertible Note, dated June 3, 2003, by and among SpaceDev and Laurus(9) . . . . . . . . . . . 10.24 Common Stock Purchase Warrant, dated June 3, 2003, issued by SpaceDev to Laurus(9). . . . . . . . . . . 10.25 Registration Rights Agreement, dated as of June 3, 2003, by and between SpaceDev and Laurus(9). . . . . 10.26 Waiver Letter, dated June 3, 2003, by and between SpaceDev and Laurus(9) . . . . . . . . . . . . . . . 10.27 Separation Agreement and General Release, by and between SpaceDev and Stuart Schaffer dated July 2, 2003(10). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.28 AFRL Small Vehicle Launch Technology SBIR contract(11) . . . . . . . . . . . . . . . . . . . . . . . . 10.29 AFRL Small Satellite Bus Technologies SBIR contract(11) . . . . . . . . . . . . . . . . . . . . . . . . 10.30 PAGE II-18 AFRL Small Shuttle Compatible Propulsion Module contract(11). . . . . . . . . . . . . . . . . . . . . . 10.31 MDA Advanced Systems Deputate for the Micro Satellite Experiment(11). . . . . . . . . . . . . . . . . . 10.32 MDA Advanced Systems Deputate for the Micro Satellite Experiment (Modification) (11). . . . . . . . . . 10.33 Lunar Enterprises of California contract(11). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.34 Hybrid Rocket Motor Systems and Components contract*(11). . . . . . . . . . . . . . . . . . . . . . . . 10.35 Third Amendment to Series A Subordinated Convertible Note - Benson1, dated Sept. 5, 2003(11) . . . . . 10.36 Third Amendment to Series A Subordinated Convertible Note - Benson2, dated Sept. 5, 2003(11) . . . . . 10.37 Third Amendment to Series A Subordinated Convertible Note - Benson3, dated Sept. 5, 2003(11) . . . . . 10.38 Third Amendment to Series A Subordinated Convertible Note - Benson4, dated Sept. 5, 2003(11) . . . . . 10.39 Third Amendment to Series A Subordinated Convertible Note - Skarupa, dated Sept. 5, 2003(11) . . . . . 10.40 Third Amendment to Series A Subordinated Convertible Note - Schaffer, dated Sept. 5, 2003(11) . . . . 10.41 Employment Offer between SpaceDev and Dario Emanuel DaPra, dated November 17, 2003(12). . . . . . . . . 10.42 Employment Offer between SpaceDev and Randall K. Simpson, dated Jan. 16, 2004(12). . . . . . . . . . . 10.43 Confidential Separation Agreement and General Release of Claims with Mr. DaPra, dated March 18, 2004(12). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.47 Missile Defense Agency Contract with SpaceDev, dated March 31, 2004 *(12) . . . . . . . . . . . . 10.48 Amendment No. 1 to Note with the Laurus Master Fund, dated March 31, 2004(12) . . . . . . . . . . . . . 10.49 Waiver Letter from Laurus Master Fund, dated March 31, 2004(12) . . . . . . . . . . . . . . . . . . . . 10.50 First Task Order Under Missile Defense Agency Contract with SpaceDev, dated April 1, 2004. . . . . . . . 10.51 Separation Agreement and General Release, by and between SpaceDev and Jeffrey Janicik dated June 18, 2004 (13). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.52 Modification to Small Shuttle Compatible Propulsion Module contract with AFRL dated July 7, 2004(13) . . 10.53 Lunar Enterprises of California contract with SpaceDev dated July 20, 2004(13). . . . . . . . . . . . . 10.54 Security Purchase Agreement, Dated August 25, 2004, by and among SpaceDev and Laurus(14). . . . . . . 10.55 PAGE II-19 Registration Rights Agreement, Dated August 25, 2004, by and among SpaceDev and Laurus(14). . . . . . . 10.56 Letter Agreement, Dated August 25, 2004, by and among SpaceDev and Laurus(14). . . . . . . . . . . . . 10.57 Air Force Research Laboratories contract with SpaceDev dated as of August 23, 2004(15). . . . . . . . . 10.58 Air Force Research Laboratories Statement of Work*(15). . . . . . . . . . . . . . . . . . . . . . . . . 10.59 List of Subsidiaries of the Company(12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21.1 Letter from Nation Smith dated June 4, 2003 (8) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23.1 SB-2 Consent Letter from Nation Smith dated September 17, 2004. . . . . . . . . . . . . . . . . . . . . 23.2 SB-2 Consent Letter from PKFdated September 17, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . 23.3 Consent of Weintraub Dillon PC (included in Exhibit 5.1 hereto) . . . . . . . . . . . . . . . . . . . . 23.4 PAGE II-20 ____________________ (1) Incorporated by reference to the corresponding Exhibit previously filed as an Exhibit to Registrant's Form 10-SB (File #000-28947). (2) Incorporated by reference to Exhibit 10.1 previously filed as an Exhibit to Registrant's Form 10-QSB filed on August 10, 2000. (3) Incorporated by reference to Exhibit 10.2 previously filed as an Exhibit to Registrant's Form 8-K filed on September 20, 2000. (4) Incorporated by reference to the corresponding Exhibit previously filed as an Exhibit to Registrant's Form 10-KSB filed on April 2, 2001. (5) Incorporated by reference to Exhibits 10.1 and 10.2 previously filed as an Exhibit to Registrant's Form 8-K filed on July 19, 2001. (6) Incorporated by reference to Exhibits 4.1, 4.2 and 4.3 previously filed as an Exhibit to Registrant's Form 10-QSB filed on November 14, 2002. (7) Incorporated by reference to the corresponding Exhibit previously filed as an Exhibit to Registrant's Form 10-KSB filed on March 28, 2003. (8) Incorporated by reference to Exhibits 16.1 previously filed as an Exhibit to Registrant's Form 8-K filed on June 4, 2003. (9) Incorporated by reference to Exhibits 10.1, 10.2, 10.3, 10.4 and 10.5 previously filed as an Exhibit to Registrant's Form 8-K filed on June 18, 2003. (10) Incorporated by reference to Exhibit 10.27 previously filed as an Exhibit to Registrant's Form SB-2 on July 25, 2003. (11) Incorporated by reference to Exhibits 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 10.9, 10.10, 10.11, 10.12 and 10.13 previously filed as an Exhibit to Registrant's Form 10-QSB on November 12, 2003. (12) Incorporated by reference to Exhibits 10.37, 10.38, 10.39, 10.40, 10.41, 10.42, 10.43, and 10.44 previously filed as an Exhibit to Registrant's Form 10-KSB filed on April 6, 2004. (13) Incorporated by reference to Exhibits 10.1, 10.2 and 10.3 previously filed as an Exhibit to Registrant's Form 10-QSB on August 9, 2004. (14) Incorporated by reference to Exhibits 3.1, 4.1, 4.2, 10.1, 10.2 and 10.3 previously filed as an Exhibit to Registrant's Form 8-K filed on August 30, 2004. (15) Incorporated by reference to Exhibits 10.1 and 10.2 previously filed as an Exhibit to Registrant's Form 8-K filed on September 1, 2004. * Registrant requested confidential treatment pursuant to Rule 406 for a portion of the referenced exhibit and has separately filed such exhibit with the Commission. PAGE II-21