UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                   Quarterly Report Under Section 13 or 15(d)
                     of the Securities Exchange Act of 1934

                                  FORM 10-QSB/A

                For the Quarterly Period Ended September 30, 2006

                        Commission File Number: 333-46424

                           CYBER DEFENSE SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

               FLORIDA                                   55-0610380
----------------------------------------            -------------------
  (State or other jurisdiction of                    (I.R.S. Employer
   incorporation or organization)                   Identification No.)

 10901 ROOSEVELT BOULEVARD, SUITE 100D
        ST. PETERSBURG, FLORIDA                             33716
----------------------------------------            -------------------
(Address of principal executive offices)                 (Zip code)

                   Registrant's telephone number: 727-577-0878

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the 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 |_|

Indicate by checkmark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act) YES |_| NO |X|

Transitional Small Business Disclosure Format: Yes |_| No [X]

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the close of the latest practical date.

            Title of Class              Number of Shares Outstanding
     ----------------------------    ----------------------------------
     Class A Common Stock
      (par value $0.001 per share)   67,367,316 as of November 16, 2006
     Class B Common Stock
      (Par Value $0.001 per share)      545,455 as of November 16, 2006
     Class C Common Stock
      Par value $0.001 per share)             2 as of November 16, 2006


                                       1
<PAGE>

                                      INDEX

                                                                           Page
                                                                          Number
                                                                          ------

                          PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements
         Condensed Consolidated Balance Sheets as of
           September 30, 2006 and December 31, 2005 (unaudited) .......       1
         Condensed Consolidated Statements of Operations
           for the Three and Nine Months Ended
           September 30, 2006 and 2005 (unaudited) ....................       2
         Condensed Consolidated Statements of Cash
           Flows for the Nine Months Ended September
           30, 2006 and 2005 (unaudited) ..............................     3-4
         Notes to the Condensed Consolidated Financial
           Statements (unaudited) .....................................    5-22

Item 2.  Management's Discussion and Analysis of
           Financial Condition or Plan of Operations ..................      23

Item 3.  Controls and procedures ......................................      28

                           PART II. OTHER INFORMATION

Item 1.  Legal Proceedings ............................................      29

Item 2.  Unregistered Sales of Equity Securities ......................      29

Item 3.  Defaults Upon Senior Securities ..............................      29

Item 4.  Submission of Matters to a Vote of Security Holders ..........      29

Item 5.  Other Information ............................................      29

Item 6.  Exhibits and Reports on Form 8-K .............................      30

Signatures ............................................................      32


                                       2
<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                             September 30, 2006   December 31, 2005
                                                             ------------------   -----------------
<S>                                                             <C>                  <C>
                                    ASSETS
CURRENT ASSETS:
Cash and cash equivalents                                       $         --         $        476
Accounts receivable                                                  154,821              364,299
Inventory                                                            891,056              336,523
Prepaid interest                                                          --               32,580
                                                                ------------         ------------
    TOTAL CURRENT ASSETS                                           1,045,877              733,878
                                                                ------------         ------------
OTHER ASSETS:
Intangible assets, net of accumulated amortization
  of $86,114 and $61,113 respectively                                 13,886               38,887
Property and equipment, net of accumulated depreciation
  of $21,805 and $10,173 respectively                                 70,977               91,973
Deposits and costs of equipment                                      150,976              150,976
Airship manufacturing license, net of accumulated
  amortization of $0 and $230,993 respectively                     2,100,000           14,024,656
Loan costs, net of accumulated amortization of $788,920
  and $364,697 respectively                                        1,006,558            1,228,897
Security deposits                                                      7,371                7,371
                                                                ------------         ------------
    TOTAL ASSETS                                                $  4,395,645         $ 16,276,638
                                                                ============         ============

                      LIABILITIES AND SHAREHOLDERS' DEFICIT

CURRENT LIABILITIES:
Accounts payable and accrued liabilities                        $  3,063,186         $  2,996,827
Accrued interest                                                     739,893              329,626
Accounts payable related parties                                          --               53,337
Deferred revenue                                                   1,833,333              450,000
Notes payable - related parties' net of discount of
  $195,291 and $0, respectively                                      671,031            1,562,315
Note payable - unrelated parties                                   1,572,875            1,728,075
Embedded derivative liability                                      8,984,765           10,057,733
                                                                ------------         ------------
    TOTAL CURRENT LIABILITIES                                     16,865,083           17,177,913
                                                                ------------         ------------
NON-CURRENT LIABILITIES:
Notes payable, net of discount of $3,295,391 and
  $2,762,333, respectively                                         1,644,388              655,358
Deferred taxes                                                            --              217,325
                                                                ------------         ------------
    TOTAL LIABILITIES                                             18,509,471           18,050,596
                                                                ------------         ------------
Commitments and contingencies                                             --                   --

SHAREHOLDERS' DEFICIT:
Class A preferred stock, $0.001 par value; 100,000,000
  Shares authorized; none issued and outstanding                          --                   --
Common stock:
Class A, $0.001 par value; 200,000,000 shares authorized;
  67,367,316 and 56,912,893 shares issued and outstanding             67,367               56,913
Class B, $0.001 par value; 200,000,000 shares authorized;
  545,455 shares issued and outstanding                                  545                  545
Class C, $0.001 par value; 200,000,000 shares authorized;
  2 shares issued and outstanding                                         --                   --
Additional paid-in capital                                        20,413,803           14,644,966
Accumulated deficit                                              (34,595,541)          16,476,382)
                                                                ------------         ------------
Total shareholders' deficit                                      (14,113,826)          (1,773,958)
                                                                ------------         ------------
    TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT                 $  4,395,645         $ 16,276,638
                                                                ============         ============
</TABLE>

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


                                       1
<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)

                           THREE AND NINE MONTHS ENDED
                                  SEPTEMBER 30,

<TABLE>
<CAPTION>
                                             For the Three Months Ended           For the Nine Months Ended
                                                    September 30,                       September 30,
                                           ------------------------------      ------------------------------
                                               2006              2005              2006              2005
                                           ------------      ------------      ------------      ------------
<S>                                        <C>               <C>               <C>               <C>
Revenue                                    $    136,137      $    114,873      $    438,031      $    180,638

Cost of sales                                    58,120            88,032           202,391           123,423
                                           ------------      ------------      ------------      ------------

Gross profit                                     78,017            26,841           235,640            57,215
                                           ------------      ------------      ------------      ------------
Operating expenses:

General and administrative                    1,630,022         1,155,939         5,246,277         2,486,713
Stock option compensation                     1,287,008            10,800         2,271,287            10,800
Research and development                         90,406                --           189,668           543,191
Impairment of license                        11,330,674                --        11,330,674                --
Impairment of goodwill                               --                --                --         4,577,069
                                           ------------      ------------      ------------      ------------
Total operating expenses                     14,338,110         1,166,739        19,037,906         7,617,773

Loss from operations                        (14,260,093)       (1,139,898)      (18,802,266)       (7,560,558)

Other income (expense)

  Other income                                       --            32,845                --            32,845
  Interest income                                    --            10,386                --            20,627
  Interest expense                           (1,157,741)       (1,028,259)       (2,543,411)       (1,889,344)
  Derivative valuation gain (loss)             (485,507)         (176,862)        3,009,193        (7,673,072)
                                           ------------      ------------      ------------      ------------
     Total other income (expense)            (1,643,248)       (1,161,890)          465,762        (9,508,944)

Loss before income taxes                    (15,903,341)       (2,301,788)      (18,336,484)      (17,069,502)
                                           ------------      ------------      ------------      ------------

Income tax benefit                                   --         1,582,328           217,325         1,582,328
                                           ------------      ------------      ------------      ------------

Net  loss                                  $(15,903,341)     $   (719,460)     $(18,119,159)     $(15,487,174)
                                           ============      ============      ============      ============
Per share data:
Net loss per common
share - basic and diluted                  $      (0.26)     $      (0.02)     $      (0.31)     $      (0.54)
                                           ============      ============      ============      ============
Weighted average Class A common
shares outstanding - basic and diluted       61,023,924        31,217,286        58,941,832        28,432,121
                                           ============      ============      ============      ============
</TABLE>

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


                                       2
<PAGE>

                           CYBER DEFENSE SYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)

                                NINE MONTHS ENDED
                                  SEPTEMBER 30,

<TABLE>
<CAPTION>
                                                          2006              2005
                                                      ------------      ------------
<S>                                                   <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES
  Net loss                                            $(18,119,159)     $(15,487,174)
  Adjustments to reconcile net loss
  to net cash from operating activities:
    Interest expense from amortization of
      loan discount                                      1,966,714         1,450,363
    Derivative valuation (gain) loss                    (3,009,193)        7,673,072
    Stock option compensation                            2,271,687            10,800
    Issuance of stock for services                         389,793           338,750
    Issuance of warrant for services                       419,760                --
    Issuance of note for services                          351,192                --
    Depreciation and amortization                        1,054,838           318,522
    Income tax benefit                                    (217,325)       (1,582,328)
    Impairment of goodwill                                      --         4,577,069
    Impairment of license                               11,330,674                --
    Write-off of intangible assets                              --             5,543
  Changes in assets and liabilities:
    Accounts receivable                                    209,478           618,698
    Inventory                                             (554,533)         (478,623)
    Prepaid expenses                                        32,580          (190,707)
    Security deposits                                           --              (215)
    Accounts payable and accrued liabilities               506,996          (358,418)
    Accrued interest                                       499,891                --
    Accounts payable - related party                            --           (76,163)
    Deferred revenue                                     1,383,333            (4,861)
                                                      ------------      ------------
NET CASH FROM OPERATING ACTIVITIES                      (1,483,274)       (3,185,672)
                                                      ------------      ------------
CASH FLOWS FROM INVESTING ACTIVITIES
   Loan to Techsphere                                           --        (1,074,362)
   Cash received in acquisition of Techsphere                   --            25,010
   Purchase of equipment                                    (2,636)          (12,000)
                                                      ------------      ------------
NET CASH FROM INVESTING ACTIVITIES                          (2,636)       (1,061,352)
                                                      ------------      ------------
CASH FLOWS FROM FINANCING ACTIVITIES
  Proceeds from notes payable                               82,000                --
  Gross Proceeds from sale of secured convertible
    Notes payable                                        1,700,000         4,000,000
  Proceeds from notes payable, related parties             281,573           288,471
  Issuance of common stock                                      --           255,209
  Payments of loan costs                                  (120,000)         (248,065)
  Principal payments on notes payable
    unrelated parties                                     (383,139)         (105,156)
  Principal payments on notes payable
    related parties                                        (75,000)          (53,740)
  Payments on debt assumed from subsidiary                      --           (33,337)
                                                      ------------      ------------
NET CASH FROM FINANCING ACTIVITIES                       1,485,434         4,103,382
                                                      ------------      ------------
Net increase (decrease) in cash                               (476)         (143,642)
Cash and cash equivalents, beginning                           476           206,270
                                                      ------------      ------------
Cash and cash equivalents, ending                     $         --      $     62,628
                                                      ============      ============
</TABLE>

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


                                       3
<PAGE>

                           CYBER DEFENSE SYSTEMS, INC.
           CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
                                   (Unaudited)

                                NINE MONTHS ENDED
                                  SEPTEMBER 30,

                                                         2006           2005
                                                      -----------    -----------
Supplemental disclosure of cash flow information:
Cash paid for interest                                $    21,445    $   109,333
Cash paid for income taxes                                     --             --

Supplemental disclosure of non-cash investing and
  financing information:
Partial payment of purchase cost of a license
  with a note payable                                          --        250,000
Payment of note payable by Mr. Robinson
  on behalf of the Company                                 74,523        288,177
Conversion of notes payable into common stock             697,243      1,479,300
Conversion of notes payable - related party into
  common stock                                            289,333             --
Conversion of accounts payable - related party
  to a note payable                                        47,930        350,000
Issuance of warrants for discount on notes
  and loan costs                                          671,044     12,150,732
Exercise of stock options                                 884,232             --
Common Stock issued for loan costs                         55,880        200,000
Common Stock issued for shares of Cyber Aerospace              --      4,603,650
Common Stock issued for Techsphere                             --      5,316,904

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


                                       4
<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION, ACQUISITIONS AND MERGERS AND CONTROLLING SHAREHOLDERS --Cyber
Defense Systems, Inc. ("the Registrant" or "Cyber Defense" or "the Company") was
incorporated on August 19, 2004 in Florida. E-City Software, Inc. ("E-City") was
organized in Nevada on May 12, 2000. On Alert Systems, Inc. ("On Alert") was
incorporated on March 17, 2003 in Nevada and acquired a control position in
E-City in May of 2003 and in Cyber Aerospace Corp. ("Cyber Aerospace") in March
2004. On Alert was merged with and into Cyber Defense on September 1, 2004. On
September 1, 2004 E-City was also merged with and into Cyber Defense following
the On Alert merger. As a result of the aforementioned, Cyber Defense became the
successor to E-City and its shares of class A common stock began trading on the
Over the Counter Bulletin Board ("OTC:BB") under the symbol CYDF on September 7,
2004. Due to the nature of the mergers, the fiscal year end of the Company was
changed to December 31 effective for Fiscal 2003 and the historical financial
statements of the Company are now those of On Alert and include results of
operations for Cyber Aerospace from its date of inception in March 2004, as it
was previously a subsidiary of On Alert, and includes the results of operations
of E-City from it's date of merger, September 1, 2004. Cyber Aerospace was
merged with and into Cyber Defense effective March 31, 2005 with the acquisition
of the 6.19% minority interest in Cyber Aerospace for 1,650,000 shares of class
A common stock and 150,000 shares of class B common stock. In addition, on
September 19, 2005, the Company acquired its wholly owned subsidiary Techsphere
Systems International, Inc. ("TSI") for 23,076,923 Class A common shares and
245,455 Class B common shares.

The controlling shareholders of the company are Proxity, Inc. ("Proxity"), a
publicly traded company ("PRXT") and Cherokee Raiders, a partnership,
("Cherokee") owning approximately 21.7% and 14.6% of the Class A common shares
of the Company, respectively. In addition, the former shareholders of TSI also
own 21,219,111 shares or 31.5% of the Class A common stock and 245,455 or 45%,
of the issued and outstanding shares of Class B common stock as of September 30,
2006. Cherokee owns 300,000 or 55% of such class B shares which allow for 1,000
votes per share and as a result, Cherokee is the controlling shareholder of the
Company. Cherokee and Proxity each own one share of the two shares of Class C
common stock issued and outstanding which have certain liquidation preference
rights. The Chief Executive Officer of both Proxity and Cherokee is Mr.
Robinson, the Chief Executive Officer of the Company.

Consolidation - The accompanying condensed consolidated financial statements
include the accounts and transactions of Cyber Defense Systems, Inc. for all
periods presented and the accounts and transactions of Cyber Defense, and its
TSI wholly owned subsidiary from its date of acquisition on September 19, 2005,
(collectively the "Company"). Intercompany accounts and transactions have been
eliminated in consolidation.

Basis of Presentation -- The unaudited financial statements included in this
Form 10-QSB/A have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-QSB/A and Item 310(b) of Regulation SB of the Securities
and Exchange Act of 1934, as amended. The financial information furnished herein
reflects all adjustments, which, in the opinion of management, are necessary for
a fair presentation of the Company's financial position, the results of
operations and cash flows for the periods presented.


                                       5
<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

Certain information and footnote disclosures normally contained in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted, pursuant to such rules and regulations.

Condensed Interim Financial Statements -- The accompanying unaudited condensed
consolidated financial statements include the accounts of Cyber Defense Systems,
Inc. and its subsidiary, collectively ("Cyber" or the "Company"). These
financial statements are condensed and, therefore, do not include all
disclosures normally required by accounting principles generally accepted in the
United States of America. In the opinion of management, all adjustments
necessary for a fair presentation have been included in the accompanying
condensed consolidated financial statements and consist of only normal recurring
adjustments. The results of operations presented in the accompanying condensed
consolidated financial statements are not necessarily indicative of the results
that may be expected for the full year ending December 31, 2006 and such
financial statements should be read in conjunction with the Company's Form
10-KSB for the year ended December 31, 2005 and other filings made with the
Securities and Exchange Commission.

Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Business Condition - The accompanying financial statements have been prepared on
a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. For the nine
months ended September 30, 2006 the Company recorded revenues of $438,031 and
incurred a net loss of $18,119,159. For the year ended December 31, 2005, the
Company recorded revenues of $461,244 and incurred a net loss of $15,579,024. As
of September 30, 2006 and December 31, 2005 the net working capital deficit was
$15,819,206 and $16,444,035, respectively. The lack of sufficient revenues and
the loss from operations raise substantial doubt about the Company's ability to
continue as a going concern for a reasonable period of time. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded assets or the amount and classification of
liabilities which might be necessary should the Company be unable to continue as
a going concern. The Company's continuation as a going concern is dependent upon
its ability to generate sufficient cash flows to meet its obligations on a
timely basis, to obtain additional financing as further discussed in Notes 5, 6
and 10 as may be required, and ultimately to attain successful operations.

Cash and Cash Equivalents -- Cash equivalents include highly liquid short-term
investments with original maturities of three months or less, readily
convertible to known amounts of cash. At September 30, 2006 and December 31,
2005 the Company had no cash in excess of federally insured limits.

Inventory -- At September 30, 2006 and December 31, 2005, inventory of $891,056
and $336,523, respectively primarily consists of parts for the airships and
Unmanned Aerial Vehicles ("UAV's") that the Company sells, leases and services.

Property and Equipment -- Property and equipment is recorded at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets ranging from 3 to 5 years. Expenditures for
maintenance, repairs, and renewals are charged to expense as incurred.
Expenditures for major renewals and betterments that extend the useful lives of
existing equipment are capitalized and depreciated. On retirement or disposition
of property and equipment, the cost and accumulated depreciation are removed and
any resulting gain or loss is recognized in the statement of operations.


                                       6
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

Long-lived assets are reviewed for impairment when events or changes in
circumstances indicate that the carrying amount may not be recoverable.
Recoverability of assets to be held and used is measured by comparison of the
carrying amount of an asset to future net cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount that the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell. For the nine
months ended September 30, 2006, management has determined an impairment of its
long lived assets was required. Management determined that the value of the
license from 21st Century Airships was impaired. As a result of this
determination, the Company recorded an impairment loss for $11,330,674 as of
September 30, 2006. In addition, management determined that the estimated
remaining useful life to be 7 years. For the nine months ended September 30,
2005, goodwill of $4,577,069 relating to the acquisition of the 6.19% minority
interest in Cyber Aerospace as of March 31, 2005 was impaired.

Manufacturing License -- The Company acquired an exclusive manufacturing license
initially valued at $14,255,649 with the acquisition of TSI in September, 2005.
Accumulated amortization relating to the license was $824,975 at September 30,
2006 prior to the above mentioned impairment loss. The Company evaluated the
carrying value of the license to determine if the carrying amount warranted
revision or may not be recoverable. In management's opinion, an adjustment was
required at September 30, 2006. The adjustment was to reduce the carrying value
of the asset to $2,100,000 based upon management's estimate of the fair value of
the asset as of September 30, 2006. In addition, the estimated remaining useful
life was reduced from 18 years from the date of acquisition to 7 years from
September 30, 2006.

Fair Values of Financial Instruments -- The carrying amounts reported in the
balance sheet for notes payable approximate their fair values because the
interest rates approximate current interest rates to be charged on similar
borrowings.

Revenue Recognition - The Company recognizes service revenues when the services,
as specified by the customer and agreed to by the Company, have been performed
and the customer accepts the services, and the services are billed. Airship and
UAV sales are recognized when contract specifications are met, the price is
determined, title passes to the customer and the customer is billed. Lease
revenue on airships is recognized over the term of the lease. Reasonableness of
collectibility of all revenue transactions is a key element before the
transactions are recorded.

Share Based Payments - In December 2004, the Financial Accounting Standards
Board issued Statement Number 123 ("FAS 123 (R)"), Share-Based Payments, which
was adopted by the Company on January 1, 2006. The Company recognizes
compensation expense in an amount equal to the fair value of share based
payments such as stock options granted to employees. The Company has elected to
apply FAS 123 (R) using the modified prospective method. Under this method, the
Company records compensation expense as awards that were outstanding at the date
of adoption continue to vest for the unvested portion of the awards. If the
Company had accounted for share based payments under the provisions of FAS
123(R) for the nine months ended September 30, 2005 approximately $7,863 in
expense would have been recorded for the stock options issued on September 19,
2005.

Prior to January 1, 2006 the Company used Statement of Financial Accounting
Standards No. 148 "Accounting for Stock-Based Compensation - Transition and
Disclosure" (SFAS No. 148) to account for stock based compensation arrangements.
This statement amended the disclosure provision of FASB statement No. 123 to
require prominent disclosure about the effects on reported net income of an
entity's accounting policy decisions with respect to stock-based employee
compensation. As permitted by SFAS No. 123 and amended by SFAS No. 148, we
continued to apply the intrinsic value method under Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," to account
for our stock-based employee compensation arrangements.


                                       7
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

Derivative Instruments - The Company does not hold or issue derivative
instruments for trading purposes. However, the Company has convertible notes
payable that contain embedded derivatives that require separate valuation from
the convertible notes under Emerging Issues Task Force Abstract (EITF) 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock". The Company recognizes these derivatives as
liabilities in the accompanying balance sheet and measures them at estimated
fair value each quarter, and recognizes changes in estimated fair value in the
statement of operations in the respective period. The Company has estimated the
fair value of these embedded derivatives using the Black-Scholes model.

Income Taxes -- No income taxes have been paid or accrued because the Company
has had no net taxable income since inception. The Company recognizes the amount
of income taxes payable or refundable for the current year and recognizes
deferred tax assets and liabilities for the future tax consequences attributable
to differences between the financial statement amounts of certain assets and
liabilities and their respective tax bases. Deferred tax assets and deferred
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years those temporary differences are expected to be recovered or
settled. Deferred tax assets are reduced by a valuation allowance to the extent
that uncertainty exists as to whether the deferred tax assets will ultimately be
realized.

Earnings (Loss) Per Share --Basic earnings (loss) per share is calculated by
dividing earnings (loss) available to Class A common shareholders by the
weighted-average number of Class A common shares outstanding during each period.
Fully diluted income (loss) per share for the three and nine months ended
September 30, 2006 is the same as basic due to losses for the three and nine
months ended September 30, 2006.

The following potentially dilutive common shares are excluded from the
computation of diluted net loss per share for all periods presented because the
effect is anti-dilutive:

                                                   For the Nine Months
                                                   Ended September 30,
                                                -------------------------
                                                   2006           2005
                                                ----------     ----------
      Shares underlying Warrants                 6,870,000      4,400,000
      Shares underlying Options                  9,106,838     11,379,900
      Shares underlying Convertible Debt        50,699,342     10,577,513
      Shares underlying Convertible Debt
       to related parties                        2,887,735      2,103,695
                                                ----------     ----------

      Total potentially dilutive securities     69,563,915     28,461,108
                                                ==========     ==========

Recent Accounting Pronouncements -- In February 2006, the FASB issued Statement
of Financial Accounting Standards No. 155, "Accounting for Certain Hybrid
Financial Instruments," referred to as SFAS No. 155. This statement amends SFAS
No. 133 "Accounting for Derivative Instruments and Hedging Activities" and SFAS
No. 140 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." SFAS No. 155 permits fair value remeasurement
for hybrid financial instruments that contain embedded derivatives that would
require separate accounting. In addition, the statement establishes a
requirement to evaluate interests in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain embedded derivatives. SFAS No. 155 is effective for all
financial instruments acquired or issued beginning after an entity's fiscal year
beginning on or after September 15, 2006 with earlier adoption permitted.
Management believes this Statement will have no impact on the financial
statements of the Company once adopted.


                                       8
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

In March 2006, the FASB issued FASB Statement No. 156, which amends FASB
Statement No. 140. This Statement establishes, among other things, the
accounting for all separately recognized servicing assets and servicing
liabilities. This Statement amends Statement 140 to require that all separately
recognized servicing assets and servicing liabilities be initially measured at
fair value, if practicable. This Statement permits, but does not require, the
subsequent measurement of separately recognized servicing assets and servicing
liabilities at fair value. An entity that uses derivative instruments to
mitigate the risks inherent in servicing assets and servicing liabilities is
required to account for those derivative instruments at fair value. Under this
Statement, an entity can elect subsequent fair value measurement to account for
its separately recognized servicing assets and servicing liabilities. By
electing that option, an entity may simplify its accounting because this
Statement permits income statement recognition of the potential offsetting
changes in fair value of those servicing assets and servicing liabilities and
derivative instruments in the same accounting period. This Statement is
effective for financial statements for fiscal years beginning after September
15, 2006. Earlier adoption of this Statement is permitted as of the beginning of
an entity's fiscal year, provided the entity has not yet issued any financial
statements for that fiscal year. Management believes this Statement will have no
impact on the financial statements of the Company once adopted.

In June, 2006 the FASB issued FIN 48, "Accounting for Uncertainty in Income
Taxes--an interpretation of FASB Statement No. 109". This Interpretation
clarifies, among other things, the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. This Interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition and is effective for fiscal years beginning after
December 15, 2006. Earlier application is encouraged if the enterprise has not
yet issued financial statements, including interim financial statements, in the
period the Interpretation is adopted. FIN 48, Accounting for Uncertainty in
Income Taxes--an interpretation of FASB Statement No. 109, is effective for
fiscal years beginning after December 15, 2006. Earlier application is
encouraged if the enterprise has not yet issued financial statements, including
interim financial statements, in the period the Interpretation is adopted.
Management believes this Statement will have no impact on the financial
statements of the Company once adopted.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measures" ("SFAS
157"). SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. This statement
applies under other accounting pronouncements that require or permit fair value
measurements. However, it does not apply to SFAS 123(R). This statement shall be
effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. Earlier
application is encouraged, provided that the reporting entity has not issued
financial statements for that fiscal year, including any financial statements
for an interim period within that fiscal year. The provisions of this statement
should be applied prospectively as of the beginning of the fiscal year in which
this Statement is initially applied, except in some circumstances where the
statement shall be applied retrospectively. The Company is currently evaluating
the effect, if any, of SFAS 157 on its financial statements.

In September 2006, the 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 132(R)" ("SFAS 158"). This Statement requires
recognition of the overfunded or underfunded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income. It
also requires an employer to measure the funded status of a plan as of the date
of its year-end statement of financial position. The statement is effective as
of the end of the fiscal year ending after December 15, 2006. Management
believes that adoption of this standard will not have a material impact on the
Company's financial statements.


                                       9
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

In September, 2006 the Securities and Exchange Commission issued Staff
Accounting Bulletin 108 ("SAB 108"), "Considering the Effects of Prior year
Misstatements When Quantifying Misstatements in Current Year Financial
Statements." SAB 108 clarifies the staff's views regarding the process of
quantifying financial statement misstatements. More specifically, the staff
noted that certain registrants do not consider the effects of prior year errors
on current year financial statements, thereby allowing improper assets or
liabilities to remain unadjusted. The staff believes this approach is not in the
best interests of the users of the financial statements. SAB 108 is effective
for fiscal years ending on or after November 15, 2006 with earlier adoption
encouraged. The Company is currently evaluating the impact that the adoption of
SAB 108 will have, if any, on its financial statements and notes thereto.

NOTE 2 - RELATED PARTY TRANSACTIONS

Cyber Aerospace - Prior to March 31, 2005, Cyber Aerospace ("Aerospace") had
previously been consolidated with the Company as it was a 93.8% owned
subsidiary. All transactions and account balances between the Company and
Aerospace were eliminated during consolidation. On March 31, 2005, the Company
purchased the minority interest so that Aerospace became a wholly owned
subsidiary and was then merged with and into the Company.

Cherokee Raiders - Cherokee's general partner is William C. Robinson. Cherokee
also owns 300,000 Class B common shares, each of which entitles the holder to
1,000 votes. As a result, Cherokee is the controlling shareholder of the
Company.

William C. Robinson - Mr. Robinson is President, CEO and Chairman of the Company
and has significant ownership and control in Proxity and Cherokee Raiders.

During the nine months ended September 30 2006, Mr. Robinson advanced an
aggregate of $274,582 and converted and aggregate of $485,000 to Class A common
stock under his $1,000,000 line of credit to the Company. In addition, Mr.
Robinson paid the January 17, 2006 unsecured note in the principal amount of
$74,523 to a vendor. See Note 5. Mr. Frank Lively, a director of the Company
advanced an additional $16,722. All of Mr. Lively's loans to the Company have
been converted to Class A common stock as of September 30, 2006.

On April 20, 2006 David Barnes, the Company's Chief Financial Officer utilized
$11,000 of fees due him to exercise options for 55,000 shares of the Company's
Class A common stock at the exercise price of $0.20 per share. On July 21, 2006
the Board approved Mr. Barnes conversion of an additional $7,000 in fees into
46,666 shares of Class A common stock at a price of $0.15. The price was
determined based on the market pricing as of the date of conversion.

See Note 6 - Related Party Notes for additional related party disclosure.


                                       10
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

NOTE 3 - ACQUISITION OF TSI

On September 19, 2005, Cyber Defense Systems, Inc. acquired all 100,000 common
shares of the outstanding stock of TSI in exchange for 23,076,923 shares of
Cyber Class A common stock and 245,455 shares of Cyber Class B common stock
valued at $5,340,226 collectively, and TSI became a wholly owned subsidiary of
Cyber. The transaction was accounted for as a purchase business combination in
accordance with FAS 141, "Business Combinations". An independent valuation was
obtained for both the Cyber stock and TSI's exclusive manufacturing license. In
connection with the acquisition by Cyber, TSI underwent a reorganization
intended to qualify as a reorganization within the meaning of Section
368(a)(1)(A) and (a)(1)(D) of the Internal Revenue Code of 1986, as amended
resulting in TSI becoming a regular corporation from a limited liability
corporation. The 100,000 shares of TSI stock were then exchanged for the Cyber
stock mentioned above. Negative goodwill was not recognized in connection with
the acquisition of Techsphere. Instead, the excess of the fair value of the net
assets over the purchase price was allocated as a pro rata reduction of the
amounts that otherwise would have been assigned to the long-term assets.

The unaudited consolidated pro forma results of operations assuming consummation
of the purchase of TSI as of January 1, 2005, are summarized as follows:

                                                 Unaudited Pro Forma
                                       ---------------------------------------
                                       Three Months Ended   Nine Months Ended
                                       September 30, 2005   September 30, 2005
                                       ------------------   ------------------
   Total revenue                        $       466,144      $     1,917,661
   Net loss                             $    (2,051,141)     $   (17,489,835)
   Basic and diluted loss per share     $         (0.07)     $         (0.56)

NOTE 4- INTANGIBLE ASSETS AND MANUFACTURING LICENSE

With the acquisition of TSI in September, 2005 the Company acquired an
exclusive, worldwide license with 21st Century Airships, Inc. for the
manufacture of its airships. The value recorded for the license was $14,255,649
pursuant to an independent valuation which was originally being amortized over
the 18 year life of the license, resulting in monthly amortization of $65,998
through September 30, 2006. Amortization expense for the nine months ended
September 30, 2006 was $593,982. On September 30, 2006 management determined
that the value of this asset was impaired. As a result of this determination,
the Company recorded an impairment loss for $11,330,674 as of September 30,
2006. In addition, management determined the estimated remaining useful life to
be 7 years. The book value of the asset was reduced to $2,100,000 and the
monthly amortization is $25,000.

The license agreement stipulates royalty payments relating to the sales of
airships ranging from $450,000 for a low altitude airship, $600,000 for a medium
altitude airship, 10% of the gross sales price of a high altitude airship and
$400,000 for the manufacture of a low altitude airship used for commercial
advertising purposes. Payments are to be made on any royalties due upon receipt
of payment from the customer on a proportionate basis as defined in the
agreement and in full within 120 days of completion of the manufacturing
process.

The license agreement calls for a minimum annual royalty payment of $1,000,000
for the period of January 17, 2005 through January 16, 2006 and each annual
period thereafter ending January 16. The Company has accrued $1,300,000 related
to this royalty as of September 30, 2006. The Company has executed an amendment
to the license agreement in April, 2006 providing payment terms with respect to
the $1,000,000 royalty through January 16, 2006 of $200,000 each on May 15 and
July 15, 2006, and $150,000 each for four months on the fifteenth of each month
ending November 15, 2006. The Company has made the payment of $200,000 relating
to May 15, 2006.


                                       11
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On August 24, 2006, the Company, TSI and 21st Century entered into another
amendment to the license agreement executed August 25, 2006 pursuant to which
the parties agreed upon another revised payment schedule (the "August Payment
Schedule"). The Company paid $200,000 under this revised payment schedule. On
October 23, 2006, the Company amended the payment schedule of the license
agreement providing for $225,000 to be paid by October 23, 2006 and $375,000 to
be paid by December 1, 2006. The Company has made the October 23, 2006 payment.
If the December 1, 2006 payment should come into default, it is the intent of
21st Century to terminate the License Agreement and, as a result, TSI may be
unable to manufacture its spherical airship products.

In addition, the Company granted permission to 21st Century Airships, Inc. to
sell two Low or Medium altitude airships to be used for surveillance or similar
applications outside the United States.

In 2004, the Company purchased designs and plans for unmanned air vehicles
(UAV's) which have a useful life of 3 years. The cost was $100,000 and the
monthly amortization is $2,778. Amortization expense was $25,002 for the nine
months ended September 30, 2006 and 2005.

NOTE 5- NOTES PAYABLE

On March 15, 2006, the Company entered into a Securities Purchase Agreement,
dated as of March 14, 2006 with AJW Partners, LLC, AJW Offshore, Ltd., AJW
Qualified Partners, LLC, and New Millennium Capital Partners II, LLC ("AJW")
whereby the Company authorized the sale of an aggregate of $2,000,000 of 6%
Callable Secured Convertible Notes and warrants to purchase 2,000,000 shares of
common stock for a total offering price of $2,000,000. The $2,000,000 is to be
funded in three tranches ($1,000,000 on March 15, 2006, $500,000 upon filing a
Registration Statement and $500,000 upon effectiveness of the Registration
Statement). The conversion price is the lesser of $3.00 or 55% of the average of
the lowest three intra-day trading prices for the Company's common stock during
the 20 trading days immediately preceding the conversion date. The warrants to
purchase Class A common stock are priced at $1.25 per share. The warrants are
exercisable for a period of five years from the date of issuance. In connection
with the sale, the Company also entered into a Registration Rights Agreement
with AJW, requiring it to file a registration statement with the Securities and
Exchange Commission registering the shares of common stock issuable upon
conversion of the Notes and exercise of the Warrants. The Notes are secured by
all of the Company's assets, except for its accounts receivable and proceeds of
inventory. In addition, the lenders have agreed to subordinate to an
institutional lender. On March 15, 2006 the Company received $1,000,000 and
issued warrants for 1,100,000 shares of common stock valued at $542,190 on the
date of issuance which was recorded as a derivative liability. An aggregate of
$49,290 was recognized as loan costs and $492,900 was recognized as a derivative
valuation loss on issuance of the warrants. The beneficial conversion feature
was valued at $2,599,655 and was recorded as a derivative liability. An
aggregate of $1,000,000 was allocated to discounts on the individual notes,
representing 100% of the face value of the notes which will accrete over the
three year life of the notes, with the remaining $1,599,655 recognized as a
derivative valuation loss. The Company incurred loan costs totaling $134,290 in
conjunction with the above which consisted of fees paid in cash of $85,000 and a
warrant to purchase 100,000 shares of Class A common stock valued at $49,290
which will be amortized over the three year term of the notes.

On June 30, 2006 the Company filed a Registration Statement with the Securities
and Exchange Commission and, accordingly on July 6, 2006 the Company received
$500,000 representing the second tranche of the March 14, 2006 Securities
Purchase Agreement in exchange for 6% Callable Secured Convertible Notes and
issued five year warrants to purchase 550,000 shares of common stock priced at
$1.25 valued at $81,180 on the date of issuance which was recorded as a
derivative liability. An aggregate of $7,380 was recognized as loan costs and
$73,800 was recognized as a derivative valuation loss on issuance of the
warrants. The beneficial conversion feature was valued at $867,984 and was
recorded as a derivative liability. An aggregate of $500,000 was allocated to
discounts on the individual notes, representing 100% of the face value of the
notes which will accrete over the three year life of the notes, with the
remaining $367,984 recognized as a derivative valuation loss. The Company
incurred loan costs totaling $32,380 which consists of fees to be paid in cash
of $25,000 and a five year warrant to purchase 50,000 shares of common stock
priced at $1.25 valued at $7,380 on the date of issuance which will be amortized
over the three year term of the notes.


                                       12
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On September 11, 2006 AJW made an advance of $200,000 related to the $500,000
third tranche of financing pursuant to the March 14, 2006 Securities Purchase
Agreement in exchange for 6% Callable Secured Convertible Notes and issued five
year warrants to purchase 220,000 shares of common stock priced at $1.25 valued
at $47,674 on the date of issuance which was recorded as a derivative liability.
An aggregate of $4,334 was recognized as loan costs and $43,340 was recognized
as a derivative valuation loss on issuance of the warrants. The beneficial
conversion feature was valued at $359,664 and was recorded as a derivative
liability. An aggregate of $200,000 was allocated to discounts on the individual
notes, representing 100% of the face value of the notes which will accrete over
the three year life of the notes, with the remaining $159,664 recognized as a
derivative valuation loss. The Company incurred loan costs totaling $14,334
which consists of fees to be paid in cash of $10,000 and a five year warrant to
purchase 20,000 shares of common stock priced at $1.25 valued at $4,334 on the
date of issuance which will be amortized over the three year term of the notes.
Concurrent with this advance, the Company reduced the price of the 4,400,000
warrants issued under the April 1, 2005 Securities Purchase Agreement from $4.25
per share to $0.45 per share and extended the term of the warrants by two years.
The aggregate value of the warrants increased as a result of the exercise price
reduction and the extension of the expiration date resulting in the recognition
of additional derivative valuation loss of $66,374 determined by the fair value
of the warrants immediately before the changes compared to the fair value
immediately after the changes.

An analysis of the three tranches of issuances under the March 14, 2006
Securities Purchase Agreement and the significant assumptions used to value the
warrants and the beneficial conversion feature are contained in the following
table:

<TABLE>
<CAPTION>
                                                           March 14, 2006  March 14, 2006  March 14, 2006
                                                             Agreement        Agreement      Agreement
                                                             Tranche 1        Tranche 2      Tranche 3
                                                           --------------  --------------  --------------
<S>                                                          <C>             <C>             <C>
Issue date                                                    3/14/2006        7/6/2006       9/11/2006
Aggregate note amounts                                       $1,000,000      $  500,000      $  200,000
Conversion price on issue dates                              $     0.19      $     0.08      $     0.12
Term of notes at issuance                                       3 years         3 years         3 years
Shares issuable upon conversion                               5,172,414       5,928,854       1,678,322
Warrants issued                                               1,100,000         550,000         220,000
Exercise price of warrants                                   $     1.25      $     1.25      $     1.25
Term of warrants at issuance                                    5 years         5 years         5 years
Market Price on issue dates                                  $     0.51      $     0.15      $     0.22
Risk free interest rate on issuance date                           4.00%           5.17%           4.77%
Volatility on date of issuance                                   261.79%         242.90%         239.80%
Fair value per share of conversion shares                        0.5026          0.1464          0.2143
Beneficial conversion feature fair value                     $2,599,655      $  867,984      $  359,664
Note discount amount                                         $1,000,000      $  500,000      $  200,000
Warrant fair value per share at issuance                     $   0.4929      $   0.1476      $   0.2167
Fair values of warrants at issuance dates                    $  542,190      $   81,180      $   47,674
Value of warrants allocable to loan costs                    $   49,290      $    7,380      $    4,334
Fair value of derivative related to warrants                 $  492,900      $   73,800      $   43,340
Fair value of derivative allocated to beneficial
conversion feature                                           $1,599,655      $  367,984      $  159,664
Aggregate fair value allocated to derivative instruments     $2,141,845      $  449,164      $  207,338
</TABLE>


                                       13
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On June 6, 2006 AJW converted an aggregate of $114,487 related to the 8%
Callable Secured Convertible Notes issued April 1, 2005 at $0.1879 per share.
Accordingly, the Company issued an aggregate of 609,300 shares of its Class A
common stock to AJW. On September 19, 2006 AJW converted an aggregate of $63,324
related to the 8% Callable Secured Convertible Notes issued April 1, 2005 at
$0.104 per share. Accordingly, the Company issued an aggregate of 609,846 shares
of its Class A common stock to AJW. The conversion prices for the April 1, 2005
note represent the note's stated conversion price of 60% of the average of the
lowest three intra-day trading prices for the Company's common stock during the
20 trading days immediately preceding the conversion date.

An analysis of the conversions of the AJW Notes and the significant assumptions
used to value the beneficial conversion feature recognized upon conversion are
contained in the following table:

<TABLE>
<CAPTION>
      Conversion date                                            June 6, 2006   September 19, 2006
                                                                 ------------   ------------------
<S>                                                               <C>               <C>
      Original proceeds from note                                 $ 1,500,000       $ 1,500,000
      Note amount converted                                       $   114,487       $    63,424
      Principal remaining after conversion                        $   802,996       $   739,572
      Conversion price                                            $     0.188       $     0.104
      Term of notes at conversion                                  1.82 years        1.53 years
      Shares issued on conversion                                     609,300           609,846
      Potential remaining conversion shares                         4,273,528         7,111,269
      Common Stock Price on conversion date                       $      0.40       $      0.25
      Risk free interest rate at conversion date                         4.99%             4.72%
      Volatility on conversion dates                                   241.68%           240.74%
      Fair value per share of conversion shares                        0.3736            0.2291
      Fair value of derivative                                    $ 1,596,590       $ 1,629,192
      Derivative liability reclassified to additional paid-in
         capital upon conversion                                  $   227,634       $   139,716
      Derivative valuation loss recognized
       on conversion                                              $   (13,184)      $   (45,305)
</TABLE>

The carrying value of the AJW notes issued under the March 14, 2006 Securities
Purchase Agreement, as well as the notes issued in 2005 to AJW as of September
30, 2006 and December 31, 2005 was $1,644,388 and $655,358 net of discount,
respectively. The carrying value will be increased each quarter over the
respective three year lives of the notes as the accretion of the discount
related to the embedded derivatives is recorded until the carrying value equals
the face value of the notes.


                                       14
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

As of September 30, 2006 the derivative instruments related to AJW had a fair
value of $8,857,124. An analysis of the valuation of the individual tranches of
the AJW Notes as of September 30, 2006 and the significant assumptions used to
value the warrants and the beneficial conversion feature are contained in the
following table:

<TABLE>
<CAPTION>
                                April 1,       April 1,       April 1,      March 14,      March 14,      March 14,
                                  2005           2005           2005           2006           2006           2006
                               Agreement      Agreement      Agreement      Agreement      Agreement      Agreement
                               Tranche 1      Tranche 2      Tranche 3      Tranche 1      Tranche 2      Tranche 3        Total
                              -----------    -----------    -----------    -----------    -----------    -----------    -----------
<S>                           <C>            <C>            <C>            <C>            <C>            <C>            <C>
Revaluation date                9/30/2006      9/30/2006      9/30/2006      9/30/2006      9/30/2006      9/30/2006
Aggregate note amounts        $   739,729    $ 1,300,000    $ 1,200,000    $ 1,000,000    $   500,000    $   200,000    $ 4,939,729
Aggregate interest amounts    $    42,703    $    68,697    $    44,362    $    17,753    $     6,164    $       263
Conversion price              $     0.103    $     0.103    $     0.103    $     0.103    $     0.094    $     0.094
Remaining term of notes        1.50 years     1.65 years     1.85 years     2.45 years     2.77 years     2.95 years
Shares issuable upon
conversion                      7,594,905     13,288,320     12,081,181     10,779,383      5,295,675      2,121,056     51,160,520
Warrants outstanding            1,650,000      1,430,000      1,320,000      1,100,000        550,000        220,000      6,270,000
Exercise price of warrants    $      0.45    $      0.45    $      0.45    $      1.25    $      1.25    $      1.25
Remaining term of warrants     5.50 years     5.65 years     5.85 years     4.45 years     4.77 years     4.95 years
Common stock price            $     0.165    $     0.165    $     0.165    $     0.165    $     0.165    $     0.165
Risk free interest rat               4.62%          4.62%          4.62%          4.62%          4.62%          4.62%
Volatility                         239.76%        239.76%        239.76%        239.76%        239.76%        239.76%
Fair value per share of
conversion shares             $    0.1472    $    0.1497    $    0.1522    $    0.1580    $    0.1597    $    0.1605
Beneficial conversion
feature fair value            $ 1,117,970    $ 1,989,262    $ 1,838,756    $ 1,703,143    $   845,719    $   340,429    $ 7,835,279
Warrant fair value per share  $    0.1638    $    0.1638    $    0.1638    $    0.1606    $    0.1615    $    0.1620
Fair value of derivative
related to warrants           $   270,270    $   234,234    $   216,216    $   176,660    $    88,825    $    35,640    $ 1,021,845
Fair value of derivative
related to beneficial
conversion feature            $ 1,117,970    $ 1,989,262    $ 1,838,756    $ 1,703,143    $   845,719    $   340,429    $ 7,835,279
                              -----------    -----------    -----------    -----------    -----------    -----------    -----------

Aggregate fair value of
derivative instruments        $ 1,388,240    $ 2,223,496    $ 2,054,972    $ 1,879,803    $   934,544    $   376,069    $ 8,857,124
                              ===========    ===========    ===========    ===========    ===========    ===========    ===========
</TABLE>

The derivative liability is comprised of the following as of September 30, 2006
and December 31, 2005:

                                          September 30, 2006   December 31, 2005
                                          ------------------   -----------------
     AJW Notes                                $ 7,835,279         $ 1,515,756
     AJW Warrants                               1,021,845           8,541,977
     William Robinson Note (See Note 6)           127,641                  --
                                              -----------         -----------
     Total derivative liability               $ 8,984,765         $10,057,733
                                              ===========         ===========


                                       15
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

As of December 31, 2005, the derivative instruments had a fair value of
$10,057,733. An analysis of the valuation of the individual tranches as of
December 31, 2005 and the significant assumptions used to value the warrants and
the beneficial conversion feature are contained in the following table:

<TABLE>
<CAPTION>
                                                     Tranche 1          Tranche 2          Tranche 3            Total
                                                   -------------      -------------      -------------      -------------
<S>                                                <C>                <C>                <C>                <C>
Valuation date                                       12/31/2005         12/31/2005         12/31/2005
Aggregate note amounts                             $     917,691      $   1,300,000      $   1,200,000      $   3,417,691
Conversion price                                   $       0.156      $       0.156      $       0.156
Term of notes                                         2.25 years          2.4 years          2.6 years
Shares issuable upon conversion                        5,957,684          8,333,333          7,692,308
Warrants outstanding                                   1,650,000          1,430,000          1,320,000          4,400,000
Exercise price of warrants                         $        4.25      $        4.25      $        4.25
Term of warrants                                      4.25 years          4.4 years          4.6 years
Stock Price                                        $        0.40      $        0.40      $        0.40
Risk free interest rate                                     4.37%              4.37%              4.37%
Volatility                                                252.54%            252.54%            252.54%
Fair value per share of conversion shares                 0.3867             0.3883             0.3903
Beneficial conversion feature fair value           $   2,303,836      $   3,235,833      $   3,002,308      $   8,541,977
Warrant fair value per share at year end           $      0.3367      $      0.3447      $      0.3540
Fair value of derivative related to warrants       $     555,555      $     492,921      $     467,280      $   1,515,756
Fair value of derivative related to
   beneficial conversion feature                   $   2,303,836      $   3,235,833      $   3,002,308      $   8,541,977
                                                   -------------      -------------      -------------      -------------
Aggregate fair value of derivative instruments     $   2,859,391      $   3,728,754      $   3,469,588      $  10,057,733
                                                   =============      =============      =============      =============
</TABLE>

The derivative valuation loss reported in the accompanying condensed
consolidated statements of operations results from the revaluation to fair value
of the beneficial conversion feature and attached warrants associated with the
above notes. As the fair value of the derivative changes, a gain or a loss is
recognized. The components of the derivative valuation loss for the three and
nine months ended September 30, 2006 and 2005 consisted of the following:

<TABLE>
<CAPTION>
                                                                  Three months ended               Nine months ended

                                                             September 30,   September 30,   September 30,   September 30,
                                                                 2006            2005            2006            2005
                                                             ------------    ------------    ------------    ------------
<S>                                                          <C>             <C>             <C>             <C>
Derivative valuation (loss) on issuance of notes - AJW       $   (527,648)   $ (1,338,882)   $ (2,127,303)   $ (3,313,576)
Derivative valuation (loss) on issuance of warrants -AJW         (117,140)     (2,376,600)       (610,040)    (11,046,172)
Derivative valuation (loss) on conversion -AJW                    (45,305)       (182,001)        (58,489)       (182,001)
Derivative valuation gain on conversion -Robinson                  20,010              --          20,010              --
Derivative valuation gain on conversion -Lively                     4,193              --           4,193              --
Derivative valuation gain on conversion -Gardiner                      --              --             840              --
Derivative valuation (loss) on issuance of note - Gardiner             --              --         (37,050)             --
Derivative valuation (loss) on issuance of note- Robinson              --              --        (368,608)             --
Derivative valuation (loss) - beneficial conversion
  revaluation - Robinson                                           24,960                         767,572              --
Derivative valuation (loss) on issuance of notes - Lively              --              --         (58,306)             --
Derivative valuation (loss) - beneficial conversion
  revaluation - Lively                                                 --              --         106,799              --
Derivative valuation (loss) - beneficial conversion
  revaluation - Gardiner                                               --              --         (20,520)             --
Derivative valuation gain (loss) - warrant revaluation AJW         (9,779)      7,665,119       1,164,955      10,866,669
Derivative valuation gain (loss)- beneficial conversion
  revaluation - AJW                                               165,202      (3,944,498)      4,225,140      (3,997,992)
                                                             ------------    ------------    ------------    ------------
                                                             $   (485,507)   $   (176,862)   $  3,009,193    $ (7,673,072)
                                                             ============    ============    ============    ============
</TABLE>


                                       16
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On October 19, 2006, the Company received an additional advance of $300,000
pursuant to the fourth tranche of financing from the March 14, 2006 Securities
Purchase Agreement with AJW in exchange for 6% Callable Secured Convertible
Notes and issued five year warrants to purchase 330,000 shares of common stock
priced at $1.25 valued at $58,344 on the date of issuance which was recorded as
a derivative liability. An aggregate of $5,304 was recognized as loan costs and
$53,040 was recognized as a derivative valuation loss on issuance of the
warrants. The beneficial conversion feature was valued at $624,664 and was
recorded as a derivative liability. An aggregate of $300,000 was allocated to
discounts on the individual notes, representing 100% of the face value of the
notes which will accrete over the three year life of the notes, with the
remaining $324,664 recognized as a derivative valuation loss. The Company
incurred loan costs totaling $25,704 which consists of fees of $15,000 to be
paid in cash, 30,000 shares of Class A common stock valued at $5,400 based on
the $0.18 market price on the date of issuance and a five year warrant to
purchase 30,000 shares of common stock priced at $1.25 valued at $5,304 using
the Black Scholes method on the date of issuance which will be amortized over
the three year term of the notes.

An analysis of the October 19, 2006 issuance under the March 14, 2006 Securities
Purchase Agreement with AJW and the significant assumptions used to value the
warrants and beneficial conversion feature are contained in the following table:

                                                               March 14, 2006
                                                                  Agreement
                                                                  Tranche 4
                                                               --------------
    Issue date                                                   10/19/2006
    Aggregate note amounts                                       $  300,000
    Conversion price                                             $     0.08
    Term of notes                                                   3 years
    Shares issuable upon conversion                               3,557,312
    Warrants issued                                                 330,000
    Exercise price of warrants                                   $     1.25
    Term of warrants                                                5 years
    Stock price                                                  $     0.18
    Risk free interest rate                                            4.79%
    Volatility                                                       237.66%
    Fair value per share of conversion shares                        0.1756
    Beneficial conversion feature fair value                     $  624,664
    Note discount amount                                         $  300,000
    Warrant fair value per share                                 $   0.1768
    Fair values of warrants                                      $   58,344
    Value of warrants allocable to loan costs                    $    5,304
    Fair value of derivative related to warrants                 $   53,040
    Fair value of derivative allocated to beneficial
    conversion feature                                           $  324,664
    Aggregate fair value allocated to derivative instruments     $  383,008

The Company will record the above mentioned transactions in the fourth quarter
of 2006.


                                       17
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On January 15, 2006 the Company issued an unsecured note to James Gardiner in
the amount of $90,000 in exchange for cash of $82,000 and fees of $8,000. The
note is due December 31, 2007, is unsecured and bears interest at the rate of
12% and is convertible into Class A common stock at $0.30 per share at any time.
The note contains a beneficial conversion feature due to the conversion price of
$0.30 being lower than the market price of $0.53 on the date of issuance. The
beneficial conversion feature was valued at $127,050 using the Black Scholes
method on the date of issuance, and was recorded as a derivative liability on
the date of issuance. The Company allocated $90,000 of the beneficial conversion
feature as a discount on the note, which will accrete over the life of the note.
As of March 31, 2006, the derivative liability was valued at $147,570, which
resulted in an additional $20,520 of derivative valuation loss recorded in the
three month period ended March 31, 2006. On April 20, 2006 the holder converted
the note into 300,000 shares of the Company's Class A common stock. The
derivative on the date of conversion was valued at $146,730. As a result of the
conversion, the Company will recognize a derivative valuation gain of $840
representing the change of the value from the March 31, 2006 valuation date to
the date of conversion and as a result, reclassified $146,730 to additional paid
in capital and expensed the remaining discount on the note in the amount of
$85,000 to interest expense during the quarter ending June 30, 2006.

An analysis of the valuation of the beneficial conversion feature and the
significant assumptions used are contained in the following table:

<TABLE>
<CAPTION>
                                                 Issuance date        Report date         Conversion date
Valuation date                                  January 15, 2006     March 31, 2006       April 20, 2006
                                                ----------------     --------------       --------------
<S>                                               <C>                 <C>                  <C>
Aggregate note amounts                            $     90,000        $     90,000         $     90,000
Conversion price                                  $       0.30        $       0.30         $       0.30
Remaining Term of note                              1.95 years          1.75 years           1.70 years
Shares issuable upon conversion                        300,000             300,000              300,000
Market Price                                      $       0.45        $       0.53         $       0.53
Risk free interest rate                                   4.39%               4.80%                4.89%
Volatility                                              253.76%             247.96%              246.20%
Fair value per share of conversion shares               0.4235              0.4919               0.4891
Beneficial conversion feature fair value          $    127,050        $    147,570         $    146,730
Note discount amount                              $     90,000        $     85,000         $         --
Fair value of derivative related to
   beneficial conversion feature                  $     37,050        $     57,570         $     56,730
Derivative valuation gain (loss) recognized                           $    (20,520)        $        840
</TABLE>

On January 17, 2006 the Company issued an unsecured note in the amount of
$88,637 bearing interest at the rate of 5.0% to a vendor in exchange for
services previously rendered. The note was originally due in full on April 19,
2006. The Company and the vendor have agreed to amend the payment terms of the
note. Payments of $15,000 were made during the three months ended June 30, 2006
and monthly payments remain of $25,000 on July 20, 2006 with the remaining
balance of principal and accrued interest due August 30, 2006. The note is
personally guaranteed by Mr. Robinson who has pledged certain of his personal
assets as collateral. During the three months ended September 30, 2006, Mr.
Robinson paid the note and all accrued interest in full on behalf of the
Company.

On March 20, 2006 the Company issued an unsecured note in the amount of $57,052
to a vendor in exchange for services previously rendered. The note was
originally due in three equal monthly installments of $19,024 beginning March
25, 2006. No interest is due if payments are paid by the due dates. If any
monthly installment is past due, the note bears interest at the rate of 10% per
annum. The Company renegotiated the terms of the note due to its default and, on
September 29, 2006 the vendor converted the note and all accrued interest
totaling $60,019 at a conversion rate of $0.20 into 300,097 shares of Class A
common stock.

On April 20, 2006 Mayo Hadden converted $200,000 of his outstanding Convertible
Note into 666,667 shares of common stock at the conversion price of $0.30 per
share. On June 28, 2006, he converted the remaining balance of $131,250 plus
$11,563 of accrued interest at the conversion price of $0.30 into 476,043 shares
of Class A Common Stock. On September 28, 2006 the Company issued an additional
317,362 shares of Class A common stock to Mr. Hadden relative to an agreement
lowering the conversion price from $0.30 to $0.18. The additional shares issued
were valued at $0.18, the market price as of the date of issuance. The value of
$57,125 was recorded as additional interest on the note in the accompanying
statements of operations the nine months ending September 30, 2006.


                                       18
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On April 25, 2006 the Company issued a note to Sierra Nevada Corporation
pursuant to an agreement as more fully described in Note 9 dated April 25, 2006
due August 25, 2006 under certain conditions in the amount of $500,000. The note
is non-interest bearing until August 25, 2006, at which time it will bear
interest at the rate of 8.5% and is secured by certain inventory of the Company.
The Company recorded the initial net present value of $486,192 related to the
note using an 8.5% interest rate. The note is being accreted to the face value
at 8.5% using the effective interest method and accordingly, recognized
accretion of the note of $13,808 as interest expense, bringing the face value to
$500,000 as of September 30, 2006. (See Note 9).

On July 21, 2006 Equipment Depot converted their $25,000 note and $1,500 of
accrued interest into 106,000 shares of Company Class A common stock at a
conversion price of $0.25 per share. The conversion price exceeded the market
price on the conversion date of July 21, 2006 of $0.18 thus no beneficial
conversion was recognized.

The Company is currently in discussions with Charles McClure to amend his note
agreement which continues to be in default.

<TABLE>
<CAPTION>
                                                                                    September 30,   December 31,
                                                                                         2006           2005
                                                                                    -------------   ------------
<S>                                                                                   <C>            <C>
Current - Unrelated parties

Convertible Note payable - Mayo Hadden, unsecured, interest accrues
 at 10.0% per annum due February 25, 2007 .......................................     $       --     $  331,250

Convertible Notes payable C.M.G. Tech., unsecured, interest accrues
 at 10% per annum due February 25, 2007 .........................................        822,094        822,094

Note payable Charles McClure, secured by an airship, interest accrues
 at 25.0% per annum and was due December 31, 2005, currently in default .........        250,000        250,000

Notes payable to Vendors - unsecured, interest accrues at 12% per annum due in
 4 equal payments from March 5, 2006 to June 5, 2006 ............................             --        151,761

Note payable to Vendors - unsecured, interest accrues at 12% per annum due in
 June 5, 2006, currently in default .............................................            781          3,126

Commercial Promissory Note, - Equipment Depot, Inc., interest at 9.0%
 per annum, secured, due June 19, 2006, in default at June 30, 2006 .............             --         25,000

Note payable - 21st Century Airship, Inc. - interest accrues at 12%
 per annum, the Note was due on August 24, 2005, paid in full
 in March, 2006 .................................................................             --        144,844

Note payable - Sierra Nevada Corporation - non interest bearing secured by
 certain inventory due August 25, 2006 net of unamortized discount of $6,335 ....        500,000             --
                                                                                      ----------     ----------
TOTAL CURRENT UNRELATED PARTIES .................................................     $1,572,875     $1,728,075
                                                                                      ==========     ==========
Long-term - unrelated parties

Notes payable - AJW Partners, LLP and affiliates, callable secured
 convertible notes bearing interest at 8.0% per annum, $739,573 due April
 4, 2008; $1,300,000 due May 25, 2008, $1,200,000 due August 4, 2008,
less total discount of $1,821,236 and $2,762,333, respectively ..................      1,418,543        655,358

Notes payable - AJW Partners, LLP and affiliates, callable secured
 convertible notes bearing interest at 6.0% per annum, $500,000 due July 5,
 2008 and $200,000 due September 10, 2008 due March 13, 2009
 less total discount of $1,474,155 ..............................................        225,845             --
                                                                                      ----------     ----------
TOTAL LONG TERM NOTES PAYABLE ...................................................     $1,644,388     $  655,358
                                                                                      ==========     ==========
</TABLE>


                                       19
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

NOTE 6 - NOTES PAYABLE - RELATED PARTIES

On April 19th, 2006, the Board approved a $1,000,000 line of credit with Mr.
Robinson. On April 19, 2006 pursuant to the line of Credit, the Company entered
into a convertible variable promissory note in the principal amount as of March
31, 2006 of $565,188 including all related accrued interest. The note bears
interest at the rate of 12% per annum, is unsecured and is convertible into
Class A common stock at $0.30 per share. The note is due on December 31, 2007.
The note contains a beneficial conversion due to the conversion price of $0.30
being lower than the market price of $0.53 on the date of issuance. The
beneficial conversion feature was valued at $926,720 on the date of issuance and
recorded as a derivative liability. The Company has allocated $565,188 of the
beneficial conversion feature as a discount on the note, which represents 100%
of the face value of the note, which will accrete over the life of the note. In
addition, the Company recognized a derivative valuation loss on the issuance of
the note in the amount of $361,533.

Mr. Robinson advanced an additional $75,272 during the three months ended June
30, 2006, resulting in additional loan discount and derivative liability being
recorded by the Company of $65,796. In addition, Mr. Robinson converted an
aggregate of $52,123 of accounts payable to the line of credit. An additional
$94,884 was advanced for the three months ended September 30, 2006, resulting in
additional loan discounts and derivative liability being recorded by the Company
in the amount of $55,453, representing approximately 58% of the value of the
additional advances made under the line of credit. An analysis of the valuation
upon issuance and the revaluation as of September 30, 2006 of the beneficial
conversion feature related to Mr. Robinson's note and the significant
assumptions used are contained in the following table:

<TABLE>
<CAPTION>
                                                                        Issuances               Issuances
                                               Issuance date         from April 1 to         from July 1 to           Report date
                                               March 31, 2006         June 30, 2006        September 30, 2006     September 30, 2006
                                             -----------------      ------------------     ------------------     ------------------
<S>                                          <C>                    <C>                    <C>                    <C>
Aggregate note amounts                       $         565,188      $          127,395     $           94,884     $         302,466
Conversion price                             $            0.30      $             0.30     $             0.30     $            0.30
Term of notes                                       1.75 years        1.55 - 1.7 years      1.30 - 1.47 years            1.25 years
Shares issuable upon conversion                      1,883,960                 424,649                316,279             1,008,219
Market Price                                 $            0.53           $0.29 - $0.50          $0.16 - $0.24     $            0.17
Risk free interest rate on issue date                     4.80%          4.96% - 5.14%          5.03% - 5.20%                  4.91%
Volatility                                              247.96%      240.51% - 246.75%      239.40% - 241.84%                239.76%
Fair value per share of conversion shares               0.4919           $0.25 - $0.46          $0.13 - $0.20                0.1266
Beneficial conversion feature fair value     $         926,720      $          116,620     $           55,453     $         127,641
Note discount amount                         $         565,188      $          109,545     $           55,453     $         195,291
Fair value of derivative related to
   beneficial conversion feature             $         361,532      $            7,075     $               --     $         127,641
</TABLE>

On April 20, 2006, Mr. Robinson converted $50,000 of the balance at the stated
conversion rate into 166,667 shares of Class A common stock. On September 29,
2006, Mr. Robinson On September 28, 2006 Mr. Robinson utilized the $350,000 of
the balance owed to him under the note to exercise 1,250,000 vested options
priced at $0.20 and $85,000 of the balance owed to him under the note to
exercise 500,000 vested options priced at $0.17 under the 2005 Stock Option
Plan. An aggregate of 2,250,000 shares were issued. Total accretion of $534,895
was recorded during the nine months ended September 30, 2006. The carrying value
of the note is $107,175, net of discount of $195,291 and is recorded in Notes
Payable - related parties in the accompanying balance sheet as of September 30,
2006. As a result of the conversions, the Company recognized a derivative
valuation loss of $20,010 representing the change of the value from the previous
valuation date to the date of conversion and as a result, reclassified an
aggregate of $265,087 to additional paid in capital and recorded interest
expense for the associated discount on the line of credit in the amount of
$385,804 during the nine months ending September 30, 2006.


                                       20
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

An analysis of the valuation of the beneficial conversion feature related to Mr.
Robinson's note and the significant assumptions used are contained in the
following table:

<TABLE>
<CAPTION>
Conversion date                                                April 20, 2006     September 29, 2006
                                                               --------------     ------------------
<S>                                                              <C>                  <C>
Original proceeds from note                                      $  565,188           $  565,188
Note amount converted                                            $   50,000           $  435,000
Principal remaining after conversion                             $  515,188           $  302,466
Conversion price                                                 $     0.30           $     0.30
Term of notes at conversion                                      1.70 years           1.25 years
Shares issued on conversion                                         166,667            1,450,000
Potential remaining conversion shares                             1,717,293            1,008,220
Common Stock Price on conversion date                            $     0.53           $    0.165
Risk free interest rate at December 31, 2005                           4.89%                4.91%
Volatility on conversion dates                                       246.20%              239.76%
Fair value per share of conversion shares                            0.4891               0.1266
Fair value of derivative                                         $  839,928           $  127,641
Derivative liability reclassified to additional paid-in
   capital upon conversion                                       $   81,517           $  183,570
Derivative valuation gain recognized                             $       --           $   20,010
</TABLE>

On April 19, 2006, the Board approved two convertible promissory notes for
amounts as of April 17th, 2006, of $83,726 and $13,056, respectively with Frank
Lively for cash advanced for working capital plus fees and interest. The notes
bear interest at the rate of 12% per annum, are unsecured and are convertible
into Class A common stock at $0.30 per share. The notes are due on December 31,
2007. The notes contain a beneficial conversion feature due to the conversion
price of $0.30 being lower than the market price of $0.53 on the date of
issuance. The beneficial conversion feature was valued at $149,457 on the date
of issuance and recorded as a derivative liability. The Company has allocated
$91,151 of the beneficial conversion feature as a discount on the balance of the
notes as of March 31, 2006 which will accrete over the life of the notes. In
addition, the Company recognized a derivative valuation loss on the issuance of
the note in the amount of $58,306. Total accretion of $12,986 was recorded
during the three months ended June 30, 2006. The Company paid $15,000 of
principal and accrued interest in July 2006 to Mr. Lively.

On September 29, 2006 Mr. Lively utilized the balance owed to him under the
notes, including principal and all related interest of $92,973 to exercise
vested options at an exercise price of $0.20 per share under the 2005 Stock
Option Plan. An aggregate of 464,465 shares were issued to him and the Notes
were cancelled. The Company recorded the remaining discount of $78,165 to
interest expense during the quarter ended September 30, 2006. In addition, the
Company reclassified $38,466 to additional paid in capital and recognized a
derivative valuation loss of $4,193 upon the conversion of the notes.


                                       21
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

An analysis of the valuation upon issuance, upon revaluation as of June 30, 2006
and upon conversion as of September 29, 2006 of the beneficial conversion
feature related to Mr. Lively's note and the significant assumptions used are
contained in the following table:

<TABLE>
<CAPTION>
                                                Issuance date        Report date        Conversion Date
                                               March 31, 2006       June 30, 2006     September 29, 2006
                                               --------------       -------------     ------------------
<S>                                             <C>                 <C>                  <C>
Aggregate note amounts                          $     91,151        $     91,151         $     91,151
Conversion price                                $       0.30        $       0.30         $       0.30
Term of notes                                     1.75 years          1.50 years           1.25 years
Shares issuable upon conversion                      303,837             303,836              303,836
Market Price                                    $       0.53        $       0.17         $      0.165
Risk free interest rate                                 4.80%               5.16%                4.91%
Volatility on issue date                              247.96%             242.54%              239.76%
Fair value per share of conversion shares             0.4919              0.1404               0.1266
Beneficial conversion feature fair value        $    149,457        $     42,659         $     38,466
Note discount amount                            $     91,151        $     78,165         $         --
Fair value of derivative related to
   beneficial conversion feature                $     58,306        $    (35,506)        $     38,466
Derivative valuation loss recognized
 on conversion                                                                           $     (4,193)
</TABLE>

On April 19, 2006, the Board approved a convertible promissory note for an
aggregate amount as of April 17th, 2006 in the amount of $312,255 plus accrued
interest with Cherokee Raiders, LP, by way of cash advanced for working capital
plus fees and interest. The note bears interest at the rate of 12% per annum, is
unsecured and is convertible into Class A common stock at $0.30 per share. The
note is due on December 31, 2007. This note replaces the note dated December 31,
2005 on identical terms.

The three notes discussed above provide for acceleration of payment from amounts
in excess of a minimum of $7,000,000 that are raised in any type of financing.
Such prepayments would be made on a pro rata basis among certain note holders.
As a result of this acceleration provision, the notes have all been treated as
current liabilities.

On April 20, 2006 the Company issued an aggregate of 937,776 shares upon
exercise of the conversion rights to Class A common stock at a conversion price
of $0.30 per share associated with Convertible Notes in the aggregate amount of
$281,333. The four executive employees converted an aggregate of $131,419, Frank
Lively converted one of his notes representing deferred salary in the amount of
$41,914, and Mr. Robinson and Cherokee each converted $50,000.

On September 28, 2006 the remaining balance due to the executive employees, John
Youngbeck and Keith Vierela utilized the balances owed to them under their notes
including principal and all related interest of $55,096 and $80,062,
respectively to exercise 398,317 and 280,474 vested options, respectively under
the 2005 Stock Option Plan. An aggregate of 678,791 shares were issued and the
Notes were cancelled. No beneficial conversion features were present on these
notes.


                                       22
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On September 28, 2006 James Alman utilized the balance owed to him under his
note, including principal and all related interest of $68,286 to exercise
341,432 vested options under the 2005 Stock Option Plan. An aggregate of 341,432
shares were issued to him and the Note was cancelled. There was no beneficial
conversion feature recognized on this note.

During the nine months ended September 30, 2006 the Company paid an aggregate of
$50,000 of the principal balance of the Convertible Note payable to Proxity,
Inc.

<TABLE>
<CAPTION>
                                                                             September 30,       December 31,
                                                                                 2006                2005
                                                                             -------------       ------------
<S>                                                                           <C>                 <C>
Convertible Promissory Note - Cherokee Raiders, interest at 12%
  per annum, due December 31, 2007, unsecured .............................      262,255             312,255

Convertible Promissory Note - Proxity Inc., interest at 12% per annum,
  due July 31, 2008, unsecured ............................................      301,600             351,600

Convertible Promissory Note - William Robinson, interest at 12% per
  annum, due December 31, 2007, unsecured, net of discount of
  $195,291 and $0, respectively ...........................................      107,176             460,851

Convertible Promissory Note - Jim Alman - interest at 12% per
  annum, due December 31, 2007, unsecured .................................           --              50,000

Convertible Promissory Notes - executive employees - interest at
  12% per annum, unsecured, due December 31, 2007 .........................           --             263,266

Convertible Promissory Notes - Frank Lively - interest at 12% per annum,
  unsecured, due December 31, 2007 ........................................           --             124,343
                                                                              ----------          ----------
                                                                              $  671,031          $1,562,315
                                                                              ==========          ==========
</TABLE>

NOTE 7- STOCKHOLDERS' DEFICIT

COMMON STOCK - At September 30, 2006 and December 31, 2005, the Company had
67,367,316 and 56,912,893 shares of Class A Common Stock outstanding,
respectively, 545,455 shares of Class B Common Stock, and 2 shares of Class C
Common Stock issued and outstanding with 200,000,000 shares of Class A and Class
B Common Stock authorized, par value $.001, and 200,000,000 shares of Class C
Common Stock authorized, par value $.001. In addition, the Company had
100,000,000 shares of Class A Preferred Stock authorized, par value $.001, with
no shares issued and outstanding. Class B Common Stock allows for 1,000 votes
per share. Class C Common Stock allows for one vote per share and entitles the
holder to receive the net assets of the Company upon dissolution. Additional
paid in capital at September 30, 2006 and December 31, 2005 was $20,413,803 and
$14,644,966, respectively. The accumulated deficit as at September 30, 2006 and
December 31, 2005 was $34,595,541 and $16,476,382, respectively.

STOCK OPTIONS - During the three months ended September 30, 2006, the Company
issued an aggregate of 3,575,000 options under the 2005 Stock Option Plan. The
weighted average exercise price was $0.17 and the term was 10 years from the
date of grant. The grants were made at or above the closing market price on the
date of grant.


                                       23
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On September 28, 2006 an aggregate of 4,496,162 options issued pursuant to the
2005 Stock Option Plan were exercised at a weighted average exercise price of
$0.20. There were no cash proceeds realized by the Company in the exercise. As
discussed in Note 7, Messrs. Robinson, Lively, Youngbeck, Vierela and Alman
utilized the balances owed to them under their respective notes, including
principal and all related interest of $732,718 to exercise 3,735,088 vested
options under the 2005 Stock Option Plan. In addition on September 28, 2006, an
aggregate of 761,064 options were exercised by employees and Board members. No
proceeds were received by the Company on the exercise. Rather, the employees
utilized amounts due to them by the Company for commissions, consulting fees and
board fees as consideration for the options.

STOCK ISSUANCES - The Company issued the following shares of Class A Common
Stock during the nine months ended September 30, 2006.

On April 20, 2006, the Company issued an aggregate of 337,618 shares of its
Class A common stock at a price of $0.53 valued at $178,938 to vendors in
exchange for services and to settle existing obligations of the Company.

On April 20, 2006 the Company issued 55,000 shares of its Class A common stock
upon the conversion of $11,000 of accounts payable by David Barnes, its Chief
Financial Officer at the price of $0.20 per share.

On April 20, 2006 the Company issued an aggregate of 937,776 shares of its Class
A common stock upon the conversion of related party convertible notes at a
conversion price of $0.30 for a total amount of $281,333.

On April 20, 2006 the Company issued an aggregate of 966,667 shares of its Class
A common stock upon the conversion of unrelated convertible notes at a
conversion price of $0.30 for a total amount of $290,000.

On June 6, 2006 the Company issued 609,300 shares of its Class A common stock to
AJW upon conversion of $114,487 of their convertible notes at a conversion price
of $0.1879.

On June 28, 2006 the Company issued 476,043 shares of its Class A common stock
upon conversion of $142,813 of unrelated convertible notes at a conversion price
of $0.30. On September 28, 2006 the Company issued an additional 317,362 shares
of Class A common stock to relative to an agreement lowering the conversion
price from $0.30 to $0.18.

On July 21, 2006 the Company issued 46,666 shares of its Class A common stock
upon the conversion of $7,000 of accounts payable by its Chief Financial
Officer, David M. Barnes at a price of $0.15 per share.

On July 21, 2006 the Company issued 616,000 shares of its Class A common stock
at a price of $0.18 per share valued at $110,880 to vendors for services
rendered.

On July 21, 2006 the Company issued 106,000 shares of its Class A common stock
to Equipment Depot in conversion of their Note and all related accrued interest
of $26,500 at a conversion price of $0.25 per share.

On September 18, 2006 the Company issued 609,846 shares to AJW upon conversion
of $63,424 of their Notes at a conversion price of $0.104 per share.

On September 28, 2006 the Company issued 300,097 shares of its Class A common
stock upon conversion of $60,019 of unrelated convertible notes and related
interest at a conversion price of $0.20.

On September 28, 2006 an aggregate of 4,496,162 shares were issued pursuant to
the exercise of options as discussed above.

On September 28, 2006 the Company issued an additional 317,362 shares of Class A
common stock valued at $57,125 to Mayo Hadden valued at $0.18 per share
representing the market price as June 28, 2006, the date of the conversion of
the remaining balance of his note.


                                       24
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On September 30, 2006, the Company issued 579,886 shares of its Class A common
stock to two vendors at a price of $0.20 with a total value of $115,977 for
services rendered.

NOTE 8- INCOME TAXES

The Company has paid no federal or state income taxes since its incorporation.
As of September 30, 2006 and December 31, 2005, the Company had net operating
loss carry forwards for federal income tax reporting purposes of approximately
$10,170,000 and $6,154,864 respectively, which if unused, will expire through
2026. Deferred tax assets are reduced by a valuation allowance to the extent
that uncertainty exists as to whether the deferred tax assets will ultimately be
realized.

NOTE 9- COMMITMENTS AND CONTINGENCIES

On January 1, 2006 we entered into a new employment agreement with Mr. Robinson,
the CEO, Chairman and President of the Company. The term of this agreement is
for a period of one year subject to renewal for successive one year periods,
unless 14 days prior written notice is provided by either party. Mr. Robinson
will receive an annual salary of not less than $250,000. The agreement provides
for standard benefits, vacation and participation in the Company's bonus pool as
defined in the agreement. In addition, the Company shall issue to Employee
options to purchase shares of Company stock (Shares) in accordance with the
Company's Stock Option Plan. The agreement may be terminated for due cause, upon
death, upon disability, voluntary termination by him, or the Company, without
due cause by providing 14 days prior written notice. Mr. Robinson is subject to
a non-compete and non-solicitation provision during the employment term and
during a specified Post-Employment Period (as defined in the employment
agreement).

On January 1, 2006, we entered into a new employment agreement with our Vice
President, James D. Alman. The term of this agreement is for a period of one
year, subject to renewal for successive one year periods, unless 14 days prior
written notice is provided by either party. Mr. Alman will receive an annual
salary of not less than $135,000. The agreement provides for standard benefits,
vacation and participation in the Company's bonus pool as defined in the
agreement. In addition, the Company shall issue to Employee options to purchase
shares of Company stock (Shares) in accordance with the Company's Stock Option
Plan. The Agreement may be terminated for due cause, upon death, upon
disability, voluntary termination by him, or the Company without due cause by
providing 14 days prior written notice. Mr. Alman is subject to a non-compete
and non-solicitation provision during the employment term and during a specified
Post-Employment Period.

On January 1, 2006, The Company entered into a new employment agreement with
Keith Vierela as Chief Operating Officer. The term of this agreement is one
year, subject to renewal for successive one year periods, unless 14 days prior
written notice is provided by either party. Mr. Vierela will receive an annual
salary of not less than $150,000. The agreement provides for standard benefits,
vacation and participation in the Company's bonus pool as defined in the
agreement. In addition, the Company shall issue to Employee options to purchase
shares of Company stock (Shares) in accordance with the Company's Stock Option
Plan. The Agreement may be terminated for due cause, upon death, upon
disability, voluntary termination by him, or the Company without due cause by
providing 14 days prior written notice. Mr. Vierela is subject to a non-compete
and non-solicitation provision during the employment term and during a specified
Post-Employment Period. On November 15, 2006 Mr. Vierela and the Company
terminated the contract under an agreement as of that date.


                                       25
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

On January 1, 2006, TSI entered into a new employment agreement with John
Youngbeck as Executive Vice President. The term of this agreement is one year,
subject to renewal for successive one year periods, unless 14 days prior written
notice is provided by either party. Mr. Youngbeck will receive an annual salary
of not less than $100,000. The agreement provides for standard benefits,
vacation and participation in the Company's bonus pool as defined in the
agreement. In addition, the Company shall issue to Employee options to purchase
shares of Company stock (Shares) in accordance with the Company's Stock Option
Plan. The Agreement may be terminated for due cause, upon death, upon
disability, voluntary termination by him, or the Company without due cause by
providing 14 days prior written notice. Mr. Youngbeck is subject to a
non-compete and non-solicitation provision during the employment term and during
a specified Post-Employment Period.

On January 1, 2006, TSI entered into a new employment agreement with Michael
Lawson as Corporate Marketing Officer. The term of this agreement is one year,
subject to renewal for successive one year periods, unless 14 days prior written
notice is provided by either party. Mr. Lawson will receive an annual salary of
not less than $100,000. The agreement provides for standard benefits,
commissions of 2% of all gross sales less costs registered by the employee,
vacation and participation in the Company's bonus pool as defined in the
agreement. In addition, the Company shall issue to Employee options to purchase
shares of Company stock (Shares) in accordance with the Company's Stock Option
Plan. The Agreement may be terminated for due cause, upon death, upon
disability, voluntary termination by him, or the Company without due cause by
providing 14 days prior written notice. Mr. Lawson is subject to a non-compete
and non-solicitation provision during the employment term and during a specified
Post-Employment Period.

On January 1, 2006, the Company entered into an hourly consulting agreement with
Frank Lively. The consulting agreement provides for the cancellation of Mr.
Lively's prior employment agreement. Fees due under the consulting agreement are
convertible into Class A common shares of the Company by Mr. Lively at the
lesser of $0.30 per share or the closing price on the date of conversion. This
contract was terminated on July 15, 2006.

On January 1, 2006, the Company entered into an hourly consulting agreement with
Steve Johnson. Fees due under the consulting agreement are convertible into
Class A common shares of the Company by Mr. Johnson at the lesser of $0.30 per
share or the closing price on the date of conversion.

In January, 2006 the Company entered into a Strategic Consulting Agreement for
finance consulting services. The agreement calls for a minimum term of 90 days
and the payment of the equivalent of $120,000 of the Company's Class A common
stock at a 30% discount to the closing price and 150,000 warrants at a price to
be determined upon the close of a financing transaction as defined in the
agreement. The agreement was cancelled effective April 19, 2006 and the Company
issued an aggregate of 114,285 shares of Class A Common stock valued at $60,571
pursuant to the terms of a cancellation agreement. The warrants potentially
issuable in the agreement were not issued.


                                       26
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

In February, 2006, the Company entered into an Investor Relations Agreement for
a term of one year with Osprey Partners to provide investor and shareholder
relations services to the Company. The agreement calls for a monthly retainer of
$6,000 and the issuance of warrants to purchase 600,000 shares of the Company's
Class A common stock at a strike price of $0.45 per share with a value of
$419,760 on the date of grant using the Black Scholes method. The warrants
expire 7 years after the anniversary date. The warrants vest monthly over one
year, with 50,000 warrants vesting at the signing of the agreement, subject to
immediate vesting of all remaining warrants should the retainer become 30 days
past due. During June, 2006 the retainer became 30 days past due and
accordingly, the Company recognized compensation expense of $419,760 within
general and administrative expenses in the accompanying statement of operations
for the six months ended June 30, 2006.

In March, 2006 the Company executed a Due Diligence Agreement with GreenHills
Ventures, LLC. ("GreenHills"). Under the agreement, the Company paid GreenHills
$10,750 plus expenses for GreenHills to perform due diligence on behalf of
potential investors as a due diligence fee. In addition, the Company agreed to
compensate GreenHills for any financing transaction (debt, equity, hybrid
security, merger and acquisition or other similar arrangement financing) with
any qualified purchaser as defined in the agreement. The compensation consists
of the payment of cash of 10% of the aggregate value of any equity or non-loan
financing and 7% of the value to be paid in Class A common stock of the Company.
In the event of a non-equity financing, the compensation consists of payment of
cash of 3% of the aggregate value of the transaction and 7% of the value to be
paid in Class A common stock of the Company.

The agreement calls for the payment of a breakup fee to be paid under certain
conditions as defined in the agreement of 2.5% of the first $5,000,000 of a
financing plus 1% of any amount greater than $5,000,000.

On April 27, 2006 the "Company entered into an Agreement, (the "Agreement")
dated as of April 25, 2006, by and among the Company, Sierra Nevada Corporation
"Sierra" and TSI. The Agreement is intended to clarify the relationship and
obligations of the parties, which arise from three prior agreements (the
Exclusive Agreement to Provide Integration Services, dated June 30, 2004, the
Memorandum of Agreement dated November 4, 2004 and the Subcontract Agreement
dated May 11, 2005) which were entered into prior to Techsphere becoming a
wholly-owned subsidiary of the Company. The Agreement provides that SNC will
serve as the prime contractor to Government End-Users for all Techsphere
Airships and provided that Sierra will give Techsphere the right of first
refusal to lease or sell other non-Techsphere manufactured airships to Sierra on
competitive terms. The Agreement also is intended to arrive at an understanding
with respect to amounts claimed by Sierra as owed, which arose from certain
expenditures made by Sierra for which they are seeking reimbursement. The
Agreement provides that if all other conditions of the Agreement are fulfilled
that (i) Sierra will reduce its claim from $780,000 to $500,000; (ii) the
Company will within 90 days deliver four MAA-90 airship pods to Techsphere free
and clear of any liens and encumbrances and (iii) if a delivery order is awarded
and Techsphere delivers the completed MAA-90 airship to Sierra, Sierra will
set-off the $500,000 payment due from the Company. The Company has delivered the
four MAA-90 airship pods and is currently in negotiations whereby a delivery
order in excess of $1,000,000 calling for the completion of the MAA-90 airship
as well as certain additional operating features and accessories is anticipated
from Sierra. Final terms are anticipated to include a $500,000 credit against
the note provided that a completed airship is delivered no later than 120 days
subsequent to the receipt and acceptance of the delivery order by Sierra. If the
delivery order is not awarded, the Company's promissory note to Sierra will
become due and payable in accordance with its terms.

Pursuant to the Agreement, the Company issued a note to Sierra dated April 25,
2006 in the amount of $500,000 which bears interest at the rate of 8.5%
beginning August 25, 2006 secured by the above referenced airship pods. The
Company recognized the net present value of the note as Selling, General and
Administrative expenses in the accompanying statements of operations. (See Note
5)


                                       27
<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

During the quarter ended June 30, 2006, the Company executed an Airship
Advertising Agreement with a fortune 100 publicly traded company for the lease
and operation of two of its SA-60A spherical airships. The lease term is
expected to commence in fiscal 2007 upon completion of the manufacturing of the
airship and provides for an initial six-month term which can be extended at the
discretion of the lessee. Future minimum lease payments to be received by the
Company are as follows:

                 Due at launch of first airship         700,000
                 Due at launch of second airship        700,000
                 Due three months from launch           700,000
                 Due at end of initial term             700,000
                                                     ----------
                   Total                             $2,800,000
                                                     ==========

The Company is responsible for all operating, maintenance, insurance, permits,
taxes and related costs. Certain travel related costs incurred will be
reimbursed by the lessee.

In addition, the lessee granted a non-exclusive, non-transferable personal
license to the Company to make and distribute airship related merchandise in
exchange for a royalty of four percent (4.0%) of all net sales of merchandise as
defined in the agreement.

The Company received two payments for $700,000 and $686,000, net of vendor
discounts of $14,000 during the nine months ended September 30, 2006 and has
classified $1,400,000 as deferred revenue in the accompanying balance sheet as
of June 30, 2006. Revenue from the lease will be recognized over the six month
term of the lease.

NOTE 10- SUBSEQUENT EVENTS

On October 9, 2006 the Company issued a warrant to purchase 500,000 shares of
Class A common stock at a price of $0.45 to a vendor for services rendered. The
value of the warrant is $75,200 as determined by the Black Scholes method will
be charged to General and administrative expenses in the fourth quarter of 2006.

On April 17, 2006 the Company entered into agreements with Equipment Depot,
Inc., to acquire approximately $4,100,000, as valued, of aerospace R & D and
production equipment to further the fulfillment of the Company's anticipated
contracts and purchase orders. The Company would pay approximately $2.7 million,
in a combination of $700,000 in cash and the exchange of 1,700,000 newly issued
common stock of the Company, valued at $1.00 a share for the purposes of the
transactions, to complete the purchase. As of August, 2006, Equipment Depot,
Inc. has indicated to the Company that it is aware of at least one financing
source for completing this transaction. On November 13, 2006 the Company
notified Equipment Depot that if the agreements do not close by December 12,
2006 the agreements will be cancelled.

On November 15, 2006 Keith Vierela, the Chief Operating Officer of Techsphere
and a director of the Company resigned as officer and director and mutually
agreed to terminate the employment agreement dated January 1, 2006. Under the
terms of the agreement, Mr. Vierela was released from all restrictive covenants
of his employment agreement in exchange for the return and cancellation of
500,000 shares of Class A common stock held by Mr. Vierela.


                                       28
<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
LIQUIDITY AND CAPITAL RESOURCES

GENERAL

The following discussion and analysis should be read in conjunction with the
Condensed Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Form 10-QSB/A.

This management's discussion and analysis of financial conditions and results of
operations contains certain "forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995. Such statements relating to
future events and financial performance are forward-looking statements that
involve risks and uncertainties, detailed from time to time in the Company's
various SEC filings. No assurance can be given that any such matters will be
realized.

RESULTS OF OPERATIONS

The Three Months Ended September 30, 2006 Compared to the Three Months Ended
September 30, 2005

Revenue totaled $136,137 for the three months ended September 30, 2006, an
increase of $21,264 as compared to $114,873 for the three months ended September
30, 2005. The increase is primarily due to increased sales of the Techsphere
related product and integration services as there was no revenue recognized in
the three months ended September 30, 2005 due to Techsphere being acquired on
September 19, 2005.

Research and development expense totaled $90,406 for the three months ending
September 30, 2006 for which no comparable expense exists for the three months
ended September 30. The expense for the 2006 period pertains to development of
the Company's UAV's and airships.

General and administrative expenses totaled $1,630,022 for the three months
ended September 30, 2006 as compared to $1,155,939 for the three months ended
September 30, 2005, a net increase of $474,083. The increase is primarily due to
increases in TSI related expenses as detailed below offset by decreases at Cyber
for the three months ended September 30, 2006. The TSI expenses for the three
months ended September 30, 2006 of $781,399 were comprised of $250,000 of
royalty expense and $197,994 of amortization related to the Century 21 Airships
license and $334,405 related to general overheads, an increase of $671,875 as
compared to $109,524 for the prior year TSI expenses from September 19, 2005 to
September 30, 2005 and totaled $109,524 comprised of $33,000 of royalty expense
and $32,999 of amortization related to the Century 21 Airships license and
$43,525 related to general overheads.

Stock option compensation expense for the three months ended September 30, 2006
totaled $1,287,008 relating to the fair value of stock options that vested or
were accelerated during the period, an increase of $1,276,208 as compared to the
prior year expense of $10,800 for the three months ended September 30, 2005. The
increase is due to the accelerated vesting of the options granted on September
19, 2005 effective September 28, 2006 that resulted in compensation expense of
$697,133. In addition, the Company granted an additional 3,575,000 options
during the quarter ended September 30, 2006 which vested upon grant resulting in
compensation expense of $589,875.

The impairment loss of $11,330,674 for the three months ended September 30, 2006
is related to the exclusive manufacturing license from 21st Century Airships.
Management determined that the asset was impaired due to the reduced expected
revenues and cash flows for the license, creating the impairment.

Other income and expense for the three months ended September 30, 2006 and 2005
was comprised of interest expense, interest income and derivative valuation
losses. Interest expense for the three months ended September 30, 2006 was
$1,157,741, of which $922,337 represents amortization of discounts on notes to
AJW, Mr. Robinson, Mr. Lively and James Gardiner compared to interest expense of
$1,028,259 of which $772,116 represents amortization of loan discount for the
three months ended September 30, 2005. Other income and expense for the three
months ended September 30, 2005 consists of other income of $32,845 and interest
income of $10,386 for which no amount exists for the three months ended
September 30, 2006.


                                       29
<PAGE>

Derivative valuation loss for the three months ended September 30, 2006 in the
amount of $485,507 relates to the issuance, conversion and revaluation of Notes
and Warrants to AJW and various notes issued to Mr. Robinson, Mr. Lively and
James Gardiner treated as derivative securities. Derivative valuation loss for
the three months ended June 30, 2005 in the amount of $176,862 relates to the
issuance, conversion and revaluation of Notes and Warrants to AJW treated as
derivative securities. The components of the derivative valuation gains (losses)
for the three months ended September 30, 2006 and 2005 are presented in the
following table:

<TABLE>
<CAPTION>
                                                                                        Three months ended
                                                                                 September 30,       September 30,
                                                                                      2006                2005
                                                                                 -------------       -------------
<S>                                                                               <C>                 <C>
Derivative valuation (loss) on issuance of notes - AJW                            $  (527,648)        $(1,338,882)
Derivative valuation (loss) on issuance of warrants -AJW                             (117,140)         (2,376,600)
Derivative valuation (loss) on conversion -AJW                                        (45,305)           (182,001)
Derivative valuation gain on conversion -Robinson                                      20,010                  --
Derivative valuation gain on conversion -Lively                                         4,193                  --
Derivative valuation gain on conversion -Gardiner                                          --                  --
Derivative valuation (loss) on issuance of note - Gardiner                                 --                  --
Derivative valuation (loss) on issuance of note- Robinson                                  --                  --
Derivative valuation (loss) - beneficial conversion revaluation - Robinson             24,960                  --
Derivative valuation (loss) on issuance of notes - Lively                                  --                  --
Derivative valuation (loss) - beneficial conversion revaluation - Lively                   --                  --
Derivative valuation (loss) - beneficial conversion revaluation - Gardiner                 --                  --
Derivative valuation gain (loss) - warrant revaluation AJW                             (9,779)          7,665,119
Derivative valuation gain (loss)- beneficial conversion revaluation - AJW             165,202          (3,944,498)
                                                                                  -----------         -----------
                                                                                  $  (485,507)        $  (176,862)
                                                                                  ===========         ===========
</TABLE>

The Company uses the Black Scholes method to value the derivatives contained in
the securities it has issued. The assumptions used in the valuation of the
derivatives have been detailed in Note 5 and 6 of the financial statements. The
most significant valuation assumption components in the valuation calculations
are the closing stock price on the date of the valuation and the number of
shares issuable upon conversion, which is based upon a discount applied to the
average of the lowest three intra-day trading prices for the Company's common
stock during the 20 trading days immediately preceding the valuation date.

The derivative losses for the three months ended September 30, 2006 are
primarily due to the issuances of the 6% Convertible Notes to AJW in the
aggregate amount of $700,000 and the 770,000 warrants granted relative to the
issuance treated as derivative securities during the three months ended
September 30, 2006. The stock price was $0.17 as of June 30, 2006 as compared to
$0.165 as of September 30, 2006.

The derivative losses for the three month period ended June 30, 2005 result
primarily from the price of the stock on the date of issuance of the AJW
securities on April 1, 2005 of $3.60 and the price on May 25, 2005 of $2.75
resulted in significant losses upon issuance when using the Black Scholes
method. The price of the stock at the valuation date of June 30, 2005 decreased
to $2.00, .resulting in a decrease in the value of the warrants and the
recognition of a derivative valuation gain that partially offset the issuance
losses.

The Nine Months Ended September 30, 2006 Compared to the Nine Months Ended
September 30, 2005

Revenues totaled $438,031 for the nine months ended September 30, 2006, an
increase of $257,393 as compared to $180,638 for the three months ended
September 30, 2005. The increase is primarily due to increased sales of the
Techsphere related product and integration services as there was no revenue
recognized in the nine months ended September 30, 2005 due to Techsphere being
acquired on September 19, 2005.

Research and development expense totaled $189,666 for the nine months ending
September 30, 2006 as compared to $543,191 for the nine months ended September
30, 2005 a net decrease of $353,525. The expense for the 2006 period pertains to
development of the Company's UAV's while the comparable 2005 period pertains to
the airship propulsion systems for which no current period comparable expense
exists.


                                       30
<PAGE>

General and administrative expenses totaled $5,246,277 for the nine months ended
September 30, 2006 as compared to $2,486,713 for the nine months ended September
30, 2005, a net increase of $2,759,564. The increase is primarily due to share
based compensation expense relative to warrants of $419,760 as well as increased
payroll, marketing related activities, specialized consulting and legal fees and
a general increase in overheads. Also included in the nine months ended
September 30, 2006 is an aggregate of $2,131,355 pertaining to TSI, an increase
of $2,021,831 over the expense for the prior year TSI expenses from September
19, 2005 to September 30, 2005 of 109,524. The TSI expenses for the three months
ended September 30, 2006 are comprised of $744,122 of royalty expense and
$593,982 of amortization related to the Century 21 Airships license and
$1,077,527 related to salaries, rents and general overheads.

Stock option compensation expense for the nine months ended September 30, 2006
totaled $2,271,287 relating to the fair value of stock options that vested or
were accelerated during the period, an increase of $2,260,487 as compared to the
prior year expense of $10,800 for the nine months ended September 30, 2005. The
increase is due to the normal and accelerated vesting of the options granted on
September 19, 2005 effective September 28, 2006 that resulted in aggregate
compensation expense of $1,681,412. In addition, the Company granted an
additional 3,575,000 options during the quarter ended September 30, 2006 which
vested upon grant resulting in compensation expense of $589,875.

The impairment loss of $11,330,674 for the nine months ended September 30, 2006
is related to the exclusive manufacturing license from 21st Century Airships.
Management determined that the asset was impaired due to the reduced expected
revenues and cash flows for the license, creating the impairment. The impairment
of goodwill in the amount of $4,577,069 for the nine months ended September 30,
2005 pertains to goodwill associated with the acquisition of Cyber Aerospace.

Other income and expense for the three months ended September 30, 2006 and 2005
was comprised of interest expense, interest income and derivative valuation
losses, Interest expense for the nine months ended September 30, 2006 was
$2,543,411, of which $1,649,390 represents amortization of discounts on notes to
AJW, Mr. Robinson, Mr. Lively and James Gardiner. Interest expense for the nine
months ended September 30, 2005 was $1,889,344 of which $933,334 represents
amortization of discounts on notes to AJW. Other income and expense for the nine
months ended September 30, 2005 other income of $32,845 and interest income of
$20,627, for which no amount exists for the nine months ended September 30,
2006.

Also included in other income is the derivative valuation gain for the nine
months ended September 30, 2006 in the amount of $3,255,959 relating to the
issuance of Notes and Warrants to AJW and various notes issued to Mr. Robinson,
Mr. Lively and James Gardiner treated as derivative securities., Also included
in other income and expense is the derivative valuation loss for the nine months
ended September 30, 2005 in the amount of $7,673,072 relating to the issuance of
Notes and Warrants to AJW. The components of the derivative valuation gains
(losses) for the nine months ended September 30, 2006 and 2005 are presented in
the following table:

<TABLE>
<CAPTION>
                                                                                          Nine months ended
                                                                                  September 30,        September 30,
                                                                                      2006                 2005
                                                                                  -------------        -------------
<S>                                                                               <C>                  <C>
Derivative valuation (loss) on issuance of notes - AJW                            $ (2,127,303)        $ (3,313,576)
Derivative valuation (loss) on issuance of warrants -AJW                              (610,040)         (11,046,172)
Derivative valuation (loss) on conversion -AJW                                         (58,489)            (182,001)
Derivative valuation gain on conversion -Robinson                                       20,010                   --
Derivative valuation gain on conversion -Lively                                          4,193                   --
Derivative valuation gain on conversion -Gardiner                                          840                   --
Derivative valuation (loss) on issuance of note - Gardiner                             (37,050)                  --
Derivative valuation (loss) on issuance of note- Robinson                             (368,608)                  --
Derivative valuation (loss) - beneficial conversion revaluation - Robinson             767,572                   --
Derivative valuation (loss) on issuance of notes - Lively                              (58,306)                  --
Derivative valuation (loss) - beneficial conversion revaluation - Lively               106,799                   --
Derivative valuation (loss) - beneficial conversion revaluation - Gardiner             (20,520)                  --
Derivative valuation gain (loss) - warrant revaluation AJW                           1,164,955           10,866,669
Derivative valuation gain (loss)- beneficial conversion revaluation - AJW            4,225,140           (3,997,992)
                                                                                  ------------         ------------
                                                                                  $  3,009,193         $ (7,673,072)
                                                                                  ============         ============
</TABLE>


                                       31
<PAGE>

The derivative gain for the nine months ended September 30, 2006 relates
primarily to the decrease in the value of the common stock for the nine months
ended September 30, 2006. The stock price was $0.40 as of December 31, 2005 as
compared to $0.165 as of September 30, 2006. As a result of the decrease of the
stock price, the valuation of the underlying derivatives decreased
significantly. As a result, since the Company recognizes a gain or loss
dependant upon the change in valuation at each reporting date, the decrease in
the liability related to this value as of September 30, 2006 when compared to
the December 31, 2005 resulted in gains, most notably in the AJW beneficial
conversion valuation. In addition, the issuance of notes of $1,700,000 to AJW
and related warrants for the purchase of 1,870,000 shares of common stock for
the six months ended June 30, 2006 decreased from the $4,000,000 issuance of
notes to AJW and related warrants for the purchase of 4,400,000 shares of common
stock related to issuances of new convertible notes treated as derivative
securities in the nine months ended June 30, 2005.

The derivative losses for the six month period ended June 30, 2005 result
primarily from the price of the stock on the date of issuance of the AJW
securities on April 1, 2005 of $3.60, the price on May 25, 2005 of $2.75 and the
price on August 3, 2005 of $2.10 resulted in significant losses upon issuance.
The price of the stock at the valuation date of September 30, 2005 decreased to
$0.33, .resulting in a decrease in the value of the warrants and the recognition
of a derivative valuation gain that partially offset the issuance losses.

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary needs for liquidity and capital resources are for the
production of its airships relative to the Airship Advertising Agreement, the
funding of salaries and other administrative expenses related to the management
of the Company as well as for payment of the cost of products sold and
inventory.

The Company has no cash or cash equivalents as of September 30, 2006 and must
seek additional financing.

On March 15, 2006, the Company entered into a Securities Purchase Agreement,
whereby the Company agreed to issue and sell an aggregate of $2,000,000 of 6%
Callable Secured Convertible Notes and warrants to purchase 2,000,000 shares of
common stock at a price of $1.25 per share for a total offering price of
$2,000,000. The $2,000,000 is to be funded in three tranches of which $1,000,000
was funded on March 15, 2006, $500,000 upon filing the Registration Statement
and $500,000 upon effectiveness of the Registration Statement. On June 30, 2006
the Company filed a Registration Statement with the Securities and Exchange
Commission and, accordingly on July 6, 2006 the Company received $500,000
representing the second tranche of the above referenced agreement in exchange
for 6% Callable Secured Convertible Notes and issued five year warrants to
purchase 500,000 shares of common stock priced at $1.25. There can be no
assurances that the Company's Registration Statement will be declared effective
by the Securities and Exchange Commission. On September 11, 2006 AJW made an
advance of $200,000 and on October 19, 2006 made an additional advance of
$300,000 related to the $500,000 third tranche of financing pursuant to the
March 14, 2006 Securities Purchase Agreement in exchange for 6% Callable Secured
Convertible Notes and issued five year warrants to purchase 500,000 shares of
common stock priced at $1.25 thereby completing the sales of the 6% Callable
Secured Convertible Notes under the March 14, 2006 agreement. Since there are no
additional funds available to the Company under the March 15, 2006 Securities
Purchase Agreement, the Company must still seek additional financing.

On April 20, 2006 Mayo Hadden converted $200,000 of his outstanding Convertible
Note into 666,667 shares of common stock. On June 28, 2006, he converted the
remaining balance of $131,250 plus $11,563 of accrued interest into 476,043
shares of Class A Common Stock. The conversions were at the price of $0.30 per
share. There was no beneficial conversion feature associated with this note.

On April 21, 2006 the Company issued an aggregate of 964,443 shares to related
parties upon exercise of the conversion rights to Class A common stock at a
conversion price of $0.30 per share associated with Convertible Notes in the
aggregate amount of $289,333. Four executive employees converted an aggregate of
$139,419, Frank Lively converted his note representing deferred salary in the
amount of $49,914, and Mr. Robinson and Cherokee each converted $50,000. The
conversion of Mr. Robinson's note resulted in the reclassification of a
derivative liability in the amount of $81,617 to additional paid in capital. No
gain or loss was recognized on the conversion as the value did not change since
the last revaluation date.

On June 6, 2006, AJW converted $114,487 of the Notes for 609,300 Shares of Class
A common stock of the Company. The conversions were made at a 40% discount to
market pursuant to the terms of the Secured Convertible Note agreements. The
conversion resulted in the reclassification of a derivative liability in the
amount of $227,634 to additional paid in capital and the recognition of a loss
on conversion of $13,184.


                                       32
<PAGE>

On January 15, 2006 the Company issued an unsecured note in the amount of
$90,000 in exchange for cash of $82,000 and fees of $8,000. The note is due
December 31, 2007, is unsecured and bears interest at the rate of 12% and is
convertible into Class A common stock at $0.30 per share at any time. On April
20, 2006, the holder converted the note into 300,000 shares of the Company's
Class A common stock. The conversion resulted in the reclassification of a
derivative liability in the amount of $146,730 to additional paid in capital and
the recognition of a gain on conversion of $840.

On April 17, 2006 the Company entered into agreements with Equipment Depot,
Inc., to acquire approximately $4,100,000, as valued, of aerospace R & D and
production equipment to further the fulfillment of the Company's anticipated
contracts and purchase orders. The Company would pay approximately $2.7 million,
in a combination of $700,000 in cash and the exchange of 1,700,000 newly issued
common stock of the Company, valued at $1.00 a share for the purposes of the
transactions, to complete the purchase. As of August, 2006, Equipment Depot,
Inc. has indicated to the Company that it is aware of at least one financing
source for completing this transaction. On November 13, 2006 the Company
notified Equipment Depot that if the agreements do not close by December 12,
2006 the agreements will be cancelled.

On April 19th, 2006, the Board approved a $1,000,000 line of credit with Mr.
Robinson. On April 19, 2006 pursuant to the line of Credit, the Company entered
into a convertible variable promissory note in the principal amount as of March
31, 2006 of $565,188 under the line of credit including all related accrued
interest. The note bears interest at the rate of 12% per annum, is unsecured and
is convertible into Class A common stock at $0.30 per share. The note is due on
December 31, 2007. Mr. Robinson advanced an additional $222,278 through
September 30, 2006.

On April 19, 2006, the Board approved two convertible promissory notes for
amounts as of April 17th, 2006, of $83,726 and $13,056, respectively with Frank
Lively, a director of the Company for cash advanced for working capital plus
fees and interest. The notes bear interest at the rate of 12% per annum, is
unsecured and is convertible into Class A common stock at $0.30 per share. The
notes are due on December 31, 2007. Mr. Lively has advanced an aggregate of
$16,722 for the six months ended June 30, 2006.

On May 22, 2006, Techsphere Systems International, Inc., ("TSI") closed on a
lease contract for two of its SA-60A Spherical Airships to a fortune 100
publicly held company at an estimated initial contract value of approximately
$4.2 million. The Company received an initial down payment of $700,000 with the
closing and an additional $686,000 in August, 2006. Any additional payments
under this lease are subject to the completion and delivery of the airships to
the customer.

On September 28, 2006 an aggregate of 4,496,162 options issued pursuant to the
2005 Stock Option Plan were exercised at a weighted average exercise price of
$0.20. There were no cash proceeds realized by the Company in the exercise. As
discussed in Note 7, Messrs. Robinson, Lively, Youngbeck, Vierela and Alman
utilized the balances owed to them under their respective notes, including
principal and all related interest of $732,718 to exercise 3,735,088 vested
options under the 2005 Stock Option Plan. In addition on September 28, 2006, an
aggregate of 761,064 options were exercised by employees and Board members. No
proceeds were received by the Company on the exercise. Rather, the employees
utilized amounts due to them by the Company for commissions, consulting fees and
board fees as consideration for the options.

The Company is in discussions with two potential lending sources, but there can
be no assurance that these discussions will be successful or that the Company
will obtain sufficient financing or that financing(s) will be structured on
agreeable terms.

Should the Company not obtain such additional financing, the level of operations
may have to be severely curtailed or ceased entirety.


                                       33
<PAGE>

Critical Accounting Policies

The Company's discussion and analysis of its financial condition and results of
operations are based upon Cyber Defense's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires the use of
estimates that affect the reported amounts of assets, liabilities and expenses.
The Company evaluates its estimates on an ongoing basis, including estimates for
Income tax assets and liabilities and the impairment of the value of
investments. The Company bases its estimates on historical experience and on
actual information and assumptions that are believed to be reasonable under the
circumstances at that time. Actual results may differ from these estimates under
different assumptions or conditions. The Company believes that the following
critical accounting policies affect its more significant estimates used in the
preparation of its financial statements.

Revenue Recognition

The Company recognizes service revenues when the services, as specified by the
customer and agreed to by the Company, have been performed and the customer
accepts the services, and the services are billed. Airship sales are recognized
when contract specifications are met, the price is determined, title passes to
the customer and the customer is billed. Lease revenue on airships is recognized
over the term of the lease. Reasonableness of collectibility of all revenue
transactions is a key element before the transactions are recorded.

Derivative Instruments

The Company does not hold or issue derivative instruments for trading purposes.
However, the Company has convertible notes payable that contain embedded
derivatives that require separate valuation from the convertible notes under
Emerging Issues Task Force Abstract (EITF) 00-19, "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock." The Company recognizes these derivatives as liabilities in the
accompanying balance sheet and measures them at estimated fair value each
quarter, and recognizes changes in estimated fair value in the statement of
operations in the respective period. The Company has estimated the fair value of
these embedded derivatives using the Black-Scholes model.

Share Based Payments

In December 2004, the Financial Accounting Standards Board issued Statement
Number 123 ("FAS 123 (R)"), Share-Based Payments, which was adopted by the
Company on January 1, 2006. The Company recognizes compensation expense in an
amount equal to the fair value of share-based payments such as stock options
granted to employees. The Company has elected to apply FAS 123 (R) on a modified
prospective method. Under this method, the Company records compensation expense
as awards that were outstanding at the date of adoption continue to vest for the
unvested portion of the awards.

Accounting for Income Taxes

No income taxes have been paid or accrued because the Company had no net income
for the fiscal year ended December 31, 2005 or 2004. The Company recognizes the
amount of income taxes payable or refundable for the current year and recognizes
deferred tax assets and liabilities for the future tax consequences attributable
to differences between the financial statement amounts of certain assets and
liabilities and their respective tax bases. Deferred tax assets and deferred tax
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years those temporary differences are expected to be recovered or
settled. Deferred tax assets are reduced by a valuation allowance to the extent
that uncertainty exists as to whether the deferred tax assets will ultimately be
realized.


                                       34
<PAGE>

Long Lived Assets

Long-lived assets are reviewed for impairment quarterly or when events or
changes in circumstances indicate that the carrying amount may not be
recoverable. Recoverability of assets to be held and used is measured by
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount that the carrying amount
of the assets exceeds the fair value of the assets.

ITEM 3. CONTROLS AND PROCEDURES

As required by Rule 13a-15 under the Exchange Act, as of the end of the fiscal
period covered by this report, we have carried out an evaluation of the
effectiveness of the design and operation of our disclosure controls and
procedures. This evaluation was carried out under the supervision and with the
participation of our company's management, including our chief executive officer
and chief financial officer. Based upon that evaluation, our chief executive
officer and chief financial officer concluded that our disclosure controls and
procedures are effective at September 30, 2006. There have been no changes in
our internal controls over financial reporting in connection with this
evaluation that occurred during the third quarter of fiscal 2006 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.

Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in our reports
filed or submitted under the Exchange Act (a) is recorded, processed, summarized
and reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms and (b) is accumulated and communicated to
management, including our chief executive officer and chief financial officer,
as appropriate, to allow timely decisions regarding required disclosure.


                                       35
<PAGE>

                            PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None

ITEM 2. CHANGES IN SECURITIES INCLUDING UNREGISTERED SALES OF EQUITY SECURITIES

On July 21, 2006 the Company issued 46,666 shares of its Class A common stock
upon the conversion of $7,000 of accounts payable by its Chief Financial
Officer, David M. Barnes at a price of $0.15 per share.

On July 21, 2006 the Company issued 616,000 shares of its Class A common stock
at a price of $0.18 per share valued at $110,880 to vendors for services
rendered.

On July 21, 2006 the Company issued 106,000 shares of its Class A common stock
to Equipment Depot in conversion of their Note and all related accrued interest
of $26,500 at a conversion price of $0.25 per share.

On September 18, 2006 the Company issued 609,846 shares to AJW upon conversion
of $63,424 of their Notes at a conversion price of $0.104 per share.

On September 28, 2006 the Company issued 300,097 shares of its Class A common
stock upon conversion of $60,019 of unrelated convertible notes and related
interest at a conversion price of $0.20.

On September 28, 2006 an aggregate of 4,496,162 shares were issued pursuant to
the exercise of options under the 2005 option plan.

On September 28, 2006 the Company issued an additional 317,362 shares of Class A
common stock valued at $57,125 to Mayo Hadden valued at $0.18 per share
representing the market price as June 28, 2006, the date of the conversion of
the remaining balance of his note.

On September 30, 2006, the Company issued 579,886 shares of its Class A common
stock to two vendors at a price of $0.20 with a total value of $115,977 for
services rendered.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

On September 15, 2006 the Company obtained the written consents of the holders
of 48,028,756 or more than 76.6% of the outstanding shares of Class A common
stock in order to authorize the adoption of the 2005 Stock Option Plan.

ITEM 5. OTHER INFORMATION

None


                                       36
<PAGE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

All references to the Company's Forms 8-K include reference to File No.
333-46424.

4.18 Form of Stock Purchase Warrant dated March 14, 2006 by and among the
Company and AJW Partners, LLC. ("Partners"), AJW Offshore, Ltd. ("Offshore"),
AJW Qualified Partners ("Qualified") and New Millenium Capital Partners, II, LLC
("Millenium") (incorporated by reference to Exhibit 4.1 filed with the March 20,
2006 Form 8-K).

10.25 Form of Secured Convertible Note dated March 14, 2006 by and among the
Company and AJW Partners, LLC.("Partners"), AJW Offshore, Ltd. ("Offshore"), AJW
Qualified Partners ("Qualified") and New Millenium Capital Partners, II, LLC
("Millenium") (incorporated by reference to Exhibit 10.1 filed with the March
20, 2006 Form 8-K).

10.26 Securities Purchase Agreement dated March 14, 2006 (without schedules) by
and among the Company and AJW Partners, LLC. ("Partners"), AJW Offshore, Ltd.
("Offshore"), AJW Qualified Partners ("Qualified") and New Millenium Capital
Partners, II, LLC ("Millenium") (incorporated by reference to Exhibit 10.2 filed
with the March 20, 2006 Form 8-K).

10.27 Security Agreement dated March 14, 2006 by and among the Company and AJW
Partners, LLC. ("Partners"), AJW Offshore, Ltd. ("Offshore"), AJW Qualified
Partners ("Qualified") and New Millenium Capital Partners, II, LLC ("Millenium")
(incorporated by reference to Exhibit 10.3 filed with the March 20, 2006 Form
8-K).

10.28 Intellectual Property Security Agreement dated March 14, 2006 by and among
the Company and AJW Partners, LLC. ("Partners"), AJW Offshore, Ltd.
("Offshore"), AJW Qualified Partners ("Qualified") and New Millenium Capital
Partners, II, LLC ("Millenium") (incorporated by reference to Exhibit 10.4 filed
with the March 20, 2006 Form 8-K).

10.29 Registration Rights Agreement dated March 14, 2006 by and among the
Company and AJW Partners, LLC. ("Partners"), AJW Offshore, Ltd. ("Offshore"),
AJW Qualified Partners ("Qualified") and New Millenium Capital Partners, II, LLC
("Millenium") (incorporated by reference to Exhibit 10.4 filed with the March
20, 2006 Form 8-K).

10.30 Convertible Variable Promissory Note Under A Line Of Credit Not To Exceed
$1,000,000 by and among the Company and William C. Robinson dated April 24, 2006
(incorporated by reference to exhibit 10.1 filed with the April 24, 2006 8-K).

10.31 Convertible Promissory Note by and among the Company and Harvey Frank
Lively dated April 24, 2006 (incorporated by reference to exhibit 10.2 filed
with the April 24, 2006 8-K).

10.32 Convertible Promissory Note by and among the Company and Cherokee Raiders,
LP dated April 24, 2006 (incorporated by reference to exhibit 10.3 filed with
the April 24, 2006 8-K).

10.33 Agreement by and among the Company, TSI and Sierra Nevada Corporation
dated April 25, 2006 (incorporated by reference to exhibit 10.1 filed with the
May 2, 2006 8-K).

10.34 Revised Payment Schedule by and among the Company and Century 21 Airships,
Inc. dated August 25, 2006 (incorporated by reference to exhibit 10.1 filed with
the August 30, 2006 8-K.

10.35 Advance Agreement by and among the Company and AJW Partners, LLC.
("Partners"), AJW Offshore, Ltd. ("Offshore"), AJW Qualified Partners
("Qualified") and New Millenium Capital Partners, II, LLC ("Millenium")
(incorporated by reference to Exhibit 10.1 filed with the September 15, 2006
Form 8-K).


                                       37
<PAGE>

10.36 Letter Agreement regarding the amendment of warrants by and among the
Company and AJW Partners, LLC. ("Partners"), AJW Offshore, Ltd. ("Offshore"),
AJW Qualified Partners ("Qualified") and New Millenium Capital Partners, II, LLC
("Millenium") (incorporated by reference to Exhibit 10.2 filed with the
September 15, 2006 Form 8-K).

10.37 CyberBugTM Sales Agreement by and among the Company and National Security
Associates, Inc. dated October 4, 2006 (incorporated by reference to Exhibit
10.2 filed with the October 10, 2006 Form 8-K).

10.38 Revised Payment Schedule and Amendment by and among the Company and
Century 21 Airships, Inc. dated October 22, 2006 (incorporated by reference to
exhibit 10.1 filed with the October 26, 2006 8-K/A).

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

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

32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.

(b) - Reports on Form 8-K

The Company filed a Current Report on Form 8-K on August 30, 2006 regarding the
amendment to the payment schedule with 21st Century Airships, Inc.

The Company filed a Current Report on Form 8-K on September 15, 2006 regarding
the Advance Agreement dated September 11, 2006 on the proceeds they were
entitled to under a March 14, 2006 Securities Purchase Agreement and the
repricing and extension of the warrants under the April 1, 2005 Securities
Purchase Agreement..

The Company filed a Current Report on Form 8-K on October 10, 2006 regarding the
resell agreement for CyberBugTM product line with National Security Associates,
Inc., ("NSA").

The Company filed a Current Report on Form 8-K on October 26, 2006 regarding the
amendment to the payment schedule with 21st Century Airships, Inc.

The Company filed a Current Report on Form 8-K/A on October 26, 2006 regarding
the amendment to the payment schedule with 21st Century Airships, Inc.


                                       38
<PAGE>

                                   SIGNATURES

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

                           CYBER DEFENSE SYSTEMS, INC.

                                February 7, 2007

                           By: /s/ William C. Robinson
                               -----------------------------
                               William C. Robinson
                               Chief Executive Officer,
                               President and Chairman

                           By: /s/ David M. Barnes
                               -----------------------------
                               David M. Barnes
                               Chief Financial Officer


                                       39