Edgar Filing: SPACEDEV INC

As filed with the Securities and Exchange Commission on June 29, 2006.

Registration Statement No. 333-119494

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

-------------------------
POST EFFECTIVE AMENDMENT NO. 3
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)
-------------------------

RICHARD B. SLANSKY
PRESIDENT AND CHIEF FINANCIAL OFFICER
SPACEDEV, INC.
13855 STOWE DRIVE
POWAY, CALIFORNIA 92064
(858) 375-2030
(Name, address, including zip code, and telephone number, including
area code, of agent for service)
-------------------------

Copies to:

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 AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED . . BE REGISTERED (1) PER SHARE OFFERING PRICE FEE
------------------------------- ----------------- ----------------- --------------- --------------

Common Stock, $0.0001 par value,
underlying Preferred Stock & Dividends 1,845,779 1.5400(3) 2,842,500 $360.14

Common Stock, $0.0001 par value,
underlying Warrants. . . . . . . . . . 487,000 1.7700(4) 861,990 $109.21

Common Stock, $0.0001 par value,
underlying Convertible Note. . . . . . 1,000,000(2) 1.0000(5) 1,000,000 $126.70

Common Stock, $0.0001 par value,
underlying Warrants. . . . . . . . . . 50,000 1.9250(6) 96,250 $12.19
------------------------------- ----------------- ----------------- --------------- ----------------
Total. . . . . . . . . . . . . . . . . 3,382,779 4,800,250 $608.19
------------------------------- ----------------- ----------------- --------------- ----------------
------------------------------- ----------------- ----------------- --------------- ----------------

(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 3,382,779 shares.
(2) Represents 100% of the good faith estimate of the number of shares that are
issuable to the selling security holder 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) 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.
(4) 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.
(5) 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 $1.0 million
converted under the revolving credit facility was converted in 2004
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 $1.0
million under the revolving credit facility will be convertible by Laurus
at a rate of $1.00 per share.
(6) 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.

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 ________, 2006.

PROSPECTUS

SPACEDEV, INC.

3,382,779 SHARES OF COMMON STOCK

This prospectus relates to the resale by security holders of up to
3,382,779 shares of our common stock underlying (1) convertible preferred stock
and estimated accrued dividends thereon for up to 1,845,779 shares (the
"Preferred Stock" or "Preferred Shares"), (2) a common stock purchase warrant
for up to 487,000 shares issued to Laurus on August 25, 2004, (3) 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, which were
converted in 2004, and (4) 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 holder. We have not
retained any underwriter in connection with the sale of the securities. We have
paid, on behalf of the selling security holder, the expenses of the offering
estimated to be approximately $42,000.

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 April 3,
2006, was $1.52 per share.

Our principal offices are located at 13855 Stowe Drive, Poway, California
92064, and our telephone number is (858) 375-2000.

-------------------------

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 June 29, 2006.

PAGE 1

TABLE OF CONTENTS
Page
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PROSPECTUS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
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TABLE OF CONTENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
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PROSPECTUS SUMMARY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
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Our Company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
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The Offering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
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Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . 6
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RISK FACTORS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
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SELLING SECURITY HOLDERS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
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PLAN OF DISTRIBUTION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
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USE OF PROCEEDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
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DESCRIPTION OF BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
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Forward Looking Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
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General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
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Business Strategy . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . 28
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Products and Services; Market. . . . . . . . . . . . . . . . . . . . . . . . . . 28
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Components and Raw Materials.. . . . . . . . . . . . . . . . . . . . . . . . . . 31
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Competition . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . 31
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The Laurus Master Fund, Ltd. Revolving Credit Facility . . . . . . . . . . . . . 32
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Regulation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
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Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
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Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 36
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Results Of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
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Liquidity And Capital Resources. . . . . . . . . . . . . . . . . . . . . . . . . 46
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Critical Accounting Standards. . . . . . . . . . . . . . . . . . . . . . . . . . 50
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Recent Accounting Pronouncements . . . . . . . . . . . . . . . . . . . . . . . . 52
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DESCRIPTION OF PROPERTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . . . . . . . . . . . . . . . 54
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MARKET FOR COMMON EQUITY & RELATED STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . 55
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Market Information. .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
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Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
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Dividends . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 56
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PAGE 2

DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS & CONTROL PERSONS. . . . . . . . . . . . . . 57
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EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
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Executive Officer Compensation. . . . . . . . . . . . . . . . . . . . . . . . 62
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Director Compensation. . . . .. .. . . . . . . . . . . . . . . . . . . . . . . . 63
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Employment Agreements and termination of employment arrangements and change of
Control agreements . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 63
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Employee Benefits . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 65
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. . . . . . . . . . . . 67
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DESCRIPTION OF SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
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Preferred Stock . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 70
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Voting Rights . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 70
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Liquidation Rights . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . 70
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Dividends. . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 70
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Conversion. . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 71
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Redemption. . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 71
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Warrants. . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 71
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Transfer Agent and Registrar. . .. . . . . . . . . . . . . . . . . . . . . . . . 72
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DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES . 73
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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS . . . . . . . . . . . . . . . . . . . . 73
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EXPERTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
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LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
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WHERE YOU CAN FIND MORE INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . 74
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UNAUDITED PRO FORMA COMBINED CONSOLIDATED STATEMENTS. . . . . . . . . . . . . . . . . . 75
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FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-1

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 the Laurus Master Fund, Ltd.,
or simply Laurus, this prospectus covers the resale of up to: 1) 1,845,779
shares of our common stock that are issuable upon conversion of convertible
preferred stock and accrued dividends thereon; and 2) 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 which were converted in
2004. In addition, this prospectus covers the resale of up to: (1) 537,000
shares of common stock issuable upon exercise of outstanding warrants to Laurus
(collectively referred to as the "Laurus Warrant").

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.

Starsys Research Corporation was acquired by SpaceDev on January 31,
2006 in a tax-free forward triangular merger, renamed Starsys, Inc., and is now
a wholly-owned subsidiary of SpaceDev. Starsys is engaged in the design and
manufacture of mechanical and electromechanical subsystems and components for
spacecraft. Starsys' subsystems enable critical spacecraft functions such as
pointing solar arrays and communication antennas and restraining, deploying and
actuating moving spacecraft components. Starsys manufactures a wide range of
products that include bi-axis gimbals, flat plate gimbals, solar array pointing
mechanisms, deployable booms, separation systems, thermal louvers, actuators,
restraint devices and cover systems. Starsys' products are sold both as
"off-the-shelf" catalog products, which represent previously qualified devices
with spaceflight history, and as custom systems that are developed for specific
applications. Starsys' products are typically sold directly to spacecraft
manufacturers. Starsys' customer base is segregated into three major segments:
(1) domestic and international commercial spacecraft (communication and imaging
satellites), (2) civil spacecraft (NASA) that are primarily scientific in nature
and (3) defense spacecraft that support the United States' military capability.
Starsys also offers products to non-space customers, including aerospace,
maritime, and industrial customers. See "Description of Business" for more
information.

THE OFFERING

Common stock underlying the
interest and/or principal of the
Convertible Note
which were converted in 2004 1,000,000 shares

Common stock underlying the Laurus Warrants 537,000 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 based on shares outstanding on
May 31, 2006 31,136,610 shares

PAGE 4

Termination of the Offering The offering will conclude upon the
earlier of the sale of all
3,382,779 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 Preferred Shares, 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 quarters
ended March 31, 2006 and 2005, and the fiscal years ended December 31, 2005 and
2004. The financial data as of and for the fiscal years ended December 31, 2005
and 2004 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. Our historical results are not
necessarily indicative of results to be expected for any future periods.

CONSOLIDATED STATEMENTS OF OPERATIONS DATA

THREE MONTHS ENDED YEARS ENDED
MARCH 31, DECEMBER 31,
------------------------------- ------------------------------

2006 2005 2005 2004
------------- ------------- ------------- -------------
Net revenues $ 7,174,778 $ 1,806,889 $ 9,005,011 $ 4,890,743
Income/(loss) from operations $ (46,398) $ 65,567 $ 311,500 $ 144,285
Net income/(loss) $ 7,017 $ 101,223 $ 501,264 $ (3,027,054)
Basic income/(loss) per share $ (0.00) $ 0.00 $ 0.02 $ (0.16)
Weighted average shares outstanding, basic 27,276,451 21,291,972 22,270,997 18,610,141

AS AT AS AT
MARCH 31, DECEMBER 31,
---------------------------------- ----------------------------------

2006 2005 2005 2004
---------------- ---------------- ---------------- ----------------
Cash and cash equivalents $ 1,142,595 $ 5,412,949 $ 5,750,038 $ 5,068,601
---------------- ---------------- ---------------- ----------------
Working capital $ 2,646,002 $ 5,126,732 $ 6,195,086 $ 4,897,796
---------------- ---------------- ---------------- ----------------
Total assets $ 26,565,521 $ 6,455,008 $11,008,649 $ 6,090,434
---------------- ---------------- ---------------- ----------------
Long-term debt, net of current portion $ 914,641 $ 919 044 $ 830,677 $ 963,875
---------------- ---------------- ---------------- ----------------
Stockholders' Equity $ 18,156,656 $ 4,618,393 $ 7,969,213 $ 4,335,657
---------------- ---------------- ---------------- ----------------

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.

SPACEDEV AND STARSYS HAVE EXPERIENCED LOSSES FROM OPERATIONS IN
PRIOR PERIODS AND HAVE BEEN REQUIRED TO SEEK ADDITIONAL FINANCING TO SUPPORT
THEIR BUSINESSES.

In prior years, both SpaceDev and Starsys have experienced operating losses
and, in some periods, revenues from operations have not been sufficient to fund
their respective operations. On a pro forma basis, the combined company would
have had a net loss from operations of approximately $5.0 million for the
year ended December 31, 2004 and $2.9 million for the year ended December 31,
2005, assuming the merger had occurred on January 1, 2004. The
success of the combined company's business depends upon our ability to generate
revenue from existing contracts, to execute programs cost-effectively, to
attract and complete successfully additional government and commercial
contracts, and additional financing. The likelihood of our success must
be considered in light of the expenses, difficulties and delays frequently
encountered in connection with developing businesses, those historically
encountered by us, and the competitive environment in which we operate.

IF WE ARE UNABLE TO RAISE CAPITAL, WE MAY BE UNABLE TO FUND OPERATING CASH
SHORTFALLS AND FUTURE GROWTH OPPORTUNITIES.

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 March 31, 2006 and
2005, we had a working capital of $2,646,002, and $5,126,732, respectively, and
an accumulated deficit of $14,710,427 and $14,846,800, respectively. As of those
dates, we had $1,142,595 and $5,412,949, respectively, in cash and cash
equivalents and $5,769,883 and $620,048, respectively, of accounts receivable,
net of allowance for doubtful accounts.

In the past, both SpaceDev and Starsys have relied upon cash from financing
activities to fund part of the cash requirements of their respective businesses.
We may need additional financing to fund our projected operations. Additional
financing may not be available to us on acceptable terms, or at all. Any
financing may cause additional dilution to existing shareholders. Any debt
financing or other issuance of securities senior to common stock likely will
include financial and other covenants that will restrict our operating
flexibility and our ability to pay dividends to shareholders. SpaceDev has not
paid dividends on its common stock in the past and does not anticipate paying
dividends on its common stock in the foreseeable future.

SOME OF OUR GOVERNMENT CONTRACTS ARE STAGED AND WE CANNOT GUARANTEE THAT
ALL STAGES OF THE CONTRACTS WILL BE AWARDED TO US.

Some of our government contracts are phased contracts in which the customer
may determine to terminate the contract between phases for any reason.
Accordingly, the entire contract amount may not be realized by us. In the
event that subsequent phases of some of our government contracts, including but
not limited to the Missile Defense Agency contract, are not awarded to us, it
could have a material adverse effect on our financial position and results of
operations.

PAGE 6

WE PROVIDE OUR PRODUCTS AND SERVICES PRIMARILY THROUGH FIXED-PRICE AND
COST PLUS FIXED FEE CONTRACTS. STARSYS HAS EXPERIENCED SIGNIFICANT LOSSES ON
FIXED-PRICE CONTRACTS. COST OVERRUNS MAY RESULT IN FURTHER LOSSES AND, IF
SIGNIFICANT, COULD IMPAIR OUR LIQUIDITY POSITION.

Under fixed-price contracts, our customers pay us for work performed and
products shipped without adjustment for the costs we incur in the process.
Therefore, we generally bear all or a significant portion of the risk of losses
as a result of increased costs on these contracts. Starsys has experienced
significant cost overruns on development projects under its fixed-price
contracts, resulting in estimated losses on uncompleted contracts of $2.7
million for Starsys' fiscal 2004, and an additional $2.5 million for the twelve
months ended December 31, 2005. As of December 31, 2005, based on a formal
evaluation process, Starsys reserved approximately $1.5 million for potential
risks on these remaining development projects. Fixed-price contracts may
provide for sharing of unexpected costs incurred or savings realized within
specified limits and may provide for adjustments in price depending on actual
contract performance other than costs. We bear the entire risk of cost overruns
in excess of the negotiated maximum amount of unexpected costs to be shared. Any
significant overruns in the future could materially impair our liquidity and
operations.

Under cost plus fixed fee contracts, we are reimbursed for allowable
incurred costs plus a fee, which may be fixed or variable. There is no
guarantee as to the amount of fee we will be awarded under a cost plus fixed fee
contract with a variable fee. The price on a cost plus fixed fee reimbursable
contract is based on allowable costs incurred, but generally is subject to
contract funding limitations. Therefore, we could bear the amount of costs in
excess of the funding limitation specified in the contract, and we may not be
able to recover those cost overruns.

IF WE FAIL TO INTEGRATE OUR OPERATIONS EFFECTIVELY, THE COMBINATION OF
SPACEDEV AND STARSYS WILL NOT REALIZE ALL THE POTENTIAL BENEFITS OF THE MERGER
AND MAY BE COUNTER PRODUCTIVE.

- failure to successfully manage relationships with customers and other
important relationships;

- failure of customers to accept new services or to continue using the
products and services of the combined company;

- difficulties in successfully integrating the management teams and employees
of the two companies;

- potential incompatibility of business cultures;

- challenges encountered in managing larger, more geographically dispersed
operations;

- the loss of key employees;

- diversion of the attention of management from other ongoing business
concerns;

- potential incompatibilities of processes, technologies and systems; and,

- potential difficulties integrating and harmonizing financial reporting
systems.

If the combined company's operations do not meet the expectations of
existing customers of either company, these customers may reduce the amount of
business or cease doing business with the combined company altogether, which
would harm the results of operations and financial condition of the combined
company.

If the anticipated benefits of the merger are not realized or do not meet
the expectations of financial or industry analysts, the market price of SpaceDev
common stock may decline. This could occur if, among other reasons:

- the integration of the two companies is unsuccessful;

- the combined company does not achieve the expected benefits of the merger
as quickly as anticipated or the costs of or operational difficulties
arising from the merger are greater than anticipated;

- the combined company's financial results after the merger are not
consistent with the expectations of management or financial or industry
analysts;

- the anticipated operating and product synergies of the merger are not
realized; or

- the combined company experiences the loss of significant customers or
employees as a result of the merger.

IF WE FAIL TO INTEGRATE STARSYS, INC., OUR NEW WHOLLY OWNED SUBSIDIARY, OUR
CASH FLOW AND OPERATING RESULTS COULD BE ADVERSELY AFFECTED.

We recently acquired Starsys, Inc., as a subsidiary of SpaceDev. Starsys
which was insolvent at the time of the merger and we have begun making
post-acquisition cash investments into Starsys. As stated previously, SpaceDev
and Starsys have experienced losses from operations in prior periods, requiring
that we seek additional financing to support our businesses. Our operating
plans assume revenue and cash growth from SpaceDev and Starsys. If we are
unable to effectively integrate our new subsidiary, or if we are unable to
create positive cash flow within SpaceDev or Starsys, our cash flow and
operating results could be adversely affected.

PAGE 7

A SUBSTANTIAL PORTION OF OUR NET SALES ARE GENERATED FROM GOVERNMENT
CONTRACTS, WHICH MAKES US SUSCEPTIBLE TO THE UNCERTAINTIES INHERENT IN THE
GOVERNMENT BUDGETING PROCESS. IN ADDITION, MANY OF OUR CONTRACTS CAN BE
TERMINATED BY THE CUSTOMER.

Our concentration of government work makes us susceptible to government
budget cuts and policy changes, which may impact the award of new contracts or
future phases of existing contracts. Government budgets (both in general and
as to space and defense projects) are subject to the prevailing political
climate, which is subject to change at any time. Additionally, awarded contracts
could be altered or terminated prior to the time we recognize our projected
revenue. Many contracts are awarded in phases where future phases are not
guaranteed to us. In addition, obtaining contracts and subcontracts from
government agencies is challenging, and contracts often include provisions that
are not standard in private commercial transactions. For example, government
contracts may:

- include provisions that allow the government agency to terminate the
contract without penalty under some circumstances;

- be subject to purchasing decisions of agencies that are subject to
political influence;

- contain onerous procurement procedures; and

- be subject to cancellation if government funding becomes unavailable.

Securing government contracts can be a protracted process involving
competitive bidding. In many cases, unsuccessful bidders may challenge contract
awards, which can lead to increased costs, delays and possible loss of the
contract for the winning bidder.

OUR HISTORIC SPACEDEV BUSINESS' LIMITED OPERATING HISTORY AND LACK
OF EXPERIENCE IN OUR NEW OR PROPOSED LINES OF BUSINESS MAKES IT DIFFICULT TO
PREDICT OUR FUTURE PROSPECTS.

We have a limited operating history and, as a result, our historical
financial information is of limited value in projecting our future success in
these markets. We launched our first microsatellite, CHIPSat, in January 2003
and, in June, September and October, 2004, our hybrid rocket technology was
first utilized in connection with SpaceShipOne. We hope to sell an
increasing percentage of our products and services in commercial markets, but
virtually all of our historical work has been from government contracts and
government-related work. We recently announced our intention to enter the launch
services market by providing a microsat bus, integration services, and a launch
vehicle as a package. We will be dependent on the performance of Space
Exploration Technologies, a small company with limited operating history which
has not yet had a successful launch, for our first launch vehicle. Our
microsatellites, nanosatellites and launch services may not achieve market
acceptance, and our future prospects are therefore difficult to evaluate.

WE MAY NOT SUCCESSFULLY OR TIMELY DEVELOP PRODUCTS.

Many of our products and technologies are currently under various
stages of development. Further development and testing of our products and
technologies will be required to prove additional performance capability beyond
current levels and to confirm commercial viability. Additionally, the final cost
of development cannot be determined until development is complete. Our ongoing
and future product development will depend, in part, on the ability to timely
complete our projects within estimated cost parameters and ultimately deploy the
product in a cost-effective manner. In addition, Starsys has contracted to
execute development programs under fixed price contracts. Under these contracts,
even if our costs begin to exceed the amount to be paid by the customer under
the contract, we are required to complete the contract without receiving any
additional payments from the customer. It is difficult to predict accurately the
total cost of executing these programs. If the costs to complete these programs
significantly exceed the payments from the customers under the contracts, our
results of operations will be harmed.

THE MARKETPLACE FOR OUR TECHNOLOGY AND PRODUCTS IS UNCERTAIN.

The demand for our technology, products and services is uncertain and we
may not obtain a sufficient market share to sustain our business or to increase
profitability. Our business plan assumes that near-term revenues will be
generated largely from government contracts for microsatellites and
electromechanical systems for spacecraft with a long-term commercial market
developing for private manned and unmanned space exploration. Microsatellites
and commercial space exploration are still relatively new concepts, and it is
difficult to predict accurately the ultimate size of the market. In addition, we
are developing new product areas such as large deployable structures, solar
array drives, slip rings and precision scanning assemblies for spacecraft. Many
of our products and services are new and unproven, and the true level of
customer demand is uncertain. Lack of significant market acceptance of our
products and services, delays in such acceptance, or failure of our markets to
develop or grow could negatively affect our business, financial condition, and
results of operations.

OUR OPERATING RESULTS COULD FLUCTUATE ON A QUARTERLY AND ANNUAL
BASIS, WHICH COULD CAUSE OUR STOCK PRICE TO FLUCTUATE OR DECLINE.

Our operating results may fluctuate from quarter-to-quarter
and year-to-year for a variety of reasons, many of which are beyond our control.
Factors that could affect our quarterly and annual operating results include
those listed below as well as others listed in this "Risk Factors" section:

- we may not be awarded all stages of existing or future contracts;

- the timing of new technological advances and product announcements or
introductions by us and our competitors;

- changes in the terms of our arrangements with customers or suppliers;

- our current reliance on a few customers for a significant portion of our
net sales;

PAGE 8

- the failure of our key suppliers to perform as expected;

- general political conditions that could affect spending for the products
that we offer;

- delays or failures to satisfy our obligations under our contracts on a
timely basis;

- the failure of our products to successfully launch or operate;

- the uncertain market for our technology and products;

- the availability and cost of raw materials and components for our
products; and

- the potential loss of key personnel.

As a result of these factors, period-to-period comparisons of our operating
results may not be meaningful, and you should not rely on them as an indication
of our future performance. In addition, our operating results may fall below the
expectations of public market analysts or investors. In this event, our stock
price could decline significantly.

WE FACE SIGNIFICANT COMPETITION AND MANY OF OUR COMPETITORS HAVE GREATER
RESOURCES THAN WE DO.

We face significant competition for our government and commercial
contracts. Many of our competitors have greater resources than we do and may be
able to devote greater resources than us to research and development and
marketing. Given the sophistication inherent in our operations, larger
competitors may have a significant advantage and may be able to more efficiently
adapt and implement technological advances. In addition, larger and
financially stronger corporations have advantages over us in obtaining space and
defense contracts due to their superior marketing (lobbying) resources and the
perception that they may be a better choice than smaller companies for
mission-critical projects because of the higher likelihood that they will be
able to continue in business for the necessary future period. Furthermore,
it is possible that other domestic or foreign companies or governments, some
with greater experience in the space industry and many with greater financial
resources than we possess, could seek to produce products or services that
compete with our products or services, including new mechanisms and
electromechanical subsystems using new technology which could render our
products less viable. Some of our foreign competitors currently benefit from,
and others may benefit in the future from, subsidies from or other protective
measures implemented by their home countries.

OUR PRODUCTS AND SERVICES MAY NOT FUNCTION WELL UNDER CERTAIN
CONDITIONS.

Most of our products are technologically advanced and tested, but
sometimes are not space qualified for performance under demanding operating
conditions. Our products may not be successfully launched or operated, or
perform as intended. Like most organizations that have launched satellite
programs, we have experienced and in the future will likely experience
some product and service failures, cost overruns, schedule delays, and other
problems in connection with our products. 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 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.

LAUNCH FAILURES COULD HAVE SERIOUS ADVERSE EFFECTS ON OUR BUSINESS.

Launch failures or delays of our microsatellites could have serious
adverse effects on our business. Microsatellite launches are subject to
significant risks, the realization of which can cause disabling damage to or
total loss of a microsatellite as well as damage to our reputation among
actual and potential customers. Delays in the launch could also adversely
affect our net sales. 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;

PAGE 9

- 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 and limit our ability to obtain new contracts and projects.

OUR U.S. GOVERNMENT CONTRACTS ARE SUBJECT TO AUDITS THAT COULD RESULT IN A
MATERIAL ADVERSE AFFECT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS IF
A MATERIAL ADJUSTMENT IS REQUIRED.

The accuracy and appropriateness of our direct and indirect costs and
expenses under our contracts with the U.S. government are subject to extensive
regulation and audit by the Defense Contract Audit Agency, by other agencies of
the U.S. government or prime contractors. These entities have the right to
audit our cost estimates and/or allowable cost allocations with respect to
certain contracts. From time to time we may in the future be required to make
adjustments and reimbursements as a result of these audits. Responding to
governmental audits, inquiries or investigations may involve significant expense
and divert management attention. Also, an adverse finding in any such audit,
inquiry or investigation could involve contract termination, suspension, fines,
injunctions or other sanctions.

OUR SUCCESS DEPENDS ON OUR ABILITY TO RETAIN OUR KEY PERSONNEL. THE
JANUARY 2006 IMPLEMENTATION OF FAS 123(R) AND THE RELATED DECEMBER 2005
ACCELERATION OF VESTING ALL OUTSTANDING STOCK OPTIONS REDUCED THE EFFECTIVENESS
OF THE STOCK OPTIONS AS A RETENTION DEVICE.

Our success will be dependent upon the efforts of key members of our
management and engineering team, including our chairman and chief technology
officer, James W. Benson, our chief executive officer and vice-chairman, Mark N.
Sirangelo, our president and chief financial officer, Richard B. Slansky, our
vice president of engineering, Frank Macklin, our vice president of programs and
new business development, Randall K. Simpson, the managing director of
SpaceDev, Scott Tibbitts, the president of Starsys, Inc. Robert
Vacek, and certain other SpaceDev personnel. The loss of any of these
persons, or other key employees, including personnel with security clearances
required for classified work and highly skilled technicians and engineers, could
have a material adverse effect on us. 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. At
this time we do not maintain key man life insurance on any of our key personnel.

One device we have historically used to enhance our ability to retain
and incentivize key personnel is the grant of stock options which are subject to
vesting. If the employee leaves us before the vesting period has been completed,
he must forfeit a portion of the stock options. In December 2005, in order to
avoid adverse financial reporting effects in future years under FAS 123(R), a
new accounting standard, we eliminated all future vesting requirements on all of
our 8,031,036 stock options then outstanding in the hands of employees,
officers, and directors.

OUR GROWTH MAY NOT BE MANAGEABLE AND OUR BUSINESS COULD SUFFER AS A RESULT.

Even if we are successful in obtaining new business, failure to manage the
growth could adversely affect our operations. We may experience extended periods
of very rapid growth, which 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,
improve project management systems and processes and expand, train, and
manage our workforce 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.

PAGE 10

WE MAY NOT ADDRESS SUCCESSFULLY THE PROBLEMS ENCOUNTERED IN CONNECTION WITH
ANY POTENTIAL FUTURE ACQUISITIONS.

We expect to consider opportunities to acquire or make investments in other
technologies, products and businesses that could enhance our capabilities,
complement our current products or expand the breadth of our markets or customer
base. We have limited experience in acquiring other businesses and
technologies;the Starsys acquisition was our first major acquisition.
Potential and completed acquisitions and strategic investments involve numerous
risks, including:

- problems assimilating the purchased technologies, products or business
operations;

- problems maintaining uniform standards, procedures, controls and policies;

- unanticipated costs associated with the acquisition;

- diversion of management's attention from our core business;

- adverse effects on existing business relationships with suppliers and
customers;

- risks associated with entering new markets in which we have no or limited
prior experience;

- potential loss of key employees of acquired businesses; and

- increased legal and accounting costs as a result of the newly adopted
rules and regulations related to the Sarbanes-Oxley Act of 2002.

IF OUR KEY SUPPLIERS FAIL TO PERFORM AS EXPECTED, OUR REPUTATION MAY BE
DAMAGED. WE MAY EXPERIENCE DELAYS, LOSE CUSTOMERS AND EXPERIENCE DECLINES IN
REVENUES, PROFITABILITY, AND CASH FLOW.

We purchase a significant percentage of our product components and
subassemblies from third parties. If our subcontractors fail to perform
as expected or encounter financial difficulties, we may have difficulty
replacing them or identifying qualified replacements in a timely or cost
effective manner. As a result, we may experience performance delays that could
result in additional program costs, contract termination for default or damage
to our customer relationships which may cause our revenues, profitability and
cash flow to decline. In addition, negative publicity from any failure of one of
our products or sub-systems as a result of a supplier failure could damage our
reputation and prevent us from winning new contracts.

OUR LIMITED INSURANCE MAY NOT COVER ALL RISKS INHERENT IN OUR OPERATIONS.

We may find it difficult to insure certain risks involved in our
operations, including our launch vehicle and satellite operations, accidental
damage to high value customer hardware during the manufacturing process and
damages to customer spacecraft caused by our products not working to
specification. Insurance market conditions or factors outside of our control at
the time 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, proceeds from insurance may not
be sufficient to cover losses.

SEVERAL YEARS OF LOW DEMAND AND OVERCAPACITY IN THE COMMERCIAL SATELLITE
MARKET HAVE RESULTED IN SLOW GROWTH IN DEMAND FOR SPACE PRODUCTS.

The commercial satellite market has experienced pricing pressures due to
excess capacity in the telecommunications industry and weakened demand over the
past several years. Satellite demand, and thus subsystem and component orders,
have also been impacted by the business difficulties encountered by the
commercial satellite services industry. This has resulted in a reduction in the

PAGE 11

total market size in the near term. While the market appears to be making a
recovery, growth in the demand for our products may be limited.

OUR COMPETITIVE POSITION WILL BE SERIOUSLY DAMAGED IF WE CANNOT PROTECT
INTELLECTUAL PROPERTY RIGHTS IN OUR TECHNOLOGY.

Our success, in part, depends on our ability to obtain and enforce
intellectual property protection for our technology. We rely on a combination of
patents, trade secrets and contracts to establish and protect our proprietary
rights in our technology. However, we may not be able to prevent
misappropriation of our intellectual property, and the agreements we enter into
may not be enforceable. In addition, effective intellectual property
protection may be unavailable or limited in some foreign countries.

There is no guarantee any patent will be issued on any patent
application that we have filed or may file. Further, any patent that we may
obtain will expire, and it is possible that it may be challenged, invalidated or
circumvented. If we do not secure and maintain patent protection for our
technology and products, our competitive position will be significantly harmed
because it will be much easier for competitors to sell products similar to ours.
Alternatively, a competitor may independently develop or patent technologies
that are substantially equivalent to or superior to our technology. In
addition, it is possible that any patent that we may obtain may not provide
adequateprotection and our competitive position could be significantly
harmed.

As we expand our product line or develop new uses for our products, these
products or uses may be outside the scope of our current patent applications,
issued patents, and other intellectual property rights. In addition, if we
develop new products or enhancements to existing products, there is no guarantee
that we will be able to obtain patents to protect them. Even if we do receive
patents for our existing or new products, these patents may not provide
meaningful protection. In some countries outside of the United States,
effective patent protection is not available. Moreover, some countries
that do allow registration of patents do not provide meaningful redress for
violations of patents. As a result, protecting intellectual property in these
countries is difficult and our competitors may successfully sell products in
those countries that have functions and features that infringe on our
intellectual property.

We may initiate claims or litigation against third parties in the future
for infringement of our proprietary rights or to determine the scope and
validity of our proprietary rights or the proprietary rights of competitors.
These claims could result in costly litigation and divert the efforts of our
technical and management personnel. As a result, our operating results could
suffer and our financial condition could be harmed,regardless of the outcome
of the case.

CLAIMS BY OTHER COMPANIES THAT WE INFRINGE THEIR INTELLECTUAL PROPERTY OR
THAT PATENTS ON WHICH WE RELY ARE INVALID COULD ADVERSELY AFFECT OUR BUSINESS.

From time to time, companies may assert patent, copyright and other
intellectual proprietary rights against our products or products using our
technologies or other technologies used in our industry. These claims may
result in our involvement in litigation. We may not prevail in such litigation
given the complex technical issues and inherent uncertainties in intellectual
property litigation. If any of our products were found to infringe on another
company's intellectual property rights, we could be required to redesign our
products or license such rights and/or pay damages or other compensation to such
other company. If we were unable to redesign our products or license such
intellectual property rights used in our products, we could be prohibited from
making and selling such products.

Other companies or entities also may commence actions seeking to establish
the invalidity of our patents. In the event that one or more of our patents are
challenged, a court may invalidate the patent or determine that the patent is
not enforceable, which could harm our competitive position. If any of our key
patents are invalidated, or if the scope of the claims in any of these patents
is limited by court decision, we could be prevented from licensing the
invalidated or limited portion of such patents. Even if such a patent challenge
is not successful, it could be expensive and time consuming to address, divert
management attention from our business and harm our reputation.

WE ARE SUBJECT TO SUBSTANTIAL REGULATION, SOME OF WHICH PROHIBITS US
FROM SELLIING INTERNATIONALLY. ANY FAILURE TO COMPLY WITH EXISTING
REGULATIONS, OR INCREASED LEVELS OF REGULATION, COULD HAVE A MATERIAL ADVERSE
EFFECT ON US.

Our business activities are subject to substantial regulation by various
agencies and departments of the United States 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 or, "ITAR." Exports of our products, services and technical
information require either Technical Assistance Agreements, manufacturing
license 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.
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.

In addition, the space industry has specific regulations with which we must
comply. Command and telemetry frequency assignments for space missions are
regulated internationally by the International Telecommunications Union, which
we refer to as the ITU. In the United States, the Federal Communications
Commission, which we refer to as the FCC, and the National Telecommunications
Information Agency, which we refer to as 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.

We are also subject to laws and regulations regulating the formation,
administration and performance of, and accounting for, U.S. government
contracts. With respect to such contracts, any failure to comply with applicable
laws could result in contract termination, price or fee reductions, penalties,
suspension or debarment from contracting with the U.S. government. We are also
required to obtain permits, licenses, and other authorizations under federal,
state, local and foreign laws and regulations relating to the environment. Our
failure to comply with applicable law or government regulations, including any
of the above-mentioned regulations, could have serious adverse effects on our
business.

SPACEDEV'S 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
particularly in industries (also like ours) where substantial value is ascribed
to a hope for future increase in the size of the total market, are often highly
volatile. The market price of SpaceDev common stock has fluctuated significantly
in the past. Our market price may continue to exhibit significant fluctuations
in response to a variety of factors, many of which are beyond our control,
including:

- deviations in our results of operations from estimates;

- changes in estimates of our financial performance;

- changes in our markets, including decreased government spending or the
entry of new competitors;

- our inability to obtain financing necessary to operate our business and
consummate the merger;

PAGE 12

- changes in technology;

- potential loss of key personnel;

- short selling;

- changes in market valuations of similar companies and stock market price;

- the Starsys merger; and

- volume fluctuations generally, including re-sales by former Starsys
stockholders or by Laurus.

OUR NET OPERATING LOSS CARRYFORWARDS MAY BE SUBJECT TO AN ANNUAL LIMITATION
ON THEIR UTILIZATION, WHICH MAY INCREASE OUR TAXES AND DECREASE NET INCOME AND
CASH FLOWS.

We had a net deferred tax asset of approximately $2,484,000 and $2,075,000
at March 31, 2006 and 2005, respectively, which consisted primarily of the
income tax benefits from net operating loss and capital loss carryforwards,
amortization of deferred gain on sale of building and research and development
credits. Deferred income taxes represent temporary differences in recognizing
certain income and expense items for financial and tax reporting purposes. 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 from $2,075,000 at March 31, 2005 to $2,484,000 at March 31,
2006.

We had federal and state tax net operating loss and capital loss
carryforwards of approximately $4,214,000 and $2,316,000 at March 31, 2006 and
2005, respectively. The federal tax loss carryforwards will expire in 2023 and
the state tax loss carryforwards will expire in 2013, unless previously
utilized.

CHANGES IN STOCK OPTION ACCOUNTING RULES MAY ADVERSELY AFFECT OUR REPORTED
OPERATING RESULTS PREPARED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES, OUR STOCK PRICE AND OUR EFFORTS IN RECRUITING ADDITIONAL EMPLOYEES.

Technology companies, in general, and our company in particular, depend
upon and use broad based employee stock option programs to hire, incent and
retain employees in a competitive marketplace. Through fiscal 2005, we did not
recognize compensation expense for stock options issued to employees or
directors, except in limited cases involving modifications of stock options, and
we instead disclosed in the notes to our financial statements information about
what such charges would be if they were expensed. An accounting standard setting
body has adopted a new accounting standard that will require us to record
equity-based compensation expense for stock options and employee stock purchase
plan rights granted to employees based on the fair value of the equity
instrument at the time of grant. We are now recording these expenses beginning
with the first quarter of 2006. The change in accounting rules will lead to a
decrease in reported earnings, if we have earnings, or an increased loss, if we
do not have earnings. This may negatively impact our future stock price. In
addition, this change in accounting rules could impact our ability to utilize
broad based employee stock plans to reward employees and could result in a
competitive disadvantage to us in the employee marketplace.

PAGE 13

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 May 1, 2006, our executive officers and directors together
beneficially owned approximately 50.27% of the issued and outstanding
shares of our common stock. As a result, these persons could have the ability to
exert significant influence over matters concerning us, including 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, our officers and directors
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 shareholders. 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.

WE HAVE NOT PAID DIVIDENDS ON OUR COMMON STOCK IN THE PAST AND DO NOT
ANTICIPATE PAYING DIVIDENDS ON OUR COMMON STOCK IN THE FORESEEABLE FUTURE.

We have not paid common stock dividends since our inception and
do not anticipate paying dividends in the foreseeable future. Our current
business plan provides for the reinvestment of earnings in an effort to complete
development of our technologies and products, with the goal of increasing sales
and long-term profitability and value. In addition, the revolving credit
facility with Laurus Master Fund Ltd. and the terms of our preferred stock
currently restrict, and any other credit or borrowing arrangements that we may
enter into may in the future restrict or limit, our ability to pay common stock
dividends to our shareholders.

OUR EXPANSION INTO OTHER NEW LINES OF BUSINESS MAY DIVERT MANAGEMENT'S
ATTENTION FROM OUR EXISTING OPERATIONS AND PROVE TO BE TOO COSTLY.

Our current business plan contemplates the migration of SpaceDev's
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 business. Consequently, this expansion may
divert management's time and attention away from our core business, and we may
need to incur significant expenses in order to develop the expertise, and
reputation we desire. Any revenues generated by new lines of business may not
be significant enough to offset the expenditures required to enter such
business, or provide the anticipated return on investment.

SPACEDEV COMMON SHAREHOLDERS WILL EXPERIENCE DILUTION IF OUR PREFERRED
STOCK IS CONVERTED OR OUR OUTSTANDING WARRANTS AND OPTIONS ARE EXERCISED.

As of May 1, 2006, SpaceDev is obligated to issue 9,776,177 shares
of SpaceDev common stock if all of SpaceDev's outstanding warrants are exercised
and shares of preferred stock converted. In addition, as of May 1,
2006, SpaceDev has outstanding stock options to purchase an aggregate of

PAGE 14

11,012,142 shares of SpaceDev common stock, of which 10,312,142 are
currently vested. The total number of shares, issuable upon the exercise of
currently vested warrants, options and preferred stock (20,088,319 shares)
represents approximately 70% of SpaceDev's issued and outstanding shares of
common stock as of May 1, 2006.

FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS THE PRICE OF THE COMMON STOCK.

Sales by SpaceDev's current and future shareholders of a substantial number
of shares, including sales by the Starsys shareholders following the merger, or
the expectation that such sales may occur, could significantly reduce the market
price of our common stock. As described in the immediately preceding risk
factor, SpaceDev has a significant number of shares that are issuable upon
exercise of options and warrants or upon conversion of shares of preferred
stock. All of these shares are either registered with the SEC and may be sold
without restriction (except for volume limitations applicable to our officers,
directors and significant shareholders with respect to their option shares, and
contractual lockup restrictions obtained from some of the Starsys shareholders)
or have registration rights requiring us to register these shares with the SEC.
In the future, we may issue additional shares of common stock, convertible
securities, options and warrants.

Technology companies, in general, and our company in particular, depend
upon and use broad based employee stock option programs to hire, incentivize and
retain employees in a competitive marketplace. Currently, we do not recognize
compensation expense for stock options issued to employees or directors, except
in limited cases involving modifications of stock options, and we instead
disclose in the notes to our financial statements information about what such
charges would be if they were expensed. An accounting standard setting body has
recently adopted a new accounting standard that will require us to record
equity-based compensation expense for stock options and employee stock purchase
plan rights granted to employees based on the fair value of the equity
instrument at the time of grant. We are required to record these expenses
beginning with the first quarter of the year ending December 31, 2006. The
change in accounting rules will lead to a decrease in reported earnings, if we
have earnings, or an increased loss, if we do not have earnings. This may
negatively impact our future stock price. In addition, this change in accounting
rules could impact our ability to utilize broad based employee stock plans to
reward employees and could result in a competitive disadvantage to us in the
employee marketplace.

WE ARE SUBJECT TO NEW CORPORATE GOVERNANCE AND INTERNAL CONTROL REPORTING
REQUIREMENTS, AND OUR COSTS RELATED TO COMPLIANCE WITH, OR OUR FAILURE TO COMPLY
WITH EXISTING AND FUTURE REQUIREMENTS COULD ADVERSELY AFFECT OUR BUSINESS.

We face new corporate governance requirements under the Sarbanes-Oxley Act
of 2002, as well as new rules and regulations subsequently adopted by the SEC,
the Public Company Accounting Oversight Board and any stock exchange on
which our stock may be listed in the future. These laws, rules and
regulations continue to evolve and may become increasingly stringent in the
future. In particular, we will be required to include management and independent
registered public accounting firm reports on internal controls as part of our
annual report for the year ending December 31, 2007 pursuant to Section 404 of
the Sarbanes-Oxley Act. We are in the process of evaluating our control
structure and processes to help ensure that we will be able to comply
with Section 404 of the Sarbanes-Oxley Act. We cannot assure you that we will be
able to fully comply with these laws, rules and regulations that address
corporate governance, internal control reporting and similar matters. Failure to
comply with these laws, rules and regulations could materially adversely affect
our reputation, financial condition and the value of our securities.

THE TERMS OF OUR OUTSTANDING SHARES OF PREFERRED STOCK, AND ANY
SHARES OF PREFERRED STOCK ISSUED IN THE FUTURE, MAY REDUCE THE VALUE OF YOUR
COMMON STOCK.

We are authorized to issue up to 10,000,000 shares of preferred stock
in one or more series. We currently have 248,460 outstanding shares of our
Series C Convertible Preferred Stock and 5,150 shares of our Series D-1
Preferred Stock. Our board of directors may determine the terms of future
preferred stock offerings without further action by our shareholders. If we
issue additional preferred stock, it could affect your rights or reduce the

PAGE 15

value of your common stock. In particular, specific rights granted to future
holders of preferred stock could be used to restrict our ability to merge with
or sell our assets to a third party. These terms may include voting rights,
preferences as to dividends and liquidation, conversion and redemption rights,
and sinking fund provisions. Our Series C Preferred Stock and Series
D-1 Preferred Stock rank senior to our common stock with respect to
dividends and liquidation and have other important preferred rights.

BECAUSE SPACEDEV COMMON STOCK IS SUBJECT TO THE SEC'S PENNY STOCK RULES,
BROKER-DEALERS MAY EXPERIENCE DIFFICULTY IN COMPLETING CUSTOMER TRANSACTIONS AND
TRADING ACTIVITY IN SPACEDEV SECURITIES MAY BE ADVERSELY AFFECTED.

Transactions in SpaceDev common stock are currently subject to the "penny
stock" rules promulgated under the Securities Exchange Act of 1934. Under these
rules, broker-dealers who recommend SpaceDev securities to persons other than
institutional accredited investors 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 SpaceDev securities may
be adversely affected. As a result, the market price of SpaceDev securities may
be depressed, and you may find it more difficult to sell our securities.

RISKS RELATED TO THE MERGER WITH STARSYS RESEARCH CORPORATION

IF SPACEDEV AND STARSYS FAIL TO INTEGRATE THEIR OPERATIONS EFFECTIVELY, THE
COMBINED COMPANY WILL NOT REALIZE ALL THE POTENTIAL BENEFITS OF THE MERGER.

The integration of SpaceDev and Starsys is ongoing and may be time
consuming and expensive and may disrupt the combined company's operations if it
is not completed in a timely and efficient manner. If this integration effort is
not successful, the combined company's results of operations could be harmed,
employee morale could decline, key employees could leave, customers could cancel
existing orders or choose not to place new ones and the combined company could
have difficulty entering into new contracts with customers and complying with
regulatory requirements. In addition, the combined company may not achieve
anticipated synergies or other benefits of the merger. The combined company may
encounter difficulties, costs and delays involved in integrating their
operations, including the following:

- failure to successfully manage relationships with customers and other
important relationships;

- failure of customers to accept new services or to continue using the
products and services of the combined company;

- difficulties in successfully integrating the management teams and
employees of the two companies;

- challenges encountered in managing larger, more geographically dispersed
operations;

- the loss of key employees;

- diversion of the attention of management from other ongoing business
concerns;

- potential incompatibilities of technologies and systems;

- potential difficulties integrating and harmonizing financial reporting
systems; and

- potential incompatibility of business cultures.

PAGE 16

- the integration of the two companies is unsuccessful;

- the combined company does not achieve the expected benefits of the merger
as quickly as anticipated or the costs of or operational difficulties arising
from the merger are greater than anticipated;

- the combined company's financial results after the merger are not
consistent with the expectations of management or financial or industry
analysts;

- the anticipated operating and product synergies of the merger are not
realized; or

- the combined company experiences the loss of significant customers or
employees as a result of the merger.

SELLING SECURITY HOLDERS

As of the date of this prospectus, the revolving credit facility had been
converted into 1,000,000 shares and there was no outstanding balance on the
Convertible Note. Laurus may also 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, 537,000 shares of our common stock underlying the Laurus
Warrants. 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.

The following table sets forth, to our knowledge, certain information about
Laurus as of May 31, 2006 . 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 28,877,452 shares of
common stock outstanding as of May 31, 2006 . Actual ownership of the
shares is subject to conversion of the Preferred Stock and Convertible Note and
to exercise of the Warrants.

SHARES OF COMMON SHARES OF SHARES OF COMMON
STOCK BENEFICIALLY COMMON STOCK STOCK BENEFICIALLY
OWNED PRIOR BEING OWNED AFTER
TO OFFERING REGISTERED OFFERING (1)
--------------------------- ------------------ ------------------------

SELLING SECURITY HOLDER. NUMBER PERCENTAGE NUMBER PERCENTAGE
------------------------ ------------- ------------ ------------------- --------- ------------

LAURUS MASTER FUND, LTD. 787,000(2) 3.67% 3,382,779 787,000 2.73%(2)

(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.

PAGE 18

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 holder, and any of its 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 holder 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 holder 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 holder 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 an additional post-effective amendment to the
registration statement . 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 holder , alternatively, may sell all or any part
of the shares offered under this prospectus through an underwriter. To our
knowledge, the selling security holder has 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 the 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, or the Laurus Warrants or the Warrants.
If the selling security holder transfers 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 Warrant 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 October 3, 2007 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 under this prospectus. Upon exercise of the Laurus
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, the selling security holder will
receive all proceeds directly.

DESCRIPTION OF BUSINESS

FORWARD LOOKING STATEMENTS

The following discussion should be read in conjunction with the
Company's 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).

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 the Company; 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; U.S. government budget cuts; 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 some of the 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.

Starsys Research Corporation was acquired by SpaceDev on January 31, 2006
in a tax-free forward triangular merger, renamed Starsys, Inc., and is now a
wholly-owned subsidiary of SpaceDev. Starsys is engaged in the design and
manufacture of mechanical and electromechanical subsystems and components for
spacecraft. Starsys' subsystems enable critical spacecraft functions such as
pointing solar arrays and communication antennas and restraining, deploying and
actuating moving spacecraft components. Starsys manufactures a wide range of
products that include bi-axis gimbals, flat plate gimbals, solar array pointing
mechanisms, deployable booms, separation systems, thermal louvers, actuators,
restraint devices and cover systems. Starsys' products are sold both as
"off-the-shelf" catalog products, which represent previously qualified devices
with spaceflight history, and as custom systems that are developed for specific
applications. Starsys' products are typically sold directly to spacecraft
manufacturers. Starsys' customer base is segregated into three major segments:
(1) domestic and international commercial spacecraft (communication and imaging
satellites), (2) civil spacecraft (NASA) that are primarily scientific in nature
and (3) defense spacecraft that support the United States' military capability.
Starsys also offers products to non-space customers, including aerospace,
maritime, and industrial customers.

Starsys' engineering and manufacturing capabilities position the company to
provide both mechanical and electromechanical subsystems for spacecraft.
Starsys' strategy is to identify opportunities to develop products from custom
mechanical and electromechanical subsystems. To extend the product life cycle,
Starsys has developed and expanded this "product platforms" business model.
Product platforms are subsystems for which non-recurring and development
engineering have been retired and for which there is continued customer demand.
Starsys' product offerings currently include High Output Paraffin ("HOP")
actuators, hinges, battery bypass switches, thermal louvers, bi-axial gimbals
and solar array drives, among others. The product life cycle for this type of
product within the space industry is approximately 15 years.

Our historic SpaceDev Business approach is to provide smaller
spacecraft - generally 250 kg (550 pounds) mass and less - and cleaner, safer
hybrid propulsion systems to commercial, government, university and limited
international 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, NASA's Jet Propulsion
Laboratory, Lockheed Martin, 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
$0.0001 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 currently trading on the NASD Over-the-Counter
Bulletin Board ("OTCBB") under the symbol of "SPDV."

In February 1998, we acquired Integrated Space Systems, in San Diego.
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. The acquisition provided us
access to a large cache of hybrid rocket documents, designs and test results.
The American Rocket Company 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 NASA's 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 the 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 design concepts. We subsequently
created a prototype, which led to the development of our capability to apply the
Secondary Payload Orbital Transfer Vehicle concept to our subsequent Maneuvering
and orbit Transfer Vehicle development programs.

In November 1999, we won a $4.9 million mission contract by the Space
Sciences Laboratory 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, to our knowledge, only successful mission of
NASA's low-cost University-Class Explorer series to date. Due to additional NASA
and customer reviews, additional work, schedule extensions and a fee for one
year of satellite operations, the CHIPSat contract award was increased by
approximately $2.5 million in 2001 and 2002, bringing the total contract value
for design, build, launch and operations to approximately $7.4 million. CHIPSat
launched as a secondary payload on a Delta-II rocket on January 12, 2003.
CHIPSat is the world's first orbiting Internet node. The satellite achieved
3-axis stabilization with all individual components and systems successfully
operating and continues to work well in orbit. The CHIPSat program
generated approximately $2.1 million, $3.2 million, $1.7 million, $0.4 million
and $0.1 million of revenue in 2000, 2001, 2002, 2003 and 2004, respectively.

On March 22, 2000, the California Spaceport Authority and the California
Space and Technology Alliance 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 were
used to expand our 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 potential 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.

PAGE 24

Both of those contracts were successfully completed.

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. 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 and $686,000
of revenue in 2004 from this contract and related engineering change orders,
with approximately $180,000 from engineering change orders and approximately
$506,000 from the contract.

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.

On June 21, 2004, our proprietary hybrid rocket motor technology
successfully powered SpaceShipOne on its fourth and most important
history-making flight to space. SpaceDev powered SpaceShipOne well
beyond the 50 mile altitude required to be considered a space flight, and helped
to create the world's first private sector astronaut. After being released by
the White Knight, SpaceShipOne's test pilot, Mike Melvill, fired the rocket
motor at the planned altitude and the rocket motor then propelled SpaceShipOne
to over 328,000 feet in approximately 80 seconds, flying near Mach 5.0.

On September 29, 2004 and October 4, 2004, our hybrid propulsion technology
helped propel Scaled Composites/Paul Allen's SpaceShipOne into space flight
history as the craft garnered the $10 Million Ansari X Prize, a contest created
to stimulate the development of the private sector human space flight industry.
We provided several critical components and the hybrid rocket technology for the
craft's motor, including igniter, injector and main operating valve, which
successfully performed as expected and powered SpaceShipOne on its historic
manned flight. SpaceShipOne exceeded the altitude requirement on both scheduled
flights as required by the Ansari X Prize competition. The hybrid propulsion
system burned full duration and pilot Brian Binnie steered SpaceShipOne high
above the Mojave, California desert to a height of 367,442 feet altitude (69.5
miles), which far exceeded the required 328,000 feet altitude - a sky-high goal
required by the X Prize Foundation of St. Louis, Missouri.

PAGE 25

Although we were not the recipient of the Ansari X Prize, it was a contest
designed to jumpstart the space tourism industry through competition among the
most talented entrepreneurs and rocket experts in the world. SpaceShipOne was
built and launched with private funds from Paul Allen. The craft was able to
carry equivalent weight of three people to 100 kilometers (62.5 miles) and
return safely to earth. The competition followed in the footsteps of more than
100 aviation incentive prizes offered between 1905 and 1935 credited with
spawning today's multibillion-dollar air transport industry. By helping
SpaceShipOne succeed, we were instrumental in moving the private space community
closer to realizing its vision of creating safe, affordable, commercial human
space flight.

On April 30, 2002, the Company was awarded Phase I of a contract to develop
a Shuttle-compatible propulsion module for the Air Force Research Laboratory. 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 Vehicle
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
of the contract is cost-plus fixed fee. In order to complete 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. An additional effort to develop a miniaturized Shuttle-compatible
propulsion module has been added to this contract and is worth approximately
$150,000.

On July 9, 2003, we were awarded a contract by the Missile Defense Agency
to explore the use of microsatellites in national missile defense. It was a
precursor contract to the $43 million contract mentioned below. 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
microsatellite launch and commissioning; small, low-power passive sensors;
target acquisition and tracking; formation flying and local area networking
within a cluster of microsatellites; 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. This contract was considered an investigatory phase by MDA.

Also, on July 9, 2003, we were awarded a Phase I Small Business Innovation
Research contract by Air Force Research Lab to design and effectively begin the
development of our small launch vehicle. The SpaceDev Small Launch Vehicle will
be designed to responsively and affordably lift up to 1,000 pounds to Low Earth
Orbit. The SpaceDev Small Launch Vehicle 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 was valued at
approximately $100,000, and was a fixed price, milestone-based agreement, which
was completed in about one year. The Phase II of this SBIR was awarded on
September 29, 2004 and is worth approximately $1,557,000. The contract outlines
the development and test firing of our large Common Core Booster for the
SpaceDev Small Launch Vehicle. Congress has awarded us approximately $3.0
million in additional funding for this project, which became available in
late 2005. We believe that there is additional interest by Congress in
providing further funding to expand and accelerate the scope of the work;
however, there can be no assurance that such work will be awarded to us.

PAGE 26

Also, on July 9, 2003, we were awarded a Phase I contract to develop micro
and nanosatellite bus and subsystem designs. This Air Force Research Laboratory
Small Business Innovation Research contract, valued at approximately $100,000,
has enabled us to explore the further miniaturization of our unique and
innovative microsatellite subsystems. It has also enabled 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 was
completed in about one year. On August 23, 2004, we were awarded the Phase II
of this Small Business Innovation Research grant, which was later amended on
September 8, 2004 to shorten the length of the overall contract, worth
approximately $739,000 for carry-forward work.

On July 24, 2003, we were awarded a contract by Lunar Enterprise of
California for a first phase project to begin developing a conceptual mission
and spacecraft design for a lunar lander program. The unmanned mission is being
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. The contract has been completed.

On December 18, 2003, we were awarded a contract by the Defense Advanced
Research Projects Agency for the study of Novel Satcom Microsat Constellation
Deployment. The contract was a milestone-based, fixed price contract with total
consideration of approximately $200,000. On August 6, 2004, an additional
$39,849 was added to the contract for increased scope, bringing the total
contract value on this fixed price effort to approximately $240,000. The
contract has been completed.

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 microsatellite 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 for approximately $1.1 million awarded on April 1, 2004 and completed
by September 30, 2004. The second Task Order for approximately $8.3 million was
awarded on October 20, 2004. 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 had an effective start date of March 1, 2004.
Approximately $1.14 million of revenue was generated under the first phase of
this contract. The first phase or "Task Order," resulted in a detailed mission
and microsatellite design. The second Task Order, originally expected to be
completed by January 2006, was extended at the request of the Missile Defense
Agency, and was completed in late March 2006. 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 microsatellites
to be networked on-orbit with high speed laser communications technology. The
third phase began on April 1, 2006.

On July 18, 2005, we were awarded a subcontract to provide scientific,
engineering, development and programmatic support to the development and
demonstration of innovative SSA (space situational awareness) nanosatellite
(<15kg) spacecraft. SSA is the ability to search, identify and monitor
spacecrafts for the purpose of obtaining space superiority. The subcontract
covers the conceptual/preliminary phase of development and includes all aspects
of potential systems from the platforms and associated payloads to the links and
nodes and ground support. The cost plus fixed fee subcontract resulted in
revenues of approximately $120,000. We completed this subcontract in December
2005. We submitted a proposal and were awarded the next-phase subcontract in
the amount of $1.2 million, and expect to begin work on this phase in March,
2006.

STARSYS - CUSTOMERS

Starsys' business is focused on mechanical and electro-mechanical systems,
sub-systems and components that support assembly of spacecraft by its customers.
Those customers, primarily the Prime Contractors in the aerospace market,
support the government and commercial end users by integrating its products into
higher level assemblies and spacecraft. Lockheed Martin Companies, Boeing
Company, Northrop Grumman Space Technologies, ITT Industries, and Swales
Aerospace are prime contract customers, which have each accounted for 10% or
more of Starsys' consolidated revenues in recent years. Starsys has multiple
contracts with each of these customers and we do not believe any single customer
contract is material to Starsys. The remainder of Starsys' business is with
multiple customers that support the Department of Defense through the prime
contractors, and the commercial spacecraft market, the civil spacecraft market,
and NASA, including through Small Business Innovative Research (SBIR) grants and
Long Term Agreements (LTA's) with the prime contractors.

Starsys' business development process is generally competitive bid in
response to a request for proposal (RFP) that is generated by Starsys' potential
customers. These proposals have various bases, including firm fixed price, cost
plus fixed fee, and time and materials. Starsys typically prepares between ten
and twenty proposals in a given month and it usually has one to three weeks to
respond to the request.

These proposals are managed by product area. Starsys defines three specific
product areas for its business: electromechanical systems, which include motors,
control, and logic; mechanical systems, which include spring and paraffin driven
mechanisms as well as deployable structures; and catalog products, which include
release mechanisms, hinges and thermal control devices. Starsys also executes on
long term build to print contracts with some of the prime contractors.

Starsys averages between 55 and 70 active programs at any time and the
average duration of its programs is 11 months, with programs as short as 60 days
and as long as three years. Currently this mix is approximately 70% in support
of governmental work, both open and classified, 20% commercial, and 10% with
NASA, but this mix changes frequently with new contract awards.

During 2005 and 2004, approximately 82% and 78%, respectively of Starsys'
total annual revenues were derived from contracts with the U.S. government and
its agencies or from subcontracts with other U.S. government prime contractors.
Most of Starsys' U.S. government contracts are funded incrementally on a
year-to-year basis.

Major contracts with the U.S. government primarily fall into two
categories: cost-reimbursable contracts and fixed-price contracts. Approximately
9% of revenues from U.S. government contracts in 2005 were derived from
cost-reimbursable contracts and 91% of revenues from U.S. government contracts
were derived from fixed price contracts. Approximately 5% of revenues from U. S.
government contracts in 2004 were derived from cost-reimbursable contracts and
95% of revenues from U.S. government contracts were derived from fixed-price
contracts. Under a cost-reimbursable contract, Starsys recovers its actual
allowable costs incurred, allocable overhead costs and a fee consisting of a
base amount that is fixed at the inception of the contract and/or an award
amount that is based on the customer's evaluation of its performance in terms of
the criteria stated in the contract. Starsys' fixed-price contracts include firm
fixed-price and fixed-price incentive fee contracts. Under firm fixed-price
contracts, work performed and products shipped are paid for at a fixed price
without adjustment for actual costs incurred in connection with the contract.
Therefore, Starsys bears the risk of loss due to increased cost, although some
of this risk may be passed on to subcontractors. Fixed-price incentive fee
contracts provide for sharing by Starsys and the customer of unexpected costs
incurred or savings realized within specified limits, and may provide for
adjustments in price depending on actual contract performance other than costs.
Costs in excess of the negotiated maximum (ceiling) price and the risk of loss
by reason of such excess costs are borne by Starsys, although some of this risk
may be passed on to subcontractors.

All of Starsys' U.S. government contracts and, in general, its subcontracts
with other U.S. government prime contractors provide that such contracts may be
terminated for convenience by the U.S. government or the prime contractor,
respectively. Furthermore, any of these contracts may become subject to a
government-issued stop work order under which Starsys would be required to
suspend production. In the event of a termination for convenience, contractors
generally are entitled to receive the purchase price for delivered items,
reimbursement for allowable costs for work in process and an allowance for
reasonable profit thereon or adjustment for loss if completion of performance
would have resulted in a loss. Starsys derives a significant portion of its
revenues from U.S. government contracts.

PAGE 27

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 for our historical SpaceDev operations 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 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
investors, throughout the inner solar system ;

- Join or establish a team to build a safe, affordable sub-orbital,
passenger space plane to help initiate the space tourism business; and,

- Establish a team to build a safe, affordable orbital passenger vehicle as
a potential shuttle replacement.

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,

- Tends to create barriers to entry by and competition from
competitors.

PRODUCTS AND SERVICES; MARKET

We currently have two primary lines of space products and services on which
we believe a sound foundation and profitable, cash generating business can be
built:

- Our Spacecraft Products and Services - Microsatellites & Nanosatellites,
BD-II Spacecraft Buses, and Maneuvering and orbital Transfer Vehicles; and,

- Our Propulsion Products and Services - Hybrid Propulsion and Launch
Vehicle Systems.

These products and services are being marketed and sold directly into
primarily domestic government, university, military and commercial markets. We
consider ourselves a project company rather than a product company today,
although products are generated from projects. Our long term goal and vision is
to migrate from a project company to a product company. 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 JPL Mars
MicroMission and Boeing Lunar Orbiter mission design contracts.

OUR SPACECRAFT PRODUCTS AND SERVICES
----------------------------------------

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 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 buses - 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 the University of California at Berkeley Space Sciences Laboratory's Cosmic
Hot Interstellar Plasma Spectrometer ("CHIPS") mission. CHIPSat was launched at
4:45 PM PST on January 12, 2003 from Vandenberg Air Force Base in California.
The satellite achieved 3-axis stabilization with all individual components and
systems successfully operating and continues to work well in orbit.

PAGE 28

Maneuvering and orbital Transfer Vehicle - Our Maneuvering and orbital
Transfer Vehicle system is a family of small, affordable, elegantly simple,
throttleable, and restartable propulsion and integrated satellite products. Our
Maneuvering and orbital Transfer Vehicle can be used as a standard propulsion
module to transport a customer's payload to different orbits. The Maneuvering
and orbital Transfer Vehicle provides 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.

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 MIPS.

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,
payload accommodation, total flight system integration and test and mission
operations. The customer only needs to provide the payload, and we have the
capacity 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 was 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, similar to the cluster
of microsats we are developing for the Missile Defense Agency, can be designed
to communicate directly with each other, as in a wide area network in space.
Provided 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.

PAGE 29

OUR PROPULSION PRODUCTS AND SERVICES
----------------------------------------

Hybrid Rocket Propulsion and Launch Vehicle Systems - 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.

Hybrid Orbital Vehicle - we have begun designing a reuseable, piloted,
sub-orbital space ship that could be scaled to safely and economically transport
passengers to and from Low Earth Orbit, including the International Space
Station. The name of the vehicle is the SpaceDev Dream Chaser(TM). We
signed a non-binding Space Act Memorandum of Understanding with NASA Ames
Research Center, which confirms our intention to explore novel, hybrid
propulsion based hypersonic test beds for routine human space access. We will
explore with NASA collaborative partnerships to investigate the potential of
using our proven hybrid propulsion and other technologies, and a low cost,
private space program development approach, to establish and design new piloted
small launch vehicles and flight test platforms to enable near-term, low-cost
routine space access for NASA and the United States. Unlike the more
complex SpaceShipOne, for which SpaceDev provided critical proprietary hybrid
rocket motor propulsion technologies and components, the SpaceDev Dream
Chaser(TM) would be crewed and launch vertically, like most launch vehicles,
and would glide back for a normal horizontal runway landing. The sub-orbital
SpaceDev Dream Chaser(TM) would have an altitude goal of approximately
160 km (about 100 miles) and would be powered by a single, high
performance hybrid rocket motor, under parallel development by us for the
SpaceDev Streaker(TM), a family of small, expendable launch vehicles, designed
to affordably deliver small satellites to Low Earth Orbit. The SpaceDev Dream
Chaser(TM) motor would produce approximately 100,000 pounds of thrust,
about six times the thrust of the SpaceShipOne motor, but less than one-half the
thrust of the 250,000 pounds of thrust produced by hybrid rocket motors
developed several years ago by the American Rocket Company. Our non-explosive
hybrid rocket motors use synthetic rubber as the fuel, and nitrous oxide for the
oxidizer to make the rubber burn. Traditional rocket motors use two liquids, or
a solid propellant that combines the fuel and oxidizer, but both types of rocket
motors are explosive, and all solid motors produce copious quantities of toxic
exhaust. Our hybrid rocket motors are non-toxic and do not detonate like solid
or liquid rocket motors.

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.

PAGE 30

COMPONENTS AND RAW MATERIALS

Although our historic SpaceDev business 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. Furthermore, we have not experienced difficulty in our ability to
obtain our parts or component materials, nor do we expect this to be an issue in
the future.

Starsys purchases a significant percentage of its product components,
structural assemblies and certain key satellite components and instruments from
third parties. Starsys also occasionally obtains from the U.S. government parts
and equipment that are used in the production of its products or in the
provision of its services. Generally, Starsys has not experienced material
difficulty in obtaining product components or necessary parts and equipment, and
believes that alternatives to its existing sources of supply are available,
although increased costs and possible delays could be incurred in securing
alternative sources of supply. Starsys relies upon sole source suppliers for
potentiometers, slip ring assemblies, specialized impellers, specialized heaters
and paraffin material. While alternative sources would be available, the
inability of any such supplier to provide Starsys with these items to qualified
specifications would result in an adverse effect on Starsys' ability to
manufacture its products.

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 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
corporate goals to design and build inexpensive micro-spacecraft for a mission,
which would be our direct competition. However, they have resources,
expertise, and contracts that would make them formidable competitors if they
chose to enter our markets.

We also compete with each of our competitors for qualified engineers. There
is a limited number of individuals with all of the requirements that we seek and
there can be no assurance that we can locate and recruit these individuals in a
timely and cost-effective manner. Many of our competitors have greater resources
than we do and can offer higher salaries or better incentives to attract these
individuals.

Starsys' competition varies by business segment and product areas. The
following summarizes principal organizations that compete with Starsys.

Mechanical subsystems range from customized hinges and latching devices to
cover systems and integrated structures for payloads, typically not requiring
customized, or Starsys-supplied, electromagnetic devices. Competition includes:
Alliance Spacesystems Inc. and Swales Aerospace. Starsys provides clamp band
systems for small satellite separations and deployable structures. We believe
Starsys' primary competitor in the small satellite separations market is
Planetary Systems Inc. We believe that the primary competitors in the deployable
structures market are ATK Space Systems (formerly AEC Able Engineering), NGST
Astro (formerly SPAR Astro Aerospace) and Harris Corporation.

Electromechanical subsystems range from motors and actuators (typically
motors with transmissions and various ancillary elements) to sophisticated
systems that incorporate control electronics for applications such as antenna
and solar array pointing, and instruments that sweep a pattern or actively
track. We believe that the competition for motors and actuators are MPC Products
Corporation, CDA Astro, Aeroflex (a subsidiary of UMTC), Moog Inc. and ATK
Satellite Systems. As these products become more specialized the competition may
include Aeroflex, MOOG and the Ball Aerospace & Technologies Corp. Some
competitors of Starsys are also customers of SpaceDev.

Starsys believes the alternatives for its restraint and release products
are pyrotechnic devices built by Hi-Shear and Pacific Scientific and
non-pyrotechnic products, supplied by NEA, TiNi Aerospace, and G&H Technologies.

Many of Starsys' competitors are larger and have substantially greater
resources than we do. Furthermore, it is possible that other domestic or foreign
companies or governments, some with greater experience in the space and defense
industry and many with greater financial resources than we possess, will seek to
provide products or services that compete with our products or services. Any
such foreign competitor could benefit from subsidies from or other protective
measures by its home country.

PAGE 31

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., or Laurus. In this prospectus, we refer to these
agreements as the Agreement. Pursuant to the Agreement, we received a $1
million revolving credit facility in the form of a three-year Convertible Note
secured by our assets. The net proceeds from the Convertible Note shall be used
for our general working capital needs. Advances on the Convertible Note may be
repaid at 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 the fiscal periods ended
March 31, 2006, December 31, 2005 and December 31, 2004.

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 converted after the first $1
million converted. The agreement was modified again as part of the Preferred
Stock transaction to increase the maximum principal balance that could be
outstanding at any one time under 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 2,991,417 shares to reduce the debt we owed by $2,271,750
for the twelve-months ending December 31, 2004. Laurus converted a total of
3,406,417 shares to reduce the debt by $2,500,000 since the inception of the
revolving credit facility. For the twelve-month period ending December
31,2004, we expensed $2,480,628 for the non-cash loan fee based on the fair
market value of the stock when Laurus converted and $2,607,099 for the non-cash
loan fee expense since the inception of the revolving credit facility. There
were no draws on the revolving credit facility or conversions under it during
2005. 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 trading.

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 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 defined 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. The Convertible
Note was exercised as to all such amounts during 2004. The fixed conversion
price on all future draws will be 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. The facility expired on June 3, 2006.

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 United States 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 the Company's products, services and technical data require either Technical
Assistance Agreements or licenses from the United States Department of State,
depending on the level of technology being transferred. This includes recently
published regulations restricting the ability of United States-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. 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.

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 United States, 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
that are launched from a launch site in the United States must pass certain
launch range safety regulations that are administered by the United States Air
Force. In addition, all commercial space launches that we might 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 Federal Communications Commission and National Telecommunications
and Information Administration obtain these approvals from the International
Telecommunication Union.

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.

PAGE 34

We may need to utilize the Deep Space Network on some of our missions. The
Deep Space Network is a United States 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 the Jet Propulsion Laboratory. Coordination for the use of
this facility is arranged with the Telecommunications and Mission Operations
Command.

Also, as some of our projects with the Department of Defense proceed, we
may need special clearances to continue working on and advancing our projects.
Classified programs generally will require that we comply with various Executive
Orders, Federal laws and regulations and customer security requirements that may
include specialized facilities and restrictions on how we develop, store,
protect and share information. Laboratories, manufacturing and assembly areas,
meeting spaces, office areas, storage areas, computers systems and networks and
telecommunications systems may require modification or replacement in order to
comply with customer requirements. Classified programs may require our employees
to obtain government clearances and restrict our ability to have key employees
work on these programs until these clearances are received from the appropriate
United States government agencies. In order to staff these programs we may need
to recruit personnel with the appropriate professional training, experience and
security clearances. There are a very limited number of individuals with all of
the requirements that we seek. There is no assurance that we can locate and
recruit these individuals in a timely and cost-effective manner. We may be
required to modify existing facilities and to develop new facilities and
capabilities that will only be utilized by these classified programs. We may be
required to install computer networks, communications systems and monitoring
systems that are dedicated to these classified programs. Some or all of these
requirements may entail substantial additional expense. It is uncertain whether
we will be able to recover any of the costs of these systems from our customers.
Many of these classified programs are regulated by Executive Orders, various
Federal laws and regulations and customer requirements. The failure of the
Company to comply with any of the foregoing Executive Orders, Federal laws and
regulations and customer requirements could have serious adverse effects. Also,
our ability to successfully market and sell into the Department of Defense
markets may be severely hampered if we are unable to meet classified program
requirements. There is no assurance that we will be able to successfully pass
the criteria required in order to win a classified program or to maintain
current contracts, such as our Missile Defense Agency contract (which may become
classified), and there is no assurance that we will maintain that status once it
has been obtained. We received certification for classified computer system
processing in early 2005, which was subsequently renewed in early 2006.

EMPLOYEES

At December 31, 2005, we employed approximately fifty (50) persons
full and part-time, most of whom are aerospace, mechanical and electrical
engineers. At May 31, 2006, after the Starsys acquisition, we employed a
total of approximately 200 people full and part-time. In addition to its
manufacturing operations, Starsys has a team of experienced engineers focused on
advanced engineering of mechanical and electromechanical subsystems. The
engineering group includes mechanical and aerospace engineers, engineering
technicians and designers. Areas of expertise include mechanical and
electromechanical subsystem design, analysis, test, and program management.
In addition, due to the nature of our business, although we do not anticipate
the need for a reduction in force, 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 patents, trade secrets and know-how to develop and
maintain our competitive position and technological advantage. We have protected
and intend to continue 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. In this regard, we have filed patent applications relating
to our hybrid propulsion and satellite technology. There can be no assurance
that such applications will be granted. Starsys relies, in part, on patents,
trade secrets and know-how to develop and maintain its competitive position and
technological advantage, particularly with respect to its launch vehicle and
satellite products. Starsys holds U.S. and foreign patents relating to release
devices, deployable truss structures and battery cell shorting mechanisms. The
majority of Starsys' U.S. patents relating to the noted technologies expire
between 2019 and 2022. We have entered into 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.

PAGE 35

In August 1998, we acquired rights to intellectual property (including
three patents and trade secrets) from an individual who had acquired them from
the former American Rocket Company, which specialized in hybrid rocket
technology. We are obligated to issue warrants to this individual to purchase a
minimum of 100,000 and a 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, of which none
of the warrants have been exercised and 25,000 warrants expired unexercised. We
acquired some of our expertise in hybrid propulsion technology from the American
Rocket Company; however, we are using our own technology to develop the
responsive, affordable SpaceDev Streaker(TM) small launch vehicle under an Air
Force contract.

STARSYS - QUALITY ASSURANCE AND TESTING

Starsys is ISO-9001 certified and AS9100 compliant. Starsys is currently
engaged in AS9100 certification.

Starsys utilizes test equipment that is calibrated and traceable to NBS
standards. Starsys also maintains access to certified suppliers for vibration,
shock and electromagnetic interference (EMI) testing.

STARSYS - RESEARCH AND DEVELOPMENT

Starsys invests in product-related research and development to conceive and
develop new products and to enhance existing products. Starsys' research and
development expenses totaled approximately $10,525,000 in the year ended
December 31, 2004, and approximately $11,782,000 in the year ended December 31,
2005. In addition, a large portion of Starsys' total new product development and
enhancement programs is funded under customer contracts.

MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

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.

OVERVIEW

Historic SpaceDev Business

We are engaged in the conception, design, development, manufacture,
integration and operation of space technology systems, products and services.
Our historic SpaceDev operations are currently focused on the commercial and
military development of low-cost microsatellites, nanosatellites and related
subsystems, hybrid rocket propulsion for space, launch and human flight vehicles
as well as associated engineering and technical services which are provided
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 and 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 future, virtually all of our current
work is for branches of the United States military. We are also developing
commercial hybrid rocket motors for use in small launch vehicles, targets and
sounding rockets, and small, high-performance space vehicles and subsystems for
commercial customers.

We acquired Starsys Research Corporation on January 31, 2006 in a tax-free
forward triangular merger, renamed the company Starsys, Inc., and now hold it as
a wholly-owned subsidiary of SpaceDev. Starsys is engaged in the design and
manufacture of mechanical and electromechanical subsystems and components for
spacecraft. Starsys' subsystems enable critical spacecraft functions such as
pointing solar arrays and communication antennas and restraining, deploying and
actuating moving spacecraft components. Starsys manufactures a wide range of
products that include bi-axis gimbals, flat plate gimbals, solar array pointing
mechanisms, deployable booms, separation systems, thermal louvers, actuators,
restraint devices and cover systems. Starsys' products are sold both as
"off-the-shelf" catalog products, which represent previously qualified devices
with spaceflight history, and as custom systems that are developed for specific
applications. Starsys' products are typically sold directly to spacecraft
manufacturers. Starsys' customer base is segregated into three major segments:

PAGE 36

(1) domestic and international commercial spacecraft (communication and imaging
satellites), (2) civil spacecraft (NASA) that are primarily scientific in nature
and (3) defense spacecraft that support the United States' military capability.
Starsys also offers products to non-space customers, including aerospace,
maritime, and industrial customers.

Starsys' engineering and manufacturing capabilities position the company to
provide both mechanical and electromechanical subsystems for spacecraft.
Starsys' strategy is to identify opportunities to develop products from custom
mechanical and electromechanical subsystems. To extend the product life cycle,
Starsys has developed and expanded a "product platforms" business model. Product
platforms are subsystems for which non-recurring and development engineering
have been completed and for which there is continued customer demand. Starsys'
product offerings currently include High Output Paraffin ("HOP") actuators,
hinges, battery bypass switches, thermal louvers, bi-axial gimbals and solar
array drives, among others. The product life cycle for this type of product
within the space industry is approximately 15 years.

The acquisition of Starsys fundamentally changed our profile. Starsys is a
mature operating company with 2005 revenues of approximately $18 million and
2005 losses of approximately $3.4 million. We believe there are numerous
potential synergies between the historic SpaceDev business, and Starsys'
business, including but not limited to providing SpaceDev with a production
capability as its technologies migrate from advanced systems to products, access
to quality facilities and a strong market of aerospace engineers, a
diversification of customers and revenues, and the ability to bid on larger and
more vertically integrated programs and projects.

Our historic SpaceDev business approach is to provide smaller spacecraft -
generally 250 kg (550 pounds) mass and less - and cleaner, safer hybrid
propulsion systems to commercial, government, university and limited
international 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.

During the first three months of 2006, 85% of our net sales were generated
from direct government contracts, 7% was generated from government-related work
through subcontracts with others, and 8% was generated from commercial
contracts. For the same three month period in 2005, approximately 95% of our net
sales were generated by government or government-related work. We will continue
to seek both government and commercial business and anticipate that net sales
from government sources will continue to represent in excess of 80% of our net
sales for the next several years. Currently, we are focusing on the domestic
United States 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 increased international revenue and contract
opportunities, we are restricted by export control regulations, including
International Traffic in Arms Regulations, which may limit our ability to
develop market opportunities outside the United States on some of our products.

At this time, over 70% of our forecasted sales for 2006 are under contract
or near contract award. We may not be able to win enough new business to
achieve our targeted growth projection or to maintain a positive cash flow
position. During the first three months of 2006 we submitted approximately
twenty-five bids for government or commercial programs ranging from $25,000 to
$350 million and continued our work with the United States Congress to identify
directed funding for our programs.

PAGE 37

In order to perform the Missile Defense Agency contract (described below)
on schedule and successfully execute other existing and new business
opportunities, we must substantially increase our staff and hire new engineers
or subcontract the work to third parties. We are actively seeking to hire
spacecraft and propulsion engineers, and we are investigating various
partnership arrangements to increase resource availability.

SELECTION OF SIGNIFICANT CONTRACTS

On July 18, 2005, we were awarded a subcontract to provide scientific,
engineering, development and programmatic support to the development and
demonstration of innovative SSA (space situational awareness) nanosatellite
(<15kg) spacecraft. SSA is the ability to search, identify and monitor
spacecrafts for the purpose of obtaining space superiority. The subcontract
covers the conceptual/preliminary phase of development and includes all aspects
of potential systems from the platforms and associated payloads to the links and
nodes and ground support. The cost plus fixed fee subcontract resulted in
revenues of approximately $120,000. We completed this subcontract in December
2005. In January 2006, we submitted a proposal for the next-phase subcontract
and, in March 2006, we were awarded the subcontract in the amount of
approximately $1.2 million, and began work on this phase.

On February 28, 2006, we were awarded two important Boom Technology
contracts for advance research and development of a self-deployed articulated
boom for approximately $950,000 and a jack screw deployed boom for approximately
$1.5 million by the Air Force Research Laboratory. AFRL placed these contracts
with Starsys which will leverage the significant technical talent and advances
Starsys engineers have already made in this critical space technology.

On April 1, 2006, we were awarded the third task order on 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 in
support of the Advanced Systems Deputate of the Missile Defense Agency, which
contract was originally awarded on March 31, 2004. The microsatellite
distributed sensing experiment is now intended to analyze, design, develop,
fabricate, integrate, test, operate and support a networked cluster of three
formation-flying boost phase and midcourse tracking microsatellites to support
national missile defense. The milestone-based, multiyear, multiphase contract
had an effective start date of March 1, 2004. This effort is being accomplished
in a phased approach. The first phase, or "Task Order," for approximately $1.1
million was completed on September 30, 2004 and resulted in a general mission
and microsatellite design. The second Task Order for approximately $8.3 million
was awarded in October 2004 and was originally expected to be completed by
January 2006 but was extended at the request of the Missile Defense Agency, and
subsequently completed on March 31, 2006. The second Task Order resulted in a
detailed mission and microsatellite design, as exemplified by a successful
Critical Design Review in March 2006. In addition to the three networked
microsat under our second Task Order, the $43 million contract also envisioned
an option for a second three microsats using laser communication technology. We
were informed in 2005 that the Missile Defense Agency had re-routed the laser
communications experiment to another program and that they would not be
exercising their option for the additional microsats at this time; however, the
contract vehicle remained at $43 million and left open the opportunity for some
other purchase to take its place. We estimate that the second cluster would
have represented approximately $10 million of the $43 million contract, and have
reduced our current backorder accordingly. We believe the remaining unbilled
contract backlog amount of approximately $25 million to be secure.
We completed Phase II and Task Order 2 of the MDA contract by March 31, 2006,
after a successful critical design review with our customer. The third Task
Order was awarded to us on April 1, 2006 for a total of approximately $1.5 for
the period of April 1, 2006 through May 31, 2006, in order to begin Phase III -
fabrication, integration and testing. The third Task Order was then extended to
June 30, 2006 by approximately $1 million. We expect continued modifications to
the third Task Order throughout 2006 and 2007.

PAGE 38

RESULTS OF OPERATIONS

Please refer to the consolidated financial statements, which are a part of
this report, for further information regarding the results of operations. Due to
our January 2006 acquisition of Starsys, all 2006 -vs.- 2005 comparisons are of
limited meaningfulness and usefulness.

THREE-MONTHS ENDING MARCH 31, 2006 -VS.- THREE-MONTHS ENDING MARCH 31, 2005

During the three-months ending March 31, 2006, we had net sales of
approximately $7,175,000 as compared to net sales of approximately $1,807,000
for the same period in 2005. Sales increased primarily due to our acquisition
of Starsys on January 31, 2006 which has generated revenues of approximately
$4.3 million, as well as the further work on our existing government contracts
of approximately $2.9 million, particularly our contract with the Missile
Defense Agency which generated revenues in excess of approximately $2.4 million.
For the three months ended March 31, 2006, revenue from government and
government related work was approximately $6,489,000 and revenue from commercial
customers was approximately $686,000. Our government customers include but are
not limited to the Missile Defense Agency, the Air Force Research Laboratory,
NASA, and the U.S. Army. Our government related work customers include but are
not limited to General Dynamics, Northrop Grumman and Raytheon. Commercial
customers include, Lockheed Martin and Sumitomo. Revenue for the three-months
ended March 31, 2005 primarily represented $1,444,000 of work on the second Task
Order for the Missile Defense Agency contract. Ongoing Small Business Innovation
Research contracts with the Air Force Research Laboratory represented sales of
approximately $310,000 in the three-months ending March 31, 2005.

For the three-months ended March 31, 2006, we had costs of sales (direct
and allocated costs associated with individual contracts) of approximately
$5,265,000 or 73.5% of net sales, as compared to approximately $1,397,000, or
77.3% of net sales, during the same period in 2005. The increase in cost of
sales and the improved gross margin percentage were both due to the higher
margin contracts and products sold by Starsys. We continue to focus efforts on
managing our growth including but not limited to recruiting new talented
engineers, developing and acquiring project management skills and creating or
expanding systems to assist in the efficient and effective management of our
projects.

We experienced an increase of approximately $1,612,000 in operating
expenses from approximately $344,000, or 19.1% of net sales, for the
three-months ending March 31, 2005 to approximately $1,956,000, or 27.3% of net
sales, for the three-months ending March 31, 2006. Operating expenses include
general and administrative expenses, research and development expenses,
marketing and sales expenses, and stock option expense under FASB 123(R).

- General and administrative expenses increased approximately $949,000 from
approximately $191,000, or 10.6% of net sales, for the three-months ending
March 31, 2005 to approximately $1,140,000, or 15.9% of net sales, for the
same three month period in 2006. This increase is attributed mainly to the
assumption of general and administrative costs from Starsys and the
addition of our new Chief Executive Officer. We do expect to recognize some
cost saving and efficiencies as the companies eliminate redundancies in
certain general and administrative functions.

- Research and development expenses increased during the first quarter of
2006, from approximately $8,000, or 0.1% of net sales, for the three-months
ending March 31, 2005, to approximately $82,000, or 1.1% of net sales,
during the same period in 2006. The total dollar value increased by
approximately $74,000, mainly due to a shift in cost categorization, as our
Chief Executive Officer became our Chief Technology Officer. We have begun
an effort to focus a limited amount of our resources on internal R&D
efforts.

PAGE 39

- Marketing and sales expenses increased during the first quarter of 2006,
from approximately $145,000, or 8.0% of net sales, for the three-months
ending March 31, 2005, to approximately $644,000, or 9.0% of net sales,
during the same period in 2006. The total dollar increase of approximately
$499,000 was mainly due to our decision to bid on certain large proposals
in January and February 2006 as well as absorbing a larger marketing and
sales organization as part of the merger with Starsys.

- Our stock option expense is based on a calculation using the minimum value
method as prescribed by FAS 123(R), otherwise known as the Black-Scholes
method. Under this method, we used a risk-free interest rate at the date of
grant, an expected volatility, an expected dividend yield and an expected
life of the options to determine the fair value of options granted. The
risk-free interest rate was estimated at 4.0%, expected volatility was
86.7%, the dividend yield was assumed to be zero, and the expected life of
the options was assumed to be three years based on the average vesting
period of options granted. The total expense for the three months ended
March 31, 2006 was $90,701 as compared to no expense during the same period
in 2005, as we adopted FAS 123(R) on January 1, 2006.

Non-operating expense (income) consisted 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. Non-operating expenses decreased to the point that we
recorded non-operating income beginning in 2005.

Interest expense for the three-months ending March 31, 2006 and 2005 was
insignificant as we incurred no interest expense on our revolving credit
facility, which had a zero balance for the three-months ending March 31, 2006
and 2005. We began generating interest income in late 2004, and the first
quarters of 2006 and 2005, we recognized approximately $34,000 and $8,000,
respectively in interest income due to our cash management practices.

We recognized approximately $29,000 and $29,000 of the deferred gain on the
sale of the building during the three-months ending March 31, 2006 and 2005,
respectively, and we will continue to amortize the remaining deferred gain of
approximately $801,000 into non-operating income over the remainder of the
lease.

During the three-months ending March 31, 2006, we generated net income of
approximately $7,000, or 0.1% of net sales, despite recognizing over $90,000 in
non-cash charges related to expensing stock options under FAS 123(R), compared
to net income of approximately $101,000, or 5.6% of net sales, for the same
three-month period in 2005. During the three-months ending March 31, 2006, we
incurred a positive EBITDA (earnings before interest taxes depreciation and
amortization) of approximately $192,000, or 2.7% of net sales, compared to a
EBITDA of approximately $95,000, or 5.2% of net sales, for the three-months
ending March 31, 2005.

The following table reconciles Earnings Before Interest, Taxes,
Depreciation and Amortization (EBITDA) to net income (loss) for the three-months
ending March 31, 2006 and 2005, respectively, and represents our ninth
consecutive quarter of positive and growing EBITDA:

FOR THE THREE MONTHS ENDING . . . . . MARCH 31, 2006 March 31, 2005
(UNAUDITED) (Unaudited)
NET INCOME. . . . . . . . . . . . . . $ 7,017 $ 101,223
------------------------------------- ---------------- ----------------

Interest Income . . . . . . . . . . . (33,615) (7,960)
Interest Expense. . . . . . . . . . . 5,283 1,222
Gain on Building Sale . . . . . . . . (29,318) (29,318)
Stock Option Expense . . . . . . . .. 90,701 -
Provision for income taxes. . . . . . 4,235 400
Depreciation and Amortization . . . . 147,370 29,116
------------------------------------- ---------------- ----------------
EBITDA* . . . . . . . . . . . . . . . $ 191,673 $ 94,683
------------------------------------- ---------------- ----------------
* Earnings Before Interest, Taxes, Depreciation and Amortization.

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. Beginning in 2003
through the current quarter in 2006, we showed continued progress in total
revenue as well as in EBITDA.

[GRAPHIC OMITED]

FOR THE THREE MONTHS ENDING. . . . . . . 3/31/04 6/30/04 9/30/04 12/31/04 3/31/05 6/30/05
(Unaudited). . . . . . . . . . . . . (Unaudited) (Unaudited) (Unaudited) (UNAUDITED) (UNAUDITED) (UNAUDITED)
NET INCOME (LOSS). . . . . . . . . . . . $ (442,549) $(1,286,866) $ (602,888) $ (694,750) $ 101,223 $ 110,938
---------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------

Interest Income. . . . . . . . . . . . . - - (5,619) (13,386) (7,960) (36,824)
Interest Expense . . . . . . . . . . . . 19,788 19,736 23,110 (6,707) 1,222 609
Non-Cash Interest exp. (Debt Discount) . 464,000 1,329,313 663,481 797,636 - 28,875
Gain on Building Sale. . . . . . . . . . (29,318) (29,318) (29,318) (29,318) (29,318) (29,318)
Stock Option Expense . . . . . . . . . . - - - - - -
Provision for income taxes . . . . . . . - - - 1,600 400 400
Depreciation and Amortization. . . . . . 15,954 16,533 22,749 28,250 29,116 35,077
---------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
EBITDA . . . . . . . . . . . . . . . . . $ 27,874 $ 49,398 $ 71,515 $ 83,325 $ 94,683 $ 109,758
---------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------

CONTINUED:

FOR THE THREE MONTHS ENDING. . . . . . . 9/30/05 12/31/05 3/31/06
(Unaudited). . . . . . . . . . . . . (UNAUDITED) (UNAUDITED) (UNAUDITED)
NET INCOME (LOSS). . . . . . . . . . . . $ 136,251 $ 152,851 $ 7,017
---------------------------------------- ------------ ------------ ---------

Interest Income. . . . . . . . . . . . . (24,848) (36,208) (33,615)
Interest Expense . . . . . . . . . . . . 452 590 5,283
Non-Cash Interest exp. (Debt Discount) . - - -
Gain on Building Sale. . . . . . . . . . (29,318) (29,318) (29,318)
Stock Option Expense . . . . . . . . . . - - 90,701
Provision for income taxes . . . . . . . 400 400 4,235
Depreciation and Amortization. . . . . . 44,078 83,708 147,370
---------------------------------------- ------------ ------------ ---------
EBITDA . . . . . . . . . . . . . . . . . $ 127,015 $ 172,023 $191,673
---------------------------------------- ------------ ------------ ---------
---------------------------------------- ------------ ------------ ---------

Year Ended December 31, 2005 -vs.- Year Ended December 31, 2004

Net Sales

Our net sales increased by 84% to $9,005,000 for the year ended December
31, 2005 compared to net sales of $4,891,000 for the same period in 2004. Net
sales increased due to our obtaining and our performance under new and existing

PAGE 40

government contracts. Net sales in 2005 reflected our continued work on the
Missile Defense Agency Task Order 2 contract of $6,767,000 which is part of our
March 31, 2004 Missile Defense Agency contract described above. To date,
contract revenue from Task Order 2 is $7,341,500. We also recorded net sales on
ongoing Small Business Innovation Research contracts with the Air Force Research
Laboratory. These contracts are both for Phase II efforts, and are for our
Small Launch Vehicle and our micro and nanosatellite bus and subsystem designs
work. Net sales for these contracts totaled $750,000 and $616,000 respectively
for the year ended December 31, 2005. In addition, we started our Phase I
effort with Andrews Space which had revenues for the year ended December 31,
2005 of $393,000 and smaller projects with approximately $479,000 in revenue,
which included the lunar lander project, our subcontract support and first Phase
SBIR grants.

Net sales for the year ended December 31, 2004 included $1,400,000 from the
Air Force Research Laboratory Phase II contract, $574,500 and $1,140,000 from
the Missile Defense Agency Task Order 2 and Task Order 1, respectively, $319,000
also from the Missile Defense Agency Phase 0 contract (which was the precursor
to the larger contract with multiple task orders), $686,000 from the
SpaceShipOne program and $240,000 from our Defense Advanced Research Projects
Agency contract for the study of Novel Satcom Microsat Constellation Deployment.

Cost of Sales

For the year ended December 31, 2005, cost of sales was approximately
$6,906,000, or 76.69% of net sales, as compared to approximately $3,821,000, or
78.12% of net sales, during the same period in 2004. Cost of sales consists of
direct and allocated costs associated with individual contracts. The increase in
cost of sales was directly tied to increases in net sales, and the decrease in
cost of sales as a percentage of net sales was due to improved systems and
processes for management of our projects and improved labor productivity. Gross
margin improvement has been limited due to the cost plus fixed fee nature of our
contracts.

PAGE 41

Operating Expenses

Operating expenses increased from approximately $926,000, or 18.93% of net
sales, for the year ended December 31, 2004 to approximately $1,788,000, or
19.85% of net sales, for the same twelve months ended December 31, 2005.
Operating expenses include general and administrative expenses, research and
development costs and marketing and sales expenses.

- General and administrative expenses increased from approximately $507,000,
or 10.37% of net sales, for the year ended December 31, 2004 to
approximately $1,114,000, or 12.37% of net sales, for the year ended
December 31, 2005. The increase was attributable to the increase in
personnel, including a human resources director and a contract
administrator, and compliance efforts, including those related to the
Sarbanes-Oxley Act of 2002 and FAS No. 123(R).

- We have most of our research and development expenses for new products and
services paid for by our government programs and projects.

- Marketing and sales expenses increased from approximately $419,000, or
8.56% of net sales, for the year ended December 31, 2004, to approximately
$674,000, or 7.48% of net sales, during the same period in 2005. Although
the total percent of sales decreased in 2005 the actual dollar increase was
attributable to the allocation of a portion of the personnel costs of our
vice president of new business development and our then chief executive
officer to marketing and sales expenses as well as costs associated with
the preparation and submission of proposals for new projects.

PAGE 42

Non-Operating Expense (Income)

Non-operating expense (income) consisted of amortization of deferred gain
on the sale of our building, other non-cash loan fees and expenses, and interest
expense and interest income. Interest expense did not comprise a significant
portion of non-operating expense during the year ended December 31, 2005 or
2004. For the first time, we recorded a net non-operating income for the year
ended December 31, 2005.

- We expensed approximately $3,000 and $52,000 in interest for the years
ended December 31, 2005 and 2004, respectively. The decrease was due to a
reduction in debt with fewer notes payable. We continue to pay interest
expense on certain capital leases and settlement notes, although the
balances continue to decline.

- We recognized approximately $106,000 and $19,500 in interest income in 2005
and 2004, respectively. The increase is due to an increase in cash balances
from various financing activities.

- We recognized approximately $117,000 of amortized deferred gain on the sale
of our building during each of the years ended December 31, 2005 and 2004,
and we will continue to amortize the remaining deferred gain of
approximately $831,000 into non-operating income over the remainder of the
lease of the building, which is scheduled to expire in 2013.

- We recorded loan fees related to our revolving credit facility of
approximately $29,000 and $3,254,000 of net sales for the years ended
December 31, 2005 and 2004, respectively. Although we did not have a
balance on our revolving credit facility during 2005, we recorded
approximately $29,000 in non-cash loan fees upon Laurus' exercise of
warrants to acquire 50,000 shares of our common stock, which were granted
in 2004 in connection with the revolving credit facility. Additional
non-cash loan fees will be recorded as the warrants granted to Laurus
related to the revolving credit facility are exercised. The large non-cash
2004 charge reflected a beneficial debt to equity conversion feature.

Net Income and EBITDA

Net income was approximately $501,000, or 5.57% of net sales, compared to a
net loss of approximately $3,027,000 for the years ended December 31, 2005 and
2004, respectively. During the year ended December 31, 2005, we had earnings
before interest, taxes, depreciation and amortization, or EBITDA, of
approximately $503,000, or 5.59% of net sales, compared to approximately
$228,000, or 4.65% of net sales, for the year ended December 31, 2004.

PAGE 43

The following table reconciles EBITDA to net income (loss) for the years ended
December 31, 2005 and 2004:

FOR THE YEAR ENDING. . . . . . DECEMBER 31, 2005 December 31, 2004

NET INCOME (LOSS). . . . . . . $ 501,264 $ (3,027,054)
------------------------------ ------------------- -------------------

Interest Income. . . . . . . . (105,840) (19,497)
Interest Expense . . . . . . . 2,873 52,077
Gain on Building Sale. . . . . (117,272) (117,272)
Loan Fee - Equity Conversion. 28,875 3,254,430
Provision for income taxes . . 1,600 1,600
Depreciation and Amortization. 191,978 83,531
------------------------------ ------------------- -------------------
EBITDA . . . . . . . . . . . . $ 503,578 $ 227,815
------------------------------ ------------------- -------------------

EBITDA is a non-GAAP financial measure and 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. Our management regularly evaluates our progress based on
EBITDA.

PAGE 44

[GRAPHIC OMITED]

PAGE 45

LIQUIDITY AND CAPITAL RESOURCES

CASH POSITION FOR THREE-MONTHS ENDED MARCH 31, 2006 -VS.- THREE-MONTHS
ENDED MARCH 31, 2005

Net decrease in cash during the three-months ending March 31, 2006 was
approximately $4,607,000 compared to a cash increase of $344,000 for the same
three-month period in 2005, primarily due to the acquisition of Starsys Research
Corporation and related debt repayment and transaction costs. These items were
partially offset by the sale of our Series D-1 Preferred Stock to a small group
of institutional investors in January 2006. Net cash used in operating
activities totaled approximately $3,264,000 for the three-months ending March
31, 2006, a decrease of approximately $3,500,000 as compared to approximately
$236,000 provided by operating activities during the same three-month period in
2005, primarily due to the increase in accounts receivable which we received
upon the acquisition of Starsys as well as the increase in all other operating
expenses from the acquired company

Net cash used in investing activities totaled approximately $1,391,000 for
the three-months ending March 31, 2006, compared to approximately $43,000 used
in investing activities during the same three-month period in 2005. The
increase in cash used in investing activities is primarily due to the need to
provide working capital for the operations of Starsys, which was insolvent at
the time we acquired it.

Net cash provided by financing activities totaled approximately $47,000 for
the three-months ending March 31, 2006, which is a decrease of approximately
$104,000 from the approximately $151,000 provided by financing activities during
the same three-months in 2005. This is primarily attributable to the sale of
our Series D-1 Preferred Stock in January 2006, which was then used to fund the
merger with Starsys, pay off the secured debt, and pay down payables and other
accruals on Starsys' books at the end of January 2006.

At March 31, 2006, our cash, which included cash reserves and cash
available for investment, was approximately $1,143,000, as compared to
approximately $5,413,000 at March 31, 2005, a decrease of approximately
$4,270,000 mainly due to the use of cash to fund our acquisition of Starsys in
January 2006 and to provide working capital for the combined company in the
first quarter of 2006.

As of March 31, 2006, our backlog of funded and non-funded business was
approximately $37 million, compared to approximately $45 million as of March 31,
2005. With respect to the Missile Defense Agency program, we expect over $8
million in revenue to be generated in 2006. Although the Missile Defense Agency
contract was awarded to us, there can be no assurance that the contract will be
continued through all phases, and, if continued, that it will generate the
amounts anticipated.

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 $2,484,000 and $2,075,000 as of March 31, 2006 and 2005,
respectively, consist primarily of the income tax benefits from net operating
loss and capital loss carry forwards, 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 $645,000 in 2006 from
$1,857,000 at December 31, 2005 to $2,484,000 at March 31, 2006. Of this
valuation allowance, $2,259,000, at March 31, 2006 is related to net operation
losses of the acquired business. The tax benefit of these tax loss carry
forwards, if and when realized, will reduce the existing value of goodwill.

At March 31, 2006, the Company had federal and state tax net operating loss
carry forwards of approximately $4,214,000 and $2,316,000, respectively. The
federal and state tax loss carry forwards will expire in 2023 and 2012,
respectively, unless previously utilized.

PAGE 46

The Company also has acquired federal and Colorado net operating losses in
conjunction with the acquisition of Starsys of approximately $5,727,000 and
$9,220,000, respectively. These net operating losses will be subject to an
annual limitation under internal revenue code section 382.

The Company also has federal and California research tax credit carry
forwards of approximately $68,000 and $47,000, respectively, which begin to
expire in 2018.

Pursuant to Internal Revenue Code Section 382 and 383, the Company's use of
its net operating losss and credit carry forwards may be limited as a result of
the cumulative changes in the ownership of more than 50% over a three year
period.

CASH POSITION FOR YEAR ENDED DECEMBER 31, 2005 -VS.- YEAR ENDED DECEMBER
31, 2004

Net increase in cash during the twelve months ended December 31, 2005 was
approximately $681,000 compared to a net increase of approximately $4,477,000
for the same twelve-month period in 2004. Net cash provided by operating
activities totaled approximately $397,000 for the year ended December 31, 2005,
an increase of approximately $507,000 compared to approximately $110,000 used
operating activities during 2004. The improvement in cash from operating
activities resulted from our obtaining and our performance under new and
existing government contracts.

Net cash used in investing activities totaled approximately $2,716,000 for
the year ended December 31, 2005, compared to approximately $225,000 used in
investing activities during the same twelve-month period in 2004. The increase
in cash used in investing activities was attributable to the $1.2 million bridge
loan we entered into with Starsys, our purchase of certain fixed assets related
to the construction of our fabrication and test facility for hybrid rocket
motors and the purchase of additional computer hardware and software tools.

Net cash provided by financing activities totaled approximately $3,000,000
for the year ended December 31, 2005, which is a decrease of approximately
$1,812,000 from the approximately $4,812,000 provided by financing activities
during 2004. The difference is attributable to warrant and option exercises and
the receipt of $2.5 million from the sale of preferred stock to Laurus in August
2004. While we did raise capital in exchange for the sale of our common stock
in the third quarter of 2005, the funds raised from preferred stock issuances
and common stock option exercises in 2004 exceeded the 2005 levels.

Our cash, cash reserves and cash available for investment increased
slightly to approximately $5,750,000 at December 31, 2005, compared to
approximately $5,069,000 at December 31, 2004. The increase was attributable to
cash generated from operations and the capital raised in late 2005 offset by an
increase in accounts payable from materials purchased under contract. Cash plus
accounts receivable increased from approximately $5.7 million at December 31,
2004 to approximately $7.0 million at December 31, 2005.

Our backlog of funded and non-funded business was approximately $28.6
million at December 31, 2005, compared to approximately $47 million at December
31, 2004. We were informed in September 2005 that the Missile Defense Agency
had re-routed the laser communications experiment to another program and that
they would not be exercising their option for a second cluster, at this time;
however, the Missile Defense Agency also informed us of several other
opportunities that might replace the laser communications experiment and while
we cannot be assured of any new business, the Missile Defense Agency was
interested in continuing a productive business relationship with us. As a result
of this notification, we reduced our backlog by approximately $10 million. The
Missile Defense Agency contract is an IDIQ contract, meaning it is an indefinite

PAGE 47

delivery, indefinite quantity contract which can be re-funded up to the $43
million ceiling with other microsatellites or new business without further
signature authority for the five year period of the contract. Although the
Missile Defense Agency contract was awarded to us, there can be no assurance
that the contract will be continued through all phases, and, if continued, that
it will generate the amounts anticipated.

We had a net deferred tax asset of approximately $2,127,000 and $2,350,000
at December 31, 2005 and 2004, respectively, which consisted primarily of the
income tax benefits from net operating loss and capital loss carryforwards,
amortization of deferred gain on sale of building and research and development
credits. Deferred income taxes represent temporary differences in recognizing
certain income and expense items for financial and tax reporting purposes. 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 decreased from $2,318,000 at December 31, 2004 to $2,075,000 at
December 31, 2005.

We had federal and state tax net operating loss and capital loss
carryforwards of approximately $4,214,000 and $1,608,000 at December 31, 2005
respectively. The federal tax loss carryforwards will expire in 2023 and the
state tax loss carryforwards will expire in 2013, unless previously utilized.

PAGE 48

CASH POSITION

Our ability to increase cash generation from operations and thereby
continue as a going concern without the need to raise equity capital depends
upon our ability to ultimately implement our business plan, which includes (but
is not limited to) generating substantial new revenue from the Missile Defense
Agency by successfully performing under our $43 million contract and continuing
to attract and successfully complete other government and commercial contracts.
The Missile Defense Agency contract is staged, and we cannot guarantee that all
subsequent phases will be awarded or will be awarded to us. Recent budget cuts
may affect government spending on these space-based contracts.

In order to perform the Missile Defense Agency contract on schedule and to
successfully execute other existing and new business opportunities, we must
substantially increase our staff and hire new engineers or subcontract the work
to third parties. Although we are actively and aggressively seeking to hire
spacecraft and propulsion engineers to fulfill existing and new business demand,
there can be no assurance that we will be able to attract such engineering
resources or if we are able to attract them, that they will be available in the
timeframe needed or for a reasonable cost.

In addition, we need to continue developing project management expertise to
profitably execute on new business contracts and effectively and efficiently bid
on and win new business. New business opportunities can come from a variety of
sources, including state and federal grants and government and commercial
customer programs. However, there can be no assurance that we will be able to
obtain such new business contracts or, if such 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.

PAGE 49

CRITICAL ACCOUNTING STANDARDS

Due to the acquisition of Starsys, our revenues transitioned in 2006 from
being primarily cost plus fixed fee contracts, where revenues are recognized as
costs are incurred and services are performed, to 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,.
Losses on contracts are recognized when they become known and reasonably
estimable (see the Notes to SpaceDev's 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
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation. We adopted SFAS No. 123 in 1997. Through December 31,
2005 we have elected to measure compensation expense for our stock-based
employee compensation plans using the intrinsic value method prescribed by APB
Opinion No. 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 Note 4 to SpaceDev's 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.

PAGE 50

SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure, which amends SFAS No. 123, Accounting for Stock-Based Compensation,
was published by the 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. Through December 31, 2005, we
had chosen the latter approach.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment (SFAS No. 123R), which replaces SFAS No. 123 and supersedes APB Opinion
No. 25. SFAS No. 123R requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the financial statements
based on their fair values. In addition, the adoption of SFAS No. 123R requires
additional accounting related to the income tax effects and additional
disclosure regarding the cash flow effects resulting from share-based payment
arrangements. SFAS No. 123R is effective January 1, 2006 for calendar year
companies. Accordingly, we implemented the revised standard in the first quarter
of 2006. [See Note 4 to our consolidated financial statements for additional
information.]

On December 20, 2005, in response to SFAS No. 123R, our Board of Directors
approved accelerating the vesting of all unvested stock options held by current
employees, including executive officers, and members of the Board of Directors.
The accelerated vesting was effective as of December 20, 2005.

PAGE 51

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 153, Exchanges of Nonmonetary Assets- An Amendment of APB Opinion No.
29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions,
is based on the principle that exchanges of nonmonetary assets should be
measured based on the fair value of the assets exchanged. The guidance in that
Opinion, however, included certain exceptions to that principle. SFAS No. 153
amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of
similar productive assets and replaces it with a general exception for exchanges
of nonmonetary assets that do not have commercial substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. The provisions of
SFAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Early application was permitted and
companies must apply the standard prospectively. The adoption of this standard
is not expected to have any effect on our financial position or results of
operations.

In December 2004, FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R). FAS No. 123R
revised SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related
implementation guidance. SFAS No. 123R will require compensation costs related
to share-based payment transactions to be recognized in the financial statement
(with limited exceptions). The amount of compensation cost will be measured
based on the grant-date fair value of the equity or liability instruments
issued. Compensation cost will be recognized over the period that an employee
provides service in exchange for the award.

In March 2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107 (SAB No. 107), Share-Based Payment, providing
guidance on option valuation methods, the accounting for income tax effects of
share-based payment arrangements upon adoption of SFAS No. 123R, and the
disclosures in MD&A subsequent to the adoption. In April 2005, the Securities
and Exchange Commission adopted a rule which delayed the compliance date for
small business issuers to the start of the first fiscal year beginning after
December 15, 2005. We will provide SAB No. 107 required disclosures upon
adoption of SFAS No. 123R in January 2006.

In June 2005, FASB issued SFAS No. 154, Accounting Changes and Errors
Corrections, a replacement of APB Opinion No. 20 and FAS No. 3. The Statement
applies to all voluntary changes in accounting principle, and changes the

PAGE 52

requirements for accounting for and reporting of a change in accounting
principle. SFAS No. 154 requires retrospective application to prior periods'
financial statements of a voluntary change in accounting principle unless it is
impractical. APB Opinion No. 20 previously required that most voluntary changes
in accounting principle be recognized by including in net income of the period
of the change the cumulative effect of changing to the new accounting principle.
SFAS No.154 is not expected to have any effect on our financial position or
results of operations.

In February 2006, the FASB issued FAS No. 155, Accounting for Certain
Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140
(FAS No. 155). This statement resolves issues addressed in FAS No. 133
Implementation Issue No. D1, Application of Statement 133 to Beneficial Interest
in Securitized Financial Assets. FAS No. 155 (a) permits fair value
remeasurement for any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation; (b) clarifies which
interest-only strips and principal-only strips are not subject to the
requirements of FAS No. 133; (c) establishes a requirement to evaluate
beneficial interests in securitized financial assets to identify interests that
are freestanding derivatives or that are hybrid financial instruments that
contain an embedded derivative requiring bifurcation; (d) clarifies that
concentrations of credit risk in the form of subordination are not embedded
derivatives; and (e) eliminates restrictions on a qualifying special-purpose
entity's ability to hold passive derivative financial instruments that pertain
to beneficial interests that are or contain a derivative financial instrument.
FAS No. 155 also requires presentation within the financial statements that
identifies those hybrid financial instruments for which the fair value election
has been applied and information on the income statement impact of the changes
in fair value of those instruments. We are required to apply FAS No. 155 to all
financial instruments acquired, issued or subject to a remeasurement event
beginning January 1, 2007. We do not expect the adoption of FAS No. 155 to have
a material impact on our financial statements.

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 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 for our projects and 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 $26,000 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.]

As a result of our acquisition of Starsys, we acquired a lease for a
41,400 square foot facility in Boulder, Colorado and a 5,000 square foot
facility in Durham, North Carolina. These facilities are designed for the
development, manufacture, assembly, integration and test of our projects and
products.

PAGE 53

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

James W. Benson, our chief technology officer and Chairman of the
Board of Directors, and Susan Benson, our former Corporate Secretary and
currently a director, are married but separated. Mr. Benson has personally
guaranteed the building lease on our facility and has placed his home in Poway
as collateral.

Until joining us, Mark N. Sirangelo, our chief executive officer, vice
chairman and a director, was a member of QS Advisors, LLC, and also
a member of The QuanStar Group LLC, business advisors to SpaceDev. SpaceDev and
QS Advisors entered into an agreement for which QS Advisors was paid a monthly
fee of $5,000. In addition, under the agreement (as later amended), upon the
consummation of the merger with Starsys, and for services performed in relation
to the merger, QS Advisors received $200,000 cash and 250,000 shares of our
common stock. This agreement terminated upon consummation of Mr. Sirangelo's
employment with us.

On January 31, 2006, we entered into a non-competition agreement with
Scott Tibbitts, pursuant to which Mr. Tibbitts has agreed not to be employed by
or have any interest in an entity that engages in a similar business to Starsys
related to the aerospace industry for three years, shall not solicit any
business from any past or present customer of us, not solicit or encourage
any of our employees to leave or reduce his or her employment, not to encourage
a consultant under contract with SpaceDev to cease or diminish his or her work
with us, not to use our intellectual property other than for the
benefit of us and not to make any negative or disparaging statements
regarding SpaceDev to any third party. Mr. Tibbitts will receive $100,000
annually each year he abides by the covenant not to compete.

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. We did
not incur consulting fees with Hill and Knowlton, Inc., an affiliate of Wexler &
Walker, in 2005 or 2004.

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 2005 and 2004, other than reimbursement
of Board-related travel expenses.

PAGE 54

From October 14, 2002 through November 14, 2002, we sold an aggregate of
$475,000 of 2.03% convertible debentures to three of our then directors and
officers. 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. The convertible debentures
were exercisable into a number of our common shares at a conversion price that
equaled the 20-day average asking price less 10%, which was established when the
note was issued. 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 were exercisable for three (3) years from the date
of issuance at the initial exercise 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. The
debt discount was 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 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. 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. The Company 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. Of the
614,852 remaining warrants, all were exercised in 2004 and none remained
outstanding at December 31, 2004 and December 31, 2005.

MARKET FOR COMMON EQUITY & RELATED STOCKHOLDER MATTERS

EQUITY COMPENSATION PLAN INFORMATION

The following table reflects information as of December 31, 2005.

(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 5,447,560 $ 1.19 1,458,103
approved by
security holders

------------------ --------------------------- ------------------- --------------------------
Equity . . . . . . 4,900,000 $ 1.36 -
compensation plans
not approved by
security holders

------------------ --------------------------- ------------------- --------------------------
Total. . . . . . . 10,347,560 $ 1.27 1,458,103
------------------ --------------------------- ------------------- --------------------------

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
3/31/2003. . . $ 0.55 $ 0.41
-------------- ---------- ----------
3/31/2004. . . $ 1.85 $ 0.92
6/30/2004. . . $ 2.38 $ 1.04
9/30/2004. . . $ 2.46 $ 1.43
12/31/2004 . . $ 2.42 $ 1.51
3/31/2005 . . $ 1.97 $ 1.55
6/30/2005. . . $ 1.75 $ 1.51
9/30/2005. . . $ 1.70 $ 1.43
12/31/2005 . . $ 1.65 $ 1.36
3/31/2006 . . $ 1.52 $ 1.10

HOLDERS

As of May 31, 2006, there were over 600 holders of record of our
common stock.

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 AND CONTROL PERSONS.

Our management and directors' business activities are under the control of
our Board of Directors. Our chief executive officer, Mark N. Sirangelo, our
chief technology officer, James W. Benson, our president and chief
financial officer, Richard B. Slansky, our vice president of engineering, Frank
Macklin, our vice president of new business development and project
management, Randall K. Simpson, managing director, Scott Tibbitts, and
president of Starsys, Robert Vacek manage our daily operations. Our Board
currently consists of eleven directors. Below is a list of our
executive officers and directors.

NAME POSITION HELD
--------------------------------------------------------------------------------

Mark N. Sirangelo Chief Executive Officer,
13855 Stowe Drive Director, Vice Chairman of the Board
Poway, California 92064

James W. Benson Chief Technology Officer,
13855 Stowe Drive Director, Chairman of the Board
Poway, California 92064

Richard B. Slansky President, Chief Financial Officer,
13855 Stowe Drive Director, Corporate Secretary
Poway, CA 92064

Frank Macklin Vice President, Engineering
13855 Stowe Drive
Poway, California 92064

Randall K. Simpson Vice President, New Business
13855 Stowe Drive Development & Project Management
Poway, California 92064

Scott Tibbitts Managing Director, Director
13855 Stowe Drive
Poway, California 92064

Robert Vacek President of Starsys, Inc.
13855 Stowe Drive
Poway, California 92064

Susan Benson Director
13855 Stowe Drive
Poway, CA 92064

Scott McClendon * Director
13855 Stowe Drive
Poway, California 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

Scott McClendon * Director
13855 Stowe Drive
Poway, California 92064

* Denotes Independent Director

PAGE 57

The following is a summary of the business experience of our officers and
directors as well as other key employees.

James W. Benson, age 61, is our founder and has served as our
Chairman of the Board since October 1997. Mr. Benson also served as our chief
executive officer from October 1997 until December 2005, at which time he was
succeeded by Mark N. Siranglo in such position, and became our chief technology
officer. In 1984, Mr. Benson founded Compusearch Corporation (later renamed
Compusearch Software Systems), in McLean, Virginia. The company 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. Mr. Benson and Susan C. Benson are married but separated.

Mark N. Sirangelo, age 45, was a member of QS Advisors, LLC, and also a
member of The QuanStar Group LLC, strategic and business advisors to SpaceDev,
until he was appointed vice chairman and chief executive officer of SpaceDev in
December 2005. Mr. Sirangelo's roles were as a managing member from December
2003 and chief executive officer of the Quanstar Group, LLC from December 2003
until November 2005 and the managing member of QS Advisors, LLC from February
1998 to December 2005. Mr. Sirangelo actively participated in the development in
a number of early-stage companies in aerospace, technical, scientific and other
industries. His work at Quanstar also included hands-on involvement with
technology commercialization transfer for university and government
laboratories. From 2001 until 2003, Mr. Sirangelo also served as a senior
officer of Natexis Bleichroeder, Inc., an international investment banking firm.
Mr. Sirangelo has a bachelor's degree in science, a master's degree in business
and juris doctorate, all from Seton Hall University. Mr. Sirangelo is a director
for the National Center for Missing and Exploited Children in addition to
serving as a director and treasurer of the International Center for Missing and
Exploited Children.

Richard B. Slansky, age 49, is our President, 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.

Scott Tibbitts, age 48, was appointed managing director and a director of
SpaceDev at the closing of the Starsys merger on January 31, 2006. Mr. Tibbitts
co-founded Starsys Research Corporation in 1988 and has served as president,
chief executive officer and a member of the Board of Directors from 1988 until
May 2005; and since May 2005 has served as chief executive officer and a member
of the Board of Directors. From 1986 to 1988, Mr. Tibbitts served as the
engineering manager for Maus Technologies, Inc., a developer of high technology
domestic water heaters and thermal actuator technologies. Mr. Tibbitts has a
bachelor's degree in chemical engineering from the University of Wisconsin.

Robert Vacek, age 44, was appointed president of Starsys at the closing of
the Starsys merger on January 31, 2006. Mr. Vacek previously served as president
and general manager of Starsys since June 2005. From November 2004 to June 2005,
Mr. Vacek served as vice president of programs of Starsys. From 1996 until
joining Starsys, Mr. Vacek held a variety of management positions at Ball
Aerospace and Technologies Corp., a provider of advanced imaging, communications
and information solutions to the aerospace market, including director of Defense
Systems. Mr. Vacek holds a bachelor's degree in electrical engineering from the
University of Minnesota and a master's degree from the University of New Mexico.

Frank Macklin, age 48, was appointed as our Vice President of
Engineering in 2004. Mr. Macklin has been our chief engineer of hybrid
propulsion systems and the technical leader for our National Reconnaissance
Office funded SPOTV Hybrid System Definition study, and is acting chief engineer
for our Maneuvering and orbital 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 Integrated
Space Systems, 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 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
University and is a California Board Certified Professional Engineer.

Randall K. Simpson, age 59, is our Vice President of Engineering 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.

PAGE 58

Stuart Schaffer, age 46, was appointed to our Board of Directors on
May 17, 2002. Mr. Schaffer is currently VP 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 budgets, 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 press spokesperson for the company, 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 63, 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
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 ("JPL"). Dr.
Huntress joined JPL 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 JPL in 1969. He and his JPL team gained an international reputation for their
pioneering studies of chemical evolution in interstellar clouds, comets and
planetary atmospheres. At JPL 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 JPL, and spent a year as a visiting professor in
the Department of Planetary Science and Geophysics at Caltech.

PAGE 59

Curt Dean Blake, age 48, 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 Starwave's 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 64, 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").

Robert S. Walker, age 63, , 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. Mr. 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 board
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 Wexler &
Walker in 2003.

PAGE 60

Scott McClendon, age 67, 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 data storage and transfer
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.

Susan C. Benson, age 61, was appointed to SpaceDev's Board of Directors
in April 2005. Ms. Benson joined SpaceDev in 1997, serving as corporate
secretary until 2003. From approximately 1998 to 2004, Ms. Benson was, in part,
responsible for SpaceDev's investor relations and public relations activities,
managing SpaceDev's strategic messaging to build industry and media awareness
and strengthen shareholder relations. Ms. Benson currently sits on the Board of
Directors of Space Development Institute, a non-profit organization founded by
James W. Benson and Ms. Benson. Ms. Benson and James W. Benson are married but
separated.

COMMITTEES OF THE BOARD OF DIRECTORS AND MEETING ATTENDANCE

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 Retired General Estes, Mr. Walker and Dr. Huntress and a
compensation committee comprised of Messrs. Blake and McClendon and Retired
General Estes. We do not maintain any pension, retirement or other
arrangements other than as disclosed in the table on page 63 for compensating
our Directors. Our Board of Directors took action sixteen (16) times
during the last fiscal year, with fifteen (15) being at regular or special
meetings attended by the members of the Board either personally or
telephonically. There was one unanimous written consent in 2005. Our
Audit Committee took separate action four (4) times during the last
fiscal year, each time at a regular or special meeting attended by a quorum of
the members of the committee either personally or telephonically.

PAGE 61

EXECUTIVE OFFICER COMPENSATION

Our "Named Executive Officers" are each of the two persons who served as
our chief executive officer in 2005 and each of our four other highest-paid
executive officers at December 31, 2005. Total compensation paid to the Named
Executive Officers for the past three fiscal years is set forth below:

SUMMARY COMPENSATION TABLE

OTHER ANNUAL SECURITIES ALL OTHER
NAME AND FISCAL SALARY BONUS COMPENSATION UNDERLYING COMPENSATION
PRINCIPAL POSITION YEAR ($) ($) ($) OPTIONS (#) ($)
----------------------- ---- ------- ------ ----------- ----------- ------------
Mark N. Sirangelo 2005 1,038 - - 1,900,000 -
Chief Executive Officer 2004 - - - - -
2003 - - - - -
----------------------- ---- ------- ------ ----------- ----------- ------------
James W. Benson 2005 180,000 2,587 - 1,100,000 1,400
Chief Technology Officer 2004 177,923 40,000 3,894 - 285
and former Chief 2003 150,000 - - - -
Executive Officer
----------------------- ---- ------- ------ ----------- ----------- ------------
Richard B. Slansky 2005 150,000 2,448 - 1,400,000 111,254
President and 2004 150,000 - - 395,000 27,672
Chief Financial Officer 2003 94,625 - - 355,000 2,482
----------------------- ---- ------- ------ ----------- ----------- ------------
Randall K. Simpson 2005 131,923 1,797 - 42,400 1,255
Vice President 2004 114,231 - - 250,000 600
New Business Development 2003 - - - - -
----------------------- ---- ------- ------ ----------- ----------- ------------
Frank Macklin 2005 124,231 1,667 - 40,000 1,400
Vice President 2004 109,110 4,067 - 50,000 100
Engineering 2003 - - - - -
----------------------- ---- ------- ------ ----------- ----------- ------------
David J. Streich (1) 2005 106,154 1,088 - 55,000 -
Vice President 2004 - - - 240,000 -
Human Resources 2003 - - - - -
----------------------- ---- ------- ------ ----------- ----------- ------------
----------------------- ---- ------- ------ ----------- ----------- ------------

(1) The Board of Directors has determined that Mr. Streich is not a Section 16
officer; however we are providing compensation information regarding Mr. Streich
in the interest of full disclosure.

OPTION GRANTS IN LAST FISCAL YEAR

The following table shows all stock options granted during 2005 to the
Named Executive Officers. No stock appreciation rights were granted during
fiscal year 2005.

Percent of Total
Number of Securities Options Granted to Exercise
Underlying Options Employees in Fiscal Price Expiration
Name Granted (#) Year ($/Share) Date
------------------ -------------------- ------------------- --------- -----------
Mark N. Sirangelo 1,900,000 30% 1.40 12/20/2010
James W. Benson 1,100,000 17% 1.40 12/20/2010
Richard B. Slansky 1,400,000 22% 1.40 12/20/2010
Randall K. Simpson 42,400 1% 1.40 12/20/2010
Frank Macklin 40,000 1% 1.40 12/20/2010
David J. Streich 55,000 1% 1.40 12/20/2010
------------------ -------------------- ------------------- --------- -----------
------------------ -------------------- ------------------- --------- -----------

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END
OPTION/SAR VALUES

The following table reflects information for the Named Executive Officers,
effective December 31, 2005:

Number of Securities Value of Unexercised In-the-
Underlying Unexercised Money Options/SARs at FY-End
Options/SARs at FY-End (#) ($)
--------------------------- ------------------------------
Name Shares Acquired on Value Realized Exercisable / Unexercisable Exercisable / Unexercisable
Exercise (#) ($)
------------------ ------------------ -------------- --------------------------- ------------------------------
Mark N. Sirangelo - - 1,900,000 / - $2,660,000 / -
------------------ ------------------ -------------- --------------------------- ------------------------------
James W. Benson - - 1,610,000 / - 1,839,469 / -
------------------ ------------------ -------------- --------------------------- ------------------------------
Richard B. Slansky 25,000 12,750 2,125,000 / - 2,491,700 / -
------------------ ------------------ -------------- --------------------------- ------------------------------
Randall Simpson - - 292,400 / - 357,436 / -
------------------ ------------------ -------------- --------------------------- ------------------------------
Frank Macklin - - 93,000 / - 104,583 / -
------------------ ------------------ -------------- -------------------------- -------------------------------
David J. Streich - - 295,000 / - 77,000 / -
------------------ ------------------ -------------- --------------------------- ------------------------------
------------------ ------------------ -------------- --------------------------- ------------------------------

PAGE 62

DIRECTOR COMPENSATION

Our non-employee directors received options for attending meetings of the
Board as follows: each director received 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 non-employee directors also received compensation for attending
committee meetings as follows: each director received 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 received an option to purchase 2,500 shares
for each Nominating/Governance Committee meeting attended, which options were
not subject to a cap. In addition to the above, non-employee directors receive
options for 5,000 shares on the date of election or appointment. All such
options were issued pursuant to the 1999 Stock Option Plan at fair market value
as of the date of the meeting attended, with an original vesting schedule of 50%
on the first anniversary date of the date of grant and 50% on the second
anniversary date of grant, and expiring on the three-year anniversary of the
grant date.

The following table sets forth the remuneration paid to our directors
during the fiscal year ended December 31, 2005, including options issued to
directors for projected service in 2006. We issued 2006 compensation in advance
to our December 2005 directors in order to reduce earnings charges for future
director consideration as a result of FAS No. 123R. The Board will address
non-employee director compensation for 2007 and beyond in 2006. We do not pay
directors who are also officers of the Company 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
----------------------------- -------- ------- ---------- --------- ------------
Name
----------------------------- -------- ------- ---------- --------- ------------
Mark N. Sirangelo - - - - -
----------------------------- -------- ------- ---------- --------- ------------
James W. Benson - - - - -
----------------------------- -------- ------- ---------- --------- ------------
Richard B. Slansky - - - - -
----------------------------- -------- ------- ---------- --------- ------------
Susan C. Benson - - - - -
----------------------------- -------- ------- ---------- --------- ------------
Curt Dean Blake - - - - 177,000
----------------------------- -------- ------- ---------- --------- ------------
General Howell M. Estes, III - - - - 103,000
----------------------------- -------- ------- ---------- --------- ------------
Wesley T. Huntress - - - - 108,000
----------------------------- -------- ------- ---------- --------- ------------
Scott McClendon - - - - 152,000
----------------------------- -------- ------- ---------- --------- ------------
Stuart Schaffer - - - - 72,000
----------------------------- -------- ------- ---------- --------- ------------
Robert S. Walker - - - - 77,000
----------------------------- -------- ------- ---------- --------- ------------
----------------------------- -------- ------- ---------- --------- ------------

On December 20, 2005, the vesting on all outstanding options, including
those held by independent directors, was accelerated such that all outstanding
options became fully-vested.

EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT ARRANGEMENTS AND CHANGE OF
CONTROL AGREEMENTS

On January 31, 2006, SpaceDev entered into a three year executive
employment agreement with Scott Tibbitts, pursuant to which Mr. Tibbitts is
employed as managing director of SpaceDev. Under the agreement, Mr. Tibbitts
earns an annual base salary of $150,000 and will be eligible for quarterly
performance bonuses, as determined by our board of directors or
compensation committee, up to an annual aggregate amount of 50% of his base
salary. Bonus milestones will be mutually agreed upon in good faith by Mr.
Tibbitts and by our Board of Directors or Compensation Committee.
We will pay severance to Mr. Tibbitts if his employment is terminated by
us without cause or by Mr. Tibbitts for good reason. The severance
payment is equal to: (1) if Mr. Tibbitts' employment is terminated by us
without cause, his then-current base salary per month multiplied by the number
of months remaining in the term of the agreement (prorated with respect to any
partial month); or, (2) if Mr. Tibbitts' employment is terminated by Mr.
Tibbitts for good reason, his then-current base salary per month multiplied by
the lesser of twelve months and the number of months remaining in the term of
the agreement. Under the agreement, we will indemnify Mr. Tibbitts to the
extent provided in our articles of incorporation, as may be amended from
time to time, and pursuant to SpaceDev's standard indemnification agreement with
its officers and directors, provided that we will have no obligation to
indemnify or defend Mr. Tibbitts for any action, suit or other proceeding to the
extent based on acts, omissions, events or circumstances occurring prior to the
Starsys merger.

PAGE 63

On January 31, 2006, we entered into an executive employment
agreement with Robert Vacek pursuant to which Mr. Vacek was employed as the
president of Starsys, Inc., a subsidiary of SpaceDev, Inc. The agreement has an
initial term of two years, and will be automatically renewed for a third year
unless either we or Mr. Vacek provides written notice of an intent not to
renew. Under the agreement, Mr. Vacek is entitled to receive; (1) a base salary
of $17,000 per month, subject to adjustment up to $19,000 per month upon the
happening of certain events or by the sixteenth month of service; (2)
performance-based cash bonuses based on the achievement of specific goals set
forth in the agreement; and, (3) an option to purchase up to 825,000 shares of
our common stock under the terms and conditions of our 2004 Equity
Incentive Plan, as amended. The option has an exercise price equal to $1.46 per
share, which was the closing sale price reported on the OTCBB on the date of
grant, and will expire upon the termination of Mr. Vacek's continuous
employment. We will pay severance to Mr. Vacek if his employment is
terminated by us without cause or by Mr. Vacek for good reason. The
severance payment is equal to: (1) if Mr. Vacek's employment is terminated by
us without cause, his then-current base salary per month multiplied by the
greater of (A) 12 months or (B) the number of months remaining in the term of
the agreement (prorated with respect to any partial month); or, (2) if Mr.
Vacek's employment is terminated by Mr. Vacek for good reason, his then-current
base salary per month multiplied by the lesser of (A) 12 months or (B) the
number of months remaining in the term of the agreement provided that such
number of months will not be deemed to be less than six months. Under the
agreement, we will indemnify Mr. Vacek to the extent provided in
our articles of incorporation, as may be amended from time to time, to
the maximum extent permitted by law and pursuant to our standard
indemnification agreement, if any, with our officers and directors.

On December 20, 2005, we entered into an executive employment agreement
with Mark N. Sirangelo pursuant to which Mr. Sirangelo was employed as our chief
executive officer and vice chairman effective December 30, 2005. The agreement
has an initial term of two years, and will be automatically renewed for a third
year unless either we or Mr. Sirangelo provides written notice of an intent not
to renew. Under the agreement, Mr. Sirangelo is entitled to receive (1) a base
salary of $22,500 per month, subject to adjustment up to $27,500 per month upon
the happening of certain events, (2) performance-based cash bonuses based on the
achievement of specific goals set forth in the agreement (including a bonus of
$25,000 upon the completion of the merger with Starsys), and (3) a fully-vested
option to purchase up to 1,900,000 shares of our common stock under the terms
and conditions of a non-plan stock option agreement between us and Mr.
Sirangelo. The option has an exercise price equal to $1.40 per share, which was
the closing sale price reported on the OTCBB on the date of grant, and will
expire five years after the date of grant. Some of the shares subject to the
option are subject to sale restrictions that expire upon the achievement of
certain specific milestones or four years from the date of grant, whichever
comes first. Subject to certain limitations, the option may be exercised by
means of a net exercise provision by surrendering shares with a fair market
value equal to the exercise price upon exercise. We will pay severance to Mr.
Sirangelo if his employment is terminated by us without cause or by Mr.
Sirangelo for good reason. The severance payment is equal to: (1) if Mr.
Sirangelo's employment is terminated by us without cause, his then-current base
salary per month multiplied by the greater of (A) 12 months and (B) the number
of months remaining in the term of the agreement (prorated with respect to any
partial month); or (2) if Mr. Sirangelo's employment is terminated by Mr.
Sirangelo for good reason, his then-current base salary per month multiplied by
the lesser of (A) 12 months and (B) the number of months remaining in the term
of the agreement provided that such number of months will not be deemed to be
less than six months. Under the agreement, we will indemnify Mr. Sirangelo to
the extent provided in our articles of incorporation, as may be amended from
time to time, to the maximum extent permitted by law and pursuant to our
standard indemnification agreement with our officers and directors.

On December 20, 2005, we entered into an amended and restated executive
employment agreement with Richard B. Slansky pursuant to which Mr. Slansky is
employed as our president and chief financial officer. The agreement supersedes
in full the employment agreement dated February 10, 2003 between us and Mr.
Slansky. The agreement has an initial term of two years, and will be
automatically renewed for a third year unless either we or Mr. Slansky provide
written notice of an intent not to renew. Under the agreement, Mr. Slansky is
entitled to receive (1) a base salary of $14,500 per month, subject to
adjustment up to $20,000 per month upon the happening of certain events, (2)
performance-based cash bonuses based on the achievement of specific goals set
forth in the agreement (including a bonus of $25,000 upon the completion of the
merger with Starsys), and (3) a fully-vested option to purchase up to 1,400,000
shares of our common stock under the terms and conditions of a non-plan stock
option agreement between us and Mr. Slansky. The option has an exercise price
equal to $1.40 per share, which was the closing sale price reported on the OTCBB
on the date of grant, and will expire five years after the date of grant. Some
of the shares subject to the options are subject to sale restrictions that
expire upon the achievement of certain specific milestones or four years from
the date of grant, whichever comes first. Subject to certain limitations, the
option may be exercised by means of a net exercise provision by surrendering
shares with a fair market value equal to the exercise price upon exercise. We
will pay severance to Mr. Slansky if his employment is terminated by us without
cause or by Mr. Slansky for good reason. The severance payment is equal to: (1)
if Mr. Slansky's employment is terminated by us without cause, his then-current
base salary per month multiplied by the greater of (A) 12 months and (B) the
number of months remaining in the term of the agreement (prorated with respect
to any partial month); or (2) if Mr. Slansky's employment is terminated by Mr.
Slansky for good reason, his then-current base salary per month multiplied by
the lesser of (A) 12 months and (B) the number of months remaining in the term
of the agreement provided that such number of months will not be deemed to be
less than six months. Under the agreement, we will indemnify Mr. Slansky to the
extent provided in our articles of incorporation, as may be amended from time to
time, to the maximum extent permitted by law and pursuant to our standard
indemnification agreement with our officers and directors.

PAGE 64

On December 20, 2005, we entered into an executive employment agreement
with James W. Benson pursuant to which Mr. Benson is employed as our chairman
and chief technology officer. The agreement supersedes all prior employment
agreements between us and Mr. Benson. The agreement has an initial term of two
years, and will be automatically renewed for a third year unless either we or
Mr. Benson provide written notice of an intent not to renew. Under the
agreement, Mr. Benson is entitled to receive (1) a base salary of $14,000 per
month, subject to adjustment up to $17,000 per month upon the happening of
certain events, (2) performance-based cash bonuses based on the achievement of
specific goals set forth in the agreement (including a bonus of $22,500 upon the
completion of the merger with Starsys), and (3) a fully-vested option to
purchase up to 950,000 shares of our common stock under the terms and conditions
of a non-plan stock option agreement between us and Mr. Benson. The option has
an exercise price equal to $1.40 per share, which was the closing sale price
reported on the OTCBB on the date of grant, and will expire five years after the
date of grant. Some of the shares subject to the options are subject to sale
restrictions that expire upon the achievement of certain specific milestones or
four years from the date of grant, whichever comes first. Subject to certain
limitations, the option may be exercised by means of a net exercise provision by
surrendering shares with a fair market value equal to the exercise price upon
exercise. We will pay severance to Mr. Benson if his employment is terminated by
us without cause or by Mr. Benson for good reason. The severance payment is
equal to: (1) if Mr. Benson's employment is terminated by us without cause, his
then-current base salary per month multiplied by the greater of (A) 12 months
and (B) the number of months remaining in the term of the agreement (prorated
with respect to any partial month); or (2) if Mr. Benson's employment is
terminated by Mr. Benson for good reason, his then-current base salary per month
multiplied by the lesser of (A) 12 months and (B) the number of months remaining
in the term of the agreement provided that such number of months will not be
deemed to be less than six months. Under the agreement, SpaceDev will indemnify
Mr. Benson to the extent provided in our articles of incorporation, as may be
amended from time to time, to the maximum extent permitted by law and pursuant
to our standard indemnification agreement with our officers and directors.

On December 20, 2005, Mr. Benson also received an option to purchase up to
150,000 shares of our common stock in connection with his services as our
chairman pursuant to the terms of a separate non-plan stock option agreement
between us and Mr. Benson. The option has an exercise price equal to $1.40 per
share, which was the closing sale price reported on the OTCBB on the date of
grant, and will expire five years after the date of grant. Some of the shares
subject to the option are subject to sale restrictions that expire upon the
achievement of certain specific milestones or four years from the date of grant,
whichever comes first. Subject to certain limitations, the option may be
exercised by means of a net exercise provision by surrendering shares with a
fair market value of the exercise price upon exercise.

EMPLOYEE BENEFITS

In 1999 we adopted an Incentive Employee Stock Option Plan under
which our 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.

PAGE 65

In 2000 we amended 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 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 the
Company's needs. As of December 31, 2004, all shares issuable under the 1999
Incentive Stock Option Plan had been issued or were in reserve subject to
outstanding awards under the plan.

In 2004 we adopted a 2004 Equity Incentive Plan. The 2004 Equity
Incentive Plan authorized and reserved for issuance under the Plan 2,000,000
shares of our common stock. Options granted under the plan may be
Incentive Stock Options or non-statutory stock options, as determined by the
Board of Directors or a committee appointed by the Board of Directors at the
time of grant. Limited rights and stock awards may also be granted under the
Plan. As of December 31, 2005, 8,184,698 shares were authorized for issuance
under the 1999 Stock Option Plan and the 2004 Equity Incentive Plan, 4,706,460
of which are currently subject to outstanding options and awards.

At the special meeting of our stockholders held on January 30, 2006, we
sought and obtained approval from our stockholders to increase the amount of
shares of common stock available for award under our 2004 Equity Incentive Plan
by 3,000,000 shares. This increase was obtained to provide sufficient reserves
for the issuance of options to Starsys officers and key employees as part of our
acquisition of Starsys.

In addition to the 1999 Stock Option Plan and the 2004 Equity Incentive
Plan, we have adopted a 1999 Employee Stock Purchase Plan, which
authorized our Board of Directors to make twelve consecutive offerings of our
common stock to our employees. The first employees enrolled in the plan
in August 2003. The first shares of common stock were issued under the Plan in
February 2004 and every six-month anniversary thereafter. The 1999 Employee
Stock Purchase Plan expired in June 2005; however, the Board authorized a
one-year extension of the plan at their meeting in November 2004, while the
Compensation Committee reviews the value of the plan to employees and the desire
for its continuance.

We also offer a variety of health, dental, vision, 401(k) and life
insurance benefits to our employees.

PAGE 66

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table provides information as of May 31, 2006
concerning the beneficial ownership of the Company's common stock by (i) each
director, (ii) each named executive officer, (iii) each stockholder known by us
to be the beneficial owner of more than 5% of the Company's 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.

Amount and
Nature of
Beneficial
Name and Address of Beneficial Owner Ownership(1)
---------------------------------------------- ---------- ----- ------
James W. Benson. . . . . . . . . . . . . . . . 7,799,707 (2) 25.98%

Susan C. Benson. . . . . . . . . . . . . . . . 7,762,907 (3) 25.86%

Mark N. Sirangelo. . . . . . . . . . . . . . . 1,900,000 (4) 6.27%

Richard B. Slansky . . . . . . . . . . . . . . 2,235,723 (5) 7.32%

Scott F. Tibbitts. . . . . . . . . . . . . . . 845,501 2.98%

Wesley T. Huntress Jr. . . . . . . . . . . . . 293,515 (6) 1.02%

Curt Dean Blake. . . . . . . . . . . . . . . . 332,224 (7) 1.16%

General Howell M. Estes, III . . . . . . . . . 219,667 (8) 0.77%

Robert S. Walker . . . . . . . . . . . . . . . 176,667 (9) 0.62%

Stuart Schaffer. . . . . . . . . . . . . . . . 290,206 (10) 1.02%

Scott McClendon. . . . . . . . . . . . . . . . 272,460 (11) 0.95%
---------------------------------------------- ---------- ----- ------
Officers and Directors as a group (15 Persons) 18,392,060 (12) 50.78%
---------------------------------------------- ---------- ----- ------
---------------------------------------------- ---------- ----- ------

The business address for each of these persons is 13855 Stowe Drive, Poway, CA
92064.

PAGE 67

(1) Where persons listed on this table have the right to obtain additional
shares of Common Stock through the exercise of outstanding options or
warrants or the conversion of convertible securities within 60 days from
March 3, 2006, these additional shares are deemed to be outstanding for the
purpose of computing the percentage of common stock owned by such persons,
but are not deemed outstanding for the purpose of computing the percentage
owned by any other person. Percentages are based on total outstanding
shares of 28,414,531 on May 1, 2006.

(2) Represents 3,000,000 shares held directly by Mr. James W. Benson as a
result of a stipulated order entered May 24, 2005 identifying the shares as
a separate property asset of Mr. Benson, plus beneficial ownership in
2,692,294 shares held jointly with Susan C. Benson, as to which he shares
voting and investing power with Ms. Benson, indirect beneficial ownership
interest in 497,413 shares held in Space Development Institute (where Mr.
Benson is a member of the Board of Directors along with Susan C. Benson),
as to which he shares voting and investing power with Ms. Benson, and
beneficial ownership in vested options to purchase up to an aggregate of
1,610,000 shares (which may constitute as community property with Susan C.
Benson). Excludes approximately 1.2 million shares held by children of Mr.
Benson, for which Mr. Benson disclaims beneficial ownership.

(3) Represents 2,963,200 shares held directly by Ms. Susan Benson as a result
of a stipulated order entered May 24, 2005 identifying the shares as a
separate property asset of Ms. Benson, plus beneficial ownership in
2,692,294 shares held jointly with James W. Benson, as to which she shares
voting and investing power with Mr. Benson, indirect beneficial ownership
interest in 497,413 shares held in Space Development Institute (where Ms.
Benson is a member of the Board of Directors along with James W. Benson),
as to which she shares voting and investing power with Mr. Benson, and
beneficial ownership in vested options issued in the name of James W.
Benson on 1,610,000 shares (which may constitute as community property with
James W. Benson), but as to which she no longer has shared voting and
investment power. Excludes approximately 1.2 million shares held by
children of Ms. Benson, for which Ms. Benson disclaims beneficial
ownership.

(4) Mr. Sirangelo holds vested options to purchase up to an aggregate of
1,900,000 common shares.

(5) Includes vested options to purchase up to an aggregate of 2,125,000 common
shares.

(6) Includes vested options to purchase up to an aggregate of 259,647 common
shares.

(7) Includes vested options to purchase up to an aggregate of 271,000 common
shares.

(8) Includes vested options to purchase up to an aggregate of 219,667 common
shares.

(9) Includes vested options to purchase up to an aggregate of 176,667 common
shares.

(10) Includes vested options to purchase up to an aggregate of 162,000 common
shares.

(11) Includes vested options to purchase up to an aggregate of 272,460 common
shares.

(12) Officers and directors as a group include our eleven Board members, four of
whom are also executive officers, and Messrs. Simpson, Macklin, Streich and
Vacek who are deemed for this purpose to be executive officers.

PAGE 68

DESCRIPTION OF SECURITIES

We are authorized to issue up to 100,000,000 shares of our $.0001 par value
common stock, of which 28,877,452 shares are issued and outstanding as of
May 31, 2006.

In October 2005, we entered into a securities purchase agreement with
Laurus Master Fund, Ltd. pursuant to which we issued and sold 2,032,520 shares
of our common stock to Laurus for an aggregate purchase price of $2,500,000 or
$1.23 per share. The price per share represented 80% of the 20-day volume
weighted average price of our common stock through October 28, 2005. We also
issued to Laurus a warrant to purchase up to 450,000 shares at $1.93 per share.
The warrant is exercisable from October 31, 2005 until October 31, 2010.

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.

PAGE 69

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.

On January 11, 2006, we entered into a securities purchase agreement, which
we refer to as the 2006 purchase agreement, with a limited number of
institutional accredited investors, led by Omicron Capital. On January 13,
2006, we issued and sold to these investors 5,150 shares of our Series D-1
Amortizing Convertible Perpetual Preferred Stock, par value $0.001 per share,
which we refer to as Series D-1 Preferred Stock, for an aggregate purchase price
of $5,150,000, or $1,000 per share. We also issued various warrants to these
investors under the 2006 purchase agreement.

VOTING RIGHTS

The Series C and Series D-1 Shares have no voting rights.

LIQUIDATION RIGHTS

The Series C and Series D-1 Shares carry a liquidation preference
equal to the then stated value ($10.00 per share) of the then outstanding Series
C and Series D-1 Shares. As a result, the holders of the Series C and
Series D-1 Shares will receive a distribution out of the assets of the
Company upon liquidation equal to the number of Series C and Series D-1
Shares then outstanding multiplied by $10.00 before the holders of our Common
Stock will be entitled to any distribution.

DIVIDENDS

We accrued dividends on our Series C Cumulative Convertible Preferred Stock
from August 25, 2004 through December 31, 2004 of approximately $61,000 and
approximately $171,000 for the year ended December 31, 2005. The original
accrued dividends of $61,000 became payable in January 2005 and were converted
into shares of SpaceDev common stock at a conversion rate of $1.54 per share.
Approximately $114,000 of the 2005 accrued dividends was satisfied by the
issuance of SpaceDev common stock during the twelve-months ended December 31,
2005. We also paid dividends of approximately $98,900 on our Series C Cumulative
Convertible Preferred Stock on April 1, 2006. Payment of future dividends on our
Series C Cumulative Convertible Preferred Stock may be in cash or shares of
common stock, provided that the payment of cash dividends on the Series C
Cumulative Convertible Preferred Stock is prohibited in the event of our
noncompliance with our obligations under the certificate of designations for any
series of Series D-1 Preferred Stock.

We first issued shares of Series D-1 Preferred Stock on January 13, 2006.
We paid our first dividends of approximately $98,700 for the Series D-1
Preferred Stock on March 31, 2006.

PAGE 70
CONVERSION

The Series C and Series D-1 Shares are convertible into the $0.0001
par value Common Stock of the Company at a rate of $1.54 and $1.48 per share,
respectively (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. We may redeem the Series D-1 shares in
whole or in part based on certain conditions.

Under the purchase agreement, from the date of the effectiveness of the
initial registration statement filed pursuant to the registration rights
agreement (February 14, 2006), until the one-year anniversary of that date, if
(1) on any trading day during such period the volume weighted average price of
SpaceDev common stock for each of the 20 trading days immediately prior to such
date exceeds $1.63 and (2) the average daily trading volume of SpaceDev common
stock exceeds $100,000 on each of those days, then we have the option, subject
to a number of additional conditions, to put to the investors "units" at $1,000
per unit for an aggregate purchase price of up to $2,000,000 (or a lesser amount
to the extent the preferred stock warrants issued at the initial closing of the
financing, which are described below, have been exercised to purchase these
units). Each "unit" consists of one share of Series D Preferred Stock and a
common stock warrant, which entitles the holders to purchase up to an aggregate
of 440,829 shares of common stock at an exercise price of $1.51 and otherwise
has the same terms as the warrants described in the following paragraph.

WARRANTS

The Series C 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 third anniversary date of the date of issuance. The
Series D Warrants are exercisable immediately upon issuance.

Certain warrants we issued to the investors at the closing entitle the
investors to purchase up to an aggregate of 1,135,138 shares of SpaceDev common
stock at an exercise price of $1.51 per share. The warrants are exercisable for
five years following the date of grant. The warrants have "ratchet"
anti-dilution provisions reducing the warrant exercise price if the Company
issues equity securities (other than in specified exempt transactions) at an
effective price below the warrant exercise price to such lower exercise price.

We also issued certain other warrants to the investors at the closing (the
"preferred stock warrants"). These warrants entitle the holder to purchase an
aggregate number of 2,000 "units", which are identical to the "units" described
above, at an exercise price of $1,000 per unit. The preferred stock warrants are
exercisable from the effective date (February 14, 2006) until the one-year
anniversary of that date. If any units subject to the preferred stock warrants
remain unsold after (1) their expiration date and (2) the exercise of the
Company's put option, if applicable, and any holder of a preferred stock warrant
issued in the financing has exercised the warrant in full, then the preferred
stock warrant grants that holder the right to purchase a proportionate share of
the unsold units.

PAGE 71

Other Provisions.

The Series D purchase agreement contains a number of covenants by us,
which include:

- A grant of preemptive rights to the investors to participate in future
financings until the first anniversary of the closing date of the
financing;

- An agreement not to issue any shares of our common stock or securities or
other rights to acquire shares of common stock until six (6) months after
the effective date, except under specified conditions intended to ensure
the terms are no less favorable to us than the terms of this financing;
and,

- An agreement not to effect any transaction involving the issuance of
securities convertible, exercisable or exchangeable for our common stock at
a price per share or rate which may change over time.

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.
Continental Stock Transfer can be contacted via telephone at (212)
845-3215.

PAGE 72

DISCLOSURE OF COMMISSION POSITION ON 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

None
EXPERTS

The financial statements of SpaceDev, Inc., and the 2005 financial
statements of Starsys Research Corporation in this prospectus have been audited
by PKF, Certified Public Accountants, a Professional Corporation, an independent
registered public accounting firm, to the extent and for the periods set forth
in their report included herein, and are included herein in reliance upon such
reports given upon the authority of said firm as experts in auditing and
accounting.

The 2004 financial statements of Starsys Research Corporation
included in the prospectus have been audited by Clifton Gunderson LLP, an
independent registered public accounting firm, to the extent and for the periods
set forth in their report, appearing elsewhere herein and are included in
reliance upon such report given upon the authority of said firm as experts in
auditing and accounting. The report of Clifton Gunderson LLP covering the
December 31, 2004 financial statements contains an explanatory paragraph that
states that Starsys' loss from operations and net capital deficiency raise
substantial doubt about the entity's ability to continue as a going concern. The
financial statements do not include any adjustments that might result from the
outcome of that uncertainty.

The Law Office of Gretchen Cowen, our independent legal counsel, has
provided an opinion on the validity of our common stock.

LEGAL PROCEEDINGS
None

PAGE 73

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 100 F Street, NE, 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 registration statement on Form SB-2 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

UNAUDITED PRO FORMA COMBINED CONSOLIDATED STATEMENTS

HOW THE PRO FORMA FINANCIAL STATEMENTS WERE PREPARED

The following unaudited pro forma combined financial statements give effect
to the merger of SpaceDev and Starsys using the purchase method of accounting,
as required by Statement of Financial Accounting Standard No. 141, "Business
Combinations." We legally acquired Starsys and will be viewed for
accounting purposes as the "accounting acquirer." Under this method of
accounting, the combined company will allocate the purchase price to the fair
value of assets of Starsys deemed to be acquired, including identifiable
intangible assets and goodwill. The purchase price allocation is subject to
revision when the combined company obtains additional information regarding
asset valuation. The unaudited pro forma combined financial statements are based
on respective historical consolidated financial statements and the accompanying
notes of SpaceDev, and those of Starsys included herein.

The unaudited pro forma combined statements of operations for the years
ended December 31, 2004 and 2005 assume the merger took place on January 1,
2004. The unaudited pro forma combined balance sheet assumes the merger took
place on December 31, 2005. The unaudited pro forma combined statement of
operations for the years ended December 31, 2004 and 2005 combines our
historical statement of operations for the years ended December 31, 2004 and
2005 with Starsys' historical statement of operations for the years ended
December 31, 2004 and 2005.

THESE PRO FORMA FINANCIAL STATEMENTS HAVE BEEN BASED ON ASSUMPTIONS

The unaudited pro forma combined financial statements data is based on
estimates and assumptions described in the notes to them. This data is presented
for information purposes only and is not intended to represent or be indicative
of our consolidated results of operations or financial condition
that would have been reported had the merger been completed as of the dates
presented, and should not be taken as representative of future consolidated
results of operations or financial condition of SpaceDev.

YOU SHOULD READ THESE PRO FORMA UNAUDITED COMBINED FINANCIAL STATEMENTS IN
CONJUNCTION WITH EACH COMPANY'S HISTORICAL FINANCIAL STATEMENTS

The unaudited pro forma combined financial statements should be read in
conjunction with the related notes included in our Form 10-KSB filed
on March 28, 2006 and our consolidated audited financial statements.
The unaudited pro forma combined financial statements are not necessarily
indicative of what the actual results of operations and financial position would
have been had the merger taken place on January 1, 2004 and do not indicate
future results of operations or financial position.

PAGE 75

UNAUDITED PRO FORMA COMBINED CONSOLIDATED BALANCE SHEET

DECEMBER 31, 2005

TOTAL PRO FORMA
SPACEDEV STARSYS ADJUSTMENTS PRO FORMA
----------------------------------------- ----------- ----------- ------------ --------------- -----------
ASSETS

CURRENT ASSETS
Cash. . . . . . . . . . . . . . . . . $ 5,750,038 $ 831,888 $(6,359,912) (d) & (e) $ 222,014
Accounts receivable . . . . . . . . . 1,279,027 2,734,658 - 4,013,685
Inventory . . . . . . . . . . . . . . - -
Raw materials. . . . . . . . . . . - 243,246 - 243,246
WIP: costs in excess of billings. 21,340 2,160,684 - 2,182,024
Finished goods . . . . . . . . . . - -
Prepaids - short term . . . . . . . . - 142,023 - 142,023
Other current assets. . . . . . . . . - 207,567 (153,271) (f) 54,296
Note receivable . . . . . . . . . . . 1,353,440 (1,353,440) (d) &(f) -
----------------------------------------- ----------- ----------- ------------ --------------- -----------
Total current assets . . . . . . . . . . 8,403,845 6,320,066 (7,866,623) 6,857,288

FIXED ASSETS - Net . . . . . . . . . . . 1,073,773 1,949,161 - 3,022,934

INVESTMENTS IN SUBSIDIARIES ASSETS - NET - - - -

GOODWILL . . . . . . . . . . . . . . . . - - 14,491,085 (a), (b) & (c) 14,491,085

OTHER ASSETS - DEPOSITS. . . . . . . . . 1,531,031 32,972 - 1,564,003
----------------------------------------- ----------- ----------- ------------ --------------- -----------
TOTAL ASSETS . . . . . . . . . . . . . . $11,008,649 $ 8,302,199 $ 6,624,462 $25,935,310

PAGE 76

UNAUDITED PRO FORMA COMBINED CONSOLIDATED BALANCE SHEET

DECEMBER 31, 2005

TOTAL PRO FORMA
SPACEDEV STARSYS ADJUSTMENTS PRO FORMA
----------------------------------------------------- ------------ ----------- -------------------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
Accounts payable and accrued expenses . . . . . . $ 1,237,099 $ 1,609,882 $ - $ 2,846,981
Accrued payroll, vacation and related taxes . . . 290,914 1,002,270 - 1,293,184
Current portion of notes payable. . . . . . . . . 9,457 6,213,183 (6,213,183) (d) (f) & (g) 9,457
Current portion of capitalized lease obligations. 1,469 25,593 - 27,062
Customer deposits and deferred revenue. . . . . . 153,440 - (153,440) (f) -
Billings in excess of costs incurred and
estimated earnings . . . . . . . . . . . . . . - 1,702,453 - 1,702,453
Provision for anticipated loss. . . . . . . . . . - 1,575,077 - 1,575,077
Employee stock purchase plan. . . . . . . . . . . 29,375 - - 29,375
Other accrued liabilities . . . . . . . . . . . . 487,005 1,664,826 - 2,151,831
----------------------------------------------------- ------------ ----------- -------------------------- --------------
TOTAL CURRENT LIABILITIES. . . . . . . . . . . . . . 2,208,759 13,793,284 (6,366,623) 9,635,420
-
CAPITALIZED LEASE OBLIGATIONS, LESS
CURRENT MATURITIES . . . . . . . . . . . . . . . - - - -
-
DEFERRED GAIN - ASSETS HELD FOR SALE . . . . . . . . 830,677 - - 830,677
----------------------------------------------------- ------------ ----------- -------------------------- --------------
TOTAL LIABILITIES. . . . . . . . . . . . . . . . . . 3,039,436 13,793,284 (6,366,623) 10,466,097
- -
COMMITMENTS AND CONTINGENCIES

STOCKHOLDERSEQUITY (DEFICIT) . . . . . . . . . . . . - -
Convertible preferred stock . . . . . . . . . . . 248 - - 248
Common stock. . . . . . . . . . . . . . . . . . . 2,460 522 (22) (a) & (b) 2,960
Equity from parent. . . . . . . . . . . . . . . . - - - -
Additional paid-in capital. . . . . . . . . . . . 22,541,994 69,387 7,430,113 (a) & (b) 30,041,494
Accumulated deficit . . . . . . . . . . . . . . . (14,575,489) (5,560,994) 5,560,994 (b) (14,575,489)
----------------------------------------------------- ------------ ----------- -------------------------- --------------
TOTAL STOCKHOLDERSEQUITY (DEFICIT) . . . . . . . . . 7,969,213 (5,491,085) 12,991,085 15,469,213
----------------------------------------------------- ------------ ----------- -------------------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . . . . . $ 11,008,649 $ 8,302,199 $ 6,624,462 $ 25,935,310
----------------------------------------------------- ------------ ----------- -------------------------- --------------
----------------------------------------------------- ------------ ----------- -------------------------- --------------

PAGE 77

UNAUDITED PRO FORMA COMBINED CONSOLIDATED STATEMENT OF OPERATIONS

DECEMBER 31, 2005

TOTAL PRO FORMA
SPACEDEV STARSYS ADJUSTMENTS PRO FORMA
-------------------------------------------- ------------ ------------ --------------- ------------
NET SALES . . . . . . . . . . . . . . . . . $ 9,005,011 $17,762,730 $ - $ 26,767,741
-------------------------------------------- ------------ ------------ --------------- ------------
COST OF SALES . . . . . . . . . . . . . . . 6,905,902 14,721,176 - $ 21,627,078
-------------------------------------------- ------------ ------------ --------------- ------------
GROSS MARGIN. . . . . . . . . . . . . . . . 2,099,109 3,041,554 - $ 5,140,663

OPERATING EXPENSES
Marketing and sales expense. . . . . . . 673,636 - 673,636
General and administrative . . . . . . . 1,113,973 6,000,676 - 7,114,649
-------------------------------------------- ------------ ------------ --------------- ------------
TOTAL OPERATING EXPENSES. . . . . . . . . . 1,787,609 6,000,676 - 7,788,285
-------------------------------------------- ------------ ------------ --------------- ------------
INCOME/(LOSS) FROM OPERATIONS . . . . . . . 311,500 (2,959,122) - (2,647,622)
-------------------------------------------- ------------ ------------ --------------- ------------
NON-OPERATING EXPENSE/(INCOME)
Interest income. . . . . . . . . . . . . (105,840) - - (105,840)
Rental Income. . . . . . . . . . . . . . - (88,146) (88,146)
Other Expense. . . . . . . . . . . . . . - - -
Interest expense . . . . . . . . . . . . 2,873 506,525 - 509,398
Non-cash interest expense debt discount. - - - -
Gain on Building Sale. . . . . . . . . . (117,272) - - (117,272)
Loan Fee - Equity Compensation . . . . . 28,875 - - 28,875
-------------------------------------------- ------------ ------------ --------------- ------------

TOTAL NON-OPERATING EXPENSE/(INCOME). . . . (191,364) 418,379 - 227,015
-------------------------------------------- ------------ ------------ --------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES . . . . . 502,864 (3,377,501) - (2,874,637)
Income tax provision. . . . . . . . . . . . 1,600 - - 1,600
-------------------------------------------- ------------ ------------ --------------- ------------
NET INCOME (LOSS) . . . . . . . . . . . . . $ 501,264 $(3,377,501) - $ (2,876,237)
-------------------------------------------- ------------ ------------ --------------- ------------
NET INCOME (LOSS) PER SHARE:
Net income loss. . . . . . . . . . . . $ 0.02 $ (6.49) $ (0.08)
-------------------------------------------- ------------ ------------ --------------- ------------
Shares Outstanding. . . . . . . . . . . . . 29,030,858 520,447 4,836,696 (a) 34,388,001
-------------------------------------------- ------------ ------------ --------------- ------------
-------------------------------------------- ------------ ------------ --------------- ------------

PAGE 78

UNAUDITED PRO FORMA COMBINED CONSOLIDATED STATEMENT OF OPERATIONS

DECEMBER 31, 2004

TOTAL PRO FORMA
SPACEDEV STARSYS ADJUSTMENTS PRO FORMA
-------------------------------------------- ------------ ------------ --------------- ------------
NET SALES . . . . . . . . . . . . . . . . . $ 4,890,743 $18,085,414 $ - $ 22,976,157
-------------------------------------------- ------------ ------------ --------------- ------------
COST OF SALES . . . . . . . . . . . . . . . 3,820,683 19,138,106 - 22,958,789
-------------------------------------------- ------------ ------------ --------------- ------------
GROSS MARGIN. . . . . . . . . . . . . . . . 1,070,060 (1,052,692) - 17,368

OPERATING EXPENSES
Marketing and sales expense. . . . . . . 418,831 - - 418,831
Impairment of Goodwill . . . . . . . . . - 153,254 - 153,254
General and administrative . . . . . . . 506,944 3,901,198 - 4,408,142
-------------------------------------------- ------------ ------------ --------------- ------------
TOTAL OPERATING EXPENSES. . . . . . . . . . 925,775 4,054,452 - 4,980,227
-------------------------------------------- ------------ ------------ --------------- ------------
INCOME/(LOSS) FROM OPERATIONS . . . . . . . 144,285 (5,107,144) - (4,962,859)
-------------------------------------------- ------------ ------------ --------------- ------------
NON-OPERATING EXPENSE/(INCOME)
Interest income. . . . . . . . . . . . . (19,497) (7,493) - (26,990)
Rental Income. . . . . . . . . . . . . . - (7,800) (7,800)
Other Expense. . . . . . . . . . . . . . - - -
Interest expense . . . . . . . . . . . . 52,077 306,693 - 358,770
Non-cash interest expense debt discount. - - - -
Gain on Building Sale. . . . . . . . . . (117,272) - - (117,272)
Loan Fee - Equity Compensation . . . . . 3,254,430 - - 3,254,430
-------------------------------------------- ------------ ------------ --------------- ------------
TOTAL NON-OPERATING EXPENSE/(INCOME). . . . 3,169,738 291,400 - 3,461,138
-------------------------------------------- ------------ ------------ --------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES . . . . . (3,025,453) (5,398,544) - (8,423,997)
Income tax provision. . . . . . . . . . . . 1,600 193,317 - 194,917
-------------------------------------------- ------------ ------------ --------------- ------------
NET INCOME (LOSS) . . . . . . . . . . . . . $(3,027,053) $(5,591,861) - $ (8,618,914)
-------------------------------------------- ------------ ------------ --------------- ------------
NET INCOME (LOSS) PER SHARE:
Net income loss. . . . . . . . . . . . $ (0.14) $ (10.75) $ (0.33)
-------------------------------------------- ------------ ------------ --------------- ------------
Shares Outstanding. . . . . . . . . . . . . 21,153,660 520,000 4,837,143 (a) 26,510,803
-------------------------------------------- ------------ ------------ --------------- ------------
-------------------------------------------- ------------ ------------ --------------- ------------

PAGE 79

NOTES TO THE UNAUDITED PRO FORMA COMBINED CONSOLIDATED STATEMENTS

The unaudited pro forma combined consolidated financial statements have
been prepared in accordance with generally accepted accounting principles in the
United States after eliminating all material intercompany accounts and
transactions. The acquisition of Starsys is being accounted for under the
purchase method of accounting.

The unaudited pro forma combined consolidated financial statements shown
above do not reference the closing considerations to Starsys Research
Corporation at January 31, 2006, the date of closing, and do not take into
consideration the adjustments that were made. The Audited Financial Statements
for the period ending December 31, 2005 show that there was no working capital
adjustment made to the original stock and cash considerations of $9.0 million.

The purchase price of Starsys was approximately $9.0 million and is
proposed to be allocated as follows:

DOLLARS
-------------
Current, tangible and identifiable intangible assets $ 8,302,199
Liabilities assumed. . . . . . . . . . . . . . . . . (13,793,284)
---------------------------------------------------- -------------
Net assets . . . . . . . . . . . . . . . . . . . . . (5,491,085)
Implied Intangibles/Goodwill . . . . . . . . . . . . 14,491,085
---------------------------------------------------- -------------
Total purchase consideration . . . . . . . . . . . . $ 9,000,000
---------------------------------------------------- -------------

Comprised of:
Cash . . . . . . . . . . . . . . . . . . . . . . . . $ 1,500,000
Stock consideration. . . . . . . . . . . . . . . . . 7,500,000
---------------------------------------------------- -------------
Total purchase consideration . . . . . . . . . . . . $ 9,000,000
---------------------------------------------------- -------------
---------------------------------------------------- -------------

Under the terms of the agreement and in accordance with SFAS No. 141, for
accounting purposes, we have been deemed to be the acquirer. The cash and
stock consideration has been calculated by taking the outstanding common shares
of Starsys as of December 31, 2005, of approximately 520,000 shares of common
stock, and dividing it into the $9.0 million in cash and our equity. This
calculation results in a purchase consideration greater than the net book value
of Starsys as of December 31, 2005. This difference has been reflected as an
increase in the carrying value of our acquired intangible assets. At this time,
the combined Company has not completed an independent valuation and the
allocation of the purchase price has not been completed. Thus, these numbers do
not include the effects, if any; of adjustments that might result from the
amortization of any potential identifiable intangible assets (separate from
goodwill). The purchase price was reduced due to a working capital adjustment of
approximately $2.3 million which is not reflected above. In addition, the
purchase price excludes any reorganization costs. For purposes of this
presentation, the purchase price excludes the impact of any value attributable
to assumed stock options as their value was not deemed to be material based on
the value of the consideration to be issued in the merger. There were
approximately 558,000 shares of Starsys common stock outstanding at January 31,
2006.

THE FOLLOWING PRO FORMA ADJUSTMENTS HAVE BEEN RECORDED TO REFLECT THE
ACQUISITION:

Combined Consolidated Balance Sheet-adjustments to reflect the acquisition
that occurred on January 31, 2006.

(a) The issuance of approximately 5.4 million of our common shares, and
options for the issued and outstanding common stock and outstanding options of
Starsys, at a total value of $7.5 million. Our common shares increase by
approximately $500 and additional paid in capital increased by approximately
$7.5 million.

PAGE 80

(b) Elimination of Starsys pre-acquisition shareholders' equity, as
follows:

DOLLARS
------------------------------ -----------
Common stock . . . . . . . $ (522)
Additional paid-in capital (69,387)
Accumulated deficit. . . . 5,560,994
------------------------------ -----------
$5,491,085
------------------------------ -----------
------------------------------ -----------

(c) Excess of the fair value of purchase consideration over the fair value
of the net tangible assets and identifiable intangible assets acquired. This
excess has been recorded in the pro forma statements as an increase in the
carrying value of the acquired intangible assets of Starsys. The final figure
for intangibles and/or goodwill will be increased by any reduction in net assets
at the date of closure of the acquisition and by the reorganization costs which
will be incurred as a result of the transaction.

(d) Elimination of approximately $4.6 million of short term debt of Starsys
as required by the Agreement and Plan of Merger. Also, the forgiveness of
approximately $1.3 million of notes receivable and applicable fees from us to
Starsys also based on the Agreement and Plan of Merger.

(e) Cash consideration at close of $1.5 million to Starsys and Starsys
shareholders by us. The actual allocation of the purchase price will not occur
until the closing and will be based on the respective fair values of the assets
and liabilities of Starsys at that time.

(f) For approximately $153,440 of the pro forma adjustment in current
assets represents the release of the $120,000 fee on the Bridge Loan as well as
the payment of loan premium to Starsys shareholders at close and accrued
interest on the Bridge Loan to date.

(g) Represent remaining debt in the amount of $259,912 for the remaining
short term notes payable in which Starsys will pay at time of closing.

The unaudited pro forma combined consolidated information reflects our best
estimates; however the actual financial position and results of operations may
differ from the pro forma amounts reflected herein because of various factors,
including, without limitation, access to additional information, changes in
value and changes in operating results between the date of preparation of the
unaudited pro forma combined consolidated financial information and the date on
which the acquisition closed. However, in the opinion of management any final
adjustments will not be material to our future financial position and/or results
of operations of SpaceDev.

PAGE 81

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

SPACEDEV, INC. AND SUBSIDIARIES PAGE
----
Consolidated Financial Statements for the Three Month Period Ended
March 31, 2006 and 2005

Consolidated Balance Sheets (Unaudited) F-2
Consolidated Statements of Operations (Unaudited) F-4
Consolidated Statements of Cash Flows (Unaudited) F-5
Notes to Consolidated Financial Statements F-7

Consolidated Financial Statements for the Fiscal Years Ended
December 31, 2005 and 2004

Report of Independent Registered Public Accounting Firm F-18
Consolidated Balance Sheets F-19
Consolidated Statements of Operations F-21
Consolidated Statements of Stockholders' Equity (Deficit) F-22
Consolidated Statements of Cash Flows F-25
Notes to Consolidated Financial Statements F-27

STARSYS RESEARCH CORPORATION
PAGE
----
Consolidated Financial Statements for the Fiscal Years Ended
December 31, 2005 and 2004

Reports of Independent Registered Public Accounting Firms F-53
Consolidated Balance Sheets F-55
Consolidated Statements of Operations F-57
Consolidated Statements of Stockholders' Equity (Deficit) F-58
Consolidated Statements of Cash Flows F-59
Notes to Consolidated Financial Statements F-64

PAGE F-1

SPACEDEV, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

At March 31,. . . . . . . . 2006 2005
--------------------------- ----------- ----------

ASSETS

CURRENT ASSETS
Cash. . . . . . . . . $ 1,142,595 $5,412,949
Accounts receivable . 5,769,883 620,048
Inventory (Note 2). . 3,014,626 -
Other current assets. 213,122 11,306
--------------------------- ----------- ----------
TOTAL CURRENT ASSETS . . . 10,140,226 6,044,303

FIXED ASSETS - NET . . . . 3,280,171 293,590

GOODWILL (NOTE 5). . . . . 12,246,362 -

OTHER ASSETS . . . . . . . 898,762 117,115
--------------------------- ----------- ----------
$26,565,521 $6,455,008
--------------------------- ----------- ----------
--------------------------- ----------- ----------
The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-2

SPACEDEV, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

At March 31,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2006 2005
-------------------------------------------------------------------------- ------------- -------------

LIABILITIES AND STOCKHOLDERSEQUITY

CURRENT LIABILITIES
Accounts payable and accrued expenses (Note 3(a)). . . . . . . . . . $ 2,159,367 $ 400,261
Accrued payroll, vacation and related taxes. . . . . . . . . . . . . 1,500,497 248,805
Billings in excess of costs incurred and estimated earnings (Note 2) 1,635,230 -
Other accrued liabilities (Note 2) . . . . . . . . . . . . . . . . . 2,199,130 268,505
-------------------------------------------------------------------------- ------------- -------------

TOTAL CURRENT LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . 7,494,224 917,571

CAPITALIZED LEASE OBLIGATIONS, LESS CURRENT MATURITIES. . . . . . . . . . 113,282 413

DEFERRED GAIN - ASSETS HELD FOR SALE (NOTE 3(A)). . . . . . . . . . . . . 801,359 918,631
-------------------------------------------------------------------------- ------------- -------------

TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,408,865 1,836,615

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERSEQUITY
Convertible preferred stock, $.001 par value, 10,000,000
shares authorized, and 253,610 and 250,000 shares
issued or outstanding, respectively (Note 4)
Series C Convertible preferred stock (Note 4(a)) . . . . . . . . . . 249 250
Series D-1 Convertible preferred stock (Note 4 (b)). . . . . . . . . 5 -
Common stock, $.0001 par value; 100,000,000 and 50,000,000 shares
authorized, and 28,710,496 and 21,373,980 shares issued
and outstanding, respectively (Note 4) . . . . . . . . . . . . 2,870 2,137
Additional paid-in capital (Note 4). . . . . . . . . . . . . . . . . 32,863,959 18,962,806
Additional paid-in capital - stock options . . . . . . . . . . . . . - 750,000
Deferred compensation. . . . . . . . . . . . . . . . . . . . . . . . - (250,000)
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . (14,710,427) (14,846,800)
-------------------------------------------------------------------------- ------------- -------------
TOTAL STOCKHOLDERSEQUITY. . . . . . . . . . . . . . . . . . . . . . . . . 18,156,656 4,618,393
-------------------------------------------------------------------------- ------------- -------------

TOTAL LIABILITIES AND STOCKHOLDERSEQUITY. . . . . . . . . . . . . . . . . $ 26,565,521 $ 6,455,008
-------------------------------------------------------------------------- ------------- -------------
-------------------------------------------------------------------------- ------------- -------------
The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-3

SPACEDEV, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

Three-Months Ending March 31,. . . . . . . . . . . . . 2006 % 2005 %
------------------------------------------------------- ------------ ------------ ----------- ------
NET SALES. . . . . . . . . . . . . . . . . . . . . . . $ 7,174,778 100.0% $1,806,889 100.0%

TOTAL COST OF SALES *. . . . . . . . . . . . . . . . . 5,265,106 73.4% 1,396,835 77.3%

GROSS MARGIN . . . . . . . . . . . . . . . . . . . . . 1,909,672 26.6% 410,054 22.7%
------------------------------------------------------- ------------ ------------ ----------- ------
OPERATING EXPENSES
Marketing and sales . . . . . . . . . . . . . . . . 643,560 9.0% 145,017 8.0%
Research and development. . . . . . . . . . . . . . 81,777 1.1% 8,472 0.1%
General and administrative. . . . . . . . . . . . . 1,230,733 17.2% 190,998 10.6%
------------------------------------------------------- ------------ ------------ ----------- ------
TOTAL OPERATING EXPENSES*. . . . . . . . . . . . . . . 1,956,070 344,487
------------------------------------------------------- ------------ -----------
INCOME/(LOSS) FROM OPERATIONS. . . . . . . . . . . . . (46,398) -0.6% 65,567 3.6%

NON-OPERATING INCOME/(EXPENSE)
Interest income . . . . . . . . . . . . . . . . . . 33,615 0.5% 7,960 0.4%
Interest expense. . . . . . . . . . . . . . . . . . (5,283) -0.1% (1,222) -0.1%
Gain on building sale (Note 3(a)) . . . . . . . . . 29,318 0.4% 29,318 1.6%
------------------------------------------------------- ------------ ------------ ----------- ------
TOTAL NON-OPERATING INCOME . . . . . . . . . . . . . . 57,650 0.8% 36,056 2.0%
------------------------------------------------------- ------------ ------------ ----------- ------

INCOME BEFORE TAXES. . . . . . . . . . . . . . . . . . 11,252 0.2% 101,623 5.6%

INCOME TAX PROVISION . . . . . . . . . . . . . . . . . 4,235 0.1% 400 0.0%

NET INCOME . . . . . . . . . . . . . . . . . . . . . . $ 7,017 0.1% $ 101,223 5.6%
------------------------------------------------------- ------------ ------------ ----------- ------
NET INCOME PER SHARE:
Net income. . . . . . . . . . . . . . . . . . . . $ 0 $ 0
------------------------------------------------------- ------------ -----------
Weighted-Average Shares Outstanding . . . . . . . 27,276,451 21,291,972

FULLY DILUTED NET INCOME PER SHARE:
Net income. . . . . . . . . . . . . . . . . . . . $ 0 $ 0
------------------------------------------------------- ------------ -----------
Fully Diluted Weighted-Average Shares Outstanding. 36,225,300 29,908,287
------------------------------------------------------- ------------ -----------

* The following table shows how the Company's stock option expense would be allocated to all expenses.

Cost of Sales . . . . . . . . . . . . . . . . . . . $ - $ -
Marketing and sales . . . . . . . . . . . . . . . . - -
Research and development. . . . . . . . . . . . . . - -
General and administrative. . . . . . . . . . . . . 90,701 -
------------------------------------------------------- ------------ ------------
$ 90,701 $ -
------------------------------------------------------- ------------ ------------
------------------------------------------------------- ------------ ------------
The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-4

SPACEDEV, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

Three-Months Ending March 31,. . . . . . . . . . . . . . 2006 2005
--------------------------------------------------------- ------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income. . . . . . . . . . . . . . . . . . . . . $ 7,017 $ 101,223
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization. . . . . . . . . 147,370 29,061
Gain on disposal of building sale. . . . . . . (29,318) (29,318)
Stock option expense and stock awards. . . . . 92,876 -
Change in operating assets and liabilities . . (3,481,569) 135,217

NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES. . . (3,263,624) 236,183

CASH FLOWS FROM INVESTING ACTIVITIES
Other assets, capitalized acquisition costs . . . . (1,066,564) -
Purchases of fixed assets . . . . . . . . . . . . . (324,256) (43,269)
--------------------------------------------------------- ------------ -----------
NET CASH USED IN INVESTING ACTIVITIES . . . . . . . . . (1,390,820) (43,269)

CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on notes payable . . . . . . . . (4,675,832) (8,997)
Principal payments on capitalized lease obligations (8,815) (883)
Dividend payments on Series D-1 Preferred . . . . . (98,774) -
Employee stock purchase plan. . . . . . . . . . . . 42,767 9,846
Proceeds from issuance of preferred stock . . . . . 4,764,296 151,468
Proceeds from issuance of common stock. . . . . . . 23,359 -
--------------------------------------------------------- ------------ -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES. . . . . . . . 47,001 151,434
--------------------------------------------------------- ------------ -----------
NET (DECREASE)/INCREASE IN CASH. . . . . . . . . . . . . (4,607,443) 344,348
--------------------------------------------------------- ------------ -----------
CASH AT BEGINNING OF PERIOD. . . . . . . . . . . . . . . 5,750,038 5,068,601
--------------------------------------------------------- ------------ -----------
CASH AT END OF PERIOD. . . . . . . . . . . . . . . . . . $ 1,142,595 $5,412,949
--------------------------------------------------------- ------------ -----------
--------------------------------------------------------- ------------ -----------
The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-5

SPACEDEV, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONT'D.
(UNAUDITED)

--------------------------------------------------- ------ --------
Three-Months Ending March 31,. . . . . . . . . . . 2006 2005
--------------------------------------------------- ------ --------

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest . . . . . . . . . . . . . . . . $5,283 $313,978
--------------------------------------------------- ------ --------

NONCASH INVESTING AND FINANCING ACTIVITIES:

During the three-months ending March 31, 2006 and 2005 the Company converted
$34,516 and $11,303 of employee stock purchase plan contributions into
24,885 and 7,915 shares of common stock, respectively.

During the three-months ending March 31, 2006 and 2005 the Company declared
dividends payable of $41,967 and $42,226, repectively to the holders of its
Series C preferred stock.

During the three-months ending March 31, 2005 the Company paid dividends valued
at $60,967 in the form of 39,589 shares of common stock to the holders of
its Series C preferred stock.

During the three-months ending March 31, 2006 the Company declared and paid
dividends payable of $98,774 to the holders of its Series D-1 preferred
stock.

During the three-months ending March 31, 2006, the Company financed $125,687 in
fixed assets through a capital lease obligation.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-6

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 subsidiary, Starsys,
Inc. and its inactive subsidiary SpaceDev Oklahoma, an Oklahoma corporation.
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
March 28, 2006 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 been modified, as a result of
the Company's acquisition of Starsys Research Corporation, to include a
"percentage-of-completion" method of revenue recognition and inventory policies.
The consolidated results of operations for the three-months ending March 31,
2006 are not necessarily indicative of results that may be expected for the
fiscal year ending December 31, 2006 or any future period, and the Company
makes no representations related thereto.

On March 31, 2004, the Company was awarded a contract from the Missile Defense
Agency for approximately $43.3 million. The microsatellite distributed sensing
experiment was intended to analyze, design, develop, fabricate, integrate, test,
operate and support a networked cluster of three formation-flying boost phase
and midcourse tracking microsatellites and a second cluster of microsatellites
with laser communication technology to support national missile defense. We were
informed in 2005 that the Missile Defense Agency had re-routed the part of the
contract related to the laser communications experiment to another program and
that they would not be exercising their option for the additional microsats at
this time; however, the contract vehicle remained at $43.3 million and left open
the opportunity for some other purchase to take its place. We estimate that the
second cluster would have represented approximately $10 million of the $43.3
million contract, and have reduced our current backorder accordingly. We believe
the remaining unbilled contract backlog amount of approximately $22.4 million to
be secure. The Company has recognized approximately $10.9 million in revenue
under this contract through March 31, 2006.

Management intends to seek and obtain new government and commercial contracts,
use its revolving credit facility only for specially funded programs, if at all,
and possibly raise additional equity or debt capital in a public or private
offering or fund-raising effort in 2006 or beyond. 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 or on terms that are favorable to the Company. Management
believes that, if current contracts remain on schedule and are funded as
expected, they will be sufficient to fund the Company through 2006.

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
operations during the reporting period. Actual results could differ materially
from those estimates.

PAGE F-7

2. ACCOUNTING POLICIES

(a) Revenue Recognition

The Company's revenues for the three-months ending March 31, 2006 were derived
from United States government cost plus fixed fee (CPFF) contracts, some fixed
price contracts and some commercial sales of component and subsystem products
that the Company acquired in its acquisition of Starsys, which is compared to
primarily CPFF contracts for the same three-month period in 2005. Revenues from
the CPFF contracts during the first three-months ending March 31, 2006 and 2005
were recognized as expenses were incurred. Estimated contract profits are taken
into earnings in proportion to revenues recorded. Time and material revenues are
recognized as services are performed and costs incurred. Certain fixed price
contracts were prepared according to the "percentage-of-completion" method of
accounting for long-term contracts. The amount of revenues recognized is that
portion of the total contract amount that the actual cost expended bears to the
anticipated final total cost based on current estimates of cost to complete the
project (cost-to-cost method). Total cost that is anticipated to exceed the
contract amount, that is, the excess of cost over contract amount is immediately
recognized as a loss on the contract. Recognition of profit commences on an
individual project only when cost to complete the project can reasonably be
estimated and after there has been some meaningful performance achieved on the
project. Recognition of losses on projects are taken as soon as the loss is
reasonably determinable and accrued on the balance sheet in other accrued
liabilities. The current accrual for potential losses on exiting projects
represents approximately $1.6 million. As projects are completed, the accrual is
adjusted as projects move toward completion and more accurate estimates are
established. Changes in job performance, job conditions, and estimated
profitability, including those arising from contract penalty provisions (when
applicable), and final contract settlements may result in revisions to costs and
income and are recognized in the period in which the revisions are determined.
Contract costs include all direct material, direct labor and sub-contractor
costs, other costs such as supplies, tools and travel which are specifically
related to a particular contract. All other selling, general and administrative
costs are expensed as incurred.

(b) Inventory

Inventory is valued based on lower-of-cost-or-market method and is disbursed on
a FIFO (First-In, First-Out) basis, unless required by customer contract to be
distributed by specific identification for lot control purposes. Inventory
includes raw material inventory, finished goods inventory and work-in-process
inventory (which includes "costs and estimated earnings in excess of billings on
uncompleted contracts" and represents revenues recognized in excess of amounts
billed). 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. Time
and material revenues are recognized as services are performed and costs
incurred.

3. NOTES PAYABLE

a) Building and Settlement Notes

In December 2002, the Company entered an agreement to sell its interest in its
Poway, California headquarters 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 then 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 (10) years ending in January 2013. As of March 31,
2006, the deferred gain was $801,359. This amortization is included in the
Company's non-operating expenses and totaled $29,318 and $29,318 for the
three-months ending March 31, 2006 and 2005, respectively.

PAGE F-8

Deferred Gain consisted of the following:

Three-Months Ended March 31, 2006

Original Deferred Gain $1,172,720
Less Amortization 2003 (107,499)
Less Amortization 2004 (117,272)
Less Amortization 2005 (117,272)
Less Amortization 2006 (29,318)
---------------------- -----------
$ 801,359
-----------

In 2001, the Company entered into three settlement loan agreements with various
vendors. The total of $171,402 for all three loans called for payments between
24 and 50 months with interest that ranges from 0% to 8%. At March 31, 2005,
the outstanding balances on these notes were $37,130 with interest expense for
the three-months ending March 31, 2005 of $539. (As of March 31, 2006, no notes
remained outstanding.)

b) 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 the Laurus Master Fund, Ltd. ("Laurus"). 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 subject to the
amount of eligible accounts receivables. The net proceeds from the Convertible
Note were used for general working capital purposes. Advances on the
Convertible Note were 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 Wall Street Journal 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. Availability of funds under the
revolving credit facility is based on the Company's accounts receivable, except
as waivers are provided by Laurus. Laurus has exercised its conversion rights
from time to time on outstanding balances. Laurus converted a total of 3,406,417
shares to reduce the debt by an aggregate of $2,500,000 since the inception of
the revolving credit facility. There was no outstanding balance on the
revolving credit facility at March 31, 2006 and 2005 and there have been no
conversions during the first three months of 2006 and 2005.

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 for the initial $1 million revolving credit facility, as
stated herein. The warrant exercise price was 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. In addition to the initial warrant, the
Company issued two additional warrants: 1) to purchase 50,000 shares at an
exercise price of $1.0625 per share in relation to the $500,000 revolving credit
facility expansion convertible at $0.85 per share, which warrant was exercised
by Laurus on April 19, 2005; and, 2) to purchase 50,000 shares at an exercise
price of $1.925 per share in relation to the $1 million revolving credit
facility expansion convertible at $1.00 per share.

The Company may terminate its revolving credit facility with Laurus before the
end of the initial three year term for a fee; or, the agreement will expire on
June 3, 2006.

PAGE F-9

4. STOCKHOLDER'S EQUITY - PREFERRED STOCK, COMMON STOCK AND WARRANTS
PREFERRED STOCK

a) Series C Preferred Stock.

On August 25, 2004, the Company entered into a Securities Purchase Agreement
with the Laurus Master Fund, Ltd., whereby the Company issued 250,000 shares of
its Series C Non-Redeemable Convertible Preferred Stock, par value $0.001 per
share (the "Series C Preferred Shares"), to Laurus for an aggregate purchase
price of $2,500,000 or $10.00 per share (the "Stated Value"). The Series C
Preferred Shares are convertible into shares of the Company's common stock at a
rate of $1.54 per share at any time after the date of issuance, and accrue
quarterly, cumulative dividends at a rate of 6.85%. The first payment was due
on January 1, 2005. As of March 31, 2006 and 2005, approximately $99,000 and
$42,000 has been accrued for dividends and 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 the Company's common stock for the 20-days
preceding the conversion date exceeds 120% of the conversion rate. On January
11, 2005, $60,967 of accrued dividends were paid in the form of 39,589 shares of
the Company's common stock. Also, on May 5, 2005, $56,301 of accrued dividends
were paid in the form of 36,559 shares of the Company's common stock from
dividends accrued and on September 28, 2005, $57,708 of accrued dividends were
paid in the form of 37,473 shares of the Company's common stock. The Series C
Preferred Shares are redeemable by the Company 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 $1.48 per share 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 Series C Preferred Shares have a
liquidation right equal to the Stated Value upon the Company's dissolution,
liquidation or winding-up. The Series C Preferred Shares have no voting rights,
except as required by law.

In conjunction with the Series C Preferred Shares, the Company issued a
five-year common stock purchase warrant to Laurus for the purchase of 487,000
shares of the Company's common stock at an exercise price of $1.77 per share.

b) Series D-1 Preferred Stock.

On January 12, 2006, the Company entered into a Securities Purchase Agreement
with a limited number of institutional accredited investors, including Omicron
Capital, Tailwind Capital, Bristol Capital Management, Nite Capital and the
Laurus Master Fund, Ltd. On January 13, 2006, the Company issued and sold to
these investors 5,150 shares of our Series D-1 Amortizing Convertible Perpetual
Preferred Stock, par value $0.001 per share, for an aggregate purchase price of
$5,150,000, or $1,000 per share. The Company also issued various warrants to
these investors as described below. The Company paid cash fees and expenses of
$119,209 to a finder for the introduction of potential investors in this
financing, and paid $60,000 to the lead investor's counsel for legal expenses
incurred in the transaction. The preferred shares are convertible into shares
of the Company's common stock at a rate of $1.48 per share and accrue quarterly,
cumulative dividends at a rate of LIBOR plus 4% on the first day of the
applicable quarter with the first payment due on April 1, 2006. As of March 31,
2006, the Company accrued and paid approximately $99,000 for dividends in cash.

PAGE F-10

initial closing of the financing, which are described below, have been exercised
to purchase these units). Each "unit" consists of one share of Series D-1
Preferred Stock and a common stock warrant, which entitles the holders to
purchase up to an aggregate of 440,829 shares of common stock at an exercise
price of $1.51 and otherwise has the same terms as the warrants described in the
following paragraph.

Certain warrants the Company issued to the Series D-1 investors at the closing
entitle the investors to purchase up to an aggregate of 1,135,138 shares of the
Company's common stock at an exercise price of $1.51 per share. The warrants
are exercisable for five years following the date of grant. The warrants have
"ratchet" anti-dilution provisions reducing the warrant exercise price if the
Company issues equity securities (other than in specified exempt transactions)
at an effective price below the warrant exercise price to such lower exercise
price.

The Company also issued certain other warrants to the Series D-1 investors at
the closing (the "preferred stock warrants"). These warrants entitle the holder
to purchase an aggregate number of 2,000 "units", which are identical to the
"units" described above, at an exercise price of $1,000 per unit. The preferred
stock warrants are exercisable from the effective date (February 15, 2006) until
the one-year anniversary of that date. If any units subject to the preferred
stock warrants remain unsold after (1) their expiration date and (2) the
exercise of the Company's put option, if applicable, and any holder of a
preferred stock warrant issued in the financing has exercised the warrant in
full, then the preferred stock warrant grants that holder the right to purchase
440,829 with a strike price of $1.51 per share, the warrant has a five year
expiration date once issued.

Other Provisions.

The purchase agreement contains a number of covenants by the Company, which
include:

- A grant of preemptive rights to the investors to participate in future
financings until the first anniversary of the closing date of the
financing;

- An agreement not to issue any shares of the Company's common stock or
securities or other rights to acquire shares of common stock until six (6)
months after the effective date, except under specified conditions intended
to ensure the terms are no less favorable to the Company than the terms of
this financing; and,

- An agreement not to effect any transaction involving the issuance of
securities convertible, exercisable or exchangeable for the Company's
common stock at a price per share or rate which may change over time, which
the Company refers to as a variable-rate transaction, so long as any shares
of Series D-1 Preferred Stock are outstanding.

In connection with this financing, Laurus consented to and waived certain
contractual rights in respect of the authorization and issuance of one or more
series of Series D-1 Preferred Stock and the other transactions described below,
and certain other transactions. The Company paid Laurus Capital Management,
L.L.C., and the manager of Laurus, $87,000 in connection with Laurus's delivery
of the consent and $1,000 to Laurus' counsel for their related fees.

PAGE F-11

COMMON STOCK AND WARRANTS

The Company adopted FAS 123(R) to account for its stock-based compensation
beginning January 1, 2006. Previously, the Company elected to account for its
stock-based compensation plans under APB 25. The Company computed, for pro
forma disclosure purposes, the value of all options granted during the
three--months ending March 31, 2005 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 its options in accordance with SFAS 123(R) in
2005, the total value of options granted during the three-month period ending
March 31, 2005 would have been amortized on a pro forma basis over the vesting
period of the options. Thus, the Company's consolidated net income (loss) would
have been as follows:

Net Income (Loss). . . . . . . . . . . . . . . . . . . 2005
------------------------------------------------------- ----------
As reported. . . . . . . . . . . . . . . . . . . . . . $ 101,223
Add: Stock based employee compensation expense
included in reported net income. . . . . . . . . . . . $ -

Less: Stock based employee compensation expense
determined under the fair value based method for all
awards . . . . . . . . . . . . . . . . . . . . . . . . $(213,553)
------------------------------------------------------- ----------
Pro forma. . . . . . . . . . . . . . . . . . . . . . . $(112,330)
------------------------------------------------------- ----------
Net Income (Loss) Per Share

As reported. . . . . . . . . . . . . . . . . . . . . . $ 0.00
Pro Forma . . . . . . . . . . . . . . . . . . . . . . $ (0.01)
------------------------------------------------------- ----------

For the quarter ended March 31, 2006, the Company expensed approximately $91,000
of stock option expenses due to SFAS 123(R) in its financial statements.

5. GOODWILL

On January 31, 2006, SpaceDev acquired Starsys Research Corporation and in
accordance with U.S. generally accepted accounting principles, the merger was
accounted for using the purchase method of accounting. Under the purchase method
of accounting, the total estimated purchase price was allocated to Starsys' net
tangible assets and identifiable intangible assets based on their fair values as
of the date of completion of the merger. The excess of the purchase price over
those fair values was recorded as goodwill. Goodwill is not amortized but is
tested for impairment at least annually. The combined company will incur
additional amortization expense based on the identifiable amortizable intangible
assets acquired pursuant to the merger agreement and their relative useful
lives. Additionally, to the extent the value of goodwill or identifiable
intangible assets or other long-lived assets become impaired, the combined
company may be required to record material charges relating to the impairment.
The goodwill balance as of March 31, 2006 was approximately $12.2 million.

PAGE F-12

The following is a schedule of the goodwill incurred on the Starsys acquisition.

-------------------------------- -----------
Starsys Total Assets . . . . . . $(7,851,494)
Starsys Total Liabilities. . . . 13,054,140
Cash to Starsys Stockholders . . 410,791
Equity to Starsys Stockholders . 5,576,846
Fees Associated with Acquisition 1,056,079
-------------------------------- -----------
$12,246,362
-------------------------------- -----------
-------------------------------- -----------

6. NEW ACCOUNTING PRONOUNCEMENTS

There were no recent Accounting Pronouncements that affected the Company during
the first quarter of 2006. For past pronouncements, please refer the Company's
10-KSB filed on March 28, 2006.

7. CHANGE IN ACCOUNTING PRINCIPLE AND ACCOUNTING FOR SHARE-BASED
COMPENSATION

The Company adopted Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) No. 123 (revised 2004) (123(R)) on January
1, 2006. Upon the adoption of SFAS No. 123(R), compensation costs associated
with share-based compensation and stock option awards will be recorded to
expense over the requisite period(s) associated with the stock or options. Prior
to the adoption of SFAS 123(R), the Company accounted for share-based
compensation and stock option awards issued to employees, directors and officers
under the recognition and measurement principles of Accounting Principles Board
(APB) No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Generally, no share-based employee compensation expense was
recognized for stock option grants, as all options granted had an exercise price
equal to the fair market value of the underlying common stock at the date of
grant. Similarly, no compensation expense had been recognized under the
Company's 1999 Employee Stock Purchase Plan (ESPP).

As noted above, in the first quarter 2006, the Company adopted SFAS No. 123(R),
which requires companies to measure an equity instrument based on the grant-date
fair value of the award and expense the value. The Company uses the
Black-Scholes pricing model to determine the fair value of its options on the
measurement date. The cost is recognized over the requisite period (usually the
vesting period). During the first quarter 2006, the Company had stock option
expense of $90,701 related to a new officer stock option award coincident with
the Starsys merger. Without the adoptions of SFAS No. 123(R), the Company's
operating income, net income and net income per share would have been increased
to the pro forma non-GAAP amounts indicated below:

PAGE F-13

SPACEDEV, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATONS - SUPPLEMENTAL SCHEDULE
(UNAUDITED)

Three-Months Ending March 31,. . . . . . . . . . . . . 2006 % 2005 %
------------------------------------------------------- ------------ -------- ----------- -------
GAAP OPERATING INCOME. . . . . . . . . . . . . . . . . $ (46,398) -0.6% $ 65,567 3.6%
FAS 123(R) stock option expense . . . . . . . . . . 90,701 1.3% - 0.0%
------------------------------------------------------- ------------ -------- ----------- -------
NON-GAAP OPERATING INCOME. . . . . . . . . . . . . . . 44,303 0.6% 65,567 3.6%
------------------------------------------------------- ------------ -------- ----------- -------
NON-OPERATING INCOME/(EXPENSE)
Interest income . . . . . . . . . . . . . . . . . . 33,615 0.5% 7,960 0.4%
Interest expense. . . . . . . . . . . . . . . . . . (5,283) -0.1% (1,222) -0.1%
Gain on building sale . . . . . . . . . . . . . . . 29,318 0.4% 29,318 1.6%
------------------------------------------------------- ------------ -------- ----------- -------
TOTAL NON-OPERATING INCOME . . . . . . . . . . . . . . 57,650 0.8% 36,056 2.0%
------------------------------------------------------- ------------ -------- ----------- -------
NON-GAAP NET INCOME BEFORE TAXES . . . . . . . . . . . $ 101,953 1.4% $ 101,623 5.6%
------------------------------------------------------- ------------ -------- ----------- -------
INCOME TAX PROVISION . . . . . . . . . . . . . . . . . 4,235 0.1% 400 0.0%

NON-GAAP NET INCOME. . . . . . . . . . . . . . . . . . $ 97,718 1.4% $ 101,223 5.6%
------------------------------------------------------- ------------ -------- ----------- -------
NET INCOME PER SHARE:
Non-GAAP Net Income Per Share . . . . . . . . . . $ 0.00 0.0% $ 0.00 0.0%
------------------------------------------------------- ------------ -------- ----------- -------
Weighted-Average Shares Outstanding . . . . . . . 27,276,451 21,291,972

FULLY DILUTED NET INCOME PER SHARE:
Non-GAAP Fully Diluted Income Per Share . . . . . $ 0.00 $ 0.00
------------------------------------------------------- ------------ -----------
Fully Diluted Weighted-Average Shares Outstanding. 36,225,300 29,908,287
------------------------------------------------------- ------------ -----------
------------------------------------------------------- ------------ -----------

The Company believes that evaluating its ongoing operating results with these
non-GAAP measurements may be useful as a supplement to its standard GAAP
financial measurement presentation. Accordingly, the Company has chosen certain
non-GAAP financial information to evaluate its ongoing operations and for
internal planning and forecasting purposes. The Company believes that non-GAAP
financial measures should be considered in addition to, and not a substitute
for, financial information prepared in accordance with GAAP. The Company
presents such non-GAAP financial measures in reporting its financial results to
provide additional and supplemental disclosure to evaluate operating results.
Whenever the Company uses a non-GAAP financial measurement, it provides a
reconciliation of the non-GAAP financial measure to the most closely applicable
GAAP financial measurement.

8. UNAUDITED PRO FORMA COMBINED CONSOLIDATED STATEMENTS OF OPERATIONS

The following unaudited pro forma combined statements of operations give
effect to the merger of SpaceDev and Starsys using the purchase method of
accounting, as required by Statement of Financial Accounting Standard No. 141,
"Business Combinations." The Company acquired Starsys Research Corporation on
January 31, 2006 and is "accounting acquirer" for accounting purposes. Under
this method of accounting, the combined company will allocate the purchase price
to the fair value of assets of Starsys deemed to be acquired, including
identifiable intangible assets and goodwill. The purchase price allocation is
subject to revision when the combined company obtains additional information
regarding asset valuation. The unaudited pro forma combined statements of
operations are based on respective historical consolidated financial statements
and the accompanying notes of the Company, and those of Starsys included herein.

PAGE F-14

The unaudited pro forma combined statements of operations for the three
months ended March 31, 2006 assume the merger took place on January 1, 2006 and
combines SpaceDev's historical statement of operations for the year ended
December 31, 2005 with Starsys' historical statement of operations for the year
ended December 31, 2005 as if the merger took place on January 1, 2005. The
unaudited pro forma combined statements of operations should be read in
conjunction with the related notes included in this Form 10-QSB and the
consolidated audited financial statements of SpaceDev, Inc. The unaudited pro
forma combined statements of operations are not necessarily indicative of what
the actual results of operations and financial position would have been had the
merger taken place on January 1 of each period presented and do not indicate
future results of operations.

PAGE F-15

UNAUDITED PRO FORMA COMBINED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)

MARCH 31, 2006

SPACEDEV STARSYS PRO FORMA ADJUSTMENTS PRO FORMA
------------ ----------- ----------------------- ------------
NET SALES. . . . . . . . . . . . . . $ 2,889,592 $5,920,870 $ (51,345) $ 8,759,117
------------------------------------- ------------ ----------- ----------------------- ------------
COST OF SALES. . . . . . . . . . . . 2,097,469 4,443,218 - 6,540,687
------------------------------------- ------------ ----------- ----------------------- ------------
GROSS MARGIN . . . . . . . . . . . . 792,123 1,477,652 (51,345) 2,218,430

OPERATING EXPENSES
Marketing and sales expense . . . 497,614 265,300 (51,345) 711,569
Research and development. . . . . 67,412 9,082 - 76,494
General and administrative. . . . 364,718 1,176,493 - 1,541,211
------------------------------------- ------------ ----------- ----------------------- ------------
TOTAL OPERATING EXPENSES . . . . . . 929,744 1,450,875 (51,345) 2,329,274
------------------------------------- ------------ ----------- ----------------------- ------------
INCOME/(LOSS) FROM OPERATIONS. . . . (137,621) 26,777 - (110,844)
------------------------------------- ------------ ----------- ----------------------- ------------
NON-OPERATING INCOME/(EXPENSE)
Interest income . . . . . . . . . 33,615 28,306 - 61,921
Interest expense. . . . . . . . . (110) (27,656) - (27,766)
Gain on building sale . . . . . . 29,318 - - 29,318
------------------------------------- ------------ ----------- ----------------------- ------------
TOTAL NON-OPERATING INCOME/(EXPENSE) 62,823 650 - 63,473
------------------------------------- ------------ ----------- ----------------------- ------------
INCOME/(LOSS) BEFORE INCOME TAXES. . (74,798) 27,427 - (47,371)
Income tax provision . . . . . . . . 4,200 35 - 4,235
------------------------------------- ------------ ----------- ----------------------- ------------
NET INCOME/(LOSS). . . . . . . . . . $ (78,998) $ 27,392 $ - (51,606)
------------------------------------- ------------ ----------- ----------------------- ------------
NET INCOME/(LOSS) PER SHARE:
Net Income/(Loss) . . . . . . . $ (0.00) $ 0.05 $ - $ (0.00)
------------------------------------- ------------ ----------- ----------------------- ------------
Shares Outstanding . . . . . . . . . 28,710,496 520,000 (520,000) 28,710,496
------------------------------------- ------------ ----------- ----------------------- ------------
------------------------------------- ------------ ----------- ----------------------- ------------

PAGE F-16

UNAUDITED PRO FORMA COMBINED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)

December 31, 2005

SPACEDEV STARSYS PRO FORMA ADJUSTMENTS PRO FORMA
------------ ------------ ----------------------- ------------

NET SALES. . . . . . . . . . . . . . $ 9,005,011 $17,762,730 $ - $26,767,741
------------------------------------- ------------ ------------ ----------------------- ------------
COST OF SALES. . . . . . . . . . . . 6,905,902 14,721,176 - $21,627,078
------------------------------------- ------------ ------------ ----------------------- ------------
GROSS MARGIN . . . . . . . . . . . . 2,099,109 3,041,554 - $ 5,140,663

OPERATING EXPENSES
Marketing and sales expense . . . 673,636 - 673,636
General and administrative. . . . 1,113,973 6,000,676 - 7,114,649
------------------------------------- ------------ ------------ ----------------------- ------------
TOTAL OPERATING EXPENSES . . . . . . 1,787,609 6,000,676 - 7,788,285
------------------------------------- ------------ ------------ ----------------------- ------------
INCOME/(LOSS) FROM OPERATIONS. . . . 311,500 (2,959,122) - (2,647,622)
------------------------------------- ------------ ------------ ----------------------- ------------
NON-OPERATING INCOME/(EXPENSE)
Interest income . . . . . . . . . 105,840 - - 105,840
Rental income . . . . . . . . . . - 88,146 88,146
Interest expense. . . . . . . . . (2,873) (506,525) - (509,398)
Gain on building sale . . . . . . 117,272 - - 117,272
Loan fee - equity compensation. . (28,875) - - (28,875)
------------------------------------- ------------ ------------ ----------------------- ------------
TOTAL NON-OPERATING INCOME/(EXPENSE) 191,364 (418,379) - (227,015)
------------------------------------- ------------ ------------ ----------------------- ------------
INCOME/(LOSS) BEFORE INCOME TAXES. . 502,864 (3,377,501) - (2,874,637)
Income tax provision . . . . . . . . 1,600 - - 1,600
------------------------------------- ------------ ------------ ----------------------- ------------
NET INCOME/(LOSS). . . . . . . . . . $ 501,264 $(3,377,501) $ - (2,876,237)
------------------------------------- ------------ ------------ ----------------------- ------------
NET INCOME/(LOSS) PER SHARE:
Net Income/(Loss) . . . . . . . $ 0.02 $ (6.49) $ (0.08)
------------------------------------- ------------ ------------ ----------------------- ------------
Shares Outstanding . . . . . . . . . 29,030,858 520,447 5,357,143 34,388,001
------------------------------------- ------------ ------------ ----------------------- ------------
------------------------------------- ------------ ------------ ----------------------- ------------

The unaudited pro forma combined consolidated information reflects our best
estimates. The actual results of operations may have differed from the pro forma
amounts reflected herein because of various factors, including, without
limitation, access to additional information, changes in value and changes in
operating results. However, the Company believes that any final adjustments
will not be material to the statement of operations.

9. SUBSEQUENT EVENTS

On April 1, 2006, the Company was awarded the third task order on a $43-million
contract with the Missile Defense Agency to conduct a micro-satellite
Distributed Sensing Experiment (DSE), as well as other micro-satellite studies,
as required. The second Task Order was awarded on October 20, 2004 (although

PAGE F-17

effective October 1, 2004) and was completed on March 31, 2006. The commencement
of Phase III of this contract followed a successful DSE Critical Design Review
held from March 7 through March 8, 2006. The third Task Order was awarded for a
total of $1,547,266 and will run through May 31, 2006.

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders
SPACEDEV, INC.

We have audited the accompanying consolidated balance sheets of SPACEDEV, INC.
AND SUBSIDIARIES as of December 31, 2005 and 2004, respectively, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years 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 audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audits 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 audits provide 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, 2005 and 2004, and the
consolidated results of their operations and their cash flows for the years then
ended, in conformity with accounting principles generally accepted in the United
States of America.

/s/ PKF
San Diego, California PKF
February 3, 2006 Certified Public Accountants
A Professional Corporation

PAGE F-18

SPACEDEV, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31,. . . . . . . . . . . . . . . . . . . . 2005 2004
---------------------------------------------------- ----------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents (Notes 1(m) and 10(a)) $ 5,750,038 $5,068,601
Accounts receivable (Notes 1(d) and 10(b)) . . . 1,279,027 620,097
Work in progress . . . . . . . . . . . . . . . . 21,340 -
Note receivable (Note 11). . . . . . . . . . . . 1,353,440 -
---------------------------------------------------- ----------- ----------
Total Current Assets. . . . . . . . . . . . . . . . 8,403,845 5,688,698

FIXED ASSETs - Net (Notes 1(f) and 2) . . . . . . . 1,073,773 279,381

OTHER ASSETS (NOTE 1 (N)) . . . . . . . . . . . . . 1,531,031 122,355
---------------------------------------------------- ----------- ----------
TOTAL ASSETS. . . . . . . . . . . . . . . . . . . . $11,008,649 $6,090,434
---------------------------------------------------- ----------- ----------
---------------------------------------------------- ----------- ----------

The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-19

SPACEDEV, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2005 2004
----------------------------------------------------------------------- ------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of notes payable (Note 4(a)). . . . . . . . . . . . $ 9,457 $ 36,670
Current portion of capitalized lease obligations (Note 9(a)). . . . 1,469 3,784
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . 1,237,099 338,809
Accrued payroll, vacation and related taxes . . . . . . . . . . . . 290,914 195,045
Employee stock purchase plan (Note 7(b)). . . . . . . . . . . . . . 29,375 9,332
Deferred revenue (Note 11). . . . . . . . . . . . . . . . . . . . . 153,440 -
Other accrued liabilities (Note 9(b)) . . . . . . . . . . . . . . . 487,005 207,262
----------------------------------------------------------------------- ------------- -------------
TOTAL CURRENT LIABILITIES. . . . . . . . . . . . . . . . . . . . . . . 2,208,759 790,902

NOTES PAYABLE, LESS CURRENT MATURITIES (NOTE 4(A)) . . . . . . . . . . - 9,457

CAPITALIZED LEASE OBLIGATIONS, LESS CURRENT MATURITIES (NOTE 9(A)) . . - 1,469

DEFERRED GAIN - ASSETS HELD FOR SALE (NOTES 2 AND 4) . . . . . . . . . 830,677 947,949

DEFERRED REVENUE (NOTE 1(E)) . . . . . . . . . . . . . . . . . . . . . - 5,000
----------------------------------------------------------------------- ------------- -------------
TOTAL LIABILITIES. . . . . . . . . . . . . . . . . . . . . . . . . . . 3,039,436 1,754,777

COMMITMENTS AND CONTINGENCIES (NOTE 9)

STOCKHOLDERS' EQUITY
Convertible preferred stock, $.001 par value, 10,000,000 shares
authorized, and 248,460 and 250,000 shares issued and outstanding,
respectively (Note 8(a)). . . . . . . . . . . . . . . . . . . . . . 248 250
Common stock, $.0001 par value; 50,000,000 shares authorized, and
24,606,275 and 21,153,660 shares issued and outstanding,
respectively (Note 8(b)). . . . . . . . . . . . . . . . . . . . . . 2,460 2,114
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . 22,541,994 18,739,090
Additional paid-in capital - stock options (Note 8(d)). . . . . . . - 750,000
Deferred compensation (Note 8(d)) . . . . . . . . . . . . . . . . . - (250,000)
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . (14,575,489) (14,905,797)
----------------------------------------------------------------------- ------------- -------------
TOTAL STOCKHOLDERS, EQUITY . . . . . . . . . . . . . . . . . . . . . . 7,969,213 4,335,657
----------------------------------------------------------------------- ------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . $ 11,008,649 $ 6,090,434
----------------------------------------------------------------------- ------------- -------------
----------------------------------------------------------------------- ------------- -------------

The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-20

SPACEDEV, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, . . . . . . . . . . . . . . . 2005 % 2004 %
------------------------------------------------------- ------------ ------------ ------------ -------
NET SALES. . . . . . . . . . . . . . . . . . . . . . . $ 9,005,011 100.00% $ 4,890,743 100.00%
------------------------------------------------------- ------------ ------------ ------------ -------
COST OF SALES. . . . . . . . . . . . . . . . . . . . . 6,905,902 76.69% 3,820,683 78.12%
------------------------------------------------------- ------------ ------------ ------------ -------
GROSS MARGIN . . . . . . . . . . . . . . . . . . . . . 2,099,109 23.31% 1,070,060 21.88%

OPERATING EXPENSES
Marketing and sales expense . . . . . . . . . . . . 673,636 7.48% 418,831 8.56%
General and administrative. . . . . . . . . . . . . 1,113,973 12.37% 506,944 10.37%
------------------------------------------------------- ------------ ------------ ------------ -------
TOTAL OPERATING EXPENSES . . . . . . . . . . . . . . . 1,787,609 19.85% 925,775 18.93%
------------------------------------------------------- ------------ ------------ ------------ -------
INCOME FROM OPERATIONS . . . . . . . . . . . . . . . . 311,500 3.46% 144,285 2.95%
------------------------------------------------------- ------------ ------------ ------------ -------
NON-OPERATING (INCOME)/EXPENSE
Interest income . . . . . . . . . . . . . . . . . . (105,840) -1.18% (19,497) -0.40%
Interest expense. . . . . . . . . . . . . . . . . . 2,873 0.03% 52,077 1.06%
Gain on building sale (Note 4(d)) . . . . . . . . . (117,272) -1.30% (117,272) -2.40%
Loan fee - equity compensation (Notes 4(c) and 5) . 28,875 0.32% 3,254,430 66.54%
------------------------------------------------------- ------------ ------------ ------------ -------
TOTAL NON-OPERATING (INCOME)/EXPENSE . . . . . . . . . (191,364) -2.13% 3,169,739 64.81%
------------------------------------------------------- ------------ ------------ ------------ -------
INCOME (LOSS) BEFORE INCOME TAXES. . . . . . . . . . . 502,864 5.58% (3,025,454) -61.86%
Income tax provision (Notes 1(i) and 6). . . . . . . . 1,600 0.02% 1,600 0.03%
------------------------------------------------------- ------------ ------------ ------------ -------
NET INCOME/(LOSS). . . . . . . . . . . . . . . . . . . $ 501,264 5.57% $(3,027,054) -61.89%
------------------------------------------------------- ------------ ------------ ------------ -------
NET INCOME/(LOSS) PER SHARE:
Net income/(loss) . . . . . . . . . . . . . . . . $ 0.02 $ (0.16)
------------------------------------------------------- ------------ ------------ ------------ -------
Weighted-Average Shares Outstanding . . . . . . . 22,270,997 18,610,141

FULLY DILUTED NET INCOME/(LOSS) PER SHARE:
Net income/(loss) . . . . . . . . . . . . . . . . $ 0.02 $ (0.16)
------------------------------------------------------- -------------------------- ---------------------
Fully Diluted Weighted-Average Shares Outstanding. 29,631,118 18,610,141
------------------------------------------------------- -------------------------- ---------------------
------------------------------------------------------- -------------------------- ---------------------

The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-21

SPACEDEV, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

Preferred Stock Common Stock
------------------ --------------------
Shares Amount Shares Amount
----------------------------------------------------------------------------- ---------- ------ ----------- -------
BALANCE AT JANUARY 1, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . - $ - 16,413,260 $ 1,641
Preferred stock issued for cash (Note 8(a)) . . . . . . . . . . . . . . 250,000 250 - -
Common stock issued for cash from employee stock purchase plan (Note 7(b)). . - - 14,010 1
Common stock issued from notes on revolving credit facility (Note 4(c)) . . . - - 2,991,417 299
Common stock issued from employee stock options (Notes 7(b) and 8(d)) . . . . - - 1,005,035 100
Common stock issued from private placement memorandum warrants (Note 8(b)). . - - 115,085 12
Common stock issued from convertible debt program warrants (Notes 5 and 8(c)) - - 614,853 61
Declared dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - - -

Net Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - - -
----------------------------------------------------------------------------- ---------- ------ ----------- -------
BALANCE AT DECEMBER 31, 2004. . . . . . . . . . . . . . . . . . . . . . . . . 250,000 250 21,153,660 2,114
Preferred stock issued for cash (Note 8(a)) . . . . . . . . . . . . . . - - - -
Common stock issued for cash from employee stock purchase plan (Note 7(b)). . - - 27,540 3
Common stock issued from conversion of preferred stock (Note 8(a)). . . . . . (1,540) (2) 10,000 1
Common stock issued from employee stock options (Notes 7(b) and 8(d)) . . . . - - 237,000 24
Common stock issued from private placement memorandum warrants (Note 8(b)). . - - 1,014,327 101
Common stock issued from convertible debt program warrants (Notes 5 and 8(c)) - - 17,607 2
Common stock issued from securities purchase agreement (Note 8(b)). . . . . . - - 2,032,520 204
Common stock issued from conversion of declared dividends (Note 8(a)) . . . . - - 113,621 11
Stock option forfeiture (Notes 7(b) and 8(d)) . . . . . . . . . . . . . . . . - - - -
Declared dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - - -

Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - - -
----------------------------------------------------------------------------- ---------- ------ ----------- -------
BALANCE AT DECEMBER 31, 2005. . . . . . . . . . . . . . . . . . . . . . . . . 248,460 $ 248 24,606,275 $ 2,460
----------------------------------------------------------------------------- ---------- ------ ----------- -------
----------------------------------------------------------------------------- ---------- ------ ----------- -------

The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-22

SPACEDEV, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

Additional
Additional Paid-In
Paid-in Capital - Deferred
Capital Stock Options Compensation
----------------------------------------------------------------------------- ----------- -------------- -------------
BALANCE AT JANUARY 1, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,243,507 $ 750,000 $ (250,000)
Preferred stock issued for cash (Note 8(a)) . . . . . . . . . . . . . . 2,366,250 - -
Common stock issued for cash from employee stock purchase plan (Note 7(b)). . 12,626 - -
Common stock issued from notes on revolving credit facility (Note 4(c)) . . . 4,752,079 - -
Common stock issued from employee stock options (Notes 7(b) and 8(d)) . . . . 1,264,649 - -
Common stock issued from private placement memorandum warrants (Note 8(b)). . 88,738 - -
Common stock issued from convertible debt program warrants (Notes 5 and 8(c)) 1,011,241 - -
Declared dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - -

Net Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - -
----------------------------------------------------------------------------- ----------- -------------- -------------
18,739,090 750,000 (250,000)
BALANCE AT DECEMBER 31, 2004
Preferred stock issued for cash (Note 8(a)) . . . . . . . . . . . . . . -
Common stock issued for cash from employee stock purchase plan (Note 7(b)). . 38,323 - -
Common stock issued from conversion of preferred stock (Note 8(a)). . . . . . 1 - -
Common stock issued from employee stock options (Notes 7(b) and 8(d)) . . . . 241,021 - -
Common stock issued from private placement memorandum warrants (Note 8(b)). . 500,840 - -
Common stock issued from convertible debt program warrants (Notes 5 and 8(c)) 28,874 - -
Common stock issued from securities purchase agreement (Note 8(b)). . . . . . 2,318,880 - -
Common stock issued from conversion of declared dividends (Note 8(a)) . . . . 174,965 - -
Stock option forfeiture (Notes 7(b) and 8(d)) . . . . . . . . . . . . . . . . 500,000 (750,000) 250,000
Declared dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - -

Net Income - - -
----------------------------------------------------------------------------- ----------- -------------- -------------
BALANCE AT DECEMBER 31, 2005. . . . . . . . . . . . . . . . . . . . . . . . . $22,541,994 $ - $ -
----------------------------------------------------------------------------- ----------- -------------- -------------
----------------------------------------------------------------------------- ----------- -------------- -------------

The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-23

SPACEDEV, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

Accumulated
Deficit Total
----------------------------------------------------------------------------- ------------- ------------
BALANCE AT JANUARY 1, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . $(11,817,776) $(2,072,628)
Preferred stock issued for cash (Note 8(a)) . . . . . . . . . . . . . . - 2,366,500
Common stock issued for cash from employee stock purchase plan (Note 7(b)). . - 12,627
Common stock issued from notes on revolving credit facility (Note 4(c)) . . . - 4,752,378
Common stock issued from employee stock options (Notes 7(b) and 8(d)) . . . . - 1,264,749
Common stock issued from private placement memorandum warrants (Note 8(b)). . - 88,750
Common stock issued from convertible debt program warrants (Notes 5 and 8(c)) - 1,011,302
Declared dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (60,967) (60,967)
Net Loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,027,054) (3,027,054)
----------------------------------------------------------------------------- ------------- ------------
BALANCE AT DECEMBER 31, 2004. . . . . . . . . . . . . . . . . . . . . . . . . (14,905,797) 4,335,657
Preferred stock issued for cash (Note 8(a)) . . . . . . . . . . . . . . - -
Common stock issued for cash from employee stock purchase plan (Note 7(b)). . - 38,326
Common stock issued from conversion of preferred stock (Note 8(a)). . . . . . - -
Common stock issued from employee stock options (Notes 7(b) and 8(d)) . . . . - 241,045
Common stock issued from private placement memorandum warrants (Note 8(b)). . - 500,941
Common stock issued from convertible debt program warrants (Notes 5 and 8(c)) - 28,876
Common stock issued from securities purchase agreement (Note 8(b)). . . . . . - 2,319,084
Common stock issued from conversion of declared dividends (Note 8(a)) . . . . - 174,976
Stock option forfeiture (Notes 7(b) and 8(d)) . . . . . . . . . . . . . . . . - -
Declared dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (170,956) (170,956)
Net Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 501,264 501,264
----------------------------------------------------------------------------- ------------- ------------
BALANCE AT DECEMBER 31, 2005. . . . . . . . . . . . . . . . . . . . . . . . . $(14,575,489) $ 7,969,213
----------------------------------------------------------------------------- ------------- ------------
----------------------------------------------------------------------------- ------------- ------------

The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-24

SPACEDEV, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, . . . . . . . . . . . . . . . . . . . 2005 2004
--------------------------------------------------------------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income/(loss) . . . . . . . . . . . . . . . . . . . . . $ 501,264 $(3,027,054)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization. . . . . . . . . . . . . . 191,978 83,531
Closing Costs from sale of building
Gain on disposal of building . . . . . . . . . . . . . . (117,272) (117,272)
Non-cash interest expense - convertible debt program . . - 773,802
Non-cash loan fees . . . . . . . . . . . . . . . . . . . 28,874 2,480,628
Change in operating assets and liabilities:
Accounts receivable. . . . . . . . . . . . . . . . . . (658,930) (433,035)
Work in Progress . . . . . . . . . . . . . . . . . . . (21,340) 110,490
Prepaid and other current assets . . . . . . . . . . . (605,721) (74,587)
Inventory. . . . . . . . . . . . . . . . . . . . . . . - 9,961
Interest on revolving line of credit . . . . . . . . . - 18,349
Accounts payable and accrued expenses. . . . . . . . . 898,290 27,203
Accrued payroll, vacation and related taxes. . . . . . 95,869 111,044
Customer deposits and deferred revenue . . . . . . . . (5,000) -
Interest - related party . . . . . . . . . . . . . . . - 29,256
Other accrued liabilities. . . . . . . . . . . . . . . 89,008 (102,235)
--------------------------------------------------------------- ------------ ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES. . . . . . 397,020 (109,919)
--------------------------------------------------------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Notes receivable. . . . . . . . . . . . . . . . . . . . . (1,353,440) -
Other assets, capitalized acquisition costs . . . . . . . (375,930) -
Purchases of fixed assets . . . . . . . . . . . . . . . . (986,370) (225,380)
--------------------------------------------------------------- ------------ ------------
NET CASH USED IN INVESTING ACTIVITIES . . . . . . . . . . . . . (2,715,740) (225,380)
--------------------------------------------------------------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on notes payable . . . . . . . . . . . (36,670) (41,464)
Principal payments on capitalized lease obligations . . . (3,784) (10,332)
Payments on notes payable - related party . . . . . . . . - (427,280)
Proceeds from revolving credit facility . . . . . . . . . - 1,504,508
Employee stock purchase plan. . . . . . . . . . . . . . . 58,369 16,460
Other assets, capitalized preferred stock issuance costs. (78,828) -
Proceeds from issuance of preferred stock . . . . . . . . - 2,366,500
Proceeds from issuance of common stock. . . . . . . . . . 3,061,070 1,403,502
--------------------------------------------------------------- ------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES. . . . . . . . . . . 3,000,157 4,811,894
--------------------------------------------------------------- ------------ ------------
Net increase in cash . . . . . . . . . . . . . . . . . . . . . 681,437 4,476,595
--------------------------------------------------------------- ------------ ------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR . . . . . . . . 5,068,601 592,006
--------------------------------------------------------------- ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR . . . . . . . . . . . $ 5,750,038 $ 5,068,601
--------------------------------------------------------------- ------------ ------------
--------------------------------------------------------------- ------------ ------------

The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-25

SPACEDEV, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31 2005 2004
--------------------------------------------------------- --------- ---------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest. . . . . . . . . . . . . . . . . . . . . $ 2,873 $ 313,978
Income Taxes. . . . . . . . . . . . . . . . . . . 1,600 1,600

NONCASH INVESTING AND FINANCING ACTIVITIES:

During 2005 and 2004, the Company converted $38,326 and $12,627 of employee
stock purchase plan contributions into 27,540 and 14,010 shares of common
stock, respectively.

During 2005 and 2004, the Company declared dividends payable of $170,956 and
$60,967, respectively to the holders of its preferred stock.

During 2005, the Company converted dividends payable to the holders of its
preferred stock of $174,976 into 113,621 shares of common stock.

During the year ending December 31, 2004, the Company issued 2,991,417 shares of
its common stock to Laurus Master Fund, Ltd. from conversions of
indebtedness under its revolving credit facility, thereby realizing a
corresponding reduction in current liabilities of approximately $2,271,750.
The Company recorded additional non-cash loan fees of $2,480,628, and
charged these fees to expense.

During the year ending December 31, 2004, the Company issued 614,853 shares of
its common stock to the participants in its prior convertible debt program
from conversions of warrants, thereby receiving cash in the amount of
$237,500. The Company recorded additional non-cash loan fees of $773,802
and charged these fees to expense.

During the year ending December 31, 2005, the Company issued 17,607 shares of
its common stock to the participants in its' prior convertible debt program
from conversions of warrants. In the noncash transaction 25,000 warrants
were converted into 17,607 shares. The Company recorded additional non-cash
loan fees of $28,875 for the difference in the warrant price versus the
current share price, and charged these fees to expense.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

The accompanying notes are an integral part of these consolidated financial
statements.

PAGE F-26

SPACEDEV, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A summary of the Company's significant accounting policies 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, subsystems, products and services. The Company is currently focused on
the development of low-cost microsatellites, nanosatellites and related
subsystems, and 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 and military customers.

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
Nevada"), formed on August 22, 1997. On October 22, 1997, PDGI issued 8,245,000
of its $0.0001 par value common stock for 100 percent (1,000,000 shares) of
SpaceDev Nevada's common stock owned by SpaceDev, LLC. Upon the acquisition of
the SpaceDev Nevada stock, SpaceDev Nevada 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. For accounting purposes, the
transaction was accounted for as a reverse merger with the Company as the
acquirer. Since SpaceDev Nevada 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 "SPDV."

In February 1998, the Company's operations were expanded with the acquisition of
Integrated Space Systems, Inc. ("ISS"), a provider of engineering and technical
services related to space-based systems. The ISS employee base, acquired upon
acquisition, largely consisted of former Atlas and General Dynamics personnel
and enlarged the Company's then current employee base to 20 employees. ISS was
purchased for approximately $3.6 million, paid in Company common stock.

On March 31, 2004, the Company was awarded a $43,362,271 contract from the
Missile Defense Agency. Management intends to continue efforts to obtain new
commercial and government contracts.

(b) Principles of consolidation

The consolidated financial statements include the accounts of the Company and
its wholly-owned inactive subsidiaries, SpaceDev Oklahoma, Inc., and Monoceros
Acquisition Corp., a Colorado Corporation.

PAGE F-27

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.

(d) Accounts Receivable and Allowances for Uncollectible Accounts

Accounts receivable are stated at the historical carrying amount net of
write-offs and allowances for uncollectible accounts. The Company establishes an
allowance for uncollectible accounts based on historical experience and any
specific customer collection issues that the Company has identified.
Uncollectible accounts receivable are written-off when a settlement is reached
for an amount that is less than the outstanding balance or when the Company has
determined that balance will not be collected. At December 31, 2005 and 2004,
the allowance for uncollectible accounts was $32,281 and $32,637 respectively.

(e) Revenue recognition

The Company's revenues in 2005 and 2004 were derived primarily from United
States government cost plus fixed fee ("CPFF") contracts compared to a
predominance of fixed price contracts prior to 2003. Revenues from the CPFF
contracts during 2005 and 2004 were recognized as expenses were incurred.
Estimated contract profits were taken into earnings in proportion to expenses
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, would be recorded upon
achievement of performance milestones or using the cost-to-cost method of
accounting where revenues and profits would be recorded based on the ratio of
costs incurred to estimated total costs at completion. Losses on contracts
would be recognized when estimated costs were 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 are incurred.

Deferred revenue represents amounts collected from customers for projects,
products or services to be provided at a future date.

(f) Depreciation and amortization

Fixed assets are depreciated over their estimated useful lives of Three-
to-fifteen 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 sale 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 this sale, the Company entered into a non-cancelable
operating lease with the buyer to lease-back its facilities for ten years. The
base rent is increased by 3.5% per year (see Note 2).

(g) Research and development

The Company is engaged in design and development activities with its commercial
and government customers. The Company has Small Business Innovation Research
("SBIR") grants from the government and continues to seek new SBIR
opportunities. Costs incurred under SBIR grants are charged against revenues

PAGE F-28

received under SBIR grants. Non-reimbursable research and development
expenditures relating to possible future products are expensed as incurred. The
Company incurred $31,940 and $39,473 in non-reimbursable research and
development costs during 2005 and 2004, respectively.

(h) 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.

(i) Stock-based compensation

The Company has elected to account for its stock-based compensation plans under
APB Opinion No. 25. However, the Company has computed, for pro forma disclosure
purposes, the value of all options granted during the years ended December 31,
2005 and 2004 using the minimum value method as prescribed by SFAS No. 123 and
amended by SFAS No. 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 73% to 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 No. 123,
the total value of options granted during the years ended December 31, 2005 and
2004 would be amortized over the vesting period of the options. Thus, on a pro
forma basis, the Company's consolidated net income (loss) would have been as
follows:

-------------------------------------------------- ------------ ------------
NET INCOME (LOSS). . . . . . . . . . . . . . . . 2005 2004
-------------------------------------------------- ------------ ------------
As reported. . . . . . . . . . . . . . . . . . . $ 501,264 $(3,027,054)
Add: Stock based employee compensation expense. $ -
included in reported net income
Deduct: Stock based employee compensation . . . $(7,488,859) $ (390,773)
expense determined under the
fair value based method for all awards
-------------------------------------------------- ------------ ------------
Pro forma. . . . . . . . . . . . . . . . . . . . $(6,987,595) $(3,417,827)
-------------------------------------------------- ------------ ------------
NET INCOME (LOSS) PER SHARE:

As reported - basic. . . . . . . . . . . . . . . $ 0.02 $ (0.16)
As reported - diluted. . . . . . . . . . . . . . $ 0.02 $ (0.16)
Pro forma - basic. . . . . . . . . . . . . . . . $ (0.31) $ (0.18)
Pro forma - diluted. . . . . . . . . . . . . . . $ (0.24) $ (0.18)
-------------------------------------------------- ------------ ------------
-------------------------------------------------- ------------ ------------

PAGE F-29

SFAS No. 123, Accounting for Stock-Based Compensation, established accounting
and disclosure requirements using a fair-value-based method of accounting for
stock-based employee compensation plans. In December 2004, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 123 (revised 2004),
Share-Based Payment (SFAS No. 123R), which replaces SFAS No. 123 and supersedes
APB Opinion No. 25. SFAS No. 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
financial statements based on their fair values. In addition, the adoption of
SFAS No. 123R requires additional accounting related to the income tax effects
and additional disclosure regarding the cash flow effects resulting from
share-based payment arrangements. SFAS No. 123R is effective January 1, 2006 for
calendar year companies. Accordingly, the Company will implement the revised
standard in the first quarter of 2006 (See Note 7).

On December 20, 2005, in response to SFAS No. 123R the Company's Board of
Directors approved accelerating the vesting of all unvested stock options held
by current employees, including executive officers, and members of the Board of
Directors. In order to avoid adverse financial reporting effects in future years
under the new accounting standard, we eliminated all future vesting requirements
on approximately 8.0 million stock options then outstanding in the hands of
employees, officers, and directors which had a calculated future value of
approximately $5.5 million.

(j) Net profit (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 was not computed in 2004, as the
computation would result in anti-dilution.

YEAR ENDED DECEMBER31,
-------------------------------------------------

2005 2004
----------------------- -------------------
Numerator:
Net income (loss) $ 501,264 $ (3,027,054)

Plus: Dividends on convertible preferred stock 174,976 N/A
----------------------- -------------------
$ 676,240 $ (3,027,054)
----------------------- -------------------
Denominator:
Weighted-average shares used to compute basic EPS 22,270,997 18,610,141

Adjusted weighted-average shares for
conversion of preferred stock, options, and warrants 7,360,121 N/A
----------------------- -------------------
Weighted-average shares used to compute diluted EPS 29,631,118 18,610,141
----------------------- -------------------
Net earnings per share:
Basic $ 0.02 $ (0.16)
----------------------- -------------------
Diluted $ 0.02 $ N/A
----------------------- -------------------
----------------------- -------------------

PAGE F-30

The potential shares, which are included in the computation of diluted net
income per share are as follows:

YEAR ENDED DECEMBER31,
-----------------------------

2005 2004
----------------------- ----
Incremental shares from assumed conversions:
Warrants . . . . . . . . . . . . . . . . 1,897,579 -
Options. . . . . . . . . . . . . . . . . 5,967,128 -
Convertible preferred stock. . . . . . . 1,620,637 -
----------------------- ----
Dilutive potential common shares . . . . . . 9,485,345 -
Anti-dilutive shares . . . . . . . . . . . . (2,125,224)
----------------------- ----
Adjusted weighted-average shares . . . . . . 7,360,121 -
----------------------- ----
----------------------- ----

(k) Financial instruments

The Company's financial instruments consist primarily of cash, short-term notes
receivable, accounts receivable, capital leases, accounts payable, and notes
payable. These financial instruments are stated at their respective carrying
values, which approximate their fair values.

(l) Segment reporting

The Company has determined that it operates in one business segment dedicated to
space technology.

(m) New accounting standards

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets-
An Amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29,
Accounting for Nonmonetary Transactions, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of
the assets exchanged. The guidance in that Opinion, however, included certain
exceptions to that principle. SFAS No. 153 amends Opinion No. 29 to eliminate
the exception for nonmonetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of nonmonetary assets that do
not have commercial substance. A nonmonetary exchange has commercial substance
if the future cash flows of the entity are expected to change significantly as a
result of the exchange. The provisions of SFAS No. 153 are effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. Early application was permitted and companies must apply the standard
prospectively. The adoption of this standard is not expected to have any effect
on the Company's financial position or results of operations.

In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R). FAS No. 123R
revised SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related
implementation guidance. SFAS No. 123R will require compensation costs related
to share-based payment transactions to be recognized in the financial statement
(with limited exceptions). The amount of compensation cost will be measured
based on the grant-date fair value of the equity or liability instruments
issued. Compensation cost will be recognized over the period that an employee
provides service in exchange for the award.

PAGE F-31

In March 2005, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 107 ("SAB No. 107"), Share-Based Payment, providing guidance on
option valuation methods, the accounting for income tax effects of share-based
payment arrangements upon adoption of SFAS No. 123R, and the disclosures in MD&A
subsequent to the adoption. In April 2005, the Securities and Exchange
Commission adopted a rule which delayed the compliance date for small business
issuers to the start of the first fiscal year beginning after December 15, 2005.
The Company will provide SAB No. 107 required disclosures upon adoption of SFAS
No. 123R in January 2006 and is currently evaluating the impact the adoption of
the standard will have on the Company's financial condition and results of
operations.

In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Errors
Corrections, a replacement of APB Opinion No. 20 and FAS No. 3. The Statement
applies to all voluntary changes in accounting principle, and changes to the
requirements for accounting for and reporting of a change in accounting
principle. SFAS No. 154 requires retrospective application to prior periods'
financial statements of a voluntary change in accounting principle unless it is
impractical. APB Opinion No. 20 previously required that most voluntary changes
in accounting principle be recognized by including in net income of the period
of the change the cumulative effect of changing to the new accounting principle.
SFAS No.154 is not expected to have any effect on the Company's financial
position or results of operations.

In February 2006, the FASB issued FAS No. 155, Accounting for Certain Hybrid
Financial Instruments-an amendment of FASB Statements No. 133 and 140 ("FAS No.
155"). This statement resolves issues addressed in FAS No. 133 Implementation
Issue No. D1, Application of Statement 133 to Beneficial Interest in Securitized
Financial Assets. FAS No. 155: (a) permits fair value remeasurement for any
hybrid financial instrument that contains an embedded derivative that otherwise
would require bifurcation; (b) clarifies which interest-only strips and
principal-only strips are not subject to the requirements of FAS No. 133; (c)
establishes a requirement to evaluate beneficial interests in securitized
financial assets to identify interests that are freestanding derivatives or that
are hybrid financial instruments that contain an embedded derivative requiring
bifurcation; (d) clarifies that concentrations of credit risk in the form of
subordination are not embedded derivatives; and, (e) eliminates restrictions on
a qualifying special-purpose entity's ability to hold passive derivative
financial instruments that pertain to beneficial interests that are or contain a
derivative financial instrument. FAS No. 155 also requires presentation within
the financial statements that identifies those hybrid financial instruments for
which the fair value election has been applied and information on the income
statement impact of the changes in fair value of those instruments. The Company
is required to apply FAS No. 155 to all financial instruments acquired, issued
or subject to a remeasurement event beginning January 1, 2007. The Company does
not expect the adoption of FAS No. 155 to have a material impact on the
Company's financial statements.

(n) Other Assets

Other assets are made up of a variety of prepaid and other cash advances for
items which will occur at a future date. Following is a description of what
makes up our other assets total at December 31, 2005 and 2004.

PAGE F-32

Other Assets - December 31,. . . . . . . . . . . . . . . . . . . 2005 2004
------------------------------------------------------------------ --------- -------
Cost Accrued in Conjunction with Starsys Acquisition. . . . . . . 724,127 -
SpaceDev Launch Package - Deposit . . . . . . . . . . . . . . . . 650,000 -
Cost Accrued in Conjunction with 2006 Security Purchase Agreement 78,828 -
Software Prepaid License. . . . . . . . . . . . . . . . . . . . . 17,788 -
Insurance Prepaid . . . . . . . . . . . . . . . . . . . . . . . . - 81,186
2006 Property Tax Prepayment. . . . . . . . . . . . . . . . . . . 14,562 -
All Other Deposits. . . . . . . . . . . . . . . . . . . . . . . . 45,727 41,169
------------------------------------------------------------------ --------- -------
Total Other Assets. . . . . . . . . . . . . . . . . . . . . . . . 1,531,031 122,355
------------------------------------------------------------------ --------- -------
------------------------------------------------------------------ --------- -------

(o) Cash and Cash Equivalents

Cash and cash equivalents are made up of cash as well as short term treasury
strips that will mature in a relatively short amount of time and represents only
the present value of the strip. These treasury strips can be redeemed at any
time, which is also why they are deemed to be cash and cash equivalents.

(p) Advertising Costs

Direct advertising costs are expensed as they are incurred by the Company.

2. FIXED ASSETS

In January 2003, the Company sold 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 this facility (see Note 9(c)). The gain
on the sale of the facility was deferred and is being amortized over the
remaining term of the lease. This amortization is included in the Company's
non-operating income and expense.

The gain of $1,172,720 on the sale of the facility was deferred and is being
amortized on a straight-line basis over the ten (10) year term of the lease at
the rate of $117,272 per year. As of December 31, 2005 and 2004, the deferred
gain was $830,677 and $947,949, respectively. This amortization is included in
the Company's non-operating income and expense and totaled $117,272 in 2005 and
2004.

PAGE F-33

Deferred Gain consisted of the following:

December 31,. . . . . . . 2005 2004
------------------------- ----------- -----------

Deferred Gain . . . . . . $1,172,720 $1,172,720
Less Amortization to date (342,043) (224,771)
------------------------- ----------- -----------
$ 830,677 $ 947,949
------------------------- ----------- -----------
------------------------- ----------- -----------

Fixed assets consisted of the following:

December 31, . . . . . . . . . . . . . . 2005 2004
---------------------------------------- ----------- ----------
Capital leases . . . . . . . . . . . . . $ 155,499 $ 155,499
Computer equipment . . . . . . . . . . . 699,592 383,512
Building improvements. . . . . . . . . . 230,588 14,124
Furniture and fixtures . . . . . . . . . 10,976 6,224
Construction in Process. . . . . . . . . 446,621 -
---------------------------------------- ----------- ----------
1,543,276 559,360
Less accumulated depreciation
and amortization. . . . . . . . . . . (469,503) (279,979)
---------------------------------------- ----------- ----------
$1,073,773 $ 279,381
---------------------------------------- ----------- ----------
---------------------------------------- ----------- ----------

Depreciation and amortization expense for fixed assets was approximately
$192,000 and $83,500 for the years ended December 31, 2005 and 2004,
respectively. Depreciation and amortization expense was higher during 2005 due
to the purchase of new fixed assets, mainly new computer hardware and software,
during 2005 and the construction of our fabrication and test facilities for our
hybrid rock motor systems, also located in Poway, California. Of the above
depreciation, approximately $17,000 and $33,000, for the years ended December
31, 2005 and 2004, respectively, was for depreciation on equipment under capital
leases.

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.

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 has been modified and may be 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.

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 may receive a

PAGE F-34

warrant to purchase a number of shares, if revenue is 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
and 25,000 additional warrants expired on March 19, 2005.

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%, a 0% 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.

4. NOTES PAYABLE

(a) Building and settlement notes

In January 2003, the company sold 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 leaseback this facility. 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 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, 2005
and 2004, the outstanding balances on these notes were $9,457 and $46,127, with
interest expense of $1,474 and $3,258, respectively.

(b) Related parties
The Company had a note payable to its CEO, which was part of the Company's
preferred stock offering (see Note 8(a)), and was paid in full during the third
quarter of 2004.

Interest expense on this note was $29,256 for 2004.

In June 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"). Pursuant to the agreements, the Company
received a $1 million revolving credit facility, later modified to increase the
facility to $1.5 million, in the form of a three-year Convertible Note secured
by the Company's assets subject to the amount of eligible accounts receivables.
The net proceeds from the Convertible Note were used for general working capital
purposes. Advances on the Convertible Note may be repaid in cash or through the
issuance of shares of the Company's common stock at the Company's option,
provided the market price of the common stock was 118% of the fixed conversion
price or greater. The Convertible Note carries an interest rate of Prime plus
0.75% on any outstanding balance. In addition, the Company is required to pay a

PAGE F-35

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 $19,500 in interest and approximately $5,000 in fees were expensed
under the revolving credit facility in 2004. There was no outstanding balance
on the revolving credit facility at December 31, 2005 and 2004.

The Convertible Note includes a right of conversion in favor of Laurus. Laurus
exercised its conversion rights from time to time in 2004 on outstanding
balances. 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 of the accounts receivable restrictions 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 further modified on August 25, 2004 to provide for a
fixed conversion price to Laurus of $1.00 per share on the next $1 million.
Thereafter, the fixed conversion price will be adjusted to 103% of the then fair
market value of the Company's common stock ("Adjusted Fixed Conversion Price").

Laurus converted 2,991,417 shares to reduce the Company's debt by $2,271,750 for
the year ended December 31, 2004. For the year ended December 31, 2004, the
Company expensed $2,480,628 for the non-cash loan fee based on the fair market
value of the stock when Laurus converted. The fair market value of the common
stock used in 2004 was established using the closing price on the date of
conversion.

Availability of funds under the revolving credit facility is based on the
Company's accounts receivable, except as waivers provided by Laurus. An initial
three 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. Laurus subsequently extended the waiver for two additional
six-month periods in 2004, under which Laurus permitted a credit advance up to
$1 million, which amount would have otherwise exceeded eligible accounts
receivable.

In conjunction with this transaction, Laurus was paid a fee of $10,000, which
was recorded as additional interest expense in 2004. The Company paid a
continuation fee of $10,000 for 2005. In addition, Laurus received a warrant to
purchase 200,000 shares of the Company's common stock. The warrant exercise
price was 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 may be exercised for the balance of the
shares at any time or from time to time until June 3, 2008.

In addition to the initial warrant, the Company was 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 was converted under the revolving credit
facility. On June 18, 2004, the Company issued an additional warrant to
purchase 50,000 shares at an exercise price of $1.0625 per share in relation to
the March 31, 2004 credit facility modification. This additional warrant was
exercised by Laurus in April 2005 and resulted in a non-cash interest expense of
$28,875 for the year ended December 31, 2005. Since no more than an aggregate
100,000 shares of the Company's common stock were authorized as additional
warrants under the Laurus Agreements, on August 25, 2004, the Company issued an

PAGE F-36

additional warrant to purchase 50,000 shares at an exercise price of $1.925 per
share in relation to the August 25, 2004 credit facility modification, i.e.,
there was a 100,000 share ceiling on the number of warrants to be issued
regardless of the amount converted under the revolving credit facility.

The Company may terminate its agreements with Laurus before the end of the
initial three year term, i.e., June 3, 2006, 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 two percent (2%) of the total amount available under
the revolving credit facility if such payment occurs after June 3, 2005 and
prior to June 3, 2006. The early payment fee is also due and payable by the
Company to Laurus if Laurus terminates its Agreement after the occurrence of an
Event of Default, as defined in the agreements.

As a result of the amendments and modifications discussed above, at December 31,
2005 the revolving credit facility provided for up to a maximum of $1.5 million
in principal amount of aggregate borrowing. The fixed conversion price for
future amounts under the revolving credit facility will be set at 103% of the
fair market value of the Company's common stock.

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 matured. The
maturity on the notes was six months from issue date. On March 25, 2003, an
amendment was executed which extended these notes an additional six 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 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, 2004, all of the warrants under the convertible debt program
had been converted to equity and the Company received approximately $50,000 in
cash, recorded a reduction of $187,500 in related party debt and expensed
$773,802 in non-cash loan fees.

PAGE F-37

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 $2,127,000 and $2,350,000 as of December 31, 2005 and
2004, respectively, consisted primarily of the income tax benefits from net
operating loss, amortization of the financial reporting gain on the
sale-leaseback arrangement, and research and development credits. A valuation
allowance has been recorded to fully offset the deferred tax asset as the
Company believes it is more likely than not that the assets will not be
utilized. The valuation allowance decreased approximately $243,000 in 2005 from
$2,318,000 at December 31, 2004 to $2,075,000 at December 31, 2005.
Significant components of the benefit for income taxes for the years ended
December 31, 2005 and 2004 are as follows:

2005 2004
------------------ ------ ------
Current
Federal . . . . . $ - $ -
State . . . . . . 1,600 1,600
------------------ ------ ------
1,600 1,600

Deferred
Federal . . . . . - -
State . . . . . . - -
------------------ ------ ------
- -

Income tax expense $1,600 $1,600
------------------ ------ ------
------------------ ------ ------

At December 31, 2005, the Company had federal and state tax net operating loss
and capital loss carryforwards of approximately $4,214,000 and $1,608,000,
respectively. The federal and state tax loss carryforwards will begin to expire
in 2012 and 2007, respectively, unless previously utilized.

A reconciliation of the statutory income tax rates and the Company's effective
tax rate is as follows:

Years Ended December 31,. . . . . . . . . . 2005 2004
------------------------------------------- -------- --------
Statutory U.S. federal rate . . . . . . . . 35.00% 35.00%
State income taxes - net of federal benefit 5.70% 5.70%
Permanent differences . . . . . . . . . . . 7.40% (37.80%)
Change in valuation allowance . . . . . . . (48.10%) (2.90%)
------------------------------------------- -------- --------
Provision for income taxes. . . . . . . . . 0.00%) 0.00%
------------------------------------------- -------- --------
------------------------------------------- -------- --------

PAGE F-38

The tax effects of temporary differences and carryforwards that give rise to
deferred tax assets consist of the following:

December 31,. . . . . . . . . . . . . 2005 2004
--------------------------------------- ------------ ------------
Deferred tax assets:
Loss carryforwards. . . . . . . . $ 1,567,000 $ 1,765,000
Deferred gain on sale of building 338,000 416,000
Other . . . . . . . . . . 123,000 77,000
Research and development credits. 99,000 92,000
--------------------------------------- ------------ ------------
Gross deferred tax assets . . . . . . 2,127,000 2,350,000
Deferred tax liability-Depreciation (52,000) (32,000)
--------------------------------------- ------------ ------------
2,075,000 2,318,000
Valuation allowance . . . . . . . . . (2,075,000) (2,318,000)
--------------------------------------- ------------ ------------
$ - $ -
--------------------------------------- ------------ ------------
--------------------------------------- ------------ ------------

As of December 31, 2005, the Company recorded a valuation allowance of $218,000
related to deferred tax assets created by the exercise and/or disposition of
employee stock options in recent periods. The deferred tax asset originating
from deductions for the exercise and/or disposition of stock options and the
related valuation allowance have been recorded against additional paid-in
capital and did not affect the net earnings for the period. Any tax benefits
realized from the reduction of this valuation allowance will be recorded to
additional paid-in capital.

The Company has unused U.S. and state tax credits of approximately $69,000 and
$47,000, that begin to expire 2013 and 2008, respectively.

7. EMPLOYEE BENEFIT PLAN

(a) Profit sharing 401(k) plan

During 2004, the Company amended its previous 401(k) retirement savings plan
from 1997 for its employees, which allows each eligible employee to voluntarily
make pre-tax salary contributions up to 93% of their compensation or statutory
limits per year, whichever is lower, for the year ended December 31, 2005. The
Company has elected to begin making a matching contribution of 10% of employee
contributions, which matching portion vests over 5 years as specified in the
plan amendment. During 2005 and 2004, the Company contributed $18,235 and
$2,705 to the Plan, respectively.

(b) Incentive stock option and employee stock purchase plans

In 1999, the Company adopted a stock option plan under which its Board of
Directors had the ability to grant its employees, directors and affiliates
Incentive Stock Options, non-statutory stock options and other forms of
stock-based compensation, including bonuses or stock purchase rights. Incentive
Stock Options, which provided for preferential tax treatment, were only
available to employees, including officers and affiliates, and were not issued
to non-employee directors. The exercise price of the Incentive Stock Options is
100% of the fair market value of the stock on the date the options were granted.
Pursuant to the plan, the exercise price for the non-statutory stock options was
to be not less than 95% of the fair market value of the stock on the date the
option was granted.

In 2000, the Company amended the 1999 Stock Option Plan, increasing the number
of shares eligible for issuance under the Plan to 30% of the then outstanding
common stock to 4,184,698 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 has not made any such
adjustment since.

PAGE F-39

In 2004, the Company adopted the 2004 Equity Incentive Plan authorizing options
on 2,000,000 shares. An amendment increasing this to 4,000,000 shares was
adopted in August 2005. As of December 31, 2005, 8,184,698 shares were
authorized for issuance under both plans, 5,447,560 of which were subject to
outstanding options and awards and 1,279,035 which have been exercised for the
Company's common stock.

During 2005, the Company issued non-statutory options to purchase 629,000 shares
to its independent directors for attendance at its 2005 and 2006 Board of
Directors meetings.

In 1999, the Company adopted the 1999 Employee Stock Purchase Plan with
1,000,000 shares reserved under the plan and authorized the Board of Directors
to make twelve consecutive offerings of common stock to its employees. 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 95% of the fair
market value of the stock on the date the stock is purchased. During 2005 and
2004 employees contributed $58,369 and $16,464 to the Employee Stock Purchase
Plan, and 27,540 and 14,010 shares were issued under the plan as of December 31,
2005 and 2004, respectively. The 1999 Employee Stock Purchase Plan was to
expire in June 2005; however, the Board of Directors extended the plan for
another year at their Board meeting in November 2004.

8. STOCKHOLDERS' EQUITY

(a) Convertible preferred stock

In August 2004, the Company entered into a Securities Purchase Agreement with
Laurus, whereby the Company issued 250,000 shares of its Series C Convertible
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 "Stated Value"). The preferred
shares are convertible into shares of the Company's common stock at a rate of
$1.54 per share at any time after the date of issuance, and are entitled to
quarterly, cumulative dividends at a rate of 6.85% beginning on January 1, 2005.
For the year ended December 31, 2005 and 2004, approximately $170,000 and
$61,000 has been accrued for dividends earned in 2005 and 2004, respectively.
Approximately $175,000 of accrued dividends was satisfied by the issuance of the
Company's common stock during the year ended December 31, 2005. Dividends are
payable in cash or shares of the Company's common stock at the holder's option
with the exception that dividends must be paid in shares of the Company's common
stock for up to 25% of the aggregate dollar trading volume if the fair market
value of the Company's common stock for the 20-days preceding the conversion
date exceeds $1.85 per share. In January 2005, $60,967 was converted into
39,589 shares of the Company's common stock from previous dividend accruals. In
May 2005, $56,300 was converted into 36,559 shares of the Company's common stock
from dividends accrued from January through April 2005 and in September 2005,
$57,708 was converted into 37,473 shares of the Company's common stock from
dividends accrued from May through August 2005. The preferred shares are
redeemable by the Company 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 preferred stock
conversion exceeds the Stated Value. The preferred shares have a liquidation
preference equal to the Stated Value upon the Company's dissolution, liquidation
or winding-up. The preferred shares have no voting rights. As of December 31,
2005, 1,540 preferred shares had been converted into 10,000 shares of the
Company's common stock

In conjunction with the preferred stock, the Company issued a five-year common
stock purchase warrant to Laurus for the purchase of 487,000 shares of the
Company's common stock at an exercise price of $1.77 per share.

PAGE F-40

(b) Common stock

On October 31, 2005, the Company entered into a Securities Purchase Agreement
with Laurus Master Fund, Ltd. pursuant to which the Company issued and sold
2,032,520 shares of the Company's common stock to Laurus for an aggregate
purchase price of $2,500,000 or $1.23 per share. The price per share represents
80% of the 20-day volume weighted average price of the Company's common stock
through October 28, 2005. The Company also issued to Laurus a warrant to
purchase up to 450,000 shares at $1.93 per share. The warrant is exercisable
from October 31, 2005 until October 31, 2010. The Company also paid Laurus a fee
equal to $87,500 in connection with this financing.

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, 2004, all of
the warrants under the convertible debt program had been converted and the
Company received $237,500 in cash and expensed $773,802 in non-cash loan fees.

As of December 31, 2005, the Company had other warrants outstanding issued as
part of its private placement and other equity raising ventures as well as
services that allow the holders to purchase up to 1,755,750 shares of common
stock at prices between $0.435 and $2.79 per share. The warrants may be
exercised any time within three (3) and five (5) years of issuance.

(d) Stock options and employment agreements

In November 1997, the Company entered into an employment agreement with Mr.
James W. Benson, its chief executive officer. On July 16, 2000, the Company
amended the employment agreement with Mr. Benson extending the term until July
16, 2005. As part of the amendment to the original employment agreement, the
Company granted options to Mr. Benson to purchase up to 2,500,000 of non-plan,
non-registered shares of the Company's common stock. Options for 500,000 of
these shares were vested prior to the expiration of Mr. Benson's employment
agreement and those options remain outstanding, and the balance expired
unvested. The vested options have an exercise price of $1.00 and expire in
January 2010.

On December 20, 2005, the Company entered into employment agreements and
non-qualified stock option agreements with each of Mark N. Sirangelo, Richard B.
Slansky and James W. Benson. Each employment agreement has an initial term of
two years, and will be automatically renewed for a third year unless either
party provides written notice of its intent not to renew.

The employment agreement with Mr. Sirangelo sets forth the terms of his
employment with the Company as chief executive officer and vice chairman and
provides for, among other matters: a base salary, performance-based cash

PAGE F-41

bonuses based on the achievement of specific goals set forth in the agreement
and an option to purchase up to 1,900,000 shares of the Company's common stock.

The employment agreement with Mr. Slansky amends and restates the employment
agreement with Mr. Slansky dated February 10, 2003. This agreement sets forth
the terms of his continued employment with the Company as president and chief
financial officer and provides for, among other matters: a base salary,
performance-based cash bonuses based on the achievement of specific goals set
forth in the agreement and an option to purchase up to 1,400,000 shares of the
Company's common stock.

The employment agreement with Mr. Benson sets forth the terms of his employment
with the Company as chief technology officer and provides for, among other
matters: a base salary, performance-based cash bonuses based on the achievement
of specific goals set forth in the agreement and an option to purchase up to
950,000 shares of the Company's common stock. Mr. Benson also received an
additional option to purchase up to 150,000 shares of the Company's common stock
in connection with his services as chairman.

Under each of the above employment agreements, the executive is an "at-will"
employee, which means that either the Company or the executive may terminate
employment at any time. However, if the executive's employment with the Company
is terminated without cause (as that term is defined in the employment
agreements), that executive will be entitled to a severance payment equal to his
then-current base salary per month multiplied by the greater of (A) 12 months or
(B) the number of months remaining in the term. If the executive's employment
is terminated for good reason (as that term is defined in the employment
agreements), that executive will be entitled to a severance payment equal to his
then-current base salary per month multiplied by the lesser of (A) 12 months or
(B) the number of months remaining in the term, but in no event less than six
months.

The options granted to each executive are fully vested and exercisable on the
date of grant, have an exercise price of $1.40 per share, which was the closing
sale price reported on the OTCBB on the date of grant, and will expire five
years after the date of grant. Some of the shares subject to the options are
subject to sale restrictions that expire upon the achievement of certain
milestones or four years from the date of grant, whichever comes first. Subject
to certain limitations, these options may be exercised by means of a net
exercise provision by surrendering shares with a fair market value equal to the
exercise price upon exercise.

PAGE F-42

Weighted
Options Average
Outstanding Exercise Prices
---------------------------- ------------ -----------------
Balance at January 1, 2004 . 5,624,807 $ 1.39
Granted. . . . . . . . . . . 2,218,500 1.23
Exercised. . . . . . . . . . (1,005,035) (1.26)
Expired. . . . . . . . . . . (459,506) (1.04)
---------------------------- ------------ -----------------

Balance at December 31, 2004 6,378,766 1.39
Granted. . . . . . . . . . . 6,368,000 1.45
Exercised. . . . . . . . . . (237,000) (1.02)
Expired. . . . . . . . . . . (2,162,206) (2.19)
---------------------------- ------------ -----------------

Balance at December 31, 2005 10,347,560 $ 1.27
---------------------------- ------------ -----------------
---------------------------- ------------ -----------------

The weighted average fair value of options granted to employees under the 1999
Stock Option Plan and the 2004 Equity Incentive Plan during 2005 and 2004 was
$1.45 and $1.23, respectively. At December 31, 2005 and 2004, there were
10,347,560 and 1,900,460 options exercisable at a weighted average exercise
price of $1.27 and $0.83 per share, respectively. The weighted average
remaining life of outstanding options under the plans at December 31, 2005 was
4.25 years.

Weighted-Average Weighted-
Range of Remaining Contractual Average
Exercise Number of Shares Life of Shares Number of Shares Exercisable
Price Outstanding Outstanding Exercisable Price
------------ --------------------- ------------------------- ----------------- ------------
$ 0.42-0.99 2,206,413 2.96 2,206,413 $ 0.72
1.00-1.99 7,998,925 4.60 7,998,925 1.40
2.00-2.99 102,222 4.72 102,222 2.11
3.00-3.99 20,000 5.58 20,000 3.20
4.00-4.80 20,000 5.58 20,000 4.80
------------ --------------------- ------------------------- ----------------- ------------
10,347,560 4.25 10,347,560 $ 1.27
------------ --------------------- ------------------------- ----------------- ------------
------------ --------------------- ------------------------- ----------------- ------------

On December 20, 2005, in response to SFAS No. 123R, the Company's Board of
Directors approved accelerating the vesting of all unvested stock options held
by current employees, including executive officers, and members of the Board of
Directors. The accelerated vesting was effective as of December 20, 2005.

PAGE F-43

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,. . . . . . . . . 2005 2004
----------------------------- ---------- ----------
Computer equipment. . . . . . $ 155,499 $ 155,499
Less accumulated depreciation (153,974) (136,640)
----------------------------- ---------- ----------
$ 1,526 $ 18,859
---------- ----------
---------- ----------

Future minimum lease payments are as follows:

Year Ending December 31:
2006 $ 1,526
--------------------------------------- --------
Total minimum lease payments. . . . . . $ 1,526
--------------------------------------- --------
Amount representing interest. . . . . . 57
--------------------------------------- --------
Present value of minimum lease payments 1,469

Total obligation. . . . . . . . . . . . 1,469
Less current portion. . . . . . . . . . (1,469)
--------------------------------------- --------
Long-term portion . . . . . . . . . . . $ -
--------------------------------------- --------
--------------------------------------- --------

(b) Other accrued liabilities

During 2005 and 2004, the Company accrued expenses in connection with current
projects, its preferred stock sale, and other commitments. The total of these
accruals were $487,005 and $207,262 as of December 31, 2005 and 2004,
respectively and consisted of the following:

Other Accrued Liabilities - December 31, . . . . 2005 2004
--------------------------------------------------- -------- --------

Employee Bonus & Relocation Accrual. . . . . . . . $160,000 $108,583
Legal Expenses Accrued through 12-31-05. . . . . . 243,608 20,000
Property and Income Tax Accruals through 12-31-05. 26,452 17,711
Laurus - Dividend (Preferred Stock Series C) . . . 56,945 60,967
--------------------------------------------------- -------- --------
Total Other Accrued Liabilities. . . . . . . . . . $487,005 $207,261
--------------------------------------------------- -------- --------
--------------------------------------------------- -------- --------

PAGE F-44

In conjunction with the sale of its headquarters facility, 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 was $25,678 per month at
lease inception and is currently $27,507 as of December 31, 2005 and will
continue to increase by 3.5% per year. Total expense for 2005 and 2004 amounted
to approximately $325,000 and $319,000, respectively.

On April 14, 2005, the Company entered into a 16-month lease to expand its
fabrication and test facilities. The additional facility is also located in
Poway, California. It is approximately 11,000 square feet and is dedicated to
fabrication of the Company's hybrid rocket motors. The cost to the Company is
approximately $107,000 over the term of the lease.

Year Ending December 31,
2006 $ 451,276
2007 353,597
2008 365,973
2009 378,782
2010 392,039
Thereafter 825,722
---------------------------- ----------
Total minimum lease payments 2,767,388
Less current portion . . . . 451,276
---------------------------- ----------
Long-term portion. . . . . . $2,316,112
---------------------------- ----------

10. CONCENTRATIONS

(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 2005 and 2004, the Company had two major customers that accounted for
sales of approximately $8,133,000, or 90% and $3,737,000, or 76% of consolidated
net sales, respectively. At December 31, 2005 and 2004, the amount receivable
from these customers was approximately $967,400 and $612,900, respectively.

11. NOTE RECEIVABLE

On September 8, 2005, the Company made a secured loan in the principal amount of
$1.2 million to Starsys Research Corporation ("Starsys"), a design, engineering,
and manufacturing company located in Boulder, Colorado which provides mechanical
systems to the aerospace industry. The loan accrues interest at 8% per annum
and matured on January 31, 2006, as amended or earlier in certain circumstances.
No principal or interest payments are due before maturity. The loan is secured
by a security interest in all of the assets of Starsys, subject to an
intercreditor agreement with Vectra Bank Colorado, National Association. In

PAGE F-45

addition, Starsys agreed to pay the Company a placement agent fee and to
reimburse the Company expenses in the aggregate amount of $120,000. This amount
was deferred until the closing of the contemplated merger agreement with Starsys
(see Note 12) and added to the principal balance of the note evidencing the
loan.

In connection with making the loan, the Company entered into an exclusivity
agreement with Starsys which provides that Starsys will not discuss a material
sale of its assets, a material sale of its stock, a merger, or similar
transaction with any other party until October 31, 2005. Prior to completion of
the loan described above, the Company and Starsys entered into a non-binding
letter of intent concerning an acquisition. On October 26, 2005, the Company and
Starsys entered into a definitive merger agreement and on January 31, 2006 the
Company completed the Merger with Starsys, and cancelled and terminated the
secured note as well as all interest and fees related to the note. (See Note
12).

12. SUBSEQUENT EVENTS

On January 12, 2006, the Company entered into a Securities Purchase Agreement
with a limited number of institutional accredited investors, including Laurus
Master Fund, Ltd. On January 13, 2006, the Company issued and sold to these
investors 5,150 shares of our Series D-1 Amortizing Convertible Perpetual
Preferred Stock, par value $0.001 per share, for an aggregate purchase price of
$5,150,000, or $1,000 per share. The Company also issued various warrants to
these investors as described below. The Company paid cash fees and expenses of
$119,209 to a finder for the introduction of potential investors in this
financing, and paid $60,000 to the lead investor's counsel for legal expenses
incurred in the transaction.

Under the purchase agreement, from the date of the effectiveness of the initial
registration statement filed pursuant to the registration rights agreement
(February 15, 2006), until the one-year anniversary of that date, if (1) on any
trading day during such period the volume weighted average price of the
Company's common stock for each of the 20 trading days immediately prior to such
date exceeds $1.63 and (2) the average daily trading volume of the Company's
common stock exceeds $100,000 on each of those days, then the Company has the
option, subject to a number of additional conditions, to put to the investors
"units" at $1,000 per unit for an aggregate purchase price of up to $2,000,000
(or a lesser amount to the extent the preferred stock warrants issued at the
initial closing of the financing, which are described below, have been exercised
to purchase these units). Each "unit" consists of one share of Series D
Preferred Stock and a common stock warrant, which entitles the holders to
purchase up to an aggregate of 440,829 shares of common stock at an exercise
price of $1.51 and otherwise has the same terms as the warrants described in the
following paragraph.

Certain warrants the Company issued to the investors at the closing entitle the
investors to purchase up to an aggregate of 1,135,138 shares of the Company's
common stock at an exercise price of $1.51 per share. The warrants are
exercisable for five years following the date of grant. The warrants have
"ratchet" anti-dilution provisions reducing the warrant exercise price if the
Company issues equity securities (other than in specified exempt transactions)
at an effective price below the warrant exercise price to such lower exercise
price.

The Company also issued certain other warrants to the investors at the closing
(the "preferred stock warrants"). These warrants entitle the holder to purchase
an aggregate number of 2,000 "units", which are identical to the "units"
described above, at an exercise price of $1,000 per unit. The preferred stock
warrants are exercisable from the effective date (February 15, 2006) until the
one-year anniversary of that date. If any units subject to the preferred stock
warrants remain unsold after (1) their expiration date and (2) the exercise of

PAGE F-46

the Company's put option, if applicable, and any holder of a preferred stock
warrant issued in the financing has exercised the warrant in full, then the
preferred stock warrant grants that holder the right to purchase a proportionate
share of the unsold units.

Other Provisions.

The purchase agreement contains a number of covenants by the Company, which
include:

- A grant of preemptive rights to the investors to participate in future
financings until the first anniversary of the closing date of the
financing;

In connection with this financing, Laurus consented to and waived certain
contractual rights in respect of the authorization and issuance of one or more
series of Series D-1 Preferred Stock and the other transactions described below,
and certain other transactions. The Company paid Laurus Capital Management,
L.L.C., the manager of Laurus, $87,000 in connection with Laurus's delivery of
the consent and $1,000 to Laurus's counsel for their related fees.

Acquisition of Starsys

On January 31, 2006, the Company completed the acquisition of Starsys Research
Corporation pursuant to a merger agreement with Starsys Research Corporation,
Scott Tibbitts, its largest shareholder, and Scott Tibbitts, as shareholder
agent for the other shareholders of Starsys. The merger agreement was dated
October 24, 2005 and amended on December 7, 2005 and January 31, 2006.

Starsys shareholders received approximately $411,000 in cash and 3.8 million
shares of the Company's common stock at the consummation of the merger. The
Company also paid approximately $705,000 in Starsys transaction expenses
connected to the merger, and reclassified from Other Assets to Investment in
Subsidiaries approximately $500,000 in certain legal and accounting expenses
incurred during the merger.

Following the merger, the pre-merger Starsys shareholders may also be entitled
to receive additional performance consideration, based on the achievement by the
Starsys business of specific financial performance criteria for fiscal years
2005, 2006 and 2007. This consideration could consist of up to an aggregate of
$1,050,000 in cash and shares of the Company's common stock valued at up to $18
million, subject to reduction for some merger related expenses and to escrow
arrangements, as follows:

For the fiscal year ended December 31, 2005, up to $350,000 in cash and up to
an aggregate number of shares of the Company's common stock equal to (A) up
to $3.0 million divided by (B) the volume weighted average price of the

PAGE F-47

Company's common stock for the 20 trading days preceding the date of the
audit opinion for Starsys' fiscal year ended December 31, 2005, but not
less than $2.00 per share;

For the fiscal year ended December 31, 2006, up to $350,000 in cash and up to
an aggregate number of shares of the Company's common stock equal to (A) up
to $7.5 million divided by (B) the volume weighted average price of the
Company's common stock for the 20 trading days preceding the date of the
audit opinion for Starsys' fiscal year ended December 31, 2006, but not
less than $2.50 per share; and

For the fiscal year ended December 31, 2007, up to $350,000 in cash and up to
an aggregate number of shares of the Company's common stock equal to (A) up
to $7.5 million divided by (B) the volume weighted average price of the
Company's common stock for the 20 trading days preceding the date of the
audit opinion for Starsys' fiscal year ended December 31, 2007, but not
less than $3.00 per share.

Starsys shareholders will be entitled to receive the maximum amount of
performance consideration for a particular fiscal year if the Company breaches
specified covenants of the merger agreement and is unable to cure the breach
within applicable the cure period set forth in the merger agreement.

Approximately one-half of the shares issued to Starsys shareholders at the
closing have been placed in escrow to satisfy any indemnification obligations of
Starsys shareholders under the merger agreement and to pay reasonable expenses
of the shareholder agent. In addition, approximately one-half of the shares (if
any) to be issued for the first performance period will similarly be placed in
escrow. The indemnification escrow will generally last until ten days following
the date of audited financial statements prepared for the Starsys business for
the fiscal year ending December 31, 2006 (approximately April 2007). In
addition, 1% of any shares of SpaceDev common stock payable as performance
consideration will be paid as transaction expenses to Robert Vacek, who became
our president, Starsys division, after the merger and who was the president of
Starsys prior to the merger.

Working Capital Contribution.

Under the merger agreement, the Company was obligated to contribute $2.5 million
to the working capital of the Starsys business through the end of 2006.
Approximately $2.25 million has already been contributed, from SpaceDev to
Starsys, Inc., after the merger on January 31, 2006.

Reservation of Options.

Under the merger agreement, the Company has agreed to reserve for issuance to
Starsys officers, employees and consultants options to buy a number of shares of
the Company's common stock equal to at least 15% of the number of shares of its
common stock issued at the closing of the merger, or approximately 570,000
shares, or as performance consideration. At the special meeting of our
stockholders held on January 30, 2006, the Company sought and obtained approval
from its stockholders to increase the amount of shares of common stock available
for awards under the Company's 2004 Equity Incentive Plan by 3,000,000 shares to
provide sufficient reserves for the issuance of the options referenced above.

Termination of Loans

On March 30, 2005, Starsys entered into a secured credit facility with Vectra
Bank Colorado. The facility included a $4.25 million line of credit, which
accrued interest at a prime rate plus 0.5% and matured March 30, 2006, a $2.1

PAGE F-48

million term note A which accrued interest at 7.25% and matured April 1, 2010,
and a $1.25 million term note B which accrued interest at LIBOR plus 5% and
matured March 30, 2006. On June 24, 2005, Starsys entered into a forbearance
agreement for various financial covenant and other violations under its existing
loans with Vectra, which provided for default interest rates of prime rate plus
3.5% on the line of credit, 10.25% on the term note A and LIBOR plus 8% on the
term note B. The forbearance agreement also required Starsys to raise the
necessary capital to bring Starsys in compliance with its borrowing base and
other financial covenants and to provide progress payments toward repayment of
the outstanding loans via cash equity infusions. The forbearance agreement also
accelerated and amended the maturity date of the term note B from March 30, 2006
to the earlier of the required cash equity amounts received or January 31, 2006.

On July 26, 2005, Starsys raised $800,000 from its current shareholders to make
the first progress payment under the Vectra forbearance agreement. The
shareholder loans had a 10% premium, which was capitalized to principal, and
accrued interest at 15% per annum. These loans would have matured on March 31,
2006.

On September 8, 2005, the Company entered into a secured bridge loan facility
with Starsys under which the Company loaned Starsys $1.2 million for the purpose
of Starsys making the second progress payment under the Vectra forbearance
agreement. The bridge loan accrued interest at 8% per annum and was originally
set to mature on December 31, 2005, or earlier in certain circumstances. On
December 20, 2005, the Company agreed to extend the final maturity date of the
bridge loan until January 31, 2006. No principal or interest payments were due
before maturity.

In connection with the consummation of the merger with Starsys on January 31,
2006, pursuant to which, Starsys became a wholly-owned subsidiary of the
Company:

The Company paid off in full the remaining principal and interest of all loans
extended to Starsys by Vectra pursuant to the credit facility and forbearance
agreement, together with all other costs incurred in connection with those
loans, which aggregated approximately $3.7 million. The credit facility and
associated security agreements with Vectra were terminated upon receipt of the
payment;

The Company cancelled and terminated its $1.2 million secured bridge loan to
Starsys, together with accrued interest, in accordance with the terms of the
merger agreement; and,

The Company paid off in full the remaining principal and interest of all
subordinated loans extended to Starsys by four of its shareholders, which
aggregated approximately $944,000.

Shareholder Agent

At the closing of the merger, on behalf of the pre-merger Starsys shareholders,
the Company transferred 69,754 shares of common stock from the escrow account to
a separate escrow account. The escrow agent will maintain the expense fund
solely for the purpose of paying the out-of-pocket fees and expenses, including
independent accounting firm fees and attorneys' fees, reasonably incurred by the
shareholder agent in connection with performing and exercising his duties under
the merger agreement and escrow agreement. The shares held in the expense fund
may not be sold or otherwise transferred until October 28, 2006. The expense
fund will be terminated after the escrow period has lapsed and the final
determination of the performance consideration (if any) for the final
performance period. Upon termination any remaining assets will be transferred
to the escrow account for release and distribution in accordance with its terms.

PAGE F-49

Entry into Non-Competition Agreement.

In connection with the consummation of the merger, the Company also entered into
a non-competition agreement with Scott Tibbitts, pursuant to which Mr. Tibbitts
has covenanted for a period of three years not to be employed by or have any
interest in an entity that engages in a similar business to Starsys related to
the aerospace industry, not to solicit any business from any past or present
customer of the Company, not to solicit or encourage any of the Company's
employees to leave or to reduce his or her employment, not to encourage a
consultant under contract with us to cease or diminish his or her work with us,
not to use our intellectual property other than for our benefit, and not to make
any negative or disparaging statements regarding the Company to any third party.
We have agreed to pay Mr. Tibbitts $100,000 annually if he abides by these
covenants. In the event Mr. Tibbitts breaches his covenants, the agreement
provides that he will no longer be entitled to his annual payments and, if the
breach was willful and material, the Company will not be required to pay Mr.
Tibbitts any further consideration under the merger agreement.

Entry into Standstill and Lock-up Agreements

In connection with the consummation of the merger, the Company entered into
standstill and lock-up agreements with 16 re-merger stockholders of Starsys,
including Messrs. Tibbitts and Vacek, each of whom individually may have been
entitled to receive more than 50,000 aggregate shares at the closing of the
merger and as performance consideration for the first performance period
pursuant to the merger. The standstill and lock-up agreement prevents the
locked-up shareholders from selling or otherwise transferring the shares of the
Company's common stock received at the closing of the merger, or to transfer an
economic interest in these shares, for a period of 270 days after the closing,
except for some exempt transactions. In addition, for a period of three years
after the closing, the standstill and lock-up agreements restrict the locked-up
shareholders from attempting to obtain control of the company, including by
prohibiting those shareholders from soliciting other shareholders and from
acquiring beneficial ownership of any shares of the Company's common stock if,
after the acquisition, the shareholder would beneficially own more than 5% of
the outstanding shares of the Company's common stock.

Amendment of 2004 Equity Incentive Plan.

In November 2005, the Company's Board of Directors approved Amendment No. 2 to
the 2004 Equity Incentive Plan, subject to stockholder approval. On January 30,
2006, at the special meeting of stockholders described herein, the Company's
stockholders approved the plan amendment. The plan amendment increased by
3,000,000 shares the number of authorized shares under the plan; added per
person annual share grant limits; and, clarified the limitation on the number of
shares which may be issued per participant as incentive stock options.

Entry into Executive Employment Agreements

In connection with the merger agreement, the Company entered into employment
agreements with Scott Tibbitts and Robert Vacek, former executives of Starsys
Research Corporation.

The employment agreement with Mr. Tibbitts sets forth the terms of his
employment with the Company as the Company's managing director and provides for,
among other matters: (1) an initial term of three years, with the option to

PAGE F-50

renew the agreement for additional one-year terms; (2) a base salary of $12,500
per month; and, (3) performance-based cash bonuses up to 50% of his base salary
per year, based on the achievement of specific goals set forth in the agreement.

The employment agreement with Mr. Vacek sets forth the terms of his employment
with the Company as president of Starsys, Inc., a subsidiary of SpaceDev, Inc.,
and provides for, among other matters: (1) an initial term of two years, with
automatic renewal for a third year unless either party provides written notice
of its intent not to renew; (2) a base salary of $17,000 per month, subject to
adjustment to $18,000 per month after eight months and $19,000 per month after
sixteen months; (3) performance-based cash bonuses up to $75,000 for fiscal year
2006 and $50,000 for fiscal year 2007 based on the achievement of specific goals
set forth in the agreement; and, (4) an option to purchase up to 825,000 shares
of the Company's common stock, the vesting of which is based on the achievement
of specific goals in the agreement and under the terms and conditions of the
Company's form of stock option agreement under the 2004 Equity Incentive Plan
between us and Mr. Vacek. The vesting of the option will accelerate in full
upon the occurrence of a change in control of the company.

Under each employment agreement, the executive is an "at-will" employee, which
means that either the Company or the executive may terminate employment at any
time. However, if the executive's employment with the Company is terminated
without cause (as that term is defined in the employment agreements), that
executive will be entitled to a severance payment equal to his then-current base
salary per month multiplied by, in the case of Mr. Tibbitts, the number of
months remaining in the term, and in the case of Mr. Vacek, the greater of (A)
12 months or (B) the number of months remaining in the term. If the executive
terminates his employment with the Company for good reason (as that term is
defined in the employment agreements), that executive will be entitled to a
severance payment equal to his then-current base salary per month multiplied by
the lesser of (A) 12 months or (B) the number of months remaining in the term,
but in no event less than six months. If the Company opts not to renew the
employment agreement with Mr. Vacek, he will be entitled to a severance payment
equal to his then-current base salary per month multiplied by six months.

Election of New Director.

The Company's board of directors appointed Scott Tibbitts as a director,
commencing February 1, 2006, pursuant to the terms of the merger agreement. Mr.
Tibbitts was also appointed as managing director of the Company, an executive
officer position, commencing on January 31, 2006.

Prior to the merger, Mr. Tibbitts was a guarantor of Starsys' obligations under
a forbearance agreement between Starsys and Vectra Bank of Colorado, Starsys'
primary lender, dated June 24, 2005. Pursuant to the merger agreement, the
Company paid approximately $3.7 million to satisfy in full Starsys' obligations
to Vectra under the forbearance agreement at the closing of the merger.

Jack Tibbitts, Steve Tibbitts, and Ted Tibbitts, relatives of Scott Tibbitts,
each loaned $100,000 to Starsys pursuant to subordinated notes issued by
Starsys. Each of these loans had a loan premium of $10,000 and bore interest at
15% per annum. Pursuant to the merger agreement, the Company paid $354,000 to
satisfy in full Starsys' obligations under these loans at the closing of the
merger.

Appointment of President, Starsys Division.

On January 31, 2006, Robert Vacek was appointed as president of the Company's,
Starsys Inc. subsidiary, pursuant to the terms of his employment agreement
described above.

PAGE F-51

Pursuant to his employment agreement with Starsys entered into prior to the
merger on June 10, 2005, Mr. Vacek was entitled to a bonus in connection with
the merger agreement. The amount of the bonus equaled 1% of the total
consideration for the merger. Pursuant to that employment agreement and the
merger agreement, the Company paid Mr. Vacek approximately $65,000 in cash and
38,000 shares of the Company's common stock, valued at approximately $56,000, at
the closing (half of which stock is subject to the escrow provisions described
above), and will pay him 1% of the performance consideration, if any, to be paid
in cash and stock to Starsys shareholders for fiscal years 2005, 2006 and 2007.

Increase in Authorized Shares

On February 1, 2006, the Company amended its articles of incorporation to
increase the authorized number of shares of common stock from 50,000,000 to
100,000,000.

Increase in Board Size.

Effective January 30, 2006, the Company's board of directors increased the
number of authorized directors from 10 to 11, and appointed Mr. Tibbitts to fill
the vacancy created by the new board seat.

PAGE F-52

INDEPENDENT AUDITORS' REPORT

Board of Directors and Stockholders
Starsys Research Corporation
Boulder , Colorado

We have audited the accompanying balance sheet of Starsys Research Corporation
(the "Company") as of December 31, 2005 and the related statements of
operations, stockholders' deficit, and cash flows for the year then ended. These
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 have conducted our audit in accordance with the 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 financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Starsys Research Corporation as
of December 31, 2005, and the results of its operations and cash flows for the
year then ended, in conformity with accounting principles generally accepted in
the United States of America.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
since fiscal 2004, has limited operating revenue and limited capital resources.
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. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.

March 3, 2006 /s/PKF
San Diego California Certified Public Accountants
A Professional Corporation

PAGE F-53

Clifton Gunderson LLP
Certified Public Accountants and Consultants

INDEPENDENT AUDITOR'S REPORT

Board of Directors
Starsys Research Corporation
Boulder, Colorado

We have audited the accompanying balance sheet of Starsys Research Corporation
as of December 31, 2004 and the related statements of operations, stockholders'
equity (deficit), and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these 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 financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Starsys Research Corporation as
of December 31, 2004 and the results of its operations and its cash flows for
the year then ended in conformity with accounting principles generally accepted
in the United States of America.

The accompanying 2004 financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 1 to the 2004
financial statements, the Company has suffered loss from operations and has a
net capital deficiency that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.

/s/ Clifton Gunderson LLP
Denver, Colorado
July 31, 2005, except for the first sentence of Note 14 as to which the date is
August 23, 2005.

PAGE F-54

STARSYS RESEARCH CORPORATION
BALANCE SHEETS
YEARS ENDED DECEMBER 31, 2005 AND 2004

2005 2004
------------ ------------
ASSETS

CURRENT ASSETS
Cash. . . . . . . . . . . . . . . . . . . $ 831,888 $ 14,139
Contracts receivable, net . . . . . . . . 2,734,018 3,639,966
Accounts receivable - employees and other 640 39,894
Current portion of notes receivable . . . - 52,768
Income taxes receivable . . . . . . . . . 16,478 317,014
Costs and estimated earnings in excess of
billings on uncompleted contracts . . . . 2,160,684 3,091,636
Inventory . . . . . . . . . . . . . . . . 243,247 277,725
Prepaid expenses. . . . . . . . . . . . . 142,022 46,738
Deferred expenses . . . . . . . . . . . . 153,271 -
Deferred income tax . . . . . . . . . . . - 231,167
Other current assets. . . . . . . . . . . 37,818 -
------------ ------------
TOTAL CURRENT ASSETS. . . . . . . . . . . . 6,320,066 7,711,047

PROPERTY AND EQUIPMENT, NET
Vehicles. . . . . . . . . . . . . . . . . 74,975 74,975
Facility equipment. . . . . . . . . . . . 2,074,778 1,045,104
Laboratory equipment. . . . . . . . . . . 487,819 351,898
Office equipment and furniture. . . . . . 312,774 312,774
Computer equipment. . . . . . . . . . . . 766,336 705,735
Leasehold improvements. . . . . . . . . . 36,041 36,041
Equipment under capital leases. . . . . . 99,037 1,059,464
------------ ------------
Total at cost . . . . . . . . . . . . . . 3,851,760 3,585,991
Less accumulated depreciation . . . . . . (1,902,599) (1,473,530)
------------ ------------
Total property and equipment. . . . . . . 1,949,161 2,112,461

OTHER ASSETS
Notes receivable, net of current portion. - 38,000
Deposits. . . . . . . . . . . . . . . . . 32,972 26,469
------------ ------------
TOTAL OTHER ASSETS. . . . . . . . . . . . . 32,972 64,469
------------ ------------

TOTAL ASSETS. . . . . . . . . . . . . . . . $ 8,302,199 $ 9,887,977
============ ============

PAGE F-55

STARSYS RESEARCH CORPORATION
BALANCE SHEETS
YEARS ENDED DECEMBER 31, 2005 AND 2004

2005 2004
------------ ------------
LIABILITIES AND STOCKHOLDERS' DEFICIT

CURRENT LIABILITIES
Accounts payable and accrued expenses. . . . . . . . . . $ 1,609,882 $ 1,334,007
Current portion of notes payable . . . . . . . . . . . . 6,213,183 3,933,343
Current portion of capitalized lease obligations . . . . 25,593 322,406
Current portion of accrued bonuses . . . . . . . . . . . - 56,695
Billings in excess of costs and estimated
earnings on uncompleted contracts. . . . . . . . . . . . 1,702,453 2,094,899
Accrued wages and benefits . . . . . . . . . . . . . . . 1,002,270 772,342
Other accrued expenses . . . . . . . . . . . . . . . . . 1,664,826 382,776
Reserve for loss on contracts in progress. . . . . . . . 1,575,077 2,681,912
Income taxes payable . . . . . . . . . . . . . . . . . . - 31,643
------------ ------------
TOTAL CURRENT LIABILITIES. . . . . . . . . . . . . . . . . 13,793,284 11,610,023
------------ ------------

NOTES PAYABLE, LESS CURRENT MATURITIES . . . . . . . . . . - 8,300

CAPITALIZED LEASE OBLIGATIONS, LESS CURRENT MATURITIES . . - 169,574

DEFERRED INCOME TAXES. . . . . . . . . . . . . . . . . . . - 231,167
Total long-term liabilities. . . . . . . . . . . . . . . - 409,041
------------ ------------
TOTAL LIABILITIES. . . . . . . . . . . . . . . . . . . . . 13,793,284 12,019,064
------------ ------------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' DEFICIT
Common stock, $.001 par value; 25,000,000
shares authorized, and 522,437 and 520,448 shares
issued and outstanding for 2005 and 2004, respectively 522 520
Additional paid-in capital . . . . . . . . . . . . . . . 69,387 51,886
Accumulated deficit. . . . . . . . . . . . . . . . . . . (5,560,994) (2,183,493)
------------ ------------
TOTAL STOCKHOLDERS' DEFICIT. . . . . . . . . . . . . . . . (5,491,085) (2,131,087)
------------ ------------

TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT. . . . . . . . $ 8,302,199 $ 9,887,977
============ ============

PAGE F-56

STARSYS RESEARCH CORPORATION
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005 AND 2004

2005 2004
------------ ------------

REVENUES. . . . . . . . . . . $17,762,730 $18,085,414
COST OF REVENUES. . . . . . . 14,721,177 19,138,106
------------ ------------

GROSS MARGIN (LOSS) . . . . . 3,041,553 (1,052,692)
------------ ------------

OPERATING EXPENSES
General and administrative. 6,000,676 3,901,198
Goodwill impairment loss. . - 153,254
------------ ------------

TOTAL OPERATING EXPENSES. . . 6,000,676 4,054,452
------------ ------------

LOSS FROM OPERATIONS. . . . . (2,959,123) (5,107,144)
------------ ------------

OTHER INCOME (EXPENSE)
Other income. . . . . . . . 88,147 7,800
Interest and other income . (14) 7,493
Interest expense. . . . . . (506,511) (306,693)
------------ ------------

TOTAL OTHER EXPENSE . . . . . (418,378) (291,400)
------------ ------------

LOSS BEFORE INCOME TAXES. . . (3,377,501) (5,398,544)
Income tax provision. . . . . - (193,317)
------------ ------------

NET LOSS. . . . . . . . . . . $(3,377,501) $(5,591,861)
============ ============

PAGE F-57

STARSYS RESEARCH CORPORATION
STATEMENTS OF STOCKHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 2005 AND 2004

COMMON STOCK ADDITIONAL
---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------------ -------- ------------ ------------ ------------

BALANCE AT DECEMBER 31, 2003 521,127 $ 521 $ 68,485 $ 3,408,368 $ 3,477,374

Stock Repurchase (680) (1) (16,599) (16,600)

Net loss . . . . . . . . . - - - (5,591,861) (5,591,861)
------------ -------- ------------ ------------ ------------

BALANCE AT DECEMBER 31, 2004 520,447 520 51,886 (2,183,493) (2,131,087)

Common stock issued. . . . 1,989 2 17,501 - 17,503

Net loss . . . . . . . . - - - (3,377,501) (3,377,501)
------------ -------- ------------ ------------ ------------

BALANCE AT DECEMBER 31, 2005 522,437 $ 522 $ 69,387 $(5,560,994) $(5,491,085)
============ ======== ============ ============ ============

PAGE F-58

STARSYS RESEARCH CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005 AND 2004

2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . $(3,377,501) $(5,591,861)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization. . . . . . . . . . . . . . 429,069 390,682
Amortization of loan premium . . . . . . . . . . . . . . 80,000 -
Goodwill impairment loss . . . . . . . . . . . . . . . . - 153,254
Deferred income taxes. . . . . . . . . . . . . . . . . . (33,271) 510,332
Effects of changes in operating assets and liabilities:
Contracts receivable . . . . . . . . . . . . . . . . . 905,949 1,356,193
Accounts receivable - employees and other. . . . . . . 39,254 (27,110)
Income taxes receivable. . . . . . . . . . . . . . . . 300,536 (317,014)
Costs and estimated earnings in excess of billings
on uncompleted contracts . . . . . . . . . . . . . . 930,952 1,916,551
Inventory. . . . . . . . . . . . . . . . . . . . . . . 34,478 (69,291)
Prepaid expenses . . . . . . . . . . . . . . . . . . . (95,284) 45,034
Other current assets . . . . . . . . . . . . . . . . . (37,818) -
Deposits . . . . . . . . . . . . . . . . . . . . . . . (6,503) (4,500)
Accounts payable . . . . . . . . . . . . . . . . . . . 275,875 (181,892)
Accrued bonuses. . . . . . . . . . . . . . . . . . . . (56,695) (18,897)
Accrued wages and benefits . . . . . . . . . . . . . . 229,928 280,677
Billings in excess of costs and estimated earnings
on uncompleted contracts . . . . . . . . . . . . . . (392,446) 977,557
Other accrued expenses . . . . . . . . . . . . . . . . 1,336,049 137,165
Reserve for loss on contracts in progress. . . . . . . (1,106,835) 2,510,913
Income taxes payable . . . . . . . . . . . . . . . . . (31,643) (181,286)
------------ ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES. . . . . (575,906) 1,886,507

CASH FLOWS FROM INVESTING ACTIVITIES
Payments received on notes receivable . . . . . . . . . . 90,768 7,225
Disbursements for notes receivable. . . . . . . . . . . . - (38,000)
Purchases of property and equipment . . . . . . . . . . . (265,769) (1,136,428)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES. . . . . . . . . . . . (175,001) (1,167,203)

PAGE F-59

2005 2004
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on capitalized lease obligations. . . . (466,387) (287,946)
Proceeds from revolving credit facility. . . . . . . . . . -
Payments to revolving credit facility. . . . . . . . . . . -
Borrowing on notes payable . . . . . . . . . . . . . . . . 6,285,152 7,195,282
Paydown on notes Payable . . . . . . . . . . . . . . . . . (3,294,151) (7,506,661)
Proceeds form revolving credit facility
Payments to revolving credit facility. . . . . . . . . . . (1,773,461) -
Proceeds on notes payable - stockholder. . . . . . . . . . 800,000 -
Increase (decrease) in bank overdraft. . . . . . . . . . . - (106,552)
Additional Paid in Capital . . . . . . . . . . . . . . . . 17,503 -
------------ ------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES. . . . . 1,568,656 (705,877)

Net increase in cash . . . . . . . . . . . . . . . . . . . . 817,749 13,427

CASH AT BEGINNING OF PERIOD. . . . . . . . . . . . . . . . . 14,139 712
------------ ------------

CASH AT END OF PERIOD. . . . . . . . . . . . . . . . . . . . $ 831,888 $ 14,139
============ ============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFROMATION:
Cash paid during the period for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . $ 657,999 $ 270,801
Income taxes . . . . . . . . . . . . . . . . . . . . . . $ - $ 181,286

NON-CASH INVESTING AND FINANCING ACTIVITIES:
Agency fee on SpaceDev loan. . . . . . . . . . . . . . . . $ 120,000 $ -
Loan premium on notes payable-stockholders . . . . . . . . $ 80,000 $ -
Common stock repurchase with a note payable. . . . . . . . $ - $ 16,600
Equipment acquired with capital lease obligations. . . . . $ - $ 277,814

PAGE F-60

STARSYS RESEARCH CORPORATION
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DECEMBER 31, 2005 AND 2004

Starsys Research Corporation (the "Company") was incorporated in the State of
Colorado on April 6, 1988. The Company specializes in contract production of
spacecraft mechanisms, actuators and structures for commercial and government
customers. The Company grants credit to its customers, which are located both in
the United States and Internationally. Significant accounting policies followed
by the Company are presented below.

USE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Significant estimates included
in these financial statements relate to revenue recognition on uncompleted
contracts, billings in excess of costs and estimated earnings and costs on
uncompleted contracts and estimated earnings in excess of billings on
uncompleted contracts (see Note 3). Revisions in estimated contract profits and
losses are made in the period in which circumstances requiring the revision
become known. The effect of changes in estimates of contract profits and losses
on contracts in process at December 31, 2004 was an increase to net loss for the
twelve months ended December 31, 2005, by approximately $2,168,485. Had these
changes in estimate been known, they would have been used as the basis of
recognition of contract profits and losses in the preceding period. The amount
of this change includes effects of changes in estimates, change orders, and
reasonably assured change orders subsequent to December 31, 2005.

CASH AND CASH EQUIVALENTS

The Company maintains its cash in multiple bank accounts which are insured by
the Federal Insurance Deposit Corporation (FDIC). At times, balances may exceed
federally insured limits. The Company has not experienced any losses in such
accounts and management believes it places its cash on deposit with financial
institutions which are financially stable.

ACCOUNTS RECEIVABLE

Accounts receivable are uncollateralized customer obligations which generally
require payment within thirty days from the invoice date. Accounts receivable
are stated at the invoice amount. Notes receivable are stated at principal plus
accrued interest.

Account balances with invoices over ninety days old are considered delinquent.
Payments of accounts receivable are applied to the specific invoices identified
on the customer's remittance advice or, if

PAGE F-61

ACCOUNTS RECEIVABLE (CONTINUED)

unspecified, to the earliest unpaid invoices. Payments of notes receivable are
allocated first to unpaid interest with the remainder to the outstanding
principal balance.

The carrying amount of accounts receivable is reduced by a valuation allowance
if necessary that reflects management's best estimate of amounts that will not
be collected. As of December 31, 2005, management has recorded an allowance of
$17,500 for future estimates of uncollectible accounts. At December 31, 2004,
no allowance was necessary as all accounts were considered collectible by
management. If there is a deterioration of a major customer's credit worthiness
or actual defaults are higher than the historical experience, management's
estimates of the recoverability of amounts due the Company could be affected.

REVENUE AND COST RECOGNITION

The accompanying financial statements are prepared according to the
"percentage-of-completion" method of accounting for long-term contracts. The
amount of revenues recognized is that portion of the total contract amount that
the actual cost expended bears to the anticipated final total cost based on
current estimates of cost to complete the project (cost-to-cost method).

If final total cost is anticipated to exceed the contract amount, the excess of
cost over contract amount is immediately recognized as a loss on the contract.
Recognition of profit commences on an individual project only when cost to
complete the project can reasonably be estimated and after there has been some
meaningful performance achieved on the project. Changes in job performance, job
conditions, and estimated profitability, including those arising from contract
penalty provisions (when applicable), and final contract settlements may result
in revisions to costs and income and are recognized in the period in which the
revisions are determined.

Contract costs include all direct material, direct labor and sub-contractor
costs, other costs such as supplies, tools and travel which are specifically
related to a particular contract. All other selling, general and administrative
costs are expensed as incurred.

The current asset reflected on the balance sheet as "Costs and estimated
earnings in excess of billings on uncompleted contracts" represents revenues
recognized in excess of amounts billed.
The current liability reflected on the balance sheet as "Billings in excess of
costs and estimated earnings on uncompleted contracts," represents billings in
excess of revenues recognized.

INVENTORIES

Inventories consist of supplies or other finished products not yet charged to a
contract and are stated at the lower-of-cost or market with cost determined
using an average-cost method.

PAGE F-62

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation and amortization, which
include amortization of property under capital leases, are provided by use of
the straight-line methods over the estimated useful lives of the related assets.
Accelerated depreciation methods are used for income tax reporting purposes.
Total depreciation expense for the years ended December 31, 2005 and 2004 was
$429,069 and $390,682, respectively.

For the year ended December 31, 2005, and in conjunction of the pay down of the
capital leases (see Notes 5 and 6), the Company reclassified certain assets from
equipment under capital leases to facility equipment. The Company will also
depreciate the remaining net book value of these assets over their useful lives
ranging between 3 and 7 years, and in conjunction with its internal policies.

DEFERRED EXPENSES

For the year ended December 31, 2005, the Company borrowed funds from four of
its stockholders and SpaceDev, Inc. lent the Company certain monies for the
Company to meet its lending requirements (see Note 5). In conjunction with these
borrowings, the Company agreed to pay an $80,000 premium and a $120,000 agency
fee, respectively. The Company is amortizing the costs associated with the loan
premium over the expected term of the loan agreement. As of December 31, 2005,
the Company has recognized interest expense of $80,000 in connection with the
amortization of the loan premium, and $54,000 in connection with the
stockholders' loans. As of December 31, 2005, the Company has deferred the
$120,000 agency fee and interest on its loan from SpaceDev, Inc. ("SpaceDev") of
$153,271.

PRODUCT WARRANTY

The Company warrants its products against defects in workmanship. The Company
accrued $72,123 for warranty claims at December 31, 2005, and 2004. The accrual
is based on an estimate of the cost to be incurred based on the claims received
and historical experience (see Note 10).

INCOME TAXES

Deferred income taxes are provided for temporary differences in the recognition
of depreciation expense for financial reporting and income tax reporting
purposes, tax credit carryforwards and for reserves for contract losses.

PAGE F-63

STOCK OPTION PLAN

The Company has a stock-based employee compensation plan which is described more
fully in Note 7. The Company accounts for this plan under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and Related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under this plan had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income if the
Company had applied the fair value recognition provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation for the years ended December 31, 2005 and 2004, respectively:

2005 2004
------------ ------------

Net loss - as reported . . . . . . $(3,377,501) $(5,591,861)
Deduct: total stock-based employee
compensation expense
determined under fair value
based method for all awards. . . (4,000) (4,302)
------------ ------------

ESTIMATED NET LOSS - PRO FORMA . . $(3,381,501) $(5,596,163)
============ ============

In December 2004, The Financial Accounting Standards Board (FASB) issued
Statement on Financial Accounting Standards No. 123 (Revised), "Shared-Based
Payment" (SFAS 123R). This standard revises SFAS No. 123, Accounting Principles
Board Option 25 and related interpretations, and eliminates use of the intrinsic
value method of accounting for stock options. The Company currently uses the
intrinsic value method to value stock options, and, accordingly, no compensation
expense has been recognized for stock options. SFAS 123R requires that all
employee share-based payments to employees, including stock options, be valued
using a fair-value-based method and recorded as expense in the statement of
operations. For the Company, SFAS 123R will first be effective for its December
31, 2006 financial statements. This new Statement will not affect accounting
for the Company's stock options currently outstanding, but it will affect
financial statement disclosures about those stock options, and it will change
the accounting for stock options issued in future years.

PAGE F-64

STARSYS RESEARCH CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004

NOTE 1 - FUTURE OPERATIONS OF THE COMPANY

The Company incurred a net loss of $3,377,501, and $5,591,861, and has an
accumulated deficit of $5,491,085, and $2,131,087 for the years ended December
31, 2005 and 2004, respectively. The Company also has negative working capital
at December 31, 2005 of $7,473,218. The Company is also in default of certain
covenants with its current lender. Management of the Company intends to fund
2006 operations primarily through revenues generated by product sales and
additional debt and additional equity investment (see Note 5). The Company's
future operations are dependent upon the profitability of the Company's
contracts and related revenues generated and its efforts to raise additional
capital. If the Company does not achieve expected revenue levels or receive
sufficient additional funding to meet its requirements with its lender, the
Company's lender is entitled to appoint a receiver to protect the lender's
collateral including the right to operate the Company's business (see Note 5).

On August 23, 2005, the Company entered into an offer to sell the shares of the
Company's stock (the "Merger Agreement") to SpaceDev, a publicly traded company.
The Merger Agreement closed on January 31, 2006. The Merger Agreement provides
for consideration to be paid at closing comprised of a cash payment of up to
$1,500,000 and shares of SpaceDev having an aggregate market value of
$7,500,000, adjustable based on the Company's working capital, as defined.
SpaceDev will also repay the remaining principal and interest of the Company's
credit facility with the bank and any subordinated debt. SpaceDev also provided
the Company with a bridge loan in the amount $1,200,000 prior to closing to
comply with the bank's requirements under the Agreement. (See Note 5)

The Merger Agreement also provides for additional consideration to be paid to
the stockholders of the Company based upon results of the audited financial
statements for the years ending December 31, 2005, 2006 and 2007.

PAGE F-65

NOTE 2 - CONTRACT RECEIVABLES

Contract receivables consist of the following at December 31, 2005 and 2004:

2005 2004
----------- ----------
Billed
Completed contracts. . . . . . . . $ 79,336 $1,502,016
Contracts in progress. . . . . . . 2,672,182 1,871,089
Unbilled . . . . . . . . . . . . . . - 266,861
----------- ----------
2,751,518 3,639,966
Less allowance for doubtful accounts (17,500) -
----------- ----------

TOTAL CONTRACTS RECEIVABLES. . . . . $2,734,018 $3,639,966
=========== ==========

Billed contract receivables consist of the following at December 31, 2005 and
2004:

2005 2004
----------- ----------

Billed commercial. . . . . . . . . . $ 415,823 $ 788,563
Billed governmental. . . . . . . . . 2,335,695 2,584,542
----------- ----------
2,751,518 3,373,105
Less allowance for doubtful accounts (17,500) -
----------- ----------

TOTAL BILLED CONTRACTS RECEIVABLES . $2,734,018 $3,373,105
=========== ==========

NOTE 3 - CONTRACTS IN PROGRESS

Contracts in progress at December 31, 2005 and 2004 are summarized as follows:

2005 2004
------------- -------------

Costs incurred on uncompleted contracts $ 45,340,921 $ 25,872,527
Estimated earnings (loss) thereon . . . (5,176,843) (1,997,034)
------------- -------------
40,164,078 23,875,493
Less billings to date . . . . . . . . . (39,705,847) (22,878,756)
------------- -------------

TOTAL . . . . . . . . . . . . . . . . . $ 458,231 $ 996,737
============= =============

PAGE F-66

NOTE 3 - CONTRACTS IN PROGRESS (CONTINUED)

These amounts are reflected in the accompanying balance sheet under the
following captions at December 31, 2005 and 2004:

2005 2004
------------ ------------

Costs and estimated earnings in excess
of billings on uncompleted contracts $ 2,160,684 $ 3,091,636

Billings in excess of costs and estimated
earnings on uncompleted contracts. . (1,702,453) (2,094,899)
------------ ------------

TOTAL . . . . . . . . . . . . . . . . . . $ 458,231 $ 996,737
============ ============

NOTE 4 - NOTES AND EMPLOYEE RECEIVABLES

Notes receivable, and the corresponding accrued interest, was paid in full as of
December 31, 2005. However, at December 31, 2004, notes receivable consisted of
notes due from employees and existing stockholders, which totaled $90,768. The
notes bore interest at 5.5% and were due on demand. Total accrued interest on
these notes was $0 and $5,963 at December 31, 2005 and 2004, respectively.

In addition, during the periods ended December 31, 2005 and 2004, the Company
had advanced amounts to various employees. Accounts receivable due from
employees as of December 31, 2005 and 2004, were $640 and $20,412, respectively.
There were no signed note agreements for these advances due to the short
repayment terms of the advances.

PAGE F-67

NOTE 5 - NOTES PAYABLE

Notes payable consists of the following at December 31, 2005 and 2004:

2005 2004
------------ ------------
Line of credit agreement with bank; maximum of
4,250,000; interest at prime plus 3.5%;
matures upon the closing of cash equity
transaction or January 31, 2006. . . . . . . . . . . $ 825,846 $ -

Two term notes for $2,100,000 and $1,250,000,
respectively; interest at 10.25% and LIBOR
plus 8%, respectively; notes mature upon
the closing of cash equity transaction
or January 31, 2006. . . . . . . . . . . . . . . . . 3,087,472 -

Line-of-credit agreement with bank; maximum of
3,200,00 maturity at February 28, 2005; interest
at prime plus .75% (a total of 6% at December
31, 2004); collateralized by account receivable,
equipment and inventory. . . . . . . . . . . . . . . - 2,479,308

Term Loan with bank; maturity at February 28,
2005; monthly payments of $29,480, with a balloon
payment of $1,403,507 due at maturity. Interest at
6.5%; collateralized by accounts receivable,
equipment and inventory. . . . . . . . . . . . . . . - 1,417,994

Note payable to SpaceDev; interest at 8%;
principal and interest is due at the earlier of the
close of the Merger Agreement or January
1,353,271 -

Stockholder notes of $800,000 plus loan
premium of $80,000; interest at 15%; principal
and unpaid interest due the earlier of the closing
of the SpaceDev Merger or July 22, 2006. . . . . . . 934,000 -

Note payable to ATC for asset purchase; interest
at 7%; quarterly payments of principal and interest
of $4,178; maturity at June 30, 2005.. . . . . . . . - 18,119

Note payable to Ford Motor Credit for asset
purchase, interest at 0%; monthly payments of
principal of $1,069; maturity at September 4,
2005; collateralized by equipment. . . . . . . . . . - 9,622

Promissory note with former stockholder; maturity
at May 1, 2006; two equal payments of principal
and accrued interest at 10% are due May 1, 2005
and May 1, 2006; uncollateralized. . . . . . . . . . 12,594 16,600
------------ ------------

Total. . . . . . . . . . . . . . . . . . . . . . . . 6,213,183 3,941,643

Less current portion . . . . . . . . . . . . . . . . (6,213,183) (3,933,343)
------------ ------------

LONG-TERM PORTION. . . . . . . . . . . . . . . . . . $ - $ 8,300
============ ============

PAGE F-68

All bank notes payable are also personally guaranteed by a stockholder of the
Company. The line of credit and term loan agreement contain restrictive
covenants relating to the financial position and operations of the Company. The
Company was in violation of these covenants at December 31, 2005.

On March 30, 2005, the Company refinanced the line-of-credit, term loan, and
certain capital leases with a new bank. The refinancing included creation of a
new line of credit having a balance of $4,250,000, which interest accrues at a
prime rate plus 0.5% and matures March 30, 2006, a new term note A of $2,100,000
which accrues interest at 7.25% and matures April 1, 2010, and a new term note B
of $1,250,000 which accrues interest at LIBOR plus 5% and matures March 30,
2006.

On June 24, 2005, the Company entered into a Forbearance Agreement (the
"Agreement") for certain financial covenant and other violations under its
existing loans with its current bank. The Agreement was later amended on July
26, 2005 and then again on November 7, 2005. The Agreement sets forth default
interest rates for the line of credit, term note A, and term note B, which
accrue interest at prime rate plus 3.5%, 10.25%, and at LIBOR plus 8%,
respectively. The amended Agreement requires the Company to raise the necessary
capital to bring the Company in compliance with its borrowing base and other
financial covenants. The Company's obligations under the amended Agreement
include, but are not limited to, the following:

PAGE F-69

- On or before July 26, 2005, the Company shall receive a minimum of $800,000
of additional cash equity.
- On or before September 8, 2005, the Company shall receive an additional
minimum of $1,200,000 of cash equity.
- On or before October 31, 2005, the Company shall receive a minimum of
$4,000,000 of additional cash equity.

The total amount of cash equity the Company is required to obtain on or before
December 15, 2005 is at least $6,000,000. The amended Agreement also requires
the Company to provide the bank a "Letter of Intent" by July 26, 2005 from a
bona fide third party for the purchase of all or a portion of the Company's
assets. The Agreement also accelerates and amends the maturity date of term
note B from March 30, 2006 to the earlier of the required cash equity amounts
received or January 31, 2006.

Any default under the Agreement constitutes a default under the existing loan
agreements with the bank and the bank shall be entitled to appoint a receiver to
preserve and protect the bank's collateral, including the right to operate the
Company's business. Any such receivership will continue until the Company's
obligations under the Agreement have been satisfied in full. The Company did
receive minimum proceeds of $800,000, a Letter of Intent to comply with the
amended Agreement, and the additional $1,200,000 cash equity as noted below.

As the Company had not closed the Merger Agreement with SpaceDev by October 31,
2005 and had not received the additional $4,000,000 minimum cash equity required
under the terms of the aforementioned lending agreement, on November 7, 2005,
the Company entered into a Third Amendment to the Forbearance Agreement (the
"Agreement"). On December 20, 2005 the Company entered into a Fourth Amendment.
The Company's obligations under the fourth amended Agreement include, but are
not limited to, the following:

- "Commitment Amount" under the Line Note is hereby modified and reduced from
$4,250,000 to $933,000.
- "Equity Infusion" shall mean Borrower's obligation to obtain $6,000,000 of
additional cash equity on or before January 31, 2006 ("Equity Infusion").
- "Term Note B Maturity Date" is hereby modified and amended to the earlier
of the date Borrower obtains the Equity Infusion, or January 31, 2006.

For the year ended December 31, 2005, the Company issued notes payable to four
of its stockholders in the amount of $800,000. These notes bear interest at 15%
per annum. These notes plus the loan premium (see Company's Policies) and any
unpaid principal and accrued interest are due on the earlier of July 22, 2006 or
the closing of the SpaceDev Merger Agreement which was January 31, 2006.

PAGE F-70

On September 8, 2005, the Company issued a secured promissory note in the
principal amount of $1.2 million to SpaceDev. The note accrues interest at 8%
per annum and matures on December 31,
2005 or earlier in certain circumstances. No principal or interest payments are
due before maturity. The loan is secured by a security interest in all of the
assets of Starsys, subject to an intercreditor agreement with Vectra Bank
Colorado, National Association ("Vectra"). In addition, the Company has agreed
to pay SpaceDev a placement agent fee and to reimburse the Company expenses in
the aggregate amount of $120,000. This amount was deferred until the closing of
the Plan of Merger (see Company's Policies) and added to the principal balance
of the note evidencing the loan.

NOTE 6 - COMMITMENTS AND CONTINGENCIES

LEASES

The Company leases certain equipment and software under capital leases which
expire at various times through 2006. Accumulated depreciation for these assets
presented as capital leased assets was $282,295 and $372,783 at December 31,
2005 and 2004, respectively. During the year ended December 31, 2005, the
Company extinguished its debt on all but one of these capital leases and
reclassified the assets from capital assets to facility equipment. The Company
leases its facility and office equipment under various non-cancelable operating
leases which expire through 2007. The Company also leases certain equipment
under month-to-month leases.

Minimum rental commitments under these leases are as follows:

CAPITAL OPERATING
LEASES LEASES
--------- ----------
YEAR ENDING DECEMBER 31,

2006 . . . . . . . . . . $ 25,911 $ 422,486
2007 . . . . . . . . . . - 44,858
---------
25,911 $467,344
=========
Less interest. . . . . . (318)
---------
25,593
Less current portion . . (25,593)

LONG TERM PORTION. . . . $ -
=========

Total rent expense for the years ended December 31, 2005 and 2004 was $645,287
and $633,859, respectively. This amount includes normal operating expenses paid
with the leases.

PAGE F-71

The Company is also subleasing a portion of its facilities under various
month-to-month subleases. Total sublease and other rental income was $3,250 and
$7,800 for the years ended December 31, 2005 and 2004, respectively.

The Company paid down certain capital leases on March 30, 2005. The balance of
the remaining capital lease obligations at December 31, 2005 and 2004 was
$25,593 and $433,138, respectively.

OTHER

The Company recently has learned that it inadvertently may have violated certain
International Traffic in Arms Regulations (ITAR) by exporting certain products
and services without licenses. These exports resulted from an error in
classifying the products and services as commercial rather than military. The
Company has prepared and filed a voluntary disclosure with the State Department
in which the details of the exports and erroneous classifications are described.
At this time, it is not possible to determine whether any fines or other
penalties will be asserted against the Company, or the materiality of any
outcome.

We self-insure a portion of our employee health and dental claims. However,
health claims in excess of our self-insurance limits are fully insured.

NOTE 7 - STOCKHOLDERS' EQUITY

STOCK OPTION PLAN

The Company adopted a Stock Option Plan in 1998 which provides for the granting
of incentive stock options to employees and nonstatutory stock options to
directors and consultants of the Company as selected by the Board of Directors.
The maximum number of shares authorized to be granted under the plan is 160,000.
The options are exercisable at a price as determined and authorized by the Board
of Directors. The options generally expire at 10 years from the date of grant.

In 1998, the Company adopted the disclosure - only provisions of Statement of
Financial Accounting Standards No. 123 for Stock-Based Compensation ("SFAS
123"). SFAS 123 encourages entities to adopt a fair value-based method of
accounting for employee stock
compensation plans, but allows companies to continue to account for those plans
using the accounting prescribed by APB Opinion 25, "Accounting for Stock Issued
to Employees" ("APB 25"). The Company has elected to continue to account for
stock based compensation using APB 25, making pro forma disclosures of net
earnings as if the fair value-based method had been applied. Accordingly, no
compensation expense has been recorded for the stock option plan.

PAGE F-72

The fair value of each option granted is estimated on the date of grant using
the minimum value option-pricing model with the following weighted average
assumptions:

Expected dividend yield 0%
Expected stock price volatility 0%
Risk-free interest rate 4.2% to 6.7%
Expected life of options 10 years

Incentive stock option transactions are summarized as follows:

WEIGHTED AVERAGE
INCENTIVE STOCK EXERCISE PRICE
OPTION SHARES PER SHARE
----------------- ---------------
OUTSTANDING, AT DECEMBER 31, 2003 106,080 $ 9.64

Options granted . . . . . . . . . - -
Options expired . . . . . . . . . - -
Options forfeited . . . . . . . . - -
Options exercised . . . . . . . . - -
----------------- ---------------
OUTSTANDING, AT DECEMBER 31, 2004 106,080 $ 9.64

Options granted . . . . . . . . . - -
Options expired . . . . . . . . . - -
Options forfeited . . . . . . . . (2,695) $ 8.80
Options exercised . . . . . . . . (1,989) $ 8.80
----------------- ---------------
OUTSTANDING, AT DECEMBER 31, 2005 101,396 $ 9.59

The following table summarizes information concerning outstanding and
exercisable options at December 31, 2005:

WEIGHTED OUTSTANDING EXERCISABLE
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
OPTION. . EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
TYPE. . . PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
--------- -------------- ----------- ------------ --------- ----------- ---------
Incentive $7.11 - $15.30 101,396 < 1 $ 9.59 101,396 $ 9.59

The number exercisable and the exercisable weighted average exercise price per
share are based upon the vesting schedules for the individual options.

PAGE F-73

AUTHORIZED STOCK

On October 29, 2004, the Company amended its articles of incorporation to
increase the number of shares of common stock it is authorized to issue from
1,000,000 to 25,000,000 at $.001 par value and to authorize the issuance of up
to 10,000,000 shares designated as preferred stock with no par value. There
were no shares of preferred stock issued or outstanding at December 31, 2005.

NOTE 8 - RETIREMENT PLAN

The Company maintains an Employees' 401(k), and, up until December 18, 2005, a
Stock Bonus Plan, which gives employees the opportunity to save a portion of
their pre-tax wages for retirement. Employees are eligible to participate in the
Company's 401(k) Plan upon date of hire. In addition to the participant's
contribution to the plan, the Company may make discretionary profit sharing and
discretionary matching 401(k) contributions under the plan. The discretionary
profit sharing contributions were paid at a rate of 50% to the employee and 50%
is accrued for conversion into shares of stock in the Company based on the
employee's respective contributions received under the plan, up until the
termination of the Stock Bonus Plan. For the years ended December 31, 2005 and
2004 the company made no discretionary profit sharing contributions. The Company
accrued discretionary matching 401(k) contributions for the years ending
December 31, 2005 and 2004 in the amounts of $68,995 and $17,537, respectively.
The above plans are not leveraged by the Company.

The total number of shares of the Company's stock allocated to and held by the
plan was 36,611 at December 31, 2005 and 2004, respectively. Any dividends paid
on the plan shares are charged to retained earnings as the Company has an
accumulated deficit.

The Stock Bonus Plan provides a put option whereby terminated participants may
elect to sell and require the Company to redeem the participant's vested common
shares at their fair market value. The Company was not required to redeem any
of the vested shares during the years ended December 31, 2005 and 2004. As
previously noted, the Stock Bonus Plan was terminated as of December 18, 2005.

PAGE F-74

NOTE 9 - INCOME TAXES

The sources of deferred tax assets and the tax effect of each at December 31,
2005 and 2004 is as follows:

2005 2004
------------ ------------

Deferred tax assets:

Accrued expenses . . . . . . . . . . . . . . . . . $ 184,900 $ 45,144
Reserve for loss on contracts in progress. . . . . 608,500 525,732
Research and development credit carryforward . . . 1,867,800 672,717
Federal and State net operating loss carryforwards 2,374,400 423,163
Valuation allowance for deferred tax assets. . . . (4,494,200) (1,435,589)
------------ ------------

TOTAL DEFERRED TAX ASSETS. . . . . . . . . . . . . . 541,400 231,167

Deferred tax liability:

Tax over financial statement depreciation. . . . . (541,400) (231,167)
------------ ------------

NET DEFERRED TAX ASSETS. . . . . . . . . . . . . . . $ - $ -
============ ============

The deferred tax asset is presented in the accompanying balance sheets at
December 31, 2005 and 2004 as follows:

2005 2004
---------- ----------
Current deferred tax asset. . . . $ - $ 231,167
Noncurrent deferred tax asset . . 541,400 -
Noncurrent deferred tax liability (541,400) (231,167)
---------- ----------

NET DEFERRED TAX ASSET. . . . . . $ - $ -
========== ==========

The (provision) benefit for income taxes at December 31, 2005 and 2004 consists
of the following:

2005 2004
----- ----------
Current . . . . . . . . . . . . . . . . . . . . $ - $ -
Deferred. . . . . . . . . . . . . . . . . . . . - (510,332)
Benefit of Federal net operating loss carryback - 317,015
----- ----------

TOTAL . . . . . . . . . . . . . . . . . . . . . $ - $(193,317)
===== ==========

PAGE F-75

The Company's provision for income taxes differs from the tax that would result
from applying statutory rates to income before income taxes primarily because of
state income taxes, nondeductible expenses, change in the valuation allowance of
approximately $3,059,000 and $1,436,000 for the years ended December 31, 2005
and 2004, respectively.

At December 31, 2005, the Company had estimated research and development credit
carryforwards of approximately $1,866,200 available to offset future years'
income taxes. These carryforwards begin to expire in 2022 to 2030. The Company
also had Federal and State net operating loss carryforwards of approximately
$5,728,000 and $9,220,000, respectively. These carryforwards begin to expire in
2024 and 2025.

Pursuant to Internal Revenue Code Sections 382 and 383, the Company's use of its
net operating loss carryforwards may be limited as a result of cumulative
changes in ownership of more than 50% over a three year period.

NOTE 10 - ACCRUED PRODUCT WARRANTY CLAIMS

The following is a reconciliation of changes in the accrued product warranty
claims liability included in other accrued expenses at December 31, 2005 and
2004 respectively:

2005 2004
--------- ---------

BEGINNING BALANCE . . . . . . . . . . . . . . . . $ 72,123 $ -

Change in product warranties issued during period 79,107 125,888
Payments made in cash or in-kind. . . . . . . . . (79,107) (53,765)
--------- ---------

ENDING BALANCE. . . . . . . . . . . . . . . . . . $ 72,123 $ 72,123
========= =========

NOTE 11 - RESEARCH AND DEVELOPMENT COSTS

Research and development costs are charged to expense when incurred. Total
research and development costs incurred for the years ended December 31, 2005
and 2004 were $11,781,580 and $10,524,603 respectively. The Company records
research and development costs specific to projects to cost of goods sold. All
other research and development costs are expensed to general and administrative
expenses.

PAGE F-76

NOTE 12 - SIGNIFICANT CONCENTRATIONS

Generally accepted accounting principles require disclosure of information about
current vulnerabilities due to certain concentrations. These matters include
the following:

REVENUES FROM MAJOR CUSTOMERS

For the year ended December 31, 2005 and December 31, 2004, approximately 55%
and 69% of the Company's revenues were from four major customers. At December
31, 2005 and December 31, 2004, these customers represented approximately 48%
and 53% of total contract receivables, respectively.

NOTE 13 - BONUS AND ROYALTY OBLIGATIONS

The Company entered into an employment agreement and an independent contractor
agreement (the "Agreements") with former employees of ATC. The Agreements
contain certain provisions for bonus payments to be made to these individuals.
In the event of voluntary termination of either
agreement by these individuals, the Company is still obligated to pay 50% of the
total bonuses to the individuals. As such, $188,982 was accrued by the Company
and must be paid over a five-year term. This amount was recorded as the
Company's bonus obligation at September 1, 2000.

For the years ended December 31, 2005 and December 31, 2004 the Company made
$112,427 and $56,695 in bonus payments, respectively. The accrued bonus
obligation for the years ended December 31, 2005 and December 31, 2004 was $0
and $56,695, respectively. The Company also accrued royalties to the two
individuals in the amount of $380,262 and $231,585 for the year ended December
31, 2005 and December 31, 2004, respectively. During the year ended December 31,
2005 and December 31, 2004, the Company received services of, $149,578, and
$114,132, respectively, from a company owned by one of the individuals.

NOTE 14 - SUBSEQUENT EVENTS

On August 23, 2005, the Company entered into an offer to sell the shares of the
Company's stock to SpaceDev, a publicly traded company.

DETAILS OF MERGER

On January 31, 2006, the Company sold all of it's common stock to SpaceDev
pursuant to the Merger Agreement dated October 24, 2005 and amended on
December 7, 2005 and January 31, 2006.

Starsys shareholders received approximately $411,000 in cash and 3.8 million
shares of SpaceDev's common stock at the consummation of the merger.

PAGE F-77

consist of up to an aggregate of $1,050,000 in cash and shares of SpaceDev's
common stock valued at up to $18 million, subject to reduction for some merger
related expenses and to escrow arrangements, as follows:

For the fiscal year ended December 31, 2005, up to $350,000 in cash and up to
an aggregate number of shares of SpaceDev's common stock equal to (A) up to
$3.0 million divided by (B) the volume weighted average price of SpaceDev's
common stock for the 20 trading days preceding the date of the audit opinion
for the Company's fiscal year ended December 31, 2005, but not less than
$2.00 per share;

For the fiscal year ended December 31, 2006, up to $350,000 in cash and up to
an aggregate number of shares of SpaceDev's common stock equal to (A) up to
$7.5 million divided by (B) the volume weighted average price of SpaceDev's
common stock for the 20 trading days preceding the date of the audit opinion
for the Company's fiscal year ended December 31, 2006, but not less than
$2.50 per share; and

For the fiscal year ended December 31, 2007, up to $350,000 in cash and up to
an aggregate number of shares of SpaceDev's common stock equal to (A) up to
$7.5 million divided by (B) the volume weighted average price of SpaceDev's
common stock for the 20 trading days preceding the date of the audit opinion
for the Company's fiscal year ended December 31, 2007, but not less than
$3.00 per share.

The Company's shareholders will be entitled to receive the maximum
amount of performance consideration for a particular fiscal year if SpaceDev
breaches specified covenants of the merger agreement and is unable to cure the
breach within the applicable cure period as set forth in the merger
agreement.

WORKING CAPITAL CONTRIBUTION

Under the merger agreement, SpaceDev was obligated to contribute $2.5 million to
the working capital of the Company through the end of 2006. SpaceDev has
contributed approximately $2.25 million since the merger on January 31, 2006.

TERMINATION OF LOANS

In connection with the consummation of the merger on January 31, 2006, pursuant
to which, the Company became a wholly-owned subsidiary of SpaceDev:

SpaceDev paid off in full the remaining principal and interest of all loans
extended to the Company by Vectra pursuant to the credit facility and
forbearance agreement, together with all other costs incurred in
connection with those loans, which aggregated approximately $3.7 million.
The credit facility and associated security agreements with Vectra were
terminated upon receipt of the payment; SpaceDev cancelled and terminated its
$1.2 million secured bridge loan to the Company,

PAGE F-78

together with accrued interest, in accordance with the terms of the merger
agreement; and, paid off in full the remaining principal and interest of
all subordinated loans extended to the Company by four of its shareholders,
which aggregated approximately $944,000.

PAYMENT OF ACCRUED ROYALTIES

As of February 2006, the Company has paid in full the outstanding liability at
December 31, 2005 for royalties payable to former employees of ATC which totaled
approximately $380,000.

TERMINATION OF OPTIONS

In conjunction with the merger all of the Company's outstanding options were
terminated.

PAGE F-79

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 3,382,779 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.

June 29, 2006

PAGE II-1

[Outside Back Cover of Prospectus]

PAGE II-2

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS

ITEM 25. 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 . . . . . . . . . . . . . $30,000
Accounting Fees . . . . . . . . . . . . . . . . . $18,000
Miscellaneous Expenses. . . . . . . . . . . . . . . $ 292
------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . . . . . . $50,000
=================================================== =======

ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES

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 the registration statement
effective 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 SEC for
public resale on the registration statementeffective August 6, 2003.

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 our revolving credit facility.
As part of the transaction, the shares were registered with the SEC for
public resale on the registration statement effective August 6, 2003.

PAGE II-3

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 our revolving credit facility.
As part of the transaction, the shares were registered with the SEC for
public resale on the registration statement effective 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 our revolving credit facility.
As part of the transaction, the shares were registered with the SEC for
public resale on the registration statement effective August 6, 2003.

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 our revolving credit facility. As
part of the transaction, the shares were registered with the S SEC for
public resale on July 1, 2004.

On August 25, 2004, we issued 250,000 shares of our Series C Non-Redeemable
Convertible Cumulative Preferred Stock, with a stated value of $10.00 per share
(the "Stated Value"), to the Laurus Master Fund Ltd. for a total purchase price
of $2.5 million. The preferred stock is convertible into Common Stock at a rate
of $1.54 per share at any time after the date of issuance. The preferred shares
are redeemable by the Company 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.

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
were registered with the SEC for resale.

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 the Preferred Stock
transaction, the underlying shares were registered with the SEC for
public 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 SEC for public
resale.

On October 31, 2005, we issued 2,032,520 shares of our common stock to
Laurus, pursuant to our Securities Purchase Agreement, Registration Rights
Agreement, and Warrant with Laurus dated October 31, 2005. As part of the
transaction, the shares were registered with the SEC for public resale on the
registration statement effective February 14, 2006.

On December 20, 2005, we issued non-plan options to purchase 4,400,000
shares of SpaceDev common stock to three of our executive officers pursuant to
the employment agreements dated December 20, 2005.

On January 13, 2006, we issued and sold to a limited number of
institutional accredited investors, including Laurus Master Fund, Ltd., 5,150
shares of our Series D-1 Amortizing Convertible Perpetual Preferred Stock, par
value $0.001 per share, which we refer to as Series D-1 Preferred Stock, for an
aggregate purchase price of $5,150,000, or $1,000 per share. We also issued
various warrants to these investors under the 2006 purchase agreement.

On January 31, 2006 we issued 3,796,756 shares of SpaceDev common stock to
Starsys shareholders and Zions Trust pursuant to the merger agreement dated
January 31, 2006.

Also, on January 31, 2006 we issued 250,000 shares of SpaceDev common stock
to QS Advisors, LLC for advisory services provided in relation to the Starsys
Merger.

On June 20, 2006, the registrant issued 1,500 shares of its common stock to
three employees pursuant to an incentive performance award.

PAGE II-4

ITEM 27. EXHIBITS

Exhibit No. Description Filed Incorporated Form Date Filed with Exhibit
Herewith by Reference SEC No.
----------- ---------------------------------- -------- ------------ -------- --------------- -------
2.1 . . . . Agreement and Plan of Merger
and Reorganization dated as of
October 24, 2005 (Starsys) X 8-K Oct. 26, 2005 2.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
2.2 . . . . Amendment No. 1 to the
Agreement and Plan of Merger
and Reorganization dated
December 7, 2005 (Starsys) X 8-K Dec. 13, 2005 2.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
2.3 . . . . Amendment No. 2 to the
Agreement and Plan of Merger
and Reorganization dated
January 31, 2006 (Starsys) X 8-K Feb. 6, 2006 2.3
----------- ---------------------------------- -------- ------------ -------- --------------- -------
2.2 . . . . Escrow Agreement dated January
31, 2006 (Starsys) X 8-K Feb. 6, 2006 2.4
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.1 . . . . Articles of Incorporation dated
December 20, 1996 X 10-SB Jan. 18, 2000 2.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.2 . . . . Articles of Amendment to
Articles of Incorporation dated
November 4, 1997 X 10-SB Jan. 18, 2000 2.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.3 . . . . Articles of Amendment to
Articles of Incorporation dated
December 17, 1997 X 10-SB Jan. 18, 2000 2.3
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.4 . . . . Articles of Amendment to
Articles of Incorporation dated
February 1, 2006 X 10-KSB Mar. 28, 2006 3.4
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.5 . . . . Amended and Restated Bylaws X 8-K Dec. 23, 2005 3.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.6 . . . . Certificate of Designation of
Series C Convertible Preferred
Stock X 8-K Aug. 30, 2004 3.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.7 . . . . Certificate of Designation of
Series D-1 Preferred Stock X 8-K Jan. 17, 2006 3.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.8 . . . . Certificate of Designation of
Series D-2 Preferred Stock X 8-K Jan. 17, 2006 3.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
3.9 . . . . Form of Warrant issued to Laurus
Master Fund August 25, 2004 X 8-K Aug. 30, 2004 4.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
4.1 . . . . Form of Common Stock
Certificate X 10-SB Jan. 18, 2005 3.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
5.1 . . . . Legal Opinion of Law Offices of
Gretchen Cowen, APC X POS AM May 2, 2005 5.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.1. . . . Secured Loan Agreement with
Starsys Research Corporation
dated September 8, 2005 X 10-QSB Nov. 14, 2005 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.2. . . . Promissory Note with Starsys
Research Corporation dated
September 8, 2005 X 10-QSB Nov. 14, 2005 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.3. . . . Subcontract Agreement with
Andrews Space, Inc. awarded
June 27, 2005 X 10-QSB/A Dec. 22, 2005 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.4. . . . Sublease between Gateway and
SpaceDev dated March 31, 2005 X 8-K April 15, 2005 10.1
-----------------------------------------------------------------------------------------------------------

PAGE II-5

-----------------------------------------------------------------------------------------------------------
Exhibit No. Description Filed Incorporated Form Date Filed with Exhibit
Herewith by Reference SEC No.
-----------------------------------------------------------------------------------------------------------
10.5. . . . Consent to Sublease between
Gateway and SpaceDev dated
April 1, 2005 X 8-K April 15, 2005 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.6. . . . AFRL Contract with SpaceDev
dated as of August 23, 2004 X 8-K Sept. 1, 2004 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.7. . . . AFRL Statement of Work dated
August 23, 2004* X 8-K Sept. 1, 2004 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.8. . . . AFRL SBIR "mini-mo" Contract
extension with SpaceDev dated
August 20, 2004* X 10-QSB Nov. 15, 2004 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.9. . . . AFRL SBIR Small Satellite Bus
Contract with SpaceDev dated
September 28, 2004 X 10-QSB Nov. 15, 2004 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.10 . . . AFRL SBIR Phase II Small
Launch Vehicle Contract with
SpaceDev dated September 29,
2004 X 10-QSB Nov. 15, 2004 10.3
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.11 . . . MDA Second Task Order with
SpaceDev dated October 20,
2004* X 10-QSB Nov. 15, 2004 10.4
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.12 . . . Separation Agreement and
General Release between
SpaceDev and Jeffrey Janicik
dated July 22, 2004 X 10-QSB Aug 9, 2004 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.13 . . . Modification to Small Shuttle
Compatible Propulsion Module
contract with AFRL dated July 7,
2004 X 10-QSB Aug. 9, 2004 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.14 . . . Lunar Dish Observatory
Contract between SpaceDev and
Lunar Enterprises Corporation
dated July 20, 2004 X 10-QSB Aug. 9, 2004 10.3
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.15 . . . Employment Offer by SpaceDev
to Randall K. Simpson dated
January 16, 2004 X 10-KSB April 6, 2004 10.38
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.16 . . . Confidential Separation
Agreement and General Release
of Claims with Dario Emanuel
DaPra dated March 18, 2004 X 10-KSB April 6, 2004 10.39
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.17 . . . Missile Defense Agency Contract
with SpaceDev dated March 31,
2004 X 10-KSB April 6, 2004 10.40
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.18 . . . Amendment No. 1 to Note issued
to Laurus Master Fund, dated
March 31, 2004 X 10-KSB April 6, 2004 10.41
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.19 . . . Waiver Letter from Laurus
Master Fund dated March 31,
2004 X 10-KSB April 6, 2004 10.42
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.20 . . . First Task Order Under Missile
Defense Agency Contract with
SpaceDev dated April 1, 2004 X 10-KSB April 6, 2004 10.43
-----------------------------------------------------------------------------------------------------------

PAGE II-6

-----------------------------------------------------------------------------------------------------------
Exhibit No. Description Filed Incorporated Form Date Filed with Exhibit
Herewith by Reference SEC No.
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.21 . . . Security Agreement between
SpaceDev and Laurus Master
Fund, Ltd. dated June 3, 2003 X 8-K June 18, 2003 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.22 . . . Secured Convertible Note issued
June 3, 2003 by SpaceDev to
Laurus Master Fund, Ltd. X 8-K June 18, 2003 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.23 . . . Common Stock Purchase
Warrant issued June 3, 2003 by
SpaceDev to Laurus Master
Fund, Ltd. X 8-K June 18, 2003 10.3
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.24 . . . Registration Rights Agreement
between SpaceDev and Laurus
Master Fund, Ltd. dated as of
June 3, 2003 X 8-K June 18, 2003 10.4
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.25 . . . Securities Purchase Agreement
with Laurus Master Fund, Ltd.
dated August 25, 2004 X 8-K Aug. 30, 2004 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.26 . . . Registration Rights Agreement
with Laurus Master Fund, Ltd.
dated August 25, 2004 X 8-K Aug. 30, 2004 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.27 . . . Letter Agreement with Laurus
Master Fund Ltd. dated August
25, 2004 X 8-K Aug. 30, 2004 10.3
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.28 . . . Employment Agreement between
SpaceDev and Stuart Schaffer
dated May 17, 2002 X 10-KSB Mar. 28, 2003 10.11
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.29 . . . First Amendment to Employment
Agreement between SpaceDev
and Stuart Schaffer dated June
11, 2002 X 10-KSB Mar. 28, 2003 10.12
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.30 . . . Employment Agreement between
SpaceDev and Emery Skarupa
dated May 24, 2002 X 10-KSB Mar. 28, 2003 10.13
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.31 . . . First Amendment to Employment
Agreement between ISS and
Thomas W. Brown dated March
15, 2000 X 10-SB/A Mar. 27, 2000 6.14
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.32 . . . Employment Agreement between
SpaceDev and Stan Dubyn dated
January 16, 2000 X 10-SB/A Mar. 27, 2000 6.15
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.33 . . . First Amendment to Employment
Agreement between SpaceDev
and Jan A. King , effective
January 20, 2000 X 10-SB/A Mar. 27, 2000 6.17
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.34 . . . Agreement of License and
Purchase of Technology between
SpaceDev and AMROC dated
August 1998 X 10-SB Jan. 18, 2000 6.4
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.35 . . . 1999 Stock Option Plan X SB-2 July 25, 2003 4.8
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.36 . . . First Amendment to 1999 Stock
Option Plan X SB-2 July 25, 2003 4.14
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.37 . . . 1999 Employee Stock Purchase
Plan X 10-SB Jan. 18, 2000 6.7
-----------------------------------------------------------------------------------------------------------

PAGE II-7

-----------------------------------------------------------------------------------------------------------
Exhibit No. Description Filed Incorporated Form Date Filed with Exhibit
Herewith by Reference SEC No.
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.38 . . . 2004 Equity Incentive Plan X S-8 Mar. 29, 2005 99.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.39 . . . First Amendment to 1999 Employee
Stock Purchase Plan X 10-KSB Mar. 28, 2006 10.39
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.40 . . . Executive Employment
Agreement between SpaceDev,
Inc., and James W. Benson dated
December 20, 2005 X 8-K Dec. 23, 2005 10.3
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.41 . . . Executive Employment
Agreement between SpaceDev,
Inc., and Mark Sirangelo dated
December 20, 2005 X 8-K Dec. 23, 2005 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.42 . . . Amended and Restated Executive
Employment Agreement between
SpaceDev, Inc., and Richard B.
Slansky dated December 20,
2005 X 8-K Dec. 23, 2005 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.43 . . . Non-Plan Stock Option
Agreement with James W.
Benson (evidencing an option to
purchase up to 950,000 shares)
dated December 20, 2005 X 8-K Dec. 23, 2005 10.6
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.44 . . . Non-Plan Stock Option
Agreement with Mark N.
Sirangelo dated December 20,
2005 X 8-K Dec. 23, 2005 10.4
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.45 . . . Non-Plan Stock Option
Agreement with Richard B.
Slansky dated December 20,
2005 X 8-K Dec. 23, 2005 10.5
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.46 . . . Falcon Launch Services
Agreement with Space
Exploration Technologies
Corporation dated November 15,
2005 * X 8-K/A Dec. 22, 2005 10.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.47 . . . Amendment No. 1 to the Secured
Promissory Note with Starsys
Research Corporation, dated
December 20, 2005 X 8-K Dec. 23, 2005 10.11
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.48 . . . Non-Plan Stock Option
Agreement with James W.
Benson (evidencing an option to
purchase up to 150,000 shares)
dated December 20, 2005 X 8-K Dec. 23, 2005 10.7
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.49 . . . Statement of Work with Andrews
Space, Inc. awarded June 27,
2005 X 10-QSB/A Dec. 23, 2005 10.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.50 . . . Securities Purchase Agreement
dated January 11, 2001 (Laurus) X 8-K Jan. 17, 2006 99.1
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.51 . . . Registration Rights Agreement
dated January 17, 2001 (Laurus) X 8-K Jan. 17, 2006 99.2
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.52 . . . Form of Preferred Stock Warrant
(Laurus) X 8-K Jan. 17, 2006 99.3
----------- ---------------------------------- -------- ------------ -------- --------------- -------
10.53 . . . Form of Common Stock Warrant
(Laurus) X 8-K Jan. 17, 2006 99.4
-----------------------------------------------------------------------------------------------------------

PAGE II-8

* Registrant requested confidential treatment pursuant to Rule 406 for a
portion of the referenced exhibit and has separately filed such exhibit with the
Commission.

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-9

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 this Post-Effective Amendment
No. 3 to Form SB-2 to be signed on its behalf by the undersigned, in the
City of San Diego, California, on the 29th day of June 2006.

SpaceDev, Inc.

By: /s/ Mark N. Sirangelo
-----------------------------
Mark N. Sirangelo, Chief Executive Officer

By: /s/ Richard B. Slansky
-------------------------------
Richard B. Slansky, President and
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 Mark N. Sirangelo 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-10

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 June 29, 2006
---------------------- Technology Officer and Director
James W. Benson

/s/ Mark N. Sirangelo Vice Chairman of the Board, Chief June 29, 2006
----------------------- Executive Officer and Director
Mark N. Sirangelo (principal executive officer)

/s/ Richard B. Slansky President, Chief Financial Officer, June 29, 2006
----------------------- Director and Corporate Secretary
Richard B. Slansky (principal financial and accounting
Officer)

/s/ Susan C. Benson Director June 29, 2006
-----------------------
Susan C. Benson

/s/ Curt Dean Blake Director June 29, 2006
-----------------------
Curt Dean Blake

/s/ Howell M. Estes, III Director June 29, 2006
-----------------------
Howell M. Estes, III

/s/ Wesley T. Huntress Director June 29, 2006
-----------------------
Wesley T. Huntress

/s/ Scott McClendon Director June 29, 2006
-----------------------
Scott McClendon

/s/ Stuart Schaffer Director June 29, 2006
-----------------------
Stuart Schaffer

/s/ Scott Tibbitts Director June 29, 2006
-----------------------
Scott Tibbitts

/s/ Robert S. Walker Director June 29, 2006
-----------------------
Robert S. Walker

PAGE II-11