---

---

# U.S. SECURITIES AND
EXCHANGE COMMISSIONWashington, D.C. 20549

# FORM 10-QSB

|x | Quarterly
report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly
period ended September 30, 2006
|- | -----------------------------------------------------------------------------------------------------------------------------------

|o | Transition   report
under Section 13 or 15(d) of the Exchange Act for the transition period from ____ to
____
|- | -------------------------------------------------------------------------------------------------------------

Commission file number:
1-9009

|Defense Industries International, Inc.                           
|-----------------------------------------------------------------
|                                                                 
|(Exact Name of Small Business Issuer as Specified in Its Charter)

|Nevada                   | 84-1421483                          
|------------------------ | ------------------------------------
|                         |                                     
|(State of Incorporation) | (I.R.S. Employer Identification No.)

|8 Brussels St. Sderot, 80100, Israel    
|----------------------------------------
|                                        
|(Address of Principal Executive Offices)

|(011) 972-8-689-1611                            
|------------------------------------------------
|                                                
|(Issuer's Telephone Number, Including Area Code)

|                                                                                  
|----------------------------------------------------------------------------------
|(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)

| | Check
whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of
the Exchange Act during the past 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Yes  x  No o

# APPLICABLE ONLY TO
CORPORATE ISSUERS

As
of November 14, 2006 the Issuer had 28,793,198 shares of Common Stock, $.0001 par value
per share, outstanding.

Transitional
Small Business Disclosure Format (check one):

Yes o    No  x



---

---



# DEFENSE INDUSTRIES
INTERNATIONAL, INC. AND SUBSIDIARIES

# INDEX

|                                |                                                                   | Page 
|------------------------------- | ----------------------------------------------------------------- | -----
|
|
|
|
|Part I - Financial Information: |                                                                  
|                               
|Item 1.                         | Condensed Consolidated Balance Sheets as of September 30, 2006   
|                                | (Unaudited) and December 31, 2005                                 | 3-4  
|                               
|                                | Condensed Consolidated Statements of Operations and              
|                                | Comprehensive Income (Loss) for the Three and Nine Months        
|                                | Ended September 30, 2006 and 2005 (Unaudited)                     | 5    
|                               
|                                | Condensed Consolidated Statements of Cash Flows                  
|                                | for the Nine Months Ended September 30, 2006 and 2005 (Unaudited) | 6-7  
|                               
|                                | Notes to Condensed Consolidated Financial Statements             
|                                | (Unaudited)                                                       | 8-18 
|                               
|Item 2.                         | Management's Discussion and Analysis of Financial Condition      
|                                | and Results of Operations                                         | 19-32
|                               
|Item 3.                         | Controls and Procedures                                           | 32-33
|                               
|Part II - Other Information:   
|                               
|Item 1.                         | Legal Proceedings                                                 | 34   
|                               
|Item 2.                         | Unregistered Sales of Equity Securities and Use of Proceeds       | 34   
|                               
|Item 3.                         | Default Upon Senior Securities                                    | 34   
|                               
|Item 4.                         | Submission of Matters to a Vote of Shareholders                   | 34   
|                               
|Item 5.                         | Other Information                                                 | 34   
|                               
|Item 6.                         | Exhibits and Reports on Form 8-K                                  | 34-35
|                               
|Signatures                      |                                                                   | 36   

2

---

---

# DEFENSE INDUSTRIES
INTERNATIONAL, INC.AND SUBSIDIARY
COMPANIES

# CONDENSED CONSOLIDATED
BALANCE SHEETS

ASSETS

|                                                                                 | September 30, 2006
(Unaudited) | December 31, 2005
|-------------------------------------------------------------------------------- | ------------------------------ | -----------------
|
|
|
|
|CURRENT ASSETS                                                                   |                                |                  
|Cash and cash equivalents                                                        |                                |                  
|Accounts receivable, net of allowance for doubtful accounts                      |                                |                  
|of $180,984 and $133,631, respectively                                           |                                |                  
|Accounts receivable - related parties, net of allowance for doubtful accounts of |                                |                  
|$101,192 and $95,489, respectively                                               |                                |                  
|Inventories                                                                      |                                |                  
|Trading securities                                                               |                                |                  
|Deferred taxes                                                                   |                                |                  
|Other current assets                                                             |                                |                  
|                                                                                 |                                |                  
|Total Current Assets                                                             |                                |                  
|                                                                                 |                                |                  
|                                                                                 |                                |                  
|PROPERTY, PLANT AND EQUIPMENT, NET                                               |                                |                  
|                                                                                 |                                |                  
|                                                                                 |                                |                  
|OTHER ASSETS                                                                     |                                |                  
|Funds in respect of employee rights upon retirement                              |                                |                  
|Deferred taxes, long-term                                                        |                                |                  
|Intangible assets, net                                                           |                                |                  
|                                                                                 |                                |                  
|Total Other Assets                                                               |                                |                  
|                                                                                 |                                |                  
|                                                                                 |                                |                  
|TOTAL ASSETS                                                                     |                                |                  
|                                                                                 |                                |                  

The
accompanying notes are an integral part of the condensed consolidated financial statements

3

---

---

# DEFENSE INDUSTRIES
INTERNATIONAL, INC.AND SUBSIDIARY
COMPANIES

# CONDENSED CONSOLIDATED
BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS' EQUITY

|                                                                                 | September 30, 2006
(Unaudited) | December 31, 2005
|-------------------------------------------------------------------------------- | ------------------------------ | -----------------
|
|
|
|
|CURRENT LIABILITIES                                                              |                                |                  
|Accounts payable                                                                 |                                |                  
|Short-term debt                                                                  |                                |                  
|Current portion of long-term debts                                               |                                |                  
|Common stock to be issued                                                        |                                |                  
|Embedded derivatives at fair value                                               |                                |                  
|Other current liabilities                                                        |                                |                  
|                                                                                 |                                |                  
|                                                                                 |                                |                  
|Total Current Liabilities                                                        |                                |                  
|                                                                                 |                                |                  
|                                                                                 |                                |                  
|LONG-TERM LIABILITIES                                                            |                                |                  
|Long-term portion of debts                                                       |                                |                  
|Liability for employee rights upon retirement                                    |                                |                  
|Common stock to be issued                                                        |                                |                  
|Embedded derivatives at fair value                                               |                                |                  
|Minority interest                                                                |                                |                  
|                                                                                 |                                |                  
|Total long-term Liabilities                                                      |                                |                  
|                                                                                 |                                |                  
|                                                                                 |                                |                  
|TOTAL LIABILITIES                                                                |                                |                  
|                                                                                 |                                |                  
|                                                                                 |                                |                  
|COMMITMENTS AND CONTINGENCIES                                                    |                                |                  
|                                                                                 |                                |                  
|SHAREHOLDERS' EQUITY                                                             |                                |                  
|Preferred stock, $.0001 par value, 50,000,000 shares authorized, none issued and |                                |                  
|outstanding                                                                      |                                |                  
|Common stock, $.0001 par value, 250,000,000 shares authorized,  28,793,198 and   |                                |                  
|27,301,930 issued and outstanding respectively                                   |                                |                  
|Additional paid-in capital                                                       |                                |                  
|Retained earnings                                                                |                                |                  
|Accumulated other comprehensive loss                                             |                                |                  
|                                                                                 |                                |                  
|Total Shareholders' Equity                                                       |                                |                  
|                                                                                 |                                |                  
|                                                                                 |                                |                  
|TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                                       |                                |                  
|                                                                                 |                                |                  

4

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

|                                                    | For the ThreeMonths EndedSeptember30, 2006 | For the ThreeMonths EndedSeptember30, 2005 | For the NineMonths EndedSeptember30, 2006 | For the NineMonths EndedSeptember30, 2005
|--------------------------------------------------- | ------------------------------------------ | ------------------------------------------ | ----------------------------------------- | -----------------------------------------
|
|
|
|
|NET REVENUES                                        |                                            |                                            | $                                         | 3,547,956                                
|                                                    |                                            |                                           
|COST OF SALES                                       |                                            |                                            |                                           | 2,351,766                                
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|GROSS PROFIT                                        |                                            |                                            |                                           | 1,196,190                                
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|OPERATING EXPENSES                                  |                                            |                                           
|Selling                                             |                                            |                                            |                                           | 196,831                                  
|General and administrative                          |                                            |                                            |                                           | 523,557                                  
|                                                    |                                            |                                            |                                           |                                          
|Total Operating Expenses                            |                                            |                                            |                                           | 720,388                                  
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|INCOME (LOSS) FROM OPERATIONS                       |                                            |                                            |                                           | 475,802                                  
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|OTHER INCOME (EXPENSES)                             |                                            |                                           
|Financial income (expenses), net                    |                                            |                                            |                                           | (95,046                                  
|Gain (loss) on fair value adjustment to embedded    |                                            |                                           
|derivatives                                         |                                            |                                            |                                           | (31,984                                  
|Other income, net                                   |                                            |                                            |                                           | 18,077                                   
|                                                    |                                            |                                            |                                           |                                          
|Total Other Income (Expenses)                       |                                            |                                            |                                           | (108,953                                 
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|INCOME (LOSS) BEFORE INCOME TAXES                   |                                            |                                            |                                           | 366,849                                  
|                                                    |                                            |                                           
|Income tax (expenses) benefit                       |                                            |                                            |                                           | (23,774                                  
|                                                    |                                            |                                            |                                           |                                          
|Income (loss) before minority interest              |                                            |                                            |                                           | 343,075                                  
|                                                    |                                            |                                           
|Minority interest (income) loss                     |                                            |                                            |                                           | (68,017                                  
|                                                    |                                            |                                            |                                           |                                          
|NET INCOME (LOSS)                                   |                                            |                                            |                                           | 275,058                                  
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|OTHER COMPREHENSIVE INCOME (LOSS)                   |                                            |                                           
|Foreign currency translation gain (loss), net of    |                                            |                                           
|minority interest portion                           |                                            |                                            |                                           | 119,839                                  
|                                                    |                                            |                                            |                                           |                                          
|Other comprehensive income (loss) before tax        |                                            |                                            |                                           | 119,839                                  
|Income tax (expenses) benefit related to items of   |                                            |                                           
|other comprehensive income (loss)                   |                                            |                                            |                                           | 57,030                                   
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|TOTAL OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX |                                            |                                            |                                           | 62,809                                   
|                                                    |                                            |                                            |                                           |                                          
|COMPREHENSIVE INCOME (LOSS)                         |                                            |                                            | $                                         | 333,867                                  
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|Net income (loss) per share - basic and diluted     |                                            |                                            | $                                         | 0.01                                     
|                                                    |                                            |                                            |                                           |                                          
|                                                    |                                            |                                           
|Weighted average number of shares outstanding -     |                                            |                                           
|basic and diluted                                   |                                            |                                            |                                           | 28,793,108                               
|                                                    |                                            |                                            |                                           |                                          

The
accompanying notes are an integral part of the condensed consolidated financial statements

5

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

|                                                                                       | For the Nine
Months Ended
September 30,
2006 | For the Nine
Months Ended
September 30,
2005
|-------------------------------------------------------------------------------------- | -------------------------------------------- | --------------------------------------------
|
|
|
|
|CASH FLOWS USED IN OPERATING ACTIVITIES:\                                              |                                              |                                             
|Net (loss) income                                                                      |                                              |                                             
|Adjustments to reconcile net (loss) income to net cash (used in) provided by operating |                                              |                                             
|activities:                                                                            |                                              |                                             
|Depreciation and amortization                                                          |                                              |                                             
|Gain from sale of property, plant and equipment                                        |                                              |                                             
|Provision for doubtful accounts                                                        |                                              |                                             
|Deferred private placement cost                                                        |                                              |                                             
|Gain on fair value adjustment to embedded derivatives                                  |                                              |                                             
|Net realized and unrealized gain on trading securities                                 |                                              |                                             
|Minority interest in income (loss) of subsidiary                                       |                                              |                                             
|Increase in deferred taxes                                                             |                                              |                                             
|(Increase) decrease in accounts receivable                                             |                                              |                                             
|Increase in other assets                                                               |                                              |                                             
|Decrease in inventories                                                                |                                              |                                             
|Increase (decrease) in accounts payable                                                |                                              |                                             
|Decrease in other liabilities                                                          |                                              |                                             
|Increase (decrease) in  liability for employee rights upon retirement                  |                                              |                                             
|                                                                                       |                                              |                                             
|Net Cash (used in) provided by Operating Activities                                    |                                              |                                             
|                                                                                       |                                              |                                             
|                                                                                       |                                              |                                             
|CASH FLOWS USED IN INVESTING ACTIVITIES:                                               |                                              |                                             
|(Increase) decrease in funds in respect of employee rights upon retirement             |                                              |                                             
|Purchases of property, plant and equipment                                             |                                              |                                             
|Proceeds from sale of property, plant and equipment                                    |                                              |                                             
|Proceeds from sale of trading securities                                               |                                              |                                             
|Cash acquired in acquisition of Own Mills                                              |                                              |                                             
|Purchases of trading securities                                                        |                                              |                                             
|                                                                                       |                                              |                                             
|Net Cash used in Investing Activities                                                  |                                              |                                             
|                                                                                       |                                              |                                             
|                                                                                       |                                              |                                             
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                  |                                              |                                             
|Short-term debt, net                                                                   |                                              |                                             
|Deferred private placement costs                                                       |                                              |                                             
|Repayments of long-term debt                                                           |                                              |                                             
|Proceeds from long term loan                                                           |                                              |                                             
|                                                                                       |                                              |                                             
|Net Cash provided by Financing Activities                                              |                                              |                                             
|                                                                                       |                                              |                                             
|                                                                                       |                                              |                                             
|EFFECT OF CHANGES IN EXCHANGE RATES ON CASH                                            |                                              |                                             
|                                                                                       |                                              |                                             
|                                                                                       |                                              |                                             
|NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                                   |                                              |                                             
|                                                                                       |                                              |                                             
|CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD                                        |                                              |                                             
|                                                                                       |                                              |                                             
|                                                                                       |                                              |                                             
|CASH AND CASH EQUIVALENTS - END OF PERIOD                                              |                                              |                                             
|                                                                                       |                                              |                                             
|                                                                                       |                                              |                                             
|INTEREST PAID                                                                          |                                              |                                             
|                                                                                       |                                              |                                             
|TAXES PAID                                                                             |                                              |                                             
|                                                                                       |                                              |                                             

The
accompanying notes are an integral part of the condensed consolidated financial statements

6

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

# SUPPLEMENTAL SCHEDULE OF
NON-CASH TRANSACTION AND INVESTING ACTIVITIES:

On February 28, 2005, the Company
acquired all the outstanding shares of Owen Mills for an aggregate amount of $351,986, see
Note 2.

The following represents the fair
value of assets acquired, net of liabilities assumed at the acquisition date:

|                              | 
|----------------------------- | 
|
|
|
|
|Assets:                       | 
|                              | 
|Accounts receivable - net     | 
|Other current assets          | 
|Property, plant and equipment | 
|Inventories                   | 
|Goodwill                      | 
|                              | 
|                              | 
|Total assets acquired         | 
|                              | 
|                              | 
|Liabilities:                  | 
|Accounts payable              | 
|Loans                         | 
|                              | 
|                              | 
|Total liabilities assumed     | 
|                              | 
|                              | 
|                              | 
|                              | 

On February 28, 2006, the Company
issued 123,077 shares of its common stock having a fair value of $40,000 at the date of
issuance to the former shareholders of Owen Mills, pursuant to the acquisition agreement.

7

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

|NOTE 1 |  | BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
|------ |  | ---------------------------------------------------------

| | A. | The
accompanying unaudited interim consolidated financial statements as of
               September 30, 2006 and for the three and nine month periods then ended
               (the Interim Financial Statements) were prepared in a
condensed form                in accordance with the instructions for Form 10-Q and,
therefore, do not include                all disclosures necessary for a complete
presentation of financial condition,                results of operations, cash flows and
all the data and notes which are required                when preparing annual financial
statements, in conformity with generally                accepted accounting principles
accepted in the United States.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | The
accounting principles used in the presentation of the Interim Financial
               Statements are consistent with those principles used in the presentation
of the                latest annual financial statements. All significant accounting
policies have                been applied consistently with year ended December 31, 2005.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | The
preparation of the Interim Financial Statements requires management to make
               estimates and assumptions that affect the reported amounts of assets and
               liabilities, the disclosure of contingent assets and liabilities at the
date of                the financial statements, and the reported amounts of revenues and
expenses                during the reported period. Actual results could differ from
those estimates. In                the opinion of management, all adjustments (consisting
of normal recurring                accruals) considered necessary for fair presentation
of the Interim Financial                Statements have been included. The results of
operations for the nine months                period ended September 30, 2006, are not
necessarily indicative of the results                that may be expected for the year
ending December 31, 2006. The Interim                Financial Statements should be read
in conjunction with the Companys                annual financial statements as of
December 31, 2005 and for the year then ended                and the accompanying notes
thereto.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Principles
of Consolidation
| | -- | ---------------------------

| | The
Interim Financial Statements include the accounts of Defense Industries International,
Inc. and its wholly owned subsidiaries, Export Erez, USA, Inc., Export Erez, Ltd.,
Mayotex, Ltd. Dragonwear Trading Ltd. its 76% owned subsidiary Achidatex Nazareth Elite
for all periods presented and Owen Mills since February 28, 2005 (the acquisition date)
(collectively, the Company). The minority interest represents the minority
shareholders proportionate share of Achidatex. All intercompany accounts and
transactions have been eliminated in consolidation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

8

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

| | E. | Earnings
per common share
| | -- | -------------------------

| | Basic
and diluted earning per common share is presented in conformity with SFAS No.128, Earnings
Per Share for all periods presented. Basic earnings per common share is computed by
dividing net income, by the weighted average number of shares of outstanding common
shares. Diluted earnings per common share is computed by dividing net income, by the
weighted average number of shares of outstanding common shares adjusted to include
incremental common shares that would have been outstanding if potentially dilutive common
shares had been issued. Common equivalent shares are excluded from the computation in
periods in which they have an antidilutive effect. For all reported periods, no potential
common shares are included in the computation of a diluted per share amount since such
potential common shares would not have a dilutive effect.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | Goodwill
and Other Intangible Assets
| | -- | ------------------------------------

| | In
accordance with Statement of Financial Accounting Standards (SFAS No. 141),
the Company allocates the purchase price of its acquisitions to the tangible assets,
liabilities and intangible assets acquired based on their estimated fair values. The
excess purchase price over those fair values is recorded as goodwill. The fair value
assigned to intangible assets acquired is either based on valuations prepared by
independent third party appraisal firms using estimates and assumptions provided by
management or negotiated at arms-length between the Company and the seller of the
acquired assets. In accordance with SFAS No. 142, goodwill and purchased intangibles with
indefinite lives are not amortized, but will be reviewed periodically for impairment.
Purchased intangibles with finite lives will be amortized on a straight-line basis over
their respective useful lives.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | Recent
Accounting Pronouncements
| | -- | --------------------------------

| | In
September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB)
No. 108, Considering the Effects of Prior Year Misstatements when Quantifying
Current Year Misstatements. SAB No. 108 requires analysis of misstatements using
both an income statement (rollover) approach and a balance sheet (iron curtain) approach
in assessing materiality and provides for a one-time cumulative effect transition
adjustment. SAB No. 108 is effective for fiscal year 2007 annual financial
statements.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently assessing the potential impact that the adoption of SAB No. 108
will have on the financial statements; the impact is not expected to be material.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

| | In
September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 158,
Employers Accounting for Defined Benefit Pension and Other Postretirement
PlansAn Amendment of FASB Statements No. 87, 88, 106, and 132R (SFAS No. 158).
SFAS No. 158 requires that the funded status of defined benefit postretirement plans
be recognized on the companys balance sheet, and changes in the funded status be
reflected in comprehensive income, effective fiscal years ending after December 15,
2006. SFAS No. 158 also requires the measurement date of the plans funded
status to be the same as the companys fiscal year-end. The Company is currently
assessing the potential impact that the adoption of SFAS No. 158 will have on its
financial statements; the impact is not expected to be material.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines
fair value, establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements. SFAS No. 157
does not require any new fair value measurements, but provides guidance on how to measure
fair value by providing a fair value hierarchy used to classify the source of the
information. This statement is effective for periods beginning July 1, 2008. The
Company is currently assessing the potential impact that the adoption of SFAS No. 157
will have on its financial statements, the impact is not expected to be material.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes. The Interpretation clarifies the
accounting for uncertainty in income taxes recognized in a companys financial
statements in accordance with Statement of Financial Accounting Standards No. 109, Accounting
for Income Taxes. The Interpretation prescribes a recognition threshold and a
measurement attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. The Interpretation also provides
guidance on the related de-recognition, classification, interest and penalties,
accounting for interim periods, disclosure and transition of uncertain tax positions. The
Interpretation is effective for fiscal years beginning after December 15, 2006, with the
cumulative effect of the change in accounting principle recorded as an adjustment to
opening retained earnings.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Although
the Companys analysis of the effect of FIN 48 has not been completed, the Company
does not anticipate recording any material adjustment as a result of adopting this
Interpretation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

10

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

| | In
June 2006, the FASB ratified the Emerging Issues Task Force (EITF) consensus
on EITF Issue No. 06-2, Accounting for Sabbatical Leave and Other Similar
Benefits Pursuant to FASB Statement No. 43". EITF Issue No. 06-2 requires
companies to accrue the costs of compensated absences under a sabbatical or similar
benefit arrangement over the requisite service period. EITF Issue No. 06-2 is
effective for periods beginning July 1, 2007. The cumulative effect of the
application of this consensus on prior period results should be recognized through a
cumulative-effect adjustment to retained earnings as of the beginning of the year of
adoption. Elective retrospective application is also permitted. The Company is currently
evaluating the financial impact of this guidance and the method of adoption that will be
used.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 2 |  | BUSINESS COMBINATION
|------ |  | --------------------

| | Effective
February 28, 2005, the Company acquired all of the outstanding shares of Rizzo Inc.
(doing business as Owen Mills Company), a Los Angeles-based manufacturing and service
company specializing in military and industrial sewing of marine and ballistic fabric
products; for a consideration of $400,000, consisting of $200,000 note payable and shares
of the Companys common stock having a value of $200,000, based on the average
closing price per share of the Companys common stock for the ten trading days
preceding the issuance of such shares. The Company will pay the $400,000 of consideration
as follows: (i) $3,333.33 each month commencing on March 31, 2005 and thereafter on the
last business day of each successive month until Buyer has paid Seller a total of
$200,000; the present value of the payments is $172,401 (ii) $40,000 in the form shares
of common stock of the Company payable within fifteen (15) business days from the date of
the Agreement; and (iii) $40,000 in the form of Company stock paid to the Seller on each
of the last business days of February 2006, February 2007, February 2008, and of February
2009. The Company acquired assets totaling $636,675and assumed liabilities of $284,689.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table reflects the unaudited pro forma combined results of operations for the
nine months ended September 30, 2005, assuming the acquisition had occurred at the
beginning of 2005.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                          | For the Nine
Months ended
September 30, 2005
| | ---------------------------------------- | --------------------------------------------
|
|
|
|
| | Revenue                                  |                                             
| |                                          |                                             
| | Net income                               |                                             
| |                                          |                                             
| | Net income per share - basic and diluted |                                             
| |                                          |                                             

11

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---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

|NOTE 3 |  | INVENTORIES
|------ |  | -----------

| | Consist
of:
| | -----------

| |                  | September 30,
2006 | December 31, 2005
| | ---------------- | ------------------ | -----------------
|
|
|
|
| | Raw materials    |                    |                  
| | Work in progress |                    |                  
| | Finished goods   |                    |                  
| |                  |                    |                  
| |                  |                    |                  
| |                  |                    |                  

|NOTE 4 |  | SHORT-TERM DEBT
|------ |  | ---------------

| | Consist
of:
| | -----------

| |                           | Interest Rates | September 30, 2006 | December 31, 2005
| | ------------------------- | -------------- | ------------------ | -----------------
|
|
|
|
| | Bank credit (1)           |                |                    | 7% - 12%         
| | Short-term bank loans (2) |                |                    | 6% - 7.5%        
| |                           |                |                    |                  
| |                           |                |                    |                  
| |                           |                |                    |                  

| | (1) | The
revolving credit facility is due on demand.
| | --- | -----------------------------------------------

| | The
revolving credit facility is utilized for the operational activities of the Company and
for the costs associated with the evacuation from the Gaza Industrial Zone. The Company
anticipates that the expenses related to its evacuation from the Gaza Strip will be
reimbursed by the Israeli Government. (See note 8)
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | On
December 29, 2005, the Company borrowed $22,523 at an interest rate of 4%.
               This loan is payable in 12 monthly payments commencing on January 28,
2006. Each                payment consists of a fixed amount of principal and accrued
interest. As of                September 30, 2006, the balance of this loan was $7,781.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 28, 2005, the Company borrowed $33,784 at an interest rate of 7.75%. This loan
will be paid in one payment on December 7, 2006. As of September 30, 2006, the balance of
this loan was $36,867.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 7, 2005, the Company borrowed $191,441 at an interest rate of 7.3%. This loan
will be paid in one payment on December 7, 2006. As of September 30, 2006, the balance of
this loan was $198,491.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12

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---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

| | On
April 26, 2006, the Company borrowed $225,225 at an interest rate of 7.5%. This loan will
be paid in one payment on July 26, 2006. As of September 30, 2006, the balance of this
loan was $235,704
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
September 22, 2006, the Company borrowed $116,225 at an interest rate of 8.25%. The Loan
is due on demand. As of September 30, 2006, the balance of this loan was $116,349.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 5 |  | LONG-TERM DEBT
|------ |  | --------------

| | On
December 24, 2003, the Company borrowed $388,216 at an interest rate of 7%. This loan is
payable in 60 monthly payments commencing on January 24, 2004. Each payment consists of a
fixed amount of principal and accrued interest. As of September 30, 2006, the balance of
this loan was $178,050, of which $79,032 was included in the current portion of long-term
debt.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
May 31, 2004, the Company entered into two loan agreements of $92,850 each at an interest
rate of 7.02%. These loans are payable in 56 monthly payments commencing on June 1, 2004.
Each payment consists of a fixed amount of principal and accrued interest. As of
September 30, 2006 the total balance of these loans was $104,438 of which $41,059, was
included in the current portion of long-term debt.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
April 18, 2005, the Company borrowed $21,909 at an interest rate of 5% linked to Israeli
Consumer Price Index (C.P.I). This loan is payable in 48 monthly payments
commencing on May 21, 2005. Each payment consists of a fixed amount of principal and
accrued interest. As of September 30, 2006, the balance of this loan was $15,552, of
which $5,827 was included in the current portion of long-term debt.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
April 18, 2005, the Company borrowed $29,502 at an interest rate of 5% linked to Israeli
C.P.I. The loan is payable in 48 monthly payments commencing May 21, 2005 Each payment
consists of a fixed amount of principal and accrued interest. As of September 30, 2006,
the balance of the loan was $21,325, of which $7,847 was included in the current portion
of long-term debt.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
July 29, 2005, the Company borrowed $543,125 at an interest rate of 6% linked to Israeli
C.P.I. This loan is payable in 24 monthly payments commencing on August 29. Each payment
consists of a fixed amount of principal and accrued interest. As of September 30, 2006,
the balance of this loan was $250,834, of which $250,834 was included in the current
portion of long-term debt.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

13

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

| | On
July 31, 2005, the Company borrowed $434,500 at an interest rate of 6.25% linked to
Israeli C.P.I. This loan is payable in 34 monthly payments commencing on August 31, 2005.
Each payment consists of a fixed amount of principal and accrued interest. As of
September 30, 2006, the balance of this loan was $222,649, of which $200,492 was included
in the current portion of long-term debt.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 29, 2005, the Company borrowed $21,725 at an interest rate of 6.5% linked to
Israeli C.P.I. This loan is payable in 36 monthly payments commencing on January 28,
2005. Each payment consists of a fixed amount of principal and accrued interest. As of
September 30, 2006, the balance of the loan was $17,992, of which $7,623 was included in
the current portion of long-term debt.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
May 24, 2006, the Company borrowed $177,180 at an interest rate of 7.75% linked to
Israeli C.P.I. This loan is payable in 36 monthly payments commencing on June 24, 2006.
Each payment consists of a fixed amount of principal and accrued interest. As of
September 30, 2006, the balance of this loan was $167,618, of which $58,758 was included
in the current portion of long-term debt.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
April 10, 2006, the Company borrowed $443,450 at an interest rate of 8.15% linked to
Israeli C.P.I. This loan is payable in 60 monthly payments commencing on May 10, 2006.
Each payment consists of a fixed amount of principal and accrued interest. As of
September 30, 2006, the balance of the loan was $435,028, of which $81,222 was included
in the current portion of long-term debt.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
May 17, 2006, the Company borrowed $37,071 at an interest rate of 6.25% linked to Israeli
C.P.I. This loan is payable in 48 monthly payments commencing on June 10, 2006. Each
payment consists of a fixed amount of principal and accrued interest. As of September 30,
2006, the balance of this loan was $35,424, of which $8,873 was included in the current
portion of long-term debt.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
May 23, 2006, the Company borrowed $198,155 at an interest rate of 8.5% linked to Israeli
C.P.I. This loan is payable in 36 monthly payments commencing on June 23, 2006 with each
payment consisting of a fixed amount of principal along with accrued interest. As of
September 30, 2006, the balance of this loan was $186,189, of which $69,736 was included
in the current portion of long-term debt.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
February 28, 2005, the Company acquired all the outstanding shares of Owen Mills Company
for an aggregate of $372,401, consisting of a note payable of $172,401 and $200,000 in
common stock of the Company, both of which are to be paid over five years. As of
September 30, 2006 the balance of the note was $125,981, of which $40,000 was included in
the current portion of long-term debt.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

14

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

| | All
of the Companys long-term debt is collateralized by a floating guarantee on
essentially all of the Companys assets.
| | -------------------------------------------------------------------------------------------------------------------------

|NOTE 6 |  | SECURITIES PURCHASE AGREEMENT
|------ |  | -----------------------------

| | On
June 15, 2005, the Company executed a Securities Purchase Agreement (the Agreement)
with a group of investors for a $1.1 million private placement of its common stock.
Pursuant to the Agreement, the Company agreed to issue 1,833,334 shares of its common
stock to the investors at a price of $0.60 per share. The Company also agreed to issue
the investors 365,000 warrants to purchase its common stock at an exercise price of $0.94
share, exercisable until June 30, 2007, and 182,500 warrants at an exercise price of
$2.40 per share, exercisable until June 30, 2010. The Agreement also provided for the
issuance by the Company to the investors of an additional 1,368,191 shares of its common
stock, on June 16, 2006, as a result of a decrease in the Companys share price from
$0.60 per share.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, the Company agreed to issue 82,133 shares of its common stock, as well as
60,000 warrants at an exercise price of $0.94 (exercisable until June 30, 2007) and
20,000 warrants at an exercise price of $2.40 per share (exercisable until June 30, 2010)
as a finders fee for services provided in connection with the transaction.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
agreement also provides for liquidated damage payments after the Registration Statement
has been declared effective by the SEC if sales of all of the registrable securities
required to be included in such Registration Statement cannot be made pursuant to such
Registration Statement. In such event, the Company is required to pay each holder of such
registrable securities an amount in cash equal to 5% (five percent) per calendar month or
portion thereof of the aggregate share purchase price paid by the holder. The maximum
amount of cash payable for such liquidated damages is $300,000.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company accounted for the warrants issued based on guidance from SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities and Emerging Issues Task Force (EITF)
No. 00-19. Accounting for Derivative Financial Instruments Indexed to and Potentially
Settled in a Companys Own stock. Accordingly, the warrants are treated as
derivatives and classified as a liability.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company allocated the proceeds from the private placement of $1.1 millions between the
common stock and the warrants based upon the fair value of the warrants at the
transaction date using the Black-Scholes pricing model. This resulted in a liability
being recorded at the transaction date for the warrants of $171,597.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

15

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

| | The
warrants are recorded at fair value, based on the Black-Scholes pricing model, and
revalued each reporting period with the change in fair value recorded as other income
(expenses). For the nine months ended September 30, 2006 the fair value adjustment
resulted in a gain of $6,376.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 7 |  | SEGMENT INFORMATION AND CONCENTRATION OF CREDIT RISK
|------ |  | ----------------------------------------------------

| | The
Company has two strategic business units: the civilian market and the military market.
The military market is further broken down between local and export sales in order to
better analyze trends in sales and profit margins. The Company does not allocate assets
between segments because several assets are used in more than one segment and any
allocation would be impractical.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A. | Sales
and Income from Operations:
| | -- | ---------------------------------

| |                                             | Civilian | Military |  
| | ------------------------------------------- | -------- | -------- | -
|
|
|
|
| | For the nine months endedSeptember 30, 2006 |          |          |  
| | Revenue from sales                          |          |          | $
| | Loss from operations                        |          |          |  
| | For the nine months endedSeptember 30, 2005 |          |         
| | Revenue from sales                          |          |          | $
| | Income from operations                      |          |          |  

| | B. | Revenues
from Sales to Single Customers Exceeding 10% of Sales:
| | -- | ---------------------------------------------------------------

| |                              | For the Nine
Months Ended
September 30, 2006 | For the Nine
Months Ended
September 30, 2005
| | ---------------------------- | -------------------------------------------- | --------------------------------------------
|
|
|
|
| | Customer A (Military Export) |                                              |                                             
| | Customer B (Military Export) |                                              |                                             
| | Customer C (Military Local)  |                                              |                                             

16

---

---

DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSFOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)

|NOTE 8 | COMMITMENTS
AND CONTINGENCIES
|------ | -----------------------------

| | A. | Contingencies
| | -- | -------------

| | The
Company has an employment agreement with the President of the Company, pursuant to which
the President is entitled to additional compensation of 1.5% of the growth in the Companys
total sales since 2002. The President, at his discretion, may receive shares of common
stock in lieu of cash. For the year ended December 31, 2004, the President was entitled
to bonus compensation in the amount of $21,102, or 42,204 shares of the Companys
common stock in lieu of such compensation (having a fair value of $48,957), which was
accrued and included in other current liabilities and subsequently paid in 2005. For the
nine months ended September 30, 2006, there was no bonus due to the President of the
Company.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Other
Matters
| | -- | -------------

| | Export
Erez Ltd. and Mayotex Ltd., received a notification of audit from the Israeli Internal
Revenue Service for the years ended December 31, 2002, 2003, and 2004. The audit is in
the initial stage and the Company is unable to determine, what effect, if any, the audit
will have on the consolidated financial statements.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Former
Operations in Gaza Strip
| | -- | -------------------------------

| | During
2004, the Israeli Government decided to evacuate the Erez Industrial Zone in the Gaza
Strip where part of the Companys operations were located. The Company had owned
facilities, leased other facilities and maintained equipment and inventory within this
area. In 2005, the Company moved its light cut and sew operation from the
Erez Industrial Zone to Sderot as well as some of its webbing equipment to Nazareth. In
August 2005, the Company evacuated its remaining operations and abandoned the buildings
owned and leased in the Erez Industrial Zone. The Israeli Governments decision to
evacuate the Gaza Strip was supported by certain resolutions, as well as the Evacuation
Lawthat was adopted by the Israeli Parliament, to compensate the Israeli Gaza Strip
settlers as well as business and property owners in the Gaza Strip and in the Erez
Industrial Zone, however, the amount of the compensation has not been finalized.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17

---

---



DEFENSE INDUSTRIES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSFOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)

| | The
Company incurred $217,477 in costs related to the evacuation of its facilities located in
the Erez Industrial Zone in the Gaza Strip, which includes $89,612 in moving expenses and
$127,865, of net book value for the building that was abandoned. The Company believes
that it will be reimbursed in full for all costs related to the evacuation as well as the
fair market value of the abandoned facilities in the Erez Industrial Zone. As a result,
the Company has reclassified the net book value of the abandoned assets as well as the
evacuation costs to a receivable from the State of Israel in the amount of $217,477 which
is included in Other Current Assets in the Consolidated Balance Sheet at September 30,
2006 and December 31, 2005.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Since
the Company believes that it will be reimbursed for the fair market value of the abandoned
building, there is a potential gain contingency that will be recorded when and if
realized.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

18

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|Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

This
information should be read in conjunction with the condensed consolidated financial
statements and notes included in Item 1 of Part I of this Quarterly Report and the audited
consolidated financial statements and notes thereto and Managements Discussion and
Analysis of Financial Condition and Results of Operations for the year ended December 31,
2005 contained in our 2005 Annual Report on Form 10-KSB. The discussion and analysis which
follows may contain trend analysis and other forward-looking statements within the meaning
of Section 21E of the Securities Exchange Act of 1934 which reflect our current views with
respect to future events and financial results. These include statements regarding our
earnings, projected growth and forecasts, and similar matters that are not historical
facts.

We
remind shareholders that forward-looking statements are merely predictions and therefore
are inherently subject to uncertainties and other factors that could cause the future
results to differ materially from those described in the forward-looking statements.

# Critical Accounting
Policies

We
have identified the following policies as critical to the understanding of our condensed
consolidated financial statements. The preparation of our consolidated financial
statements 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 condensed consolidated financial statements and the reported amounts of
sales and expenses during the reporting periods. Our condensed consolidated financial
statements have been prepared in accordance with accounting principles generally accepted
in the United States.

Revenues
and Revenue Recognition. Revenues from sales of products are recognized upon shipment
to customers. We provide a warranty on goods ranging from three to four years. Our policy
is to consider the establishment of a reserve for warranty expenses. Based upon our
historical experience, we have not established any reserves at September 30, 2006 and
September 30, 2005. If we change any of our assumptions with regard to our recognition of
revenues, or if there is a change with respect to warrant expenses our financial position
and results of operations may change materially.

Foreign
Currency Translation and Transactions. The functional currency of Export Erez, Ltd.,
Mayotex Ltd., and Achidatex Nazareth Elite is the New Israeli Shekel, or NIS. The
functional currency of Dragonwear Trading Ltd. is the Cyprus Pound, or CYP. The financial
statements of Dragonwear are translated into NIS. The financial statements for all of
these entities are then translated into U.S. dollars from NIS at period-end exchange rates
as to assets and liabilities and average exchange rates as to revenues and expenses.
Capital accounts are translated at their historical exchange rates when the capital
transactions occurred. Foreign currency transaction gains or losses from transactions
denominated in currencies other than NIS are recognized in net income in the period the
gain or loss occurs. Any change in exchange rates may have a material impact on our
financial position and results of operations.

19

---

---



Accounts
Receivable. Accounts receivable consist primarily of receivables from customers and
institutions. We record a provision for doubtful accounts, when appropriate, to allow for
any amounts which may be unrecoverable based upon an analysis of our prior collection
experience, customer creditworthiness and current economic trends.

Inventories.
          Inventories are valued at the lower of cost or market value using the first-in
          first-out method. The cost includes expenses of freight-in transportation. The
          specific identification method is used for finished goods since all orders are
          custom orders for customers. Inventories write-offs and write-down provisions
          are provided to cover risks arising from slow-moving items or technological
          obsolescence. Any change in our assumptions with respect to the need to
          write-off or write-down the value of our inventories may have material affect on
          our financial position or results of operations.

Property
Plant and Equipment Fixed assets are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated useful lives of
three to twenty-five years. These long-lived assets are generally evaluated on an
individual basis in making a determination as to whether such assets are impaired.
Periodically, we review our long-lived assets for impairment based on estimated future
non-discounted cash flows attributed to the assets. In the event such cash flows are not
expected to be sufficient to recover the recorded value of the assets, the assets are
written down to their estimated fair values. The use of different assumptions with respect
to the expected cash flows from our assets and other economic variables, primarily the
discount rate, may lead to different conclusions regarding the recoverability of our
assets carrying values and to the potential need to record an impairment loss for
our long lived assets.

# Overview

We
are a manufacturer and global provider of personal military and civilian protective
equipment and supplies. Our products are used by military, law enforcement, border patrol
enforcement, and other special security forces, corporations, non-governmental
organizations and individuals throughout the world.

Our
main products include body armor, bomb disposal suits, bullet-resistant vests and jackets,
ballistic wall coverings, bullet-resistant ceramic and polyethylene panels, V.I.P. car
armoring and lightweight armor kits for vehicles, personal military equipment, dry storage
systems, liquid logistic products, tents and other camping and travel gear.

# Material Trends

Local
Military Market.The Israeli military defense budget has been subject to reductions
since the second half of 2003. As a result, the demand for our products declined in the
second half of 2003 and stabilized at a lower level in 2004 and 2005. The trend worsened
in the nine month period ended September 30, 2006. However, as a result of the war with
Hezbollah in Lebanon in July and August 2006, the Israeli military defense budget is
expected to increase significantly in 2007. As of October 2006, the demand for our local
military products increased, and we expect to increase our sales to the local military
market in the last quarter of 2006. In 2005 and in the nine month period ended September
30, 2006 sales to the Israeli Ministry of Defense, the Israelipolice and other
local customerswere $2,297,837 and $1,516,152, accounting for 23.9% and 21.0% of
our sales.

20

---

---



In
the second half of 2005, the Israeli Government evacuated the Gaza Strip. As a result of
the Israeli Governments decisions and the evacuation, the Israeli Defense Forces, or
IDF, indicated that they will slightly reduce their manpowerand that equipment
will be stored for long periods in environments that will promote battlefield readiness
and the capability of quick deployment. In addition, as a result of the war between Israel
and the Hezbollah in Lebanon during July and August 2006, many Israeli reserve forces were
activated, and a large amount of stored equipment was removed from dry-storage
compartments and mobilized. In light of this situation, we believe that our local military
business will grow in 2007 as a result of an increase in the demand for our dry storage
systems products and other military gear. As of October 2006, the local military
markets demand for our dry storage products increased, and we expect our sales of
these products to the local military market will increase in the last quarter of 2006.

Export
Military Market. Our customers in this market are military and law enforcement
organizations, mostly in South America, North America and Europe. Their budgets fluctuate
and as a result we cannot identify definite trends in these markets. In 2005 and in the
nine month period ended September 30, 2006, we had sales of $1,271,099 and $563,899 in
North America, sales of $587,512 and $1,333,776 in South America and sales of $3,219,118
and $651,399, in Europe, respectively. In addition, in the nine month period ended
September 31, 2006 we had sales of $371,280 in Australia. The decline in sales is
primarily attributable to the general decline in sales of bullet-resistant vests.

On
November 17, 2003, in response to concerns from the law enforcement community, the U.S.
Department of Justice announced an initiative to address the reliability of body armor
used by law enforcement personnel and to examine the future of bullet-resistant technology
and testing. These concerns followed the failure of a relatively new Zylon®-based body
armor vest worn by a Pennsylvania police officer. As part of this initiative, the American
NIJ, examined Zylon®-based bullet-resistant vests (both new and used) and reviewed the
existing process by which bullet-resistant vests are certified. Zylon® (or PBO fiber
 poly-p-phenylene benzobisoxazole) is a high-strength organic fiber produced by
Toyobo Co., Ltd. On August 24, 2005, the American NIJ released a status report of its
examination to the Department of Justice in which the American NIJ announced, among other
things, that although the test results do not conclusively prove that all
Zylon®-containing body armor models have performance problems, they show that used
Zylon®-containing body armor may not provide the intended level of ballistic
resistance. The test results also imply that a visual inspection of body armor and its
ballistic panels does not indicate whether a particular piece of Zylon®-containing
body armor has maintained its ballistic performance. On such date, the American NIJ also
issued a Body Armor Standard Advisory Notice advising that it has identified Zylon® as
a material that appears to create a risk of death or serious injury as a result of
degraded ballistic performance when used in body armor. The American NIJ also introduced
the American NIJ 2005 Interim Requirements for Bullet-Resistant Body Armor, or the
American NIJ Interim Requirements, modifying and supplementing NIJ Standard 0101.04
(Ballistic Resistance of Personal Body Armor), or the American NIJ Standard 0101.04. Under
the NIJ Interim Requirements, any body armor model that was found by NIJ to be compliant
with NIJ Standard 0101.04 prior to the effective date of NIJ Interim Requirements must
obtain a notice of compliance from the NIJ in order to comply with its Interim
Requirements.

21

---

---



As
a result of these developments, legal proceedings were filed against certain U.S. based
manufacturers. In addition, certain major U.S. based manufacturers initiated exchange and
upgrade programs for bullet-resistant vests resulting in increased expenses.

Our
products do not contain Zylon®. In July 2006 we received a notice of compliance with
the American NIJ Interim Requirements with respect to our products that were previously
found by the American NIJ to be compliant with the American NIJ Standard 0101.04. We
believe that our products will qualify under the final standard to be introduced by the
American NIJ in the future.

As
a result of the above, therewas a general decline in sales of bullet-resistant
vests in our markets, which have affected our sales of bullet-resistant vests and our
results of operations since the last half of 2005. However, since the end of September2006 there was an increase in the demand for our bullet-resistant vests. We expect
that our export military business will improve in the last quarter of 2006, and in 2007.

Local
Civilian Market. Our product range to the civilian market is diversified. In 2004 and
2005, our local market business grew as a result of the improvement of the economic
situation in Israel. We expect an increase in this market in the last quarter of 2006 and
in the future.

Gross
Profit Margins.Our pricing policy, although slightly different for each product, is
based on our existing overall gross margin. We do not expect a material change in our
gross profit margins in the foreseeable in future.

Backlog.
        We had approximately $2.91 million of unfilled customer orders at September
          30, 2006 as compared to $3.85million of unfilled orders at September 30,
          2005. Out of the $2.91 million of unfilled customer orders at September 30,
          2006, approximately $265,000 was attributable to orders from military customers
          in South America, approximately $767,000 was attributable to the U.S. civilian
          market, approximately $341,000 was attributable to the local civilian market,
          approximately $1.03 million was attributable to the Israeli military,
          approximately $313,000 was attributable to orders from Europe, Asia and Africa
          and approximately $200,000 was attributable to orders from Australia.

22

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# Operations in the Erez
Industrial Zone

During
2004, the Israeli Government decided to evacuate the Erez Industrial Zone in the Gaza
Strip where part of our operations were located. We evacuated our remaining operations
from the Erez Industrial Zone in August 2005. The Israeli Governments decision to
evacuate the Gaza Strip was supported by certain resolutions as well as the Israeli
Evacuation Compensation Law (2005), that was adopted by the Israeli Parliament to
compensate the Israeli Gaza Strip settlers as well as business and property owners in the
Gaza Strip and in the Erez Industrial Zone.

During
the second half of 2004, we prepared for the eventual evacuation by merging some of our
existing production facilities. We moved one of our light cut and sew
operations to Sderot and some of our webbing equipment to Nazareth.

At
September 30, 2006 we recorded a receivable in the amount of $217,447, which represents
costs incurred related to the evacuation of the Erez Industrial Zone, which according to
the Evacuation Law are recoverable from the State of Israel. Of theses costs,
$127,865 represents the net book value of the facilities abandoned and $89,612 represents
all other moving costs. In February 2006, three of our subsidiaries, Export Erez Ltd.,
Mayotex Ltd. and Achidatex Nazareth Elite (1997) Ltd. filed a claim for compensation
pursuant to the Evacuation Compensation Law. At this stage of the proceedings,
negotiations are taking place with respect to the amount of compensation to be paid to us
under such claim. We cannot provide any assurance that the claim, which substantially
exceeded the amount of our receivable, will be approved in full, or to what extent, or
when the compensation will be paid.

# Results of Operations

# Three Months Ended
September 30, 2006 Compared with Three Months Ended September 30, 2005

# Results of Operations

Net
Revenues and Gross Profit Margin. Net revenues for the three months ended September
30, 2006 increased to $3,547,956 from $1,992,642 in the same period in 2005, an increase
of 78.0%. The increase is primarily attributable to the increase in export sales,
resulting mainly from the increase in sales of bullet-resistant vests and large size armor
plates that we started to sell recently and from the increase of our sales to the civilian
market in the U.S. In the three months ended September 30, 2006, Export Erez, Achidatex,
and Owen Mills accounted for $2,388,788 or 67.3%, $870,120 or 24.5%, and $289,048 or 8.2%
of our revenues, respectively. In the three months ended September 30, 2005 Export Erez,
Achidatex and Owen Mills accounted for $952,382 or 47.8%, $730,026 or 36.6% and $310,234
or 15.6% of our revenues, respectively.

The
following table sets forth the breakdown of sales by segment for the three months ended
September 30, 2006 and 2005.

23

---

---



|                                   | Three months ended September 30,
|---------------------------------- | --------------------------------
|
|
|
|
|Sales to the local civilian market |                                 
|Sales to the local military market |                                 
|Export military sales              |                                 
|                                   |                                 
|Total                              |                                 
|                                   |                                 

Gross
profit for the three months ended September 30, 2006 was $1,196,190compared to
$531,405 for the same period in 2005. This increase in gross profit is principally
attributable to the increase in our sales in the three months period ended September 30,
2006. In the three months ended September 30, 2006 Export Erez, Achidatex and Owen Mills
accounted for 58.8%, 33.0% and 8.2%, of our gross profit, respectively. In the three
months ended September 30, 2005 Export Erez, Achidatex and Owen Mills accounted for 39%,
51% and 10%, of our gross profit, respectively.

Selling
Expenses. Selling expenses for the three months ended September 30, 2006 decreased to
$196,831from $224,941 for the same period in 2005. The decrease in our selling
expenses was attributable to the decrease in rates of commissions paid to our agents. Export Erezs selling expenses for the three months ended September 30, 2006
were $165,383compared to $106,439for the three months ended September 30,
2005. Achidatexs selling expenses for the three months ended September 30, 2006 were
$26,522compared to $118,502for the three months ended September 30, 2005.
Owen Mills selling expenses for the three months ended September 30, 2006 were $4,926.
Owen Mills did not record any selling expense for the three months ended September 30,
2005.

General
and Administrative Expenses. General and administrative expenses for three months
ended September 30, 2006 increased to $536,137 from $431,620 for the same period in 2005,
mainly as a result of an increase in accounting services and auditing fees.

Financial
Expenses. We had financial expenses, net of $95,046 for the three months ended
September 30, 2006 as compared to financial expenses, net of $11,286 for the same period
in 2005. This increase is mainly attributable to the significant decrease in the exchange
rate between the U.S. dollar and the NIS .

Gain
on Fair Value Adjustment to Embedded Derivatives. Pursuant to a securities purchase
agreement we executed a with a group of investors on June 15, 2005, we issued to such
investors warrants to purchase 627,500 shares of our common stock. Our accounting for the
warrants was based on guidance from SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities and EITF No. 00-19. Accounting for Derivative Financial Instruments
Indexed to and Potentially Settled in a Companys Own Stock. Accordingly, the
warrants were treated as derivatives and classified as a liability. The warrants were
recorded at fair value, based on the Black-Scholes pricing model, and will be revalued
each reporting period with the change in fair value recorded as other income (expenses).
For the three months ended September 30, 2006, the fair value adjustment resulted in a
loss of $31,984.

24

---

---



Other Income (Expenses), Net. We had other income, net for the three months ended
September 30, 2006 of $18,077 as compared to other income, net of $39,763 for the same
period in 2005. Our other income in 2006 is attributable to realized and unrealized gains
from our sale of securities and gains from sale of fixed asset.

Income
               Tax Expense (Benefit). Our income tax expense for the three months ended September 30,
2006 was $23,774 as compared to an income tax benefit of $28,569 for the comparable period
in 2005. As an Israeli taxpayer, we are unable to include the losses of Owen Mills in our
consolidated income tax filings in Israel. Export Erezs income tax expense for the
three months ended September 30, 2006 was $25,836 compared to income tax benefit of
$27,853 for the three months ended September 30, 2005. Achidatexs income tax benefit
for the three months ended September 30, 2006 was $2,062 compared to a tax benefit of
$15,949 for the three months ended September 30, 2005. Defense Industries did not have any
tax expenses for the three months ended September 30, 2006 compared to a tax expense of
$15,233 for the three months ended September 30, 2005. Owen Mills did not have any
tax expenses for the three months ended September 30, 2006 or the three months ended
September 30, 2005.

Minority
Interest. Minority interest in the profits and losses of one of our consolidated
subsidiaries represents the minority shareholders share of the profits or losses in
such majority owned subsidiary. For the three months ended September 30, 2006, we
recognized and recorded minority share in our profit of $68,017 compared with the share in
our loss of $12,568 for the three months ended September 30, 2005.

Net
Income (Loss). In the three months ended September 30, 2006 we had net income of
$275,058 as compared to a net loss of $55,542 for the three months ended September 30,
2005. Export Erezs net income for the three months ended September 30, 2006 was
$261,923 compared to a net loss of $78,465, for the three months ended September 30, 2005.
Achidatexs net income for the three months ended September 30, 2006 was $146,998
compared to net income of $104,258 for the three months ended September 30, 2005. Owen
Mills net income for the three months ended September 30, 2006 was $5,538 compared
to a net loss of $25,650 for the three months ended September 30, 2005. Defense
Industries net loss for the three months ended September 30, 2006 was
$139,401compared to net loss of $55,685 for the three months ended September 30, 2005.

Other
Comprehensive Income (Loss). We had other comprehensive income, for the three months
ended September 30, 2006 of $119,839 as compared to other comprehensive loss of $8,145 for
the three months ended September 30, 2005. This income is principally attributable to the
decrease of the exchange rate of U.S. dollar against the NIS.

25

---

---



# Nine Months Ended
September 30, 2006 Compared with Nine Months Ended September 30, 2005

# Results of Operations

Net
Revenues and Gross Profit Margin. Net revenues for the nine months period ended
September 30, 2006 decreased to $7,212,354 from $9,584,813 in the same period in 2005, a
decrease of 24.7%. The decrease is primarily attributable to the decrease in export sales,
resulting mainly from the general decline in sales of bullet-resistant vests and
from a reduction in sales to the IDF due to the reduction of the IDF budget for 2006. In
the nine months ended September 30, 2006, Export Erez, Achidatex and Owen Mills accounted
for $4,265,580 or 59.1%, $2,199,393 or 30.5% and $747,381or 10.4% of our revenues,
respectively. In the nine months ended September 30, 2005 Export Erez, Achidatex and Owen
Mills accounted for $4,763,652 or 49.7%, $4,149,724 or 43.3% and $671,437 or 7% of our
revenues, respectively.

The
following table sets forth the breakdown of sales by segment for the nine months ended
September 30, 2006 and 2005.

|                                   | Nine months ended September 30,
|---------------------------------- | -------------------------------
|
|
|
|
|Sales to the local civilian market |                                
|Sales to the local military market |                                
|Export military sales              |                                
|                                   |                                
|Total                              |                                
|                                   |                                

The
Israeli Military of Defense budget has been subject to reductions since the second half of
2003.In the nine month period ended September 30, 2006 this trend continued and
worsened. The decline in export military sales is primarily attributable to the general
decline in sales of bullet-resistant vests.

Gross
profit for the nine months ended September 30, 2006 was $1,722,732compared to
$2,360,972 for the same period in 2005. This decrease in gross profit is principally
attributable to the decrease in our sales in the nine month period ended September 30,
2006. In the nine months ended September 30, 2006 Export Erez, Achidatex, and Owen Mills
accounted for 58.5%, 32.6% and 8.9%, of our gross profit, respectively. In the nine months
ended September 30, 2005 Export Erez, Achidatex and Owen Mills accounted for 40.7%, 54.3%
and 5%, of our gross profit, respectively.

Selling
Expenses. Selling expenses for the nine months ended September 30, 2006 decreased to
$414,906from $603,751 for the same the same period in 2005. The decrease in our
selling expenses was attributable to the decrease in export sales, which resulted in lower
commissions. Export Erezs selling expenses for the nine months ended September 30,
2006 were $271,201compared to $212,612 for the nine months ended September 30,
2005. Achidatexs selling expenses for the nine months ended September 30, 2006 were
$133,107compared to $391,139 for the nine months ended September 30, 2005. Owen
Mills selling expenses for the nine months ended September 30, 2006 were $10,598 Owen
Mills selling expenses for the period since its acquisition until September 30, 2006
was $178,755.

General
and Administrative Expenses. General and administrative expenses for nine months ended
September 30, 2006 increased to $1,530,204 from $1,389,667 for the same period in 2005,
mainly as a result of settling of accounts with our former auditors and an increase in
legal fees.

26

---

---



Financial
Expenses. We had financial expenses, net of $253,137 for the nine months ended
September 30, 2006 as compared to financial expenses, net of $46,723 for the same period
in 2005. This increase is mainly attributable to the decrease in the exchange rate between
the U.S. dollar and the NIS and the increase in the prevailing interest rate in Israel.

Gain
on Fair Value Adjustment to Embedded Derivatives. Pursuant to a securities purchase
agreement we executed a with a group of investors on June 15, 2005, we issued to such
investors warrants to purchase 627,500 shares of our common stock. Our accounting for the
warrants was based on guidance from SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities and EITF No. 00-19. Accounting for Derivative Financial Instruments
Indexed to and Potentially Settled in a Companys Own Stock. Accordingly, the
warrants were treated as derivatives and classified as a liability. The warrants were
recorded at fair value, based on the Black-Scholes pricing model, and will be revalued
each reporting period with the change in fair value recorded as other income (expenses).
For the nine months ended September 30, 2006, the fair value adjustment resulted in a gain
of $6,376.

Other
Income, Net. We had other income, net for the nine months ended September 30, 2006 of
$32,166 as compared to other income, net of $104,475 for the same period in 2005. Our
other income in 2006 is attributable to realized and unrealized gains from our sale of
securities and sales of fixed asset.

Income
Tax Expense (Benefit). Our income tax expense for the nine months ended September 30,
2006 was $20,310 as compared to a tax expense of $153,460 for the comparable period in
2005. As an Israeli tax payer, we are unable to include the losses of Owen Mills in our
consolidated income tax filings in Israel. Export Erezs income tax expense for the
nine months ended September 30, 2006 was $42,819 compared to income tax expense of $52,613
for the nine months ended September 30, 2005. Achidatexs income tax benefit for the
nine months ended September 30, 2006 was $23,309 compared to tax expense of $84,503 for
the nine months ended September 30, 2005. Defense Industries did not have any tax expenses
for the nine months ended September 30, 2006 compared to a tax expense of $16,344 for the
nine months ended September 30, 2005. Owen Mills income tax expense for the nine
months ended September 30, 2006 was $800. Owen Mills did not record any tax expense for
the nine months ended September 30, 2005.

Minority
Interest. Minority interest in the profits and losses of one of our consolidated
subsidiaries represents the minority shareholders share of the profits or losses in
such majority owned subsidiary. For the nine months ended September 30, 2006, we
recognized and recorded minority share in our loss of $27,195 compared with the minority
share in our profit of $39,037 for the nine months ended September 30, 2005.

Net
Income (Loss). In the nine months ended September 30, 2006 we had a net loss of
$430,088 as compared to net income of $232,809 for the nine months ended September 30,
2005. Export Erezs net income for the nine months ended September 30, 2006 was
$120,996 compared to net income of $147,561 for the nine months ended September 30, 2005.
Achidatexs net loss for the nine months ended September 30, 2006 was $226,557
compared to net income of $195,602 for the nine months ended September 30, 2005. Owen
Mills net loss for the nine months ended September 30, 2006 was $114,491 compared to
a net loss of $60,967 for the nine months ended September 30, 2005. Our net loss for the
nine months ended September 30, 2006 was $210,036 compared to net loss of $49,387 for the
nine months ended September 30, 2005.

27

---

---



Other
Comprehensive Income (Loss). We had other comprehensive income, for the nine months
ended September 30, 2006 of $280,862 as compared to other comprehensive loss of $242,712
for the nine months ended September 30, 2005. This income is principally attributable to
the decrease of the exchange rate of the U.S. dollar against the NIS.

# Liquidity and Capital
Resources

As
of September 30, 2006, we had $1,485,754 in cash and cash equivalents, $778,966 in
marketable securities and working capital of $4,670,344 as compared to $1,581,967 in cash
and cash equivalents, $739,339 in marketable securities and $4,618,405 in working capital
at December 31, 2005.

# Cash Flows

The
following table summarizes our cash flows for the periods presented:

|                                                             | Nine months ended September 30,
|------------------------------------------------------------ | -------------------------------
|
|
|
|
|Net cash provided by (used in) operating activities          |                                
|Net cash provided by (used in) investing activities          |                                
|Net cash provided by financing  activities                   |                                
|Effect of exchange rate changes on cash and cash equivalents |                                
|Increase (decrease) in cash and cash equivalents             |                                
|Cash and cash equivalents at the beginning of the period     |                                
|Cash and cash equivalents at the end of the period           |                                
|                                                             |                                

Net
cash used in operating activities was $506,075 for the nine months ended September 30,
2006 as compared to $516,318 provided from operating activities for the same period in
2005. This was primarily attributable to a net loss of $430,088 in this period, and an
increase in accounts receivable of $1,196,802, which was offset by an increase in accounts
payable of $683,957, depreciation costs of $331,422 and decrease in inventory of $103,280.

Net
cash used in investing activities was $221,524 for the nine months ended September 30,
2006 as compared to $342,780 in the nine months ended September 30, 2005. During the nine
months ended September 30, 2006, $213,678 (net of sales of fixed assets) was used to
purchase fixed assets, while $28,588 (net of purchases of trading securities) was provided
from sales of our trading securities, and $36,434 was used for the payment to employee
retirement funds in respect to employee rights upon retirement.

28

---

---



Net
cash provided by financing activities was $548,051 for the nine months ended September 30,
2006 as compared to $42,635 in the nine months ended September 30, 2005. During the nine
months ended September 30, 2006, we increased our short-term debt by $410,787, and our
long-term debt by $137,264.

Most
of our large purchase orders are supported by letters of credit. As a result, we believe
that we have limited exposure to doubtful accounts receivables. We have historically
achieved net profits on an annual basis, but our quarterly profits are not consistent on a
quarter to quarter basis. Nevertheless, we have striven to balance our accounts payable
and account receivable.

We
believe that our spending for research and development the remainder of 2006 and for 2007
will be consistent with our spending in 2005 of $70,000 per year.

We
believe that we have sufficient working capital and borrowing capability to sustain our
current level of operations for the next twelve months.

Recent Accounting
Pronouncements

In
September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 108, Considering the Effects of Prior Year Misstatements when
Quantifying Current Year Misstatements. SAB No. 108 requires analysis of
misstatements using both an income statement (rollover) approach and a balance sheet (iron
curtain) approach in assessing materiality and provides for a one-time cumulative effect
transition adjustment. SAB No. 108 is effective for fiscal year 2007 annual financial
statements.

We
are currently assessing the potential impact that the adoption of SAB No. 108 will
have on our financial statements; the impact is not expected to be material.

In
September 2006, the Financial Accounting Standards Board (FASB) issued SFAS
No. 158, Employers Accounting for Defined Benefit Pension and Other
Postretirement Plans-An Amendment of FASB Statements No. 87, 88, 106, and 132R
(SFAS No. 158). SFAS No. 158 requires that the funded status of defined benefit
postretirement plans be recognized on the companys balance sheet, and changes in the
funded status be reflected in comprehensive income, effective fiscal years ending after
December 15, 2006. SFAS No. 158 also requires the measurement date of the
plans funded status to be the same as the companys fiscal year-end. We are
currently assessing the potential impact that the adoption of SFAS No. 158 will have on
our financial statements; the impact is not expected to be material.

In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines
fair value, establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements. SFAS
No. 157 does not require any new fair value measurements, but provides guidance on
how to measure fair value by providing a fair value hierarchy used to classify the source
of the information. This statement is effective for periods beginning July 1, 2008.
We are currently assessing the potential impact that the adoption of SFAS No. 157
will have on our financial statements, the impact is not expected to be material.

29

---

---



In
June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes. The interpretation clarifies the
accounting for uncertainty in income taxes recognized in a companys financial
statements in accordance with Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes. The interpretation prescribes a recognition
threshold and a measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. The
interpretation also provides guidance on the related de-recognition, classification,
interest and penalties, accounting for interim periods, disclosure and transition of
uncertain tax positions. The interpretation is effective for fiscal years beginning after
December 15, 2006, with the cumulative effect of the change in accounting principle
recorded as an adjustment to opening retained earnings.

Although
our analysis of the effect of FIN 48 has not been completed, we do not anticipate
recording any material adjustment as a result of adopting this Interpretation.

In
June 2006, the FASB ratified the Emerging Issues Task Force
(EITF) consensus on EITF Issue No. 06-2, Accounting for
Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43".
EITF Issue No. 06-2 requires companies to accrue the costs of compensated absences
under a sabbatical or similar benefit arrangement over the requisite service period. EITF
Issue No. 06-2 is effective for periods beginning July 1, 2007. The cumulative
effect of the application of this consensus on prior period results should be recognized
through a cumulative-effect adjustment to retained earnings as of the beginning of the
year of adoption. Elective retrospective application is also permitted. We are currently
evaluating the financial impact of this guidance and the method of adoption that will be
used.

# Foreign Currency
Exchange Risk

We
develop products in Israel and sell them in North and South America, Asia and several
European countries. As a result, our financial results could be affected by factors such
as changes in foreign currency exchange rates or weak economic conditions in foreign
markets.

Our
foreign currency exposure with respect to our sales is mitigated, and we expect it will
continue to be mitigated, through salaries, materials and support operations, in which
part of these costs are denominated in NIS.

During
2005, the NIS devalued approximately 6.85% against the dollar. In the three month period
ended September 30, 2006, the U.S. dollar devaluated in relation to the NIS by
approximately 3.1%. The deflation rate in Israel was approximately 0.7% for the three
months ended September 30, 2006 compared to an annual inflation rate of 2.38% in 2005.

30

---

---



Since
most of our sales are quoted in dollars, and a portion of our expenses are incurred in
NIS, our results may be adversely affected by a change in the rate of inflation in Israel
or if such change in the rate of inflation is not offset, or is offset on a lagging basis,
by a corresponding devaluation of the NIS against the dollar and other foreign currencies.
We will also be adversely affected if the dollar depreciates against the Euro, the
currency used for many of our purchases of raw material.

We
did not enter into any foreign exchange contracts in 2005 or the nine month period ended
September 30, 2006.

# Contractual Obligations

The
following table summarizes our contractual obligations and commercial commitments as of
September 30, 2006.

|Contractual Obligations                                                                     | Payments due by Period
|------------------------------------------------------------------------------------------- | ----------------------
|
|
|
|
|Long-term debt obligations                                                                  |                       
|Capital (finance) lease obligations                                                         |                       
|Operating lease obligations                                                                 |                       
|Purchase obligations                                                                        |                       
|Other long-term liabilities
   reflected on the Company's
   balance sheet under  U.S. GAAP |                       
|                                                                                            |                       
|Total                                                                                       |                       
|                                                                                            |                       

31

---

---



# Cautionary Statement
Regarding Forward-Looking Information and Risk Factors

This
report contains forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Words such as anticipate, expect,
intend, plan, believe, seek,
outlook and estimate as well as similar words and phrases signify
forward-looking statements. Our forward-looking statements are not guarantees of future
results and conditions and important factors, risks and uncertainties may cause our actual
results to differ materially from those expressed in our forward-looking statements. These
uncertainties and other factors include, but are not limited to, the following and other
risk factors contained in our Annual Report on Form 10-KSB:

| |  | If
the decline in sales of bullet bullet-resistant vests continues, our operating results
will be negatively affected.
| | - | ----------------------------------------------------------------------------------------------------------------------

| |  | Our
significant international operations subject us to financial and regulatory risks.
| | - | --------------------------------------------------------------------------------------

| |  | Currency
exchange rate fluctuations in the world markets in which we conduct business could have a
material adverse effect on our business, results of operations and financial condition.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Sales
of our products are subject to governmental procurement procedures and practices;
termination, reduction or modification of contracts with our customers, and especially
with the government of Israel, or a substantial decrease in our customers budgets
may adversely affect on us.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
loss of one or more of our key customers would result in a loss of a significant amount
of our revenues.
| | - | ------------------------------------------------------------------------------------------------------------

|Item 3. | Controls
and Procedures
|------- | -----------------------

Our
management, including our chief executive officer and chief financial officer, evaluated
the effectiveness of our disclosure controls and procedures (as defined in Exchange Act
Rule 13a-15(e)) as of the end of the period covered by this quarterly report on Form
10-QSB. Based upon that evaluation, our chief executive officer and chief financial
officer have concluded that, as of such date, our disclosure controls and procedures were
effective to ensure that information required to be disclosed by our company in reports
that we file under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the Securities and
Exchange Commissions rules and forms and that such information was made known to
them by others within the company, as appropriate to allow timely decisions regarding
required disclosure.

32

---

---



# Changes in Internal
Controls over Financial Reporting

There
were no changes to our internal control over financial reporting that occurred during the
period covered by this quarterly report on Form 10-QSB that have materially affected, or
are reasonably likely to materially affect, our internal control over financial reporting.

# Compliance with Section
404 of Sarbanes-Oxley Act

Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002 (the Act), beginning with our Annual
Report on Form 10-KSB for our 2007 fiscal year, we will be required to furnish a report by
our management on our internal control over financial reporting. This report will contain,
among other matters, an assessment of the effectiveness of our internal control over
financial reporting as of the end of our fiscal year, including a statement as to whether
or not our internal control over financial reporting is effective. This assessment must
include disclosure of any material weaknesses in our internal control over financial
reporting identified by management. If we identify one or more material weaknesses in our
internal control over financial reporting, we will be unable to assert our internal
control over financial reporting is effective. It is unclear at this time as to whether
this report will also contain a statement that our independent registered public
accountants have issued an attestation report on managements assessment of such
internal controls and a conclusion on the operating effectiveness of those controls.

33

---

---



# PART II  OTHER
INFORMATION

# DEFENSE INDUSTRIES
INTERNATIONAL, INC. AND SUBSIDIARIES

|Item 1. | Legal
Proceedings
|------- | -----------------

We
are not a party to any pending or to the best of our knowledge, any threatening legal
proceedings. None of our directors, officers or affiliates, or owner of record of more
than five percent (5%) of our shares, or any affiliate of any such director, officer or
security holder is a party adverse to us or has a material interest adverse to us in
reference to a pending litigation.

|Item 2. | Unregistered
Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

| | None.
| | -----

|Item 3. | Default
Upon Senior Securities
|------- | ------------------------------

| | None.
| | -----

|Item 4. | Submission
of Matters to a Vote of Shareholders
|------- | -----------------------------------------------

| | None.
| | -----

|Item 5. | Other
Information
|------- | -----------------

| | None.
| | -----

|Item 6. | Exhibits
and Reports on Form 8-K
|------- | --------------------------------

|(a) | Exhibits
|--- | --------

|3.1 |  | Certificate
of Incorporation,  incorporated  herein by reference from the filing on Form
                  10-KSB for the year ended December 31, 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------

|3.1.1 |  | Certificate
of Amendment to the  Certificate of  Incorporation,  incorporated  herein by
                  reference  from the Filing on Schedule  14C,  filed with the
 Commission on December 30,                   2002.
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.2 |  | By-laws,
 incorporated  herein by reference  from the Filing on Schedule 14C, filed with
                  the Commission on June 14, 2002.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|10.1 |  | Translation
of Employment  Agreement with Mr. Tosh,  incorporated  herein by reference from
                  the filing on Form 10-KSB for the year ended December 31, 2003.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

34

---

---



|31.1 |  | Certification
 by Chief  Executive  Officer  Pursuant to Section 302 of                   the
Sarbanes-Oxley Act of 2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------

|31.2 |  | Certification
 by Chief  Financial  Officer  Pursuant to Section 302 of                   the
Sarbanes-Oxley Act of 2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------

|32.1 |  | Certification
 by  Chief  Executive   Officer  Pursuant  to  18  U.S.C.                   Section
  1350,   As   Adopted   Pursuant   to   Section   906  of  the
                  Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|32.2 |  | Certification
 by  Chief  Financial   Officer  Pursuant  to  18  U.S.C.                   Section
  1350,   As   Adopted   Pursuant   to   Section   906  of  the
                  Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

35

---

---



# SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized.

| |  | DEFENSE INDUSTRIES INTERNATIONAL, INC.
(Registrant)By: /s/ Joseph Postbinder
Joseph PostbinderChief Executive Officer
| |  | -----------------------------------------------------------------------------------------------------------------------------------

| |  | By: /s/ Tsippy Moldovan
Tsippy MoldovanChief Accounting and Financial Officer
| |  | -------------------------------------------------------------------------------------------

Date: November 14, 2006

36

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