UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
 FORM
10-Q
 
 (Mark
One)
 x
                    Quarterly
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934
 
 For the
quarterly period ended September 30, 2008
 
 o           Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
 
 For the
transition period from ___________________________  to
______________________________
 
 Commission
File Number 000-28947.
 
 SpaceDev,
Inc.
 (Exact
name of registrant as specified in its charter)
 
 Delaware
                    84-1374613(State
      or other jurisdiction of
                      incorporation
      or organization)
                    (IRS
      Employer
                      Identification
      No.)13855
      Stowe Drive, Poway, California 92064(Address
      of principal executive offices)
 
 (Registrant
's telephone number, including area code)  (858)
375-2000.
 ____________________________________________________________________________________
 (Former
name, former address and former fiscal year, if changed since last
report)
 
 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
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes x  No o
 
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
   Large
accelerated filer    o Accelerated
filer   o
   Non-accelerated
filer    o(Do not check if a
smaller reporting company) Smaller reporting company   x
   Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o  No x
  Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: 43,578,769 shares of the registrant’s
voting common stock were outstanding on November 10, 2008.
  SPACEDEV,
INC.
 FORM
10-Q
 For
The Nine Months Ended September 30, 2008
 PART
      I -- FINANCIAL INFORMATION
                1ITEM
      1. FINANCIAL STATEMENTS
                1Consolidated
      Balance Sheets
                1Consolidated
      Statements of Operations
                2Consolidated
      Statements of Cash Flows
                3NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS
                5ITEM
      2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
      AND RESULTS OF OPERATIONS
                15Overview
                15Financing
                16Selection
      of Significant Contracts
                17Results
      of Operations
                21Liquidity
      and Capital Resources
                27Critical
      Accounting Standards
                28Recent
      Accounting Pronouncements
                29Risk
      Factors
                29ITEM
      4.  CONTROLS AND PROCEDURES
                44PART
      II -- OTHER INFORMATION
                45ITEM
      1.  LEGAL PROCEEDINGS
                45ITEM
      2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS
                45ITEM
      3.  DEFAULTS UPON SENIOR SECURITIES
                45ITEM
      4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
                45ITEM
      5.  OTHER INFORMATION
                45ITEM
      6.  EXHIBITS
                46SIGNATURES
                46
     
 PART
I -- FINANCIAL INFORMATION
 
 ITEM
1. FINANCIAL STATEMENTS
 SpaceDev,
Inc. and Subsidiaries
 Consolidated
Balance Sheets
 (Unaudited)
              
              
              (Audited)September
      30, 2008
              
              
              December
      31, 2007AssetsCurrent
      AssetsCash
              
              $
              5,802,077
              
              
              $
              6,521,003Accounts
      receivable, net (Note 2(d))
              
              
              4,483,032
              
              
              
              5,019,600Costs
      in excess of billings (Note 2(b))
              
              
              658,843
              
              
              
              1,413,685Inventory
      (Note 2(b))
              
              
              1,130,934
              
              
              
              1,006,229Other
      current assets (Note 6(a))
              
              
              456,579
              
              
              
              702,120Total
      Current Assets
              
              
              12,531,465
              
              
              
              14,662,637Fixed Assets -
      Net
              
              
              5,095,024
              
              
              
              4,420,020Intangible
      Assets
              
              
              789,032
              
              
              
              746,392Goodwill
      (Note 5)
              
              
              11,875,331
              
              
              
              11,233,665Other
      Assets (Note 6(b))
              
              
              1,003,377
              
              
              
              1,045,272Total
      Assets
              
              $
              31,294,229
              
              
              $
              32,107,986Liabilities
      and Stockholders' EquityCurrent
      LiabilitiesAccounts
      payable and accrued expenses (Note 3(a))
              
              $
              1,734,197
              
              
              $
              1,491,116Current
      portion of notes payable and capitalized lease obligations
              
              
              217,495
              
              
              
              162,885Accrued
      payroll, vacation and related taxes
              
              
              1,189,446
              
              
              
              1,424,462Billings
      in excess of costs (Note 2(a))
              
              
              1,835,251
              
              
              
              2,463,366Other
      accrued liabilities (Notes 2(a) and 3)
              
              
              1,022,912
              
              
              
              1,632,768Total
      Current Liabilities
              
              
              5,999,301
              
              
              
              7,174,597Notes
      Payable and Capitalized Lease Obligations, Less Current
      Maturities
              
              
              767,616
              
              
              
              343,621Deferred
      Gain - Assets held for sale (Note 3(a))
              
              
              508,179
              
              
              
              596,133Other
      Long Term Liabilities (Note 3)
              
              
              693,660
              
              
              
              643,168Total
      Liabilities
              
              
              7,968,756
              
              
              
              8,757,519Commitments
      and ContingenciesStockholders’
      EquityConvertible
      preferred stock, $0.001 par value, 10,000,000 sharesauthorized,
      and 250,291 and 251,659 shares issued and outstanding,respectively
      (Note 4)Series
      C Convertible preferred stock (Note 4(a))
              
              
              248
              
              
              
              248Series
      D-1 Convertible preferred stock (Note 4(b))
              
              
              2
              
              
              
              3Common
      stock, $0.0001 par value; 100,000,000 shares authorized,
    and43,528,769
      and 42,306,871 shares issued and outstanding,respectively
      (Note 4)
              
              
              4,353
              
              
              
              4,231Additional
      paid-in capital
              
              
              40,194,274
              
              
              
              40,441,249Accumulated
      deficit
              
              
              (16,873,404
              )
              
              
              (17,095,264
              )Total
      Stockholders’ Equity
              
              
              23,325,473
              
              
              
              23,350,467Total
      Liabilities and Stockholders' Equity
              
              $
              31,294,229
              
              
              $
              32,107,986
 The accompanying notes are an integral part of these
consolidated financial statements.
  1
  SpaceDev,
Inc. and Subsidiaries
 Consolidated
Statements of Operations
 (Unaudited)
 Three
      Months Ended
                  
                  Nine
      Months EndedSeptember
      30,
                  
                  2008
                  
                  
                  %
                  
                  
                  2007
                  
                  
                  %
                  
                  
                  2008
                  
                  
                  %
                  
                  
                  2007
                  
                  
                  %Net
      Sales
                  
                  $
                  9,042,268
                  
                  
                  
                  100.0
                  %
                  
                  $
                  7,606,322
                  
                  
                  
                  100.0
                  %
                  
                  $
                  28,261,633
                  
                  
                  
                  100.0
                  %
                  
                  $
                  25,310,938
                  
                  
                  
                  100.0
                  %Total
      Cost of Sales*
                  
                  
                  7,263,658
                  
                  
                  
                  80.3
                  %
                  
                  
                  5,402,113
                  
                  
                  
                  71.0
                  %
                  
                  
                  22,023,363
                  
                  
                  
                  77.9
                  %
                  
                  
                  18,519,652
                  
                  
                  
                  73.2
                  %Gross
      Margin
                  
                  
                  1,778,610
                  
                  
                  
                  19.7
                  %
                  
                  
                  2,204,209
                  
                  
                  
                  29.0
                  %
                  
                  
                  6,238,270
                  
                  
                  
                  22.1
                  %
                  
                  
                  6,791,286
                  
                  
                  
                  26.8
                  %Operating
      ExpensesMarketing
      and sales
                  
                  
                  811,384
                  
                  
                  
                  9.0
                  %
                  
                  
                  796,695
                  
                  
                  
                  10.5
                  %
                  
                  
                  2,271,189
                  
                  
                  
                  8.0
                  %
                  
                  
                  2,189,571
                  
                  
                  
                  8.7
                  %Research
      and development
                  
                  
                  169,446
                  
                  
                  
                  1.9
                  %
                  
                  
                  101,890
                  
                  
                  
                  1.3
                  %
                  
                  
                  622,913
                  
                  
                  
                  2.2
                  %
                  
                  
                  265,045
                  
                  
                  
                  1.0
                  %General
      and administrative
                  
                  
                  449,728
                  
                  
                  
                  5.0
                  %
                  
                  
                  1,141,599
                  
                  
                  
                  15.0
                  %
                  
                  
                  2,758,020
                  
                  
                  
                  9.8
                  %
                  
                  
                  3,798,169
                  
                  
                  
                  15.0
                  %Total
      Operating Expenses*
                  
                  
                  1,430,558
                  
                  
                  
                  15.8
                  %
                  
                  
                  2,040,184
                  
                  
                  
                  26.8
                  %
                  
                  
                  5,652,122
                  
                  
                  
                  20.0
                  %
                  
                  
                  6,252,785
                  
                  
                  
                  24.7
                  %Income
      from Operations
                  
                  
                  348,052
                  
                  
                  
                  3.8
                  %
                  
                  
                  164,025
                  
                  
                  
                  2.2
                  %
                  
                  
                  586,148
                  
                  
                  
                  2.1
                  %
                  
                  
                  538,501
                  
                  
                  
                  2.1
                  %Non-Operating
      Income/(Expense)Interest
      and other income
                  
                  
                  22,233
                  
                  
                  
                  0.2
                  %
                  
                  
                  13,868
                  
                  
                  
                  0.2
                  %
                  
                  
                  83,004
                  
                  
                  
                  0.3
                  %
                  
                  
                  44,847
                  
                  
                  
                  0.2
                  %Interest
      and other expense
                  
                  
                  (45,929
                  )
                  
                  
                  -0.5
                  %
                  
                  
                  (63,104
                  )
                  
                  
                  -0.8
                  %
                  
                  
                  (88,440
                  )
                  
                  
                  -0.3
                  %
                  
                  
                  (196,417
                  )
                  
                  
                  -0.8
                  %Gain
      on building sale (Note 3(a))
                  
                  
                  29,318
                  
                  
                  
                  0.3
                  %
                  
                  
                  29,319
                  
                  
                  
                  0.4
                  %
                  
                  
                  87,952
                  
                  
                  
                  0.3
                  %
                  
                  
                  87,955
                  
                  
                  
                  0.3
                  %Loan
      fee (Note 3(b))
                  
                  
                  (49,635
                  )
                  
                  
                  -0.5
                  %
                  
                  
                  (86,302
                  )
                  
                  
                  -1.1
                  %
                  
                  
                  (148,814
                  )
                  
                  
                  -0.5
                  %
                  
                  
                  (259,865
                  )
                  
                  
                  -1.0
                  %Total
      Non-Operating Income/(Expense)
                  
                  
                  (44,013
                  )
                  
                  
                  -0.5
                  %
                  
                  
                  (106,219
                  )
                  
                  
                  -1.4
                  %
                  
                  
                  (66,298
                  )
                  
                  
                  -0.2
                  %
                  
                  
                  (323,480
                  )
                  
                  
                  -1.3
                  %Income
      Before Taxes
                  
                  
                  304,039
                  
                  
                  
                  3.4
                  %
                  
                  
                  57,806
                  
                  
                  
                  0.8
                  %
                  
                  
                  519,850
                  
                  
                  
                  1.8
                  %
                  
                  
                  215,021
                  
                  
                  
                  0.8
                  %Income
      tax provision
                  
                  
                  10,700
                  
                  
                  
                  0.1
                  %
                  
                  
                  -
                  
                  
                  
                  0.0
                  %
                  
                  
                  21,915
                  
                  
                  
                  0.1
                  %
                  
                  
                  800
                  
                  
                  
                  0.0
                  %Net
      Income
                  
                  $
                  293,339
                  
                  
                  
                  3.2
                  %
                  
                  $
                  57,806
                  
                  
                  
                  0.8
                  %
                  
                  $
                  497,935
                  
                  
                  
                  1.8
                  %
                  
                  $
                  214,221
                  
                  
                  
                  0.8
                  %Net
      Income
                  
                  
                  293,339
                  
                  
                  
                  
                  
                  
                  
                  57,806
                  
                  
                  
                  
                  
                  
                  
                  497,935
                  
                  
                  
                  
                  
                  
                  
                  214,221Less
      Preferred dividend payments
                  
                  
                  (80,979
                  )
                  
                  
                  
                  
                  
                  
                  (133,462
                  )
                  
                  
                  
                  
                  
                  
                  (276,075
                  )
                  
                  
                  
                  
                  
                  
                  (416,096
                  )Net Income (Loss) Available to Common Stockholders
                  
                  
                  212,360
                  
                  
                  
                  
                  
                  
                  
                  (75,656
                  )
                  
                  
                  
                  
                  
                  
                  221,860
                  
                  
                  
                  
                  
                  
                  
                  (201,875
                  )Net
      Income Per Share:
                  
                  $
                  0.00
                  
                  
                  
                  
                  
                  
                  $
                  (0.00
                  )
                  
                  
                  
                  
                  
                  $
                  0.01
                  
                  
                  
                  
                  
                  
                  $
                  (0.01
                  )Weighted-Average
      Shares Outstanding
                  
                  
                  43,337,330
                  
                  
                  
                  
                  
                  
                  
                  30,914,735
                  
                  
                  
                  
                  
                  
                  
                  42,841,536
                  
                  
                  
                  
                  
                  
                  
                  30,044,852Fully
      Diluted Net Income (Loss) Per Share:
                  
                  $
                  0.00
                  
                  
                  
                  
                  
                  
                  $
                  (0.00
                  )
                  
                  
                  
                  
                  
                  $
                  0.00
                  
                  
                  
                  
                  
                  
                  $
                  (0.01
                  )Fully
      Diluted Weighted-Average Shares Outstanding
                  
                  
                  43,563,060
                  
                  
                  
                  
                  
                  
                  
                  30,914,735
                  
                  
                  
                  
                  
                  
                  
                  47,724,890
                  
                  
                  
                  
                  
                  
                  
                  30,044,852*
      The following table shows how the Company's stock option expense would be
      allocated to all expenses.Cost
      of sales
                  
                  $
                  52,529
                  
                  
                  
                  
                  
                  
                  $
                  84,701
                  
                  
                  
                  
                  
                  
                  $
                  182,040
                  
                  
                  
                  
                  
                  
                  $
                  162,074Marketing
      and sales
                  
                  
                  16,219
                  
                  
                  
                  
                  
                  
                  
                  25,536
                  
                  
                  
                  
                  
                  
                  
                  28,277
                  
                  
                  
                  
                  
                  
                  
                  58,864Research
      and development
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  -General
      and administrative
                  
                  
                  95,103
                  
                  
                  
                  
                  
                  
                  
                  (20,197
                  )
                  
                  
                  
                  
                  
                  
                  209,962
                  
                  
                  
                  
                  
                  
                  
                  81,206Total
      Non-Cash Stock Option Expense
                  
                  $
                  163,851
                  
                  
                  
                  
                  
                  
                  $
                  90,040
                  
                  
                  
                  
                  
                  
                  $
                  420,279
                  
                  
                  
                  
                  
                  
                  $
                  302,144
 The
accompanying notes are an integral part of these consolidated financial
statements.
    2
 SpaceDev,
Inc. and Subsidiaries
 Consolidated
Statements of Operations
 (Unaudited)
 Nine
      Months Ended September 30,
                  2008
                  2007Cash
      Flows From Operating ActivitiesNet
      income
                  $      497,935
                  $               214,221Adjustments
      to reconcile net income to net cash provided byoperating
      activities:Depreciation
      and amortization
                  1,045,366
                  887,031Gain
      on disposal of building sale
                  (87,954)
                  (87,954)Stock
      option expense
                  420,279
                  302,144Non-cash
      loan fee amortization
                  212,500
                  259,865Change
      in operating assets and liabilities
                  114,647
                  (2,355,154)Net
      Cash Provided By (Used in) Operating Activities
                  2,202,773
                  (779,848)Goodwill
                  (116,667)
                  -Other
      intangible assets
                  (133,645)
                  -Purchases
      of fixed assets
                  (939,192)
                  (881,517)Net
      Cash Used in Investing Activities
                  (1,189,504)
                  (881,517)Cash
      Flows From Financing ActivitiesPrincipal
      payments on notes payable and capitalized lease
obligations
                  (211,568)
                  (41,415)Dividend
      payments on Series C and Series D-1 preferred stock
                  (314,421)
                  (436,604)Proceeds
      from revolving credit facility
                  -
                  1,984,402Employee
      stock purchase plan
                  59,791
                  49,802(Repurchase)
      Issuance of preferred stock
                  (1,361,111)
                  (859,329)Proceeds
      from issuance of common stock
                  95,114
                  4,618,674Net
      Cash (Used in) Provided by Financing Activities
                  (1,732,195)
                  5,315,530Net
      (Decrease) Increase in Cash
                  (718,926)
                  3,654,166Cash
      at Beginning of Period
                  6,521,003
                  1,438,146Cash
      at End of Period
                  $   5,802,077
                  $           5,092,312
 The accompanying
notes are an integral part of these consolidated financial
statements.
  3
 
 SpaceDev,
Inc. and Subsidiaries
 Consolidated
Statements of Cash Flows
 (Unaudited)
 
 Nine
      Months Ended September 30,
                2008
                2007Supplemental
      Disclosures of Cash Flow Information:Cash
      paid during the period for:Interest
      expense
                $          32,669
                $                                 18,471Taxes
                $          21,915
                $                                      800Noncash
      Investing and Financing Activities:During
      the nine months ended September 30, 2008 and  2007, the Company
      entered into capital leases in
      the amount of approximately $690,000 and $190,000, respectively.During the nine
      months ended September 30, 2008 and 2007, the Company converted $73,866
      and $92,577 of employee stock purchase plan contributions into 132,099 and
      126,351 shares of common stock, respectively.During
      the nine months ended September 30, 2008 and 2007, the Company converted
      $73,866 and $92,577 of
      employee stock purchase plan contributions into 132,099 and 126,351 shares
      of common stock, respectively.During
      the nine months ended September 30, 2008, the Company issued 833,333
      shares of its common stock related
      to the Starsys earnout settlement valued at approximately $525,000.
 The
accompanying notes are an integral part of these consolidated financial
statements.
 4
  NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
  1.       Basis of
Presentation
  The accompanying consolidated financial statements of
SpaceDev, Inc., a Delaware corporation (“the Company”) includes the accounts of
the Company and its subsidiaries, Starsys, Inc., a Colorado corporation, and its
inactive subsidiary Dream Chaser, Inc., a Delaware corporation.  In the
opinion of management, the consolidated financial statements reflect all normal
and recurring adjustments, which are necessary for a fair presentation of the
Company's financial position, results of operations and cash flows as of the
dates and for the periods presented.  The consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information.  Consequently, these statements do not
include all disclosures normally required by generally accepted accounting
principles of the United States of America for annual financial statements nor
those normally made in an Annual Report on Form 10-KSB or Form 10-K. 
Accordingly, reference should be made to the Company's Form 10-KSB filed on
March 28, 2008 and other reports the Company filed with the U.S. Securities and
Exchange Commission for additional disclosures, including a summary of the
Company's accounting policies, which have not materially changed.  The
consolidated results of operations for the nine months ended September 30, 2008
are not necessarily indicative of results that may be expected for the fiscal
year ended December 31, 2008 or any future period, and the Company makes no
representations related thereto.
  The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make certain estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosures of contingent assets and
liabilities and the results of operations during the reporting period. 
Actual results could differ materially from those estimates.
  2.        
Accounting Policies
  (a)  Revenue
Recognition
  The Company’s where
  The portion of the Company’s revenue which is based on
fixed price contracts is calculated on a proportional performance basis (also
referred to herein as “percentage-of-completion”) based upon assumptions
regarding the estimated total costs for each contract.  Such revenues are
recorded based on the percentage that costs incurred to date bear to the most
recent estimates of total costs to complete each contract.  Estimating
future costs and, therefore, revenues and profits, is a process requiring a high
degree of management judgment, including management’s assumptions regarding
future operations as well as general economic conditions.  In the event of
a change in total estimated contract cost or profit, the cumulative effect of
such change is recorded in the period the change in estimate occurs. 
Frequently, the period of performance of a contract extends over a long period
of time and, as such, revenue recognition and the Company’s profitability from a
particular contract may be adversely affected to the extent that estimated cost
to complete or incentive or award fee estimates are revised, delivery schedules
are delayed or progress under a contract is otherwise impeded.
 Accordingly, the Company’s recorded revenues and gross profits from period
to period can fluctuate.
  5
 The output from the Company’s contracts is generally
based on milestones or performance targets set by the Company and its
customers.  The Company’s contracts are negotiated with milestone payments
that may not coincide with the level of effort or output measurement; thereby,
creating the potential for a mismatch of costs and revenues on the front side or
back side of the project.  An example might be a contract with a large
up-front milestone payment for simply establishing a program plan.  The
Company attempts to appropriately match revenue with expense, so in this
instance, it would be inappropriate to recognize all of a milestone payment as
revenue, since the proportional level of effort or cost incurred would have not
yet been expended.
  Certain contracts include provisions for increased or
decreased revenue and profit based on performance against established targets.
When the Company has incentive and award fees, they are included in estimated
contract revenue at the time the amounts can be reasonably determined and are
reasonably assured based upon historical experience and other objective
criteria.  If performance under such contracts were to differ from previous
assumptions, current period revenues and profits would be adjusted and could
therefore fluctuate significantly.
  Revenues from CPFF contracts are recognized as expenses
are incurred.  Estimated contract profits are taken into earnings in
proportion to revenues recorded.  Time-and-material revenues are recognized
as services are performed and costs incurred.
  Recognition of losses on projects are taken as soon as
the loss is reasonably determinable and accrued on the balance sheet in other
accrued liabilities.  The current accrual for potential losses on existing
projects represents approximately $0.1 million at September 30, 2008 and $0.3
million at December 31, 2007.  The accrual is adjusted as projects move
toward completion and more accurate estimates are established.  Changes in
job performance, job conditions and estimated profitability, including those
arising from contract penalty provisions (when applicable) and final contract
settlements may result in revisions to costs and income, and are recognized in
the period in which the revisions are determined.
  Contract costs include all direct material, direct labor
and subcontractor costs, and other costs such as supplies, tools and travel
which are specifically related to a particular contract.  All other
selling, general and administrative costs are expensed as incurred.
  The majority of the Company’s revenue is derived from
United States Government and Government related contracts.  Such contracts
have certain risks which include dependence on future appropriations and
administrative allotment of funds and changes in government policies. 
Costs incurred under United States Government Contracts are subject to
audit.  The Company believes that the results of such audits will not have
a material effect on its financial position or its results of
operations.
  (b) Inventory
  Inventory is valued based on the lower-of-cost-or-market
method and is disbursed on a First-In, First-Out (FIFO) basis, unless required
by customer contract to be distributed by specific identification for lot
control purposes.  Inventory includes raw material inventory, finished
goods inventory and work-in-process inventory.  Work-in-process inventory
includes, but is not limited to, program costs in excess of customer
requirements to pay.  In those cases, costs may be held in work-in-process
while the Company negotiates for contract modifications to cover those
costs.  If the negotiations result in revenues in excess of those costs,
the Company records a profit at the conclusion of the program.  If the
negotiations result in revenues not in excess of those costs or no additional
consideration, the Company records the full estimated program loss at the time
of the notification.  The amount of such program costs held in
work-in-process inventory on September 30, 2008 and December 31, 2007 was
approximately $0.2 million and $0.5 million, respectively. The Company inventory
detail follows:
  6
   Inventory
              
              September
      30, 2008
              
              
              December
      31, 2007Raw
      Material
              
              $
              684,518
              
              
              $
              570,432Work
      in Progress
              
              
              220,415
              
              
              
              528,614Finished
      Goods
              
              
              381,001
              
              
              
              62,183Subtotal
              
              
              1,285,934
              
              
              
              1,161,229Inventory
      Allowance
              
              
              (155,000
              )
              
              
              (155,000
              )Inventory,
      Net
              
              $
              1,130,934
              
              
              $
              1,006,229
  Inventories are reviewed for estimated obsolescence or
unusable items and, if appropriate, are written down to the net realizable value
based upon assumptions about future demand and market conditions.  If
actual future demand or market conditions are less favorable than those the
Company projects, additional inventory write-downs may be required.  These
are considered permanent adjustments to the cost basis of the inventory. 
In 2007, the Company established an inventory reserve of approximately $0.2
million to cover such estimated obsolete items.  The Company evaluates the
inventory allowance quarterly and has not adjusted it this year.
  (c)
Net income (loss) per common share
  Earnings per Share
  (d)     Accounts receivable and
allowances for uncollectible accounts
  Accounts receivable are stated at the historical
carrying amount net of write-offs and allowances for uncollectible
accounts.  The Company establishes an allowance for uncollectible accounts
based on historical experience and any specific customer collection issues that
the Company has identified. Uncollectible accounts receivable are written-off
when a settlement is reached for an amount that is less than the outstanding
balance or when the Company has determined that balance will not be
collected.  At September 30, 2008 and December 31, 2007, the allowance for
uncollectible accounts was approximately $63,000 and $62,000,
respectively.
  7
   (e)
Estimates
  basis.  Time and material revenues are recognized
as services are performed and costs incurred.
  (f)
Warranty
  The Company has a warranty policy to assume obligations
in connection with certain customer contracts.  The Company records a
liability for the expected costs to service estimated warranty claims. 
This amount is included in other liabilities.  Activity in the warranty
liability account consisted of the following:
  September
      30, 2008
                December
      31, 2007Balance
      at January 1
                $                         505,984
                76,000Accruals
      during the period
                -
                557,187Reductions
      during the period
                (159,106)
                (127,203)Balance
                $                         346,877
                $                                   505,984
  (g)
Taxes
  Accounting for Uncertainty in Income
Taxes — an Interpretation of FAS 109,
  (h) Reclassification
    3.     Other
Liabilities
  Other accrued liabilities
at September 30, 2008 and December 31, 2007 consisted of the
following:
  Other
      Accrued Liabilities at
              
              September
      30, 2008
              
              
              December
      31, 2007Warranty
      accrual
              
              $
              346,877
              
              
              $
              505,984Employee
      accruals
              
              
              153,871
              
              
              
              125,000Legal,
      royalty and customer accuals
              
              
              151,526
              
              
              
              125,664Customer
      deposits and other accruals
              
              
              119,723
              
              
              
              348,054Provision
      for anticipated loss
              
              
              71,995
              
              
              
              315,544Dividend
      (Series D-1 preferred stock)
              
              
              38,070
              
              
              
              76,475Property
      and income tax accruals
              
              
              49,872
              
              
              
              30,993Deferred
      rent
              
              
              37,483
              
              
              
              37,483Dividend
      (Series C preferred stock)
              
              
              42,898
              
              
              
              42,899Employee
      Stock Purchase Plan
              
              
              10,597
              
              
              
              24,672Total
      other accrued liabilities
              
              $
              1,022,912
              
              
              $
              1,632,768
   8
 Other long term liabilities at September 30, 2008 and
December 31, 2007 consisted of the following:
   Long
      Term Other Accrued Liabilities at
              September
      30, 2008
              December
      31, 2007Long
      term portion of deferred rent
              $               693,660
              $                643,168
  a)     Building
and Deferred Gain.








b)     Revolving Credit
Facility.




On September 29, 2006, the Company entered into a $5.0
million financing arrangement with Laurus Master Fund, Ltd. (“Laurus”). 
The financing is effected through a revolving note for up to $5.0 million,
although the exact principal balance at any given time will depend on draws made
by the Company on the facility.  The Company may borrow against the
facility under an investment formula based on accounts receivable at an advance
rate equal to 90% of eligible receivables and the lesser of: (a) 50% of eligible
inventory (calculated on the basis of the lower-of-cost-or-market, on a
first-in-first-out basis); or (b) $1.0 million, provided, however, that no more
than $0.5 million of such eligible inventory may be in the form of
work-in-process inventory.  There was no balance on this revolving credit
facility at September 30, 2008 and December 31, 2007.




The facility bears interest at a rate equal to prime
plus 2%.  This rate increases or decreases on the date the Prime Rate
adjusts.  Interest is payable monthly.  Interest is due on the first
business day of each month from October 2006 through maturity.  The term of
the facility is scheduled to end on September 29, 2009.  At inception,
Laurus received, as a loan fee, 310,009 unregistered shares of the Company’s
common stock valued at $0.35 million plus cash fees of $0.18 million. The value
of these shares was determined based on the $1.13 average trading price for the
stock during the preceding ten business days and was expensed over the first
year of the note.  Laurus received an additional 283,286 unregistered
shares of the Company’s common stock valued at $0.2 million at the first
anniversary of the facility.  The value of these shares was determined
based on the average trading price for the stock during the preceding ten
business days, which was $0.72 per share, and the expense was amortized over the
second year of the note.  The Company was to issue additional restricted
shares of its common stock worth, in the aggregate, $0.2 million to Laurus on
the third anniversary date of the facility, as the facility remains in
place.  However, the Company and Laurus have agreed to postpone the
issuance until January 2009, pending the outcome of the proposed acquisition of
SpaceDev by Sierra Nevada Corporation.  If the acquisition transaction
concludes in 2008, the facility will terminate and no additional shares will be
due.  If the acquisition transaction does not conclude in 2008, the
additional shares will be payable and the pricing of these additional shares
will be based on the applicable preceding ten business day average trading price
prior to the issuance of the common stock, and will be spread over the remaining
nine months of the line.




9


Laurus agreed that when it can resell the unregistered
shares under Rule 144, its resale on any one day could not exceed 10% of the
daily trading volume.  The 310,009 and 283,286 shares previously granted
under this revolving credit facility, and referenced above, were subsequently
registered for resale on a registration statement.  The facility is not
convertible into any class of the Company’s securities at any time during its
term.  In addition, Laurus is strictly prohibited from engaging in any
short sales of the Company’s common stock during the term of the
facility.




The facility is a secured debt, collateralized by
substantially all of the Company's and its subsidiaries' assets.  The
facility contains certain default provisions.  In the event of a default by
the Company, the Company will be required to pay an additional fee per month
until the default is cured.  Laurus has the option of accelerating the
entire principal balance and requiring the Company to pay a premium in the event
of an uncured default.




The facility requires the Company to deposit all funds
(other than certain refundable deposits and proceeds from financings) into a
lockbox that will be swept on a daily basis to reduce any outstanding facility
balance.  Any funds in excess of any outstanding facility balance are
transferred to the Company on a daily basis.




The Company paid Laurus’ legal fees and expenses in
structuring the facility, conducting due diligence and escrow fees.  In
addition, the Company paid a finder’s fee in the amount of $35,000 and paid
Laurus a facility fee of 3.5%, or approximately $0.14 million, of the facility
amount, which facility fee is being expensed over the life of the note.




4.     Stockholder's
Equity - Preferred Stock, Common Stock, and Options
  a)     Series
C Preferred Stock.
 
 On August
25, 2004, the Company issued 250,000 shares of its Series C Cumulative
Convertible Preferred Stock, par value $0.001 per share (the "Series C Preferred
Stock"), to Laurus for an aggregate purchase price of $2.5 million or $10.00 per
share (the "Stated Value").  The Series C Preferred Stock was
originally convertible into shares of the Company's common stock at a rate of
$1.54 per share.  On September 21, 2007, the Company adjusted the
fixed conversion price from $1.54 to $0.62 per share due to a common stock
financing with OHB Technology AG and MT Aerospace AG.  The Company had
not previously re-priced the Series C Preferred Stock when the Series D-1
Preferred Stock was issued and the June 2007 warrant offer to preferred
stockholders was made due to Laurus’ participation in those
transactions.  The Company has received verbal and written waivers
from Laurus on these previous transactions.
 
 The
Company accrues quarterly, cumulative dividends on the Series C Preferred Stock
at a rate of 6.85% per annum.  During the nine month periods ended
September 30, 2008 and 2007, the Company declared dividends payable of
approximately $128,000 and $127,000, respectively, to the holders of its Series
C Preferred Stock. These dividends are payable in cash or shares of common stock
at the holder's option with the exception that dividends may be paid in shares
of common stock for up to 25% of the aggregate dollar trading volume if the fair
market value of the Company's common stock for the 20-days preceding the
conversion date exceeds 120% of the conversion rate.  Accrued
dividends were paid in cash during 2007 and the first and second quarters of
2008.  On September 30, 2008, accrued but unpaid dividends were
approximately $43,000; these accrued dividends were paid in cash in October
2008.
 
 10
 The
Series C Preferred Stock is redeemable by the Company in whole or in part at any
time after issuance for (a) 115% of the Stated Value if the average closing
price of the common stock for the 22 days immediately preceding the date of
redemption does not exceed $0.62 per share (adjusted in September 2007 related
to the sale of common stock to OHB Technology AG and MT Aerospace AG) or (b) the
Stated Value if the average closing price of the common stock for the 22 days
immediately preceding the date of redemption exceeds $0.62 per share (adjusted
in September 2007 related to the sale of common stock to OHB Technology AG and
MT Aerospace AG). The shares of Series C Preferred Stock have a liquidation
right equal to the Stated Value upon the Company's dissolution, liquidation or
winding-up.  The shares of Series C Preferred Stock have no voting
rights, except as required by law.
 
 In
conjunction with the issuance of the shares of Series C Preferred Stock the
Company issued a five-year common stock warrant to Laurus for the purchase of
487,000 shares of the Company's common stock at an exercise price of $1.77 per
share.  On March 7, 2008, Laurus transferred these warrants to PSource
Structured Debt Limited, a Guernsey limited liability
company.  PSource is a publicly traded company on the London exchange
that from time to time has purchased assets from Laurus and is not affiliated
with Laurus.
 
 b)     Series
D-1 Preferred Stock.
 
 On
January 12, 2006, the Company entered into a Securities Purchase Agreement with
a limited number of institutional accredited investors, including Tail Wind
Capital, Bristol Capital Management, Nite Capital, Laurus and Omicron Capital
(which has since transferred its preferred shares to Portside Growth &
Opportunity Fund and Rockmore Investment Master Fund).  On January 13,
2006, the Company issued and sold to these investors 5,150 shares of Series D-1
Amortizing Convertible Perpetual Preferred Stock, par value $0.001 per share
(the “Series D-1 Preferred Stock”), for an aggregate purchase price of $5.15
million, or $1,000 per share.  As of September 30, 2008, approximately
1,831 shares of Series D-1 Preferred Stock remain outstanding and approximately
3,319 shares of Series D-1 Preferred Stock had been repurchased through
voluntary amortization, converted to the Company’s common stock or redeemed by
investor request at a discount. In total, 75 shares of Series D-1 Preferred
Stock were converted into 50,676 shares of the Company's common stock, 3,077
shares of Series D-1 Preferred Stock have been repaid through voluntary
amortization, as provided for in the Securities Purchase Agreement, and 167
shares of Series D-1 Preferred Stock have been repurchased through an investor
request at a 15% discount.  The Company also issued various warrants
to these investors as described below.  The Company paid cash fees and
expenses of approximately $119,000 to a finder for the introduction of potential
investors in this financing, and paid $60,000 to the lead investor's counsel for
legal expenses incurred in the transaction.  The shares of Series D-1
Preferred Stock are convertible into shares of the Company's common stock at a
rate of $1.48 per share and accrue quarterly, cumulative dividends at a rate of
LIBOR plus 4% on the first day of the applicable quarter. As of September 30,
2008, the Company had accrued Series D-1 dividends of approximately $38,000,
which were paid in October 2008.
 
 Certain
warrants the Company issued to the Series D-1 investors at the closing entitled
the investors to purchase up to an aggregate of 1,135,138 shares of the
Company's common stock at an exercise price of $1.51 per share.  On
August 23, 2006, Omicron transferred and assigned to Rockmore Investment Master
Fund Ltd., warrants on 69,820 shares of the Company’s common stock.
 
 On May
31, 2007, the Company offered to all holders of these warrants the opportunity
to exercise the warrants at a specially reduced price to be calculated as 80%
times the volume weighted average price (VWAP) of its common stock for the 20
trading days preceding the warrant holder’s acceptance of the offer. Although
this written offer expired by its terms on June 15, 2007, the Company orally
extended the offer to June 29, 2007 and Laurus accepted, exercising 500,000 of
its 639,203 warrants of this series for $0.29 million cash.  The VWAP
for the 20 trading days preceding June 29, 2007 was $0.725 per share making the
strike price of the common stock warrant $0.58 which is 80% of the
$0.725.  Due to a ratchet anti-dilution provision in the warrants of
this series, the exercise price of the remaining 635,138 warrants in the series
(which included 139,203 warrants that were then still owned by Laurus) was
reduced to $0.58 per share as a result of this transaction, and otherwise the
remaining warrants remain in full force and effect in accordance with their
original terms.
 
 11
 On
October 29, 2007, Nite Capital LLC transferred and assigned to Fort Mason Master
LP and Fort Mason Partners LP warrants for the purchase of 55,104 shares of
common stock.  On March 7, 2008, Laurus transferred their remaining
139,203 warrants to PSource Structured Debt Limited.  On July 21,
2008, Omicron transferred and assigned to Warrant Strategies Fund, warrants for
the purchase of 150,595 shares of common stock.
 
 The
warrants are exercisable for five years following the original date of
grant.  The warrants feature a net exercise provision, which enables
the holder to choose to exercise the warrant without paying
cash.  However, this right is available only if a registration
statement or prospectus covering the shares subject to the warrant is not
available.  The warrants will continue to have the anti-dilution
provisions reducing the warrant exercise price, if the Company issues equity
securities (other than in specified exempt transactions) at an effective price
below the warrant exercise price, to such lower exercise price.
 
 The
Series D-1 Securities Purchase Agreement contains a number of covenants by the
Company, which includes an agreement not to effect any transaction involving the
issuance of securities convertible, exercisable or exchangeable for the
Company's common stock at a price or rate per share which floats (i.e., which
may change over time), without the consent of a majority of the Series D-1
preferred stockholders, so long as any shares of Series D-1 Preferred Stock are
outstanding, subject to certain conditions.
 
 In
connection with the Series D-1 Preferred Stock financing, Laurus consented to
and waived certain contractual rights.  The Company paid Laurus
Capital Management, L.L.C., the manager of Laurus Master Fund, an amount of
$87,000 in connection with Laurus' delivery of the consent and
waiver.
 
 c)     Common
Stock Options
 
 The
Company adopted SFAS 123(R) to account for its stock-based compensation
beginning January 1, 2006.  For the nine months ended September 30,
2008 and 2007, the Company expensed approximately $420,000 and $302,000 of stock
option expenses due to SFAS 123(R).  The Company expensed stock
options based on a calculation using the minimum value method as prescribed by
SFAS 123(R), otherwise known as the Black-Scholes method.  Under this
method, the Company used a risk-free interest rate at the date of grant, an
expected volatility, an expected dividend yield and an expected life of the
options to determine the fair value of options granted.  The risk-free
interest rate was estimated and ranged from 2.17% to 4.75%, expected volatility
ranged from 48.60% to 94.36% at the time all options were granted, the dividend
yield was assumed to be zero, and the expected life of the options was assumed
to be four years based on the average vesting period of options
granted.
 
 5.  Goodwill
and Intangible Assets
 
 In
January, 2006, the Company completed the acquisition of Starsys Research
Corporation by forward triangular merger.  The Company initially
accounted for $12.2 million of the acquired assets as goodwill and later in
2006, reduced the goodwill allocation to $11.2 million by identifying
approximately $1.0 million in fixed assets and intangible assets, which are
being amortized over their estimated useful lives. The weighted average
amortization period for these intangible assets is currently approximately 8
years.  During the nine months ended September 30, 2008 and 2007, the
Company completed its annual impairment test of goodwill and concluded that
goodwill was not impaired.
 
 12
 On July
15, 2008, the Company entered into a Release agreement with the Shareholder
Agent for the former shareholders of Starsys Research Corporation.  In
exchange for a release of potential claims by the Shareholder Agent and other
former Starsys Research Corporation shareholders related to the payment of
earnout merger consideration under the Agreement and Plan of Merger and
Reorganization dated October 24, 2005, as subsequently amended, among Starsys
Research Corporation, Monoceros Acquisition Corp., the Company and the
Shareholder Agent, the Company agreed to pay the former shareholders $116,667 in
cash and 833,333 shares of Company common stock.  The Company recorded
additional goodwill in the amount of approximately $642,000 related to this
transaction, increasing the total goodwill related to the acquisition of Starsys
Research Corporation to approximately $11.9 million.
 
 6.     Other
Assets
 
 a)     Other
Current Assets
  Other
current assets consist of a variety of prepaid items and other cash advances for
items which are expected to occur within the next year.  The following
is a listing of items that constitute the Company’s other current assets at
September 30, 2008 and December 31, 2007.


Other
      Current Assets at
            
            September
      30, 2008
            December
      31, 2007Financing
      fees
            
            $                  111,764
            $                   421,986Software
      prepaid license
            
            115,499
            152,219Rental
      prepaid short term
            
            78,573
            78,573Insurance
      prepaid
            
            54,947
            27,585All
      other short term deposits
            
            76,201
            19,110Property
      tax prepayment
            
            19,595
            2,647Total
      Other Current Assets
            
            $                  456,579
            $                   702,120




b)     Other
Assets




Other assets consist of prepaid and other cash advances
for items which are expected to occur at a date beyond twelve months into the
future. The following is a listing of items that constitute the Company’s other
assets at September 30, 2008 and December 31, 2007.








Other
      Assets at
            
            September
      30, 2008
            December
      31, 2007Louisville
      facility letter of credit
            
            $                     550,352
            $                     535,669Deposits
            
            346,224
            339,683Deferred
      expenses
            
            106,801
            169,920Total
      Other Assets
            
            $                  1,003,377
            $                  1,045,272






13
 7. 
Subsequent Events
  On
October 20, 2008, SpaceDev entered into an Agreement and Plan of Merger with
Sierra Nevada Corporation, a Nevada company, and SDV Acquisition Corp., a
Delaware corporation and a wholly owned subsidiary of Sierra Nevada
Corporation.  The Merger Agreement provides for the acquisition of the
Company by Sierra Nevada Corporation by way of a statutory merger of SDV
Acquisition Corp. with and into the Company (the “Merger”), with the Company
surviving the Merger as a wholly owned subsidiary of Sierra Nevada
Corporation.  Under the Merger Agreement, the holders of the Company’s
common stock will receive, in the aggregate with respect to their shares of
common stock, an amount equal to $38 million less amounts (where applicable, in
excess of stated thresholds) paid to repurchase, redeem or terminate the
Company’s preferred stock, stock options and certain warrants, or to satisfy
certain other expenses.  After taking into account anticipated
expenses associated with such matters, it is expected that upon consummation of
the merger, each outstanding share of common stock of the Company, other than
any dissenting shares, will be cancelled and converted into the right to receive
between $0.70 and $0.72 in cash, without interest.  The final amount
payable to holders of common stock at the effective time of the Merger will vary
based upon, among other things, the amount of such expenses actually incurred by
the Company and the effect, if any, of certain adjustment provisions set forth
in the Merger Agreement.
 
 The
closing of the Merger is subject to certain closing conditions, including
adoption of the Merger Agreement by the Company’s stockholders.  The
Company intends to file and send definitive proxy materials in connection with
soliciting proxies for adoption of the Merger Agreement.


14


ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
 The
following discussion should be read in conjunction with the Company's
consolidated financial statements and the notes thereto and the other financial
information appearing elsewhere in this document.  Readers are also
urged to carefully review and consider the various disclosures made by us which
attempt to advise interested parties of the factors which affect our business,
including without limitation the Risk Factors set forth herein.
 
 In
addition to historical information, the following discussion and other parts of
this document may contain forward-looking statements.  These
statements relate to future events or our future financial
performance.  In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expect," "plan,"
"anticipate," "believe," "estimate," "predict," "potential," or "continue," the
negative of such terms or other comparable terminology.  These
statements are only predictions.
 
 Actual
results could differ materially from those anticipated by such forward-looking
statements. Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements.  Moreover, neither we
nor any other person assumes responsibility for the accuracy and completeness of
the forward-looking statements.  We undertake no obligation to
publicly update any of the forward-looking statements after the date of this
report to conform such statements to actual results or to changes in our
expectations.
 
 Overview
  SpaceDev,
Inc., a Delaware corporation, together with our subsidiaries, (“SpaceDev,”
“we,”  “us,” “our,” or “Company”), is a leading independent space
technology company.  We are engaged in the conception, design,
development, manufacture, integration, sale, and operation of space systems,
subsystems, products and services, as well as the design, manufacture, and sale
of mechanical and electromechanical subsystems and components for
spacecraft.  We are currently focused on the commercial and military
development of low-cost small satellites and related subsystems, hybrid rocket
propulsion for space and launch vehicles, subsystems that enable critical
spacecraft functions such as pointing solar arrays and communication antennas
and restraining, deploying and actuating moving spacecraft
components.  We maintain our corporate headquarters in California and
operating centers in California, Colorado and North Carolina and currently have
approximately 173 full and part time employees.
 
 During
the nine months of 2008, approximately 68.0% of our revenues were generated from
direct government contracts, and from government-related work through
subcontracts with others, while the remaining 32.0% were generated from
commercial contracts. During the same period in 2007, approximately 74.8% of our
net sales were generated from direct government contracts, and from
government-related work through subcontracts with others, while the remaining
25.2% was generated from commercial contracts.  Currently, we are
focusing on the domestic United States government market, which we believe is
only about one-half of the global government market for our mission solutions,
products, services and technologies.  We are restricted by export
control regulations, including International Traffic in Arms Regulations, which
may limit our ability to develop market opportunities outside the United
States.  However, international revenues have historically represented
less than 5% of our total net sales and we are interested in exploring further
international contract opportunities.  Our new and evolving
relationship with OHB Technology AG and MT Aerospace AG may influence our
decision and ability to operate in the international marketplace, as well as for
them to operate in the United States government and civil
marketplace.
 
 15
 During
the first nine months of 2008, we submitted over 167 bids or proposals for
government or commercial programs and continued our work with the United States
Congress to identify directed funding for our programs.
 
 Financing
  Revolving Credit
Facility
 
 In
September 2006, we entered into a $5.0 million financing arrangement with Laurus
Master Fund, Ltd. (“Laurus”).  The financing is effected through a
revolving note for up to $5.0 million, although the exact principal balance at
any given time will depend on draws made by us on the facility.  The
revolving credit facility had a zero balance at September 30, 2008 and December
31, 2007.
 
 We are
allowed to borrow against the revolving credit facility under an investment
formula based on accounts receivable at an advance rate equal to 90% of eligible
receivables and the lesser of: (a) 50% of eligible inventory (calculated on the
basis of the lower-of-cost-or-market, on a first-in-first-out basis); or, (b)
$1.0 million, provided, however, that no more than $0.5 million of such eligible
inventory may be in the form of work-in-process inventory.
 
 The
revolving credit facility bears interest at a rate equal to prime plus 2% and is
payable monthly.  The rate will be increased or decreased on the date
the Prime Rate is adjusted.  Interest is due on the first business day
of each month through maturity.  The term of the facility is scheduled
to end on September 29, 2009.  At inception, Laurus received, as a
loan fee, 310,009 unregistered shares of our common stock valued at $0.35
million plus cash fees of $175,000.  The value of these shares was
determined based on the $1.13 average trading price for the stock during the
preceding ten (10) business days and the expense was amortized daily over the
first year of the note.  The cash loan fee is being amortized over 36
months.  In September 2007, Laurus became entitled to an additional
283,286 shares, valued at $0.2 million upon the first anniversary of the
facility.  This $0.2 million was amortized over twelve
months.  We will issue additional restricted shares of our common
stock worth, in the aggregate, $0.2 million to Laurus in January 2009, if the
facility remains in place and the pending acquisition with Sierra Nevada
Corporation does not close.  The pricing of these additional shares
will be based on the applicable preceding 10 business day average trading price
prior to the issuance of the common stock.  The facility is not
convertible into any class of our securities.
 
 Laurus
agreed that if and when it can resell the unregistered shares under Rule 144,
its resale on any one day could not exceed 10% of the daily trading volume. We
registered the 310,009 shares and 283,286 shares, which totaled 593,295 shares,
for resale in a registration statement that we filed in January 2008 and which
was declared effective by the Securities and Exchange Commission in February
2008.  In addition, Laurus is strictly prohibited from engaging in any
short sales of our common stock during the term of the facility.
 
 The
facility is a secured debt, collateralized by substantially all of our assets.
The facility contains certain default provisions.  In the event of a
default by us, we will be required to pay an additional fee per month until the
default is cured.  Laurus has the option of accelerating the entire
principal balance and requiring us to pay a premium in the event of an uncured
default.  The facility requires us to deposit all funds (other than
certain refundable deposits) into a lockbox that will be swept on a daily basis
to reduce any outstanding facility balance. Any funds in excess of any
outstanding facility balance are transferred to us on a daily
basis.


16




Selection
of Significant Contracts
 
 In June
2002, Starsys Research Corporation was awarded a contract from Northrop Grumman
Space Technology for the design, development, assembly, and test of two
configurations of flat plate gimbal drive assemblies.  These gimbals
are used to position six dish antennas and two nulling antenna systems for each
of two large spacecraft.  Subsequent to this award, Northrop Grumman
Space Technology modified this contract to include a third shipset bringing the
total contract value to approximately $7.1 million.  In addition to
eight flight unit deliveries per large spacecraft, the program includes
development and qualification hardware.  This contract was awarded as
a firm fixed price contract with the final delivery scheduled for March 2007 and
was part of our acquisition of Starsys Research Corporation on January 31,
2006.  We recorded revenues from this contract during the first nine
months of 2008 and from February 1, 2006 through December 31, 2007 of
approximately $0.1 million and $4.3 million, respectively.  We
experienced significant cost overruns on this contract.  Prior to our
merger, the contract was modified to add an additional $1.7
million.  After the merger, we negotiated contract modifications in
both the timing of payments and in the amount of additional contract
consideration of up to $1.0 million based on the achievement of specific
milestones.  Of the additional possible $1.0 million, we achieved
milestones entitling us to the majority of the incentive payments, which
partially mitigated the impact of significant cost, scope and requirement
changes and overruns.  Since we were successful in achieving our
performance targets, we defrayed some of our cost overruns.  We
completed this program during the first quarter of 2008 and the total contract
value of $9.6 million has been recognized.
 
 In March
2004, we were awarded a five-year, cost-plus fixed-fee indefinite
delivery/indefinite quantity contract for up to approximately $43 million to
conduct a microsatellite distributed sensing experiment (intended to design and
build up to six responsive, affordable, high performance microsatellites to
support national missile defense), an option for a laser communications
experiment, and other microsatellite studies and experiments as required in
support of the Advanced Systems Department of the Missile Defense
Agency.  The overall contract initially called for us to analyze,
design, develop, fabricate, integrate, test, operate and support a networked
cluster of three formation-flying boost phase and midcourse tracking
microsatellites, with an option to design, develop, fabricate, integrate, test,
operate and support a second cluster of three formation-flying microsatellites
to be networked on-orbit with high speed laser communications
technology.  This overall contract proceeded under a phased
approach.  The first phase, executed under Task Order I for
approximately $1.1 million, was awarded in April 2004, completed in September
2004, and resulted in a general mission and microsatellite
design.  The second phase, executed under Task Order II for
approximately $8.3 million, was awarded in October 2004 and was originally
expected to be completed by January 2006 but was extended at the request of the
Missile Defense Agency with an increased funding of $1.5 million, and
subsequently completed in March 2006.  Task Order II resulted in a
detailed mission and microsatellite design, which underwent a successful
Critical Design Review in March 2006.  Task Order III, the first of
several task orders expected during the third phase, was awarded in April 2006
for a total of approximately $1.5 million, which was later amended to
approximately $2.5 million and was successfully completed in June 2006. Task
Order IV was awarded by the Missile Defense Agency in July 2006, with initial
funding of approximately $4.0 million through November 2006.  Task
Order IV was subsequently amended to approximately $4.5 million and extended
through June 15, 2007.  On April 12, 2007, we finalized a contract
modification to Task Order IV with the Missile Defense Agency.  The
main content of the change was to: 1) extend the period of performance from June
15, 2007 to September 30, 2007 and subsequently to March 31, 2008; 2) increase
the funding ceiling from approximately $4.5 million to approximately $9.0
million; 3) provide approximately $1.6 million in funding toward the increased
ceiling; and 4) change the statement of work to reflect the delivery of one
microsatellite.  On May 11, 2007 the remaining $2.9 million in funding
was provided to fully fund the $9.0 million task order.  We were
informed that there was no Government Fiscal Year 2008 funds available from the
Missile Defense Agency to support our microsatellite distributed sensing
experiment beyond the funds described above.  Government contract
funds from the Missile Defense Agency from Government Fiscal Year 2007 were not
exhausted in that fiscal year and were used to cover phase completion costs
through January 2008.
 
 17
 In
January 2008, we arranged for another government agency, the Department of
Defense office of Operationally Responsive Space, to fund our continued
development through their new Jumpstart Mission.  Task Order IV was
amended to include the Jumpstart Mission, adding an additional $3.5 million in
funding on a fixed price Contract Line Item Number (“CLIN”).  In July
2008, the Missile Defense Agency transferred the contract vehicle to the U.S.
Army Space and Missile Command.  In September 2008, Task Order IV was
amended to add approximately $0.5 million in funding on a cost plus fixed fee
CLIN.  We recognized revenues of approximately $4.0 million under this
contract during the first nine month of 2008, and $25.2 million under this
contract from inception through September 30, 2008. (See Risk Factors: “Some of our government contracts
are staged and we cannot guarantee that all stages of the contracts will be
awarded to us or fully funded” and “A substantial portion of our net
sales are generated from government contracts, which makes us susceptible to the
uncertainties inherent in the government budgeting process.  In
addition, many of our contracts can be terminated by our
customer.)
 
 In
January 2005, we were awarded a firm fixed price contract from Raytheon in
Goleta, California for the design, development, manufacture, assembly and test
of the Aerosol Polarimetry Sensor, Scan Mirror Motor/Encoder
Assembly.  The Aerosol Polarimetry Sensor instrument is slated to fly
on the NASA Glory mission.  The Aerosol Polarimetry Sensor instrument
is also a prime candidate for a secondary payload on National Polar-orbiting
Operational Environmental Satellite System (NPOESS).  The Scan Mirror
Motor/Encoder Assembly consists of low ripple, precision brushless DC motor and
optical encoder assembly.  The program consists of a development unit,
engineering unit, qualification/life test unit, and flight units. This contract
was awarded as a cost-plus fixed-fee contract at a value of $2.5
million.  In July 2006, the contract was modified to add approximately
$2.5 million with incremental funding bringing the contract value to $5.0
million and extended the period of performance to March 2009.  We
continue to receive incremental funding and as of June 30, 2008 the contract
value is approximately 5.3 million.  We recorded revenues from this
contract during the first nine months of 2008 and from February 1, 2006 through
December 31, 2007 of approximately $0.7 million and $3.4 million,
respectively.
 
 In
February 2006, the Air Force Research Laboratory awarded us two deployable boom
technology contracts for advance research and development of a self-deployed
articulated boom for approximately $1.0 millionand a jack screw
deployed boom for approximately $1.5 million.  We recorded revenues
from this contract during the first nine months of 2008 and from February 2006
through December 31, 2007 of approximately $0.1 million and $2.3 million,
respectively.
 
 In June
2006, Lockheed Martin Commercial Space Systems awarded us a firm fixed price
contract for the design and fabrication of the antenna pointing gimbals onboard
the US Navy’s Mobile User Objective System (“MUOS”).  The initial award is
for two flight shipsets and includes two standard A2100 5-meter antenna gimbal
assemblies, four Ka-Band antenna gimbal assemblies and two 14-meter gimbal
assemblies.  The current contract includes the development and
qualification of the Ka-Band and 14-meter gimbal designs in addition to delivery
of standard gimbals that we have previously provided for the A-2100 bus. 
Proposals have been submitted for additional gimbals supporting three additional
MUOS spacecraft for approximately $3.0 million in addition to the baseline
procurement.  The current value of this contract is approximately $5.0
million.  We recognized $1.3 million of revenues from this contract
during the first nine months of 2008 and from June 2006 through December 31,
2007 we recorded approximately $3.0 million in revenue.  We
experienced cost overruns on this contract and are currently working with the
customer for possible additional contract modifications to this
program.
 
 18
 In July
2006, we were awarded a contract from the Air Force Research Laboratories in
support of a Broad Agency Announcement. This contract allows tasks to be
identified, approved, and funded to develop innovative technologies in the field
of deployable structures for spaceflight applications. The current contract
value is $1.8 million.  Deployable structures are designed to enable
the placement of large payloads within the constrained volume of the launch
vehicle and then to deploy, or erect, a larger system once the satellite or
vehicle is no longer constrained by the enclosed volume of the launch vehicle
fairing. The development efforts to date have focused on deployable antennae for
commercial applications, large systems for a variety of radio frequency
missions, and deployable optical systems. We recorded revenues from this
contract during the first nine months of 2008 and from July 2006 through
December 31, 2007 of approximately $0.6 million and $0.4 million,
respectively.
 
 In August
2006, we were awarded a firm fixed price contract to provide the solar array
drive, antenna pointing actuators, and gimbal control electronic assemblies for
the Lunar Reconnaissance Orbiter program from NASA Goddard Space Flight Center
and Swales Aerospace. The total contract value is in excess of $6.8
million. The Lunar
Reconnaissance Orbiter mission is scheduled to launch in late 2008 as part of
NASA's Lunar Precursor and Robotic Program. The spacecraft required two drive
actuators to align the solar panels with the sun, and a two axis pointing
mechanism to align the downlink antenna for communication with
earth.  We provided these actuators for the large spacecraft along
with the electronics to control them.  A total of seven actuators and
five control electronics assemblies were delivered under the
contract.  We recorded revenues from this contract during the first
nine months of 2008 and from August 2006 through December 31, 2007 of
approximately $0.3 million and $5.8 million, respectively.
 
 In August
and November 2006, we were awarded two contracts to provide hardware for the
H-II Transfer Vehicle for Ishikawa Aerospace and JAXA, the Japanese Space
Agency.  The H-II Transfer Vehicle will provide servicing missions to
deliver supplies to the International Space Station.  These contracts
were obtained as follow-on to a prior development contract started in
2002.  The total value of these two contracts is $1.2 million. JAXA is
continuing to market supply missions which may result in further contract growth
to this award.  We recorded revenues from these contracts during the
first nine months of 2008 and from August 1, 2006 through December 31, 2007 of
approximately $0.1 million and $1.1 million, respectively.
 
 In
February 2007, we were awarded a $1.4 million cost reimbursable design and
development subcontract with NASA’s Jet Propulsion Laboratory in support of the
Mars Science Laboratory mission.  In 2007, this contract was modified
to a value of approximately $1.9 million, and in 2008, we received an additional
contract modification bringing the total contract value today to approximately
$3.3 million.  We will develop and deliver electromechanical Descent
Brake dampers.  The contract period of performance is approximately 18
months.  NASA’s Mars Science Laboratory mission will deliver a
1,800-pound rover to the surface of Mars in 2010.  Rather than the
airbag landing system used by the Mars Exploration Rover mission, a “Skycrane”
landing system will use a rocket-decelerated Descent Stage that will hover and
gently lower the rover on a 25-foot long bridle cord.  A critical
component of the “Skycrane” landing system is the Descent Brake that will lower
the rover in less than seven seconds with a controlled speed profile that will
provide a gentle touch-down on the Martian surface.  We recorded
revenues from this contract during the first nine months of 2008 and from
inception through December 31, 2007 of approximately $1.4 million and $1.9
million, respectively.
 
 In March
2007, we received a follow-on order from Ball Aerospace and Technology
Corporation for solar array rotational drive assemblies and drive control
electronics for the Digital Globe WorldView-2 satellite program. The value of
the order is approximately $1.3 million increasing the total contract value to
$2.5 million.  The Starsys Quiet Array Drive Micro-Stepping motion control
technology will be utilized on the Ball Aerospace BCP 2000 platform, which will
articulate each of the two solar arrays for alignment with the sun. The
WorldView-2 satellite is scheduled to be ready for launch in late 2008 and is
expected to expand the capabilities of Digital Globe’s world imaging portfolio.
We recorded revenues from this contract during the first nine months of 2008 and
from inception through December 31, 2007 of approximately $0.5 million and $1.9
million, respectively.
 
 19
 In May of
2007, we were awarded a firm-fixed-price contract from Lockheed Martin to
develop several large brushless DC motor designs for an undisclosed
mission.  The original contract value was for
$248,500.  Through a series of modifications to further the design,
manufacture, and test the motors, the contract funded value has grown to over
$2.8 million through September 30, 2008.  We recorded revenues from
this contract during the first nine months of 2008 and from inception through
December 31, 2007 of approximately $1.7 million and $0.9 million,
respectively.  In July of 2008, a follow-on contract for flight motors
was awarded. This new contract has a value of over $1.6 million ($0.7 million of
which is currently funded) bringing the total value of this effort to $4.4
million.
 
 In
September 2007, we were awarded a cost reimbursable design and development
contract with the Defense Advanced Research Projects Agency to develop a Solar
Thermal Propulsion demonstration article as a subsystem of a small satellite
that is intended to enable the first Solar Thermal Propulsion flight
experiment.  The program consists of a six-month Base Program
culminating in a Critical Design Review, followed by a six-month option
culminating in a Solar Thermal Propulsion demonstration.  The award of
the option was contingent on the Defense Advanced Research Projects Agency’s
evaluation of the research results of the Base Program against a set of Go and
No-Go criteria.  The contract value for the initial Base Program is
$3.8 million. The option was exercised on May 14, 2008, bringing the total
contract value to approximately $7.3 million.  We recorded revenues
from this contract during the first nine months of 2008 and from inception
through December 31, 2007 of approximately $4.4 million and $1.2 million,
respectively.
 
 In
February 2008, we were awarded a cost-plus fixed fee contract from NASA’s Jet
Propulsion Laboratory to provide gearboxes to be used on the Mars Science
Laboratory mission. NASA’s Mars Science Laboratory mission will deliver a
1,800-pound rover to the surface of Mars in 2010.  The total contract
value is over $2.5 million and is scheduled to complete by December 31,
2008.  This contract was awarded when previously contracted efforts
with another supplier were deemed unable to satisfy the program
needs.  We recorded revenues from this contract during the first nine
months of 2008 of approximately $2.2 million.
 
 In August
2008, we were awarded a cost-plus fixed fee contract with Scaled Composites to
assist Scaled in the development of a production rocket motor for SpaceShipTwo,
the first commercial space vehicle designed for space tourism.  The
vehicle is being designed by Scaled for Virgin Galactic and is part of a
complete space system that also includes the recently unveiled WhiteKnightTwo
carrier aircraft.  The WhiteKnightTwo aircraft will ferry SpaceShipTwo
and thousands of private astronauts, science packages and payloads as the first
stage of Virgin Galactic’s sub-orbital space experience.  SpaceDev
will be providing engineering services to refine the design of the hybrid rocket
motor being developed by Scaled Composites, as well as providing the
development, manufacture and integration of key prototype rocket motor system
components.  Also, SpaceDev will be conducting ground tests on those
motor components and will be working to assist Scaled in the full-scale rocket
test program both on the ground and during SpaceShipTwo flight
tests.  The total contract value is approximately $15.2 million and
has a period of performance that runs through August 31, 2012.  We
recorded revenues on this contract from inception through September 30, 2008 of
approximately $0.6 million.
 
 20
 In August
2008, we were awarded 2 separate contracts related to NASA’s Crew Exploration
Vehicle program.  These two contracts will develop the Atmospheric Revitalization
System(ARS) Fan Motor and the Liquid Cooled
Garment (LCG) Pump Motors in support of the Orion Program for our
customer Hamilton Sundstrand, a United Technologies company.  Both motors are critical components of
the life support systems for the Orion CEV astronauts.  The ARS Fan
assembly recirculates air within the Orion vehicle. The LCG pump motor
provides coolant flow to an umbilical suit designed to support the astronauts
when missions take them outside of the vehicle cabin.  The ARS
contract is valued at $1.2 million and will likely grow as the requirements
evolve.  The second contract for the LCG is also valued at nearly $1.2
million.  Both of these efforts are expected to lead to flight
hardware production efforts when and if the development programs are
completed.
 
 In
September 2008, Space Systems Loral awarded us a modification to an existing
$0.5 million long-lead procurement contract.  This modification funds
the completion of an additional 813 of the Cell Shorting Devices, which are used
in every SSL battery flown.  This modification brings the value of
this contract to over $2.5 million.
 
 Results
of Operations
  Please
refer to the consolidated financial statements, which are a part of this report,
for further information regarding the results of operations.
 
 Nine-Months
Ended September 30, 2008 -vs.- Nine-Months Ended September 30, 2007
 
 During
the nine months ended September 30, 2008, we had net sales of approximately
$28.3 million as compared to net sales of approximately $25.3 million for the
same nine month period in 2007, an increase of approximately 12%. Sales
increased primarily due to additional cost plus fixed fee work of approximately
$2.4 million, which was offset by a decline in fixed price and time and material
contracts of approximately $1.0 million.  Government related work increased
by approximately $1.8 million in the three months ended September 30, 2008,
while non-government work declined by approximately $400,000. Revenue for the
nine months ended September 30, 2008 from government and government related work
was approximately $19.3 million, or 68.0% of net sales, and revenue from
commercial customers was approximately $8.9 million, or 32.0% of net
sales.  In comparison, in the nine months ended September 30, 2007,
revenue from government and government related work was approximately $19.0
million, or 74.8% of net sales, and revenue from commercial customers was
approximately $6.4 million, or 25.2% of net sales. As we continue to perform our
SpaceShipTwo related contract with Scaled Composites, we expect this trend to
continue.
 
 For the
nine months ended September 30, 2008, we had costs of sales (direct and
allocated costs associated with individual contracts) of approximately $22.0
million, or 77.9% of net sales, as compared to approximately $18.5 million, or
73.2% of net sales, during the same period in 2007.  Our increase in
cost of sales, or correspondingly our decrease in gross margin, was primarily
due to the following factors:  1) an increase in our overhead costs;
2) reduction in utilization of the provision for anticipated loss reserves; and
3) a write-off of certain historical loss program costs including our MUOS
program.  With respect to our overhead costs, we experienced an
increase in our overhead costs including a lower than expected labor utilization
rate and increases in our facility costs.  With respect to the
anticipated loss reserves, when we acquired Starsys in 2006, a $1.6 million
reserve was established.  The reserve was reduced during the 2006 to
2008 period as those programs were completed.  The reserve was reduced
more in 2007 (approximately $0.5 million) than it was in 2008 (approximately
$0.2 million).
 
 Our
operating expenses for the nine month period ended September 30, 2008 decreased
approximately $0.6 million to approximately $5.7 million compared to
approximately $6.3 million for the same nine month period in
2007.  Total operating expenses as a percentage of net sales decreased
4.7% from 24.7% for the nine months ended September 30, 2007 to 20.0% for the
nine months ended September 30, 2008.  The following are the
components of our operating expenses:
 
 21
 ·
              General
      and administrative expenses decreased approximately $1.0 million from
      approximately $3.8 million for the nine months ended September 30, 2007 to
      approximately $2.8 million for the same nine month period in
      2008.  The decrease can be attributed to the improved
      efficiencies of sharing certain General and Administrative services
      companywide rather than supported at each location, including but not
      limited to accounting support, information systems support and contract
      support.  General and administrative expenses as a percentage of
      total net sales declined from 15.0% for the nine months ended September
      30, 2007 to 9.8% for the same nine month period in
  2008.
 
 ·
              Research
      and development expenses increased to approximately $623,000, or 2.2% of
      net sales, for the nine months ended September 30, 2008, from
      approximately $265,000, or 1.0% of net sales, during the same period in
      2007.  This increase of internally funded research and
      development was focused on programs to enhance our satellite capabilities
      and mechanical systems, including but not limited to our in house
      development of guidance and navigational control systems, small satellite
      production, and enhanced dual-axis pointing mechanism
    project.
 
 ·
              Marketing
      and sales expenses increased to approximately $2.3 million, or 8.0% of net
      sales, for the nine months ended September 30, 2008, from approximately
      $2.2 million, or 8.7% of net sales, during the same period in
      2007.  The increase was mainly due to engineering support of new
      proposal development.
 
 ·
              Our
      stock option expense is based on a calculation using the minimum value
      method as prescribed by SFAS 123(R), otherwise known as the Black-Scholes
      method.   Under this method, we used a risk-free interest
      rate at the date of grant, an expected volatility, an expected dividend
      yield and an expected life of the options to determine the fair value of
      options granted.  The risk-free interest rate was estimated and
      ranged from 2.17% to 4.75%, expected volatility ranged from 48.60% to
      94.36% at the time all options were granted, the dividend yield was
      assumed to be zero, and the expected life of the options was assumed to be
      four years based on the average vesting period of options
      granted.  The total expense for the nine months ended September
      30, 2008 and 2007 was approximately $0.4 million and $0.3 million,
      respectively.
 
 Non-operating
expense (income) consisted of interest expense, interest income, and deferred
gain on the sale of our building, as well as other non-cash loan fees and
expenses.
 
 ·
              We
      recorded loan fees related to our revolving credit facility of
      approximately $149,000 and $260,000 for the nine months ended September
      30, 2008 and 2007, respectively.  We issued 310,009 shares of
      our common stock, valued at $0.35 million, to Laurus in September 2006 for
      revolving credit facility loan fees, which we amortized over the initial
      12 months.  We further issued 283,286 shares of our common
      stock, valued at $0.2 million, to Laurus in September 2007 for revolving
      credit facility loan fees, which we amortized from October 2007 through
      September 2008.
 
 ·
              Interest
      and other expense for the nine months ended September 30, 2008 and 2007
      was approximately $88,000 and $196,000, respectively.  The
      decrease was mainly attributable to utilization of our revolving credit
      facility in 2007; whereas, we did not utilize the revolving line of credit
      during in 2008.  Interest and other expenses also includes cash
      fees of $175,000, which we are amortizing over 36 months, in connection to
      our  revolving credit facility mentioned above, which we are
      required to expense whether we utilize the facility or not.  We
      generated interest and other income for the nine months ended September
      30, 2008 and 2007 of approximately $83,000 and $45,000, respectively,
      based on the levels of our cash balances in each period and other
      non-operating income.
 
 22
 ·
              We
      recognized approximately $88,000 of the deferred gain on the 2003 sale of
      our Poway headquarters building during each of the nine month periods
      ended September 30, 2008 and 2007, and we will continue to amortize the
      remaining deferred gain of approximately $0.5 million into non-operating
      income over the remainder of the leaseback period, which expires in
      January 2013.
 
 During
the nine months ended September 30, 2008, we generated net income of
approximately $0.5 million, or 1.8% of net sales, despite recognizing
approximately $0.4 million in non-cash charges related to expensing stock
options under SFAS 123(R), compared to net income of approximately $0.2 million,
or 0.8% of net sales, for the same nine month period in 2007, which also
included approximately $0.3 million in non-cash charges related to expensing
stock options under SFAS 123(R).  During the nine months ended
September 30, 2008, we had adjusted earnings before interest, taxes,
depreciation and amortization, loan fees on our revolving facility, stock option
expense, and gain on building sale, or Adjusted EBITDA, of approximately $2.1
million, or 7.3% of net sales, compared to approximately $1.7 million, or 6.8%
of net sales, for the nine months ended September 30, 2007.
 
 The
following table reconciles Adjusted EBITDA to net income for the nine months
ended September 30, 2008 and 2007:
 
 For
      the nine months ending
                
                September
      30, 2008
                September
      30, 2007(Unaudited)
                (Unaudited)Net
      Income
                
                $                 497,935
                $              214,221Interest
      and other Income
                
                (83,004)
                (44,847)Interest
      and other Expense
                
                88,440
                196,417Provision
      for Income Taxes
                
                21,915
                800Depreciation
      and Amortization
                
                1,045,365
                887,031Loan
      Fees on Revolving Credit Facility
                
                148,814
                259,865Stock
      Option Expense
                
                420,279
                302,144Gain
      on Building Sale
                
                (87,952)
                (87,955)Adjusted
      EBITDA
                
                $               2,051,792
                $           1,727,675
 We define
Adjusted EBITDA as net income before interest, taxes, depreciation,
amortization, loan fees on our revolving credit facility, stock option expense,
and gain on the 2003 sale of our Poway building.  Adjusted EBITDA is
not recognized under U.S. GAAP.  We believe the use of Adjusted EBITDA
along with U.S. GAAP financial measures enhances the understanding of our
operating results and is useful to our management, Board of Directors and
investors.
 
 ·
              Adjusted
      EBITDA is used by management as a performance measure for benchmarking
      against our peers and our competitors.  In particular, we
      evaluate management performance by using revenues and operating income
      (loss) before depreciation and amortization, loan fees on our revolving
      credit facility, stock option expense, and gain on our 2003 building
      sale.  We also use Adjusted EBITDA to evaluate operating
      performance, to measure performance for incentive compensation programs,
      and to evaluate future growth
opportunities.
 
 ·
              Adjusted
      EBITDA is one of the metrics used by management and our Board of
      Directors, to review the financial performance of the business on a
      monthly basis and, in part, to determine the level of compensation for
      management.  This is done by comparing the managers’
      departmental budgets without interest, taxes, depreciation and
      amortization, loan fees on our revolving credit facility, stock option
      expense, and gain on our 2003 building sale as a measure of their
      performance.
 
 23
 ·
              We
      believe Adjusted EBITDA is useful to investors and allows a comparison of
      our operating results with that of competitors exclusive of depreciation
      and amortization, interest income, interest expense, non-cash stock option
      expenses and other non-operating expenses such as loan fees and gain on
      our 2003 building sale.  Financial results of competitors in our
      industry have significant variations that can result from timing of
      capital expenditures, the amount of intangible assets recorded, the
      differences in assets’ lives, the timing and amount of investments and the
      variances in the amount of stock options granted to
    employees.
 
 Adjusted
EBITDA should not be viewed in isolation and is not presented as an alternative
to cash flow from operations as a measure of our liquidity or as an alternative
to net income as an indicator of our operating performance.  Adjusted
EBITDA should be used in conjunction with U.S. GAAP financial measures. Adjusted
EBITDA is not intended to be a measure of free cash flow for management’s
discretionary use, as it does not consider certain cash requirements such as
capital expenditures, contractual commitments, interest payments, income tax
payments and debt service requirements.  There are material
limitations associated with making the adjustments to calculate Adjusted EBITDA
and using this non-GAAP financial measure as compared to the most directly
comparable GAAP financial measure.  For instance, Adjusted EBITDA does
not include:  1) interest expense, and because we may borrow money to
finance our operations, interest expense is a necessary element of our
costs;  2) depreciation and amortization expense, and because we use
tangible and intangible capital assets, depreciation and amortization expense is
a necessary element of our costs; and,  3) income tax expense, and
despite our prospective tax loss carry forwards, because the payment of income
taxes is part of our operations, income tax expense is a necessary element of
our costs.
 
 Since not
all companies use identical calculations, our presentation of Adjusted EBITDA
may not be comparable to other similarly titled measures of other
companies.
 
 Three
Months Ended September 30, 2008 -vs.- Three Months Ended September 30,
2007
 
 During
the three months ended September 30, 2008, we had net sales of approximately
$9.0 million as compared to net sales of approximately $7.6 million for the same
three month period in 2007, an increase of approximately 19%.  Sales
increased primarily due to additional cost plus fixed fee work of approximately
$2.4 million, which was offset by a decline in fixed price and time and material
contracts of approximately $1.0 million.  Government related work increased
by approximately $1.8 million in the three months ended September 30, 2008,
while non-government work declined by approximately $400,000. Revenue for the
three months ended September 30, 2008 from government and government related
work was approximately $6.7 million, or 74.3% of net sales, and revenue from
commercial customers was approximately $2.3 million, or 25.7% of net
sales.  In comparison, in the three months ended September 30, 2007,
revenue from government and government related work was approximately $4.9
million, or 64.5% of net sales, and revenue from commercial customers was
approximately $2.7 million, or 35.5% of net sales.
  For the
three months ended September 30, 2008, we had costs of sales (direct and
allocated costs associated with individual contracts) of approximately $7.3
million, or 80.3% of net sales, as compared to approximately $5.4 million, or
71.0% of net sales, during the same period in 2007.  Our increase in
cost of sales, or correspondingly our decrease in gross margin, was primarily
due to the following factors:  1) an increase in our overhead costs;
2) reduction in utilization of the provision for anticipated loss reserves; and
3) a write-off of certain historical loss program costs including our MUOS
program.  With respect to our overhead costs, we experienced an
increase in our overhead costs including a lower than expected labor utilization
rate and increases in our facility costs.  With respect to the
anticipated loss reserves, when we acquired Starsys in 2006, a $1.6 million
reserve was established.  The reserve was reduced during the 2006 to
2008 period as those programs were completed.  The reserve was reduced
more in 2007 (approximately $0.5 million) than it was in 2008 (approximately
$0.2 million).
 
 24
 Our
operating expenses for the three month period ended September 30, 2008 decreased
approximately $0.6 million, to approximately $1.4 million compared to
approximately $2.0 million for the same period in 2007.  Total
operating expenses as a percentage of net sales decreased from 26.8% for the
three months ended September 30, 2007 to 15.8% for the three months ended
September 30, 2008.  The following are the components of our operating
expenses:
 
 ·
              General
      and administrative expenses decreased approximately $0.7 million from
      approximately $1.1 million for the three months ended September 30, 2007
      to approximately $0.4 million for the same three month period in
      2008.  The decrease can be attributed mainly to adjustments in
      our general and administrative rates, and to a lesser extent, improved
      efficiencies of sharing certain General and Administrative services
      companywide rather than supported at each location, including but not
      limited to accounting support, information systems support and contract
      support. General and administrative expenses as a percentage of total net
      sales decreased from 15.0% for the three months ended September 30, 2007
      to 5.0% for the same three month period in
2008.
 
 ·
              Research
      and development expenses increased to approximately $0.2 million, or 1.9%
      of net sales, for the three months ended September 30, 2008, from
      approximately $0.1 million, or 1.3% of net sales, of net sales, during the
      same period in 2007.  This increase of internally funded
      research and development related to programs which enhanced our satellite
      capabilities and mechanical systems, including but not limited to our in
      house development of guidance and navigational control systems, small
      satellite production, and an enhanced dual-axis pointing mechanism
      project.
 
 ·
              Marketing
      and sales expenses remained essentially flat at approximately $0.8
      million, or 9.0% of net sales, for the three months ended September 30,
      2008, from approximately $0.8 million, or 10.5% of net sales, during the
      same period in 2007.
 
 ·
              Our
      stock option expense is based on a calculation using the minimum value
      method as prescribed by SFAS 123(R), otherwise known as the Black-Scholes
      method.   Under this method, we used a risk-free interest
      rate at the date of grant, an expected volatility, an expected dividend
      yield and an expected life of the options to determine the fair value of
      options granted.  The risk-free interest rate was estimated and
      ranged from 2.62% to 3.11%, expected volatility ranged from 48.60% to
      55.83% at the time all options were granted, the dividend yield was
      assumed to be zero, and the expected life of the options was assumed to be
      four years based on the average vesting period of options
      granted.  The total expense for the three months ended September
      30, 2008 and 2007 was approximately $0.2 million and $0.1 million,
      respectively.
 
 Non-operating
expense (income) consisted of interest expense, interest income, and deferred
gain on the sale of our building, as well as other non-cash loan fees and
expenses.
 
 ·
              We
      recorded loan fees related to our revolving credit facility of
      approximately $50,000 and $86,000 for the three months ended September 30,
      2008 and 2007, respectively.  We issued 310,009 shares of our
      common stock, valued at $0.35 million, to Laurus in September 2006 for
      revolving credit facility loan fees, which we amortized over the initial
      12 months.  We further issued 283,286 shares of our common
      stock, valued at $0.2 million, to Laurus in September 2007 for revolving
      credit facility loan fees, which we are amortizing from October 2007
      through September 2008.
 
 25
 ·
              Interest
      and other expense for the three months ended September 30, 2008 and 2007
      was approximately $46,000 and $63,000, respectively.  The
      decrease was mainly attributable to utilization of our revolving credit
      facility in 2007; whereas, we did not utilize the revolving line of credit
      during in 2008.  Interest and other expenses also include cash
      fees of $175,000, which we are amortizing over 36 months in connection to
      our revolving credit facility mentioned above, which we are required to
      expense whether we utilize the facility or not.  We generated
      interest and other income in the three months ended June 30, 2008 and 2007
      of approximately $22,000 and $14,000, respectively, based on the levels of
      our cash balances in each period.
  ·
              We
      recognized approximately $29,000 of the deferred gain on the 2003 sale of
      our Poway headquarters building during each of the three month periods
      ended September 30, 2008 and 2007, and we will continue to amortize the
      remaining deferred gain of approximately $0.5 million into non-operating
      income over the remainder of the leaseback period, which expires in
      January 2013.
 
 During
the three months ended September 30, 2008, we experienced net income of
approximately $0.3 million, or 3.2% of net sales, despite recognizing
approximately $0.2 million in non-cash charges related to expensing stock
options under SFAS 123(R), compared to net income of approximately $58,000, or
0.8% of net sales, for the same three month period in 2007, which also included
approximately $0.1 million in non-cash charges related to expensing stock
options under SFAS 123(R).  During the three months ended September
30, 2008, we had adjusted earnings before interest, taxes, depreciation and
amortization, loan fees on our revolving facility, stock option expense, and
gain on building sale, or Adjusted EBITDA, of approximately $0.9 million, or
9.7% of net sales, compared to approximately $0.5 million, or 7.2% of net sales,
for the three months ended September 30, 2007.
 
 The
following table reconciles Adjusted EBITDA to net income for the three months
ended September 30, 2008 and 2007:
  For
      the three months ended
                
                September
      30, 2008
                September
      30, 2007(Unaudited)
                (Unaudited)Net
      Income
                
                $                 293,339
                $                57,806Interest
      and other Income
                
                (22,233)
                (13,868)Interest
      and other Expense
                
                45,929
                63,104Provision
      for Income Taxes
                
                10,700
                -Depreciation
      and Amortization
                
                369,655
                294,110Loan
      Fees on Revolving Credit Facility
                
                49,635
                86,302Stock
      Option Expense
                
                163,851
                90,040Gain
      on Building Sale
                
                (29,318)
                (29,319)Adjusted
      EBITDA
                
                $                 881,558
                $              548,175
 We define
Adjusted EBITDA as net income before interest, taxes, depreciation,
amortization, loan fees on our revolving credit facility, stock option expense,
and gain on the 2003 sale of our Poway building.  Adjusted EBITDA is
not recognized under U.S. GAAP.  We believe the use of Adjusted EBITDA
along with U.S. GAAP financial measures enhances the understanding of our
operating results and is useful to our management, Board of Directors and
investors.
 
 26
 ·
              Adjusted
      EBITDA is used by management as a performance measure for benchmarking
      against our peers and our competitors.  In particular, we
      evaluate management performance by using revenues and operating income
      (loss) before depreciation and amortization, loan fees on our revolving
      credit facility, stock option expense, and gain on our 2003 building
      sale.  We also use Adjusted EBITDA to evaluate operating
      performance, to measure performance for incentive compensation programs,
      and to evaluate future growth
opportunities.
 
 ·
              Adjusted
      EBITDA is one of the metrics used by management and our Board of
      Directors, to review the financial performance of the business on a
      monthly basis and, in part, to determine the level of compensation for
      management.  This is done by comparing the managers’
      departmental budgets without interest, taxes, depreciation and
      amortization, loan fees on our revolving credit facility, stock option
      expense, and gain on our 2003 building sale as a measure of their
      performance.
 
 ·
              We
      believe Adjusted EBITDA is useful to investors and allows a comparison of
      our operating results with that of competitors exclusive of depreciation
      and amortization, interest income, interest expense, non-cash stock option
      expenses and other non-operating expenses such as loan fees and gain on
      our 2003 building sale.  Financial results of competitors in our
      industry have significant variations that can result from timing of
      capital expenditures, the amount of intangible assets recorded, the
      differences in assets’ lives, the timing and amount of investments and the
      variances in the amount of stock options granted to
    employees.
 
 Adjusted
EBITDA should not be viewed in isolation and is not presented as an alternative
to cash flow from operations as a measure of our liquidity or as an alternative
to net income as an indicator of our operating performance.  Adjusted
EBITDA should be used in conjunction with U.S. GAAP financial measures. Adjusted
EBITDA is not intended to be a measure of free cash flow for management’s
discretionary use, as it does not consider certain cash requirements such as
capital expenditures, contractual commitments, interest payments, income tax
payments and debt service requirements.  There are material
limitations associated with making the adjustments to calculate Adjusted EBITDA
and using this non-GAAP financial measure as compared to the most directly
comparable GAAP financial measure.  For instance, Adjusted EBITDA does
not include:  1) interest expense, and because we may borrow money to
finance our operations, interest expense is a necessary element of our
costs;  2) depreciation and amortization expense, and because we use
tangible and intangible capital assets, depreciation and amortization expense is
a necessary element of our costs; and,  3) income tax expense, and
despite our prospective tax loss carry forwards, because the payment of income
taxes is part of our operations, income tax expense is a necessary element of
our costs.  Since not all companies use identical calculations, our
presentation of Adjusted EBITDA may not be comparable to other similarly titled
measures of other companies.
 
 Liquidity
and Capital Resources
 
 Cash
Flows for Nine Months Ended September 30, 2008 -vs.- Nine Months Ended September
30, 2007
 
 Net
decrease in cash during the nine months ended September 30, 2008 was
approximately $0.7 million from $6.5 million at December 31, 2007 to $5.8
million at September 30, 2008.  The change was primarily due to the
$1.4 million repurchase of Series D-1 Preferred Stock during the first nine
months of 2008.  This is compared to a net increase in cash for the
nine months ended September 30, 2007 of $3.7 million, from $1.4 million at
December 31, 2006 to $5.1 million at September 30, 2007.  The change
in 2007 was due to our raising approximately $4.6 million in cash from sales of
our common stock as well as borrowing approximately $2.0 million on our
revolving credit facility in the first nine months of 2007 to fund operations,
whereas in 2008 working capital funded operations.  Net cash provided
by operating activities totaled approximately $2.2 million for the nine months
ended June 30, 2008, an increase of $3.0 million from the $0.8 million used in
operations for the same nine month period in 2007.
 
 27
 Net cash
used in investing activities totaled approximately $1.2 million for the nine
months ended September 30, 2008, compared to approximately $0.8 million used in
investing activities during the same nine month period in 2007. The increase was
due to the August 2008 payment of $250,000 to former shareholders of Starsys to
settle their acquisition earnout claims (this payment was allocated to goodwill
and other intangible assets) and a slight increase in fixed assets being
purchased in the first nine months of 2008 as compared to the first nine months
of 2007.
 
 Net cash
used in financing activities totaled approximately $1.7 million for the nine
months ended September 30, 2008, which is a decrease of approximately $7.0
million from approximately $5.3 million provided by financing activities during
the same nine months in 2007.  This is primarily attributable to
raising approximately $4.6 million, primarily from sales of our common stock to
third parties in the nine months ended September 30, 2007 as well as borrowing
$2.0 million under our revolving credit facility in 2007 to fund operations
versus no use on the facility in the first nine months of 2008. In addition, we
repurchased $1.4 million of our Series D-1 Preferred Stock preferred stock in
the first nine months of 2008, versus $0.9 million in the same nine months of
2007.
 
 Liquidity and Backlog
 
 At
September 30, 2008, our cash, which included cash reserves and cash available
for investment, was approximately $5.8 million, as compared to approximately
$5.1 million at September 30, 2007, an increase of approximately $0.7
million.  At September 30, 2008, our working capital ratio was
approximately 1:2:1 versus 1:1:1 for the same date in 2007.
 
 Our
backlog was approximately $29.1 million at September 30, 2008, and at December
31, 2007.  Our backlog consists of contracted and contract-in-process
business.  Our contracted business is the estimated value of contracts
for which we are authorized to incur costs and for which orders have been
recorded, but for which revenue has not yet been
recognized.  Contracted business fluctuates due to a variety of
events, including but not limited to the timing of
awards.  Contracts-in-process business are situations where we have
been informed that our bids on new contract work have been accepted, but due to
issues, such as: delays in the adoption of the U.S. Government budget; changes
in program budgets; and finalization of mutually acceptable contract terms and
conditions, these contract opportunities have not been
formalized.  Our contracted business was approximately $29 million and
$16 million at September 30, 2008 and December 31, 2007,
respectively.  Our contract-in-process business was approximately
$100,000 at September 30, 2008 and $13 million at December 31,
2007.
 
 Critical
Accounting Standards
  Due to
the acquisition of Starsys, our revenues transitioned in 2006 from being
primarily cost-plus fixed-fee contracts, where revenues are recognized as costs
are incurred and services are performed, to a combination of cost-plus fixed-fee
contracts and fixed price contracts, where revenues are recognized using the
percentage-of-completion method of contract accounting based on the ratio of
total costs incurred to total estimated costs. Losses on contracts are
recognized when they become known and reasonably estimated (see the Notes to our
Consolidated Financial Statements).  Actual results of contracts may
differ from management's estimates and such differences could be material to the
consolidated financial statements.  In addition, when the total value
of a contract becomes uncertain (such as when a contract modification to reflect
cost overruns is being negotiated), we may be unable to report further revenues
on the contract under the percentage-of-completion method until the uncertainty
is resolved.
 
 28
 Professional
fees are billed to customers on a time-and-materials basis, a fixed price basis
or a per-transaction basis.  Time-and-material revenues are recognized
as services are performed.  Deferred revenue represents amounts
collected from customers for services to be provided at a future
date.  Research and development costs are expensed as
incurred.
 
 Recent
Accounting Pronouncements
  There
were no recent Accounting Pronouncements that affected the Company during the
first nine months of 2008.  For past pronouncements, please refer to
our Form 10-KSB filed on March 28, 2008.
 
 Risk
Factors
 
 The
following factors, among others, could cause actual results to differ materially
from those contained in forward-looking statements made herein and presented
elsewhere by management from time to time.
 
 Uncertainty
created by our proposed merger with Sierra Nevada Corporation may cause
customers to delay, defer or not award business and/or lead to loss of
employees.
 
 Our
recent announcement of the proposed acquisition of SpaceDev by Sierra Nevada
Corporation could have an adverse effect on our customers and
employees.  Current an dprospective customers may delay, defer or not
award business because they are not familiar with Sierra Nevada Corporation and
how they intend to operate once the acquisition is complete or because they fear
our operations will be hampered by transition issues.  Also, if the
transaction closes, we will no longer be a qualifying small business and may be
seen as a competitor instead of a subcontractor to some of our
customers.  The announcement could also have an adverse effect on new
or potential customers because they may have business or competitive concerns
with Sierra Nevada Corporation.
 
 Our
employees may, in anticipation of the merger transaction, decide to leave us
because of the changes that will take place once the acquisition is complete,
including the absence of equity opportunities.
 
 The
attention which our management has devoted to merger activities may have
distracted them from attention to business.
 
 Because
of the time, manpower, and issues involving the merger with Sierra Nevada
Corporation, management may not have had the time needed to focus on the
day-to-day operations that they were hired to do.
 
 Under
the terms of our merger agreement and until we close or end the transaction, we
require certain reviews and approvals from Sierra Nevada on commitments and
actions.
 
 Until we
close the acquisition transaction with Sierra Nevada Corporation, major
corporate actions such as proposals, new contracts, fixed asset purchases,
hirings, etc. must be reviewed and approved by Sierra Nevada
Corporation.  Sierra Nevada Corporation has the ability to reject or
modify these actions and therefore if the acquisition transaction does not
close, we could potentially lose an opportunity or be adversely
affected.
 
 29
 The
price of our stock may be limited to $0.72 per share due to the offer pricing
from Sierra Nevada even if the value of our business increases.
 
 Due to
the commitment under the merger agreement with Sierra Nevada Corporation, we
would be required to sell SpaceDev to Sierra Nevada Corporation for a maximum
price of $0.72 per share, regardless of the market price of the stock or other
factors, when all closing conditions have been satisfied or waived. Therefore,
our stockholders would not be able to participate in any future increase in the
value of our business.  Even stockholders who pursue Delaware
appraisal rights instead of accepting the merger price would not receive
additional money due to such potential future increases in value.
 
 If
the merger does not occur we would be harmed.
 
 If for
any reason the merger does not occur, we will be adversely affected in the
market because of loss of momentum and the possibility other market participants
would view the Company as damaged goods.  In addition, if the merger
agreement is terminated for any of certain specific reasons, we would have to
pay Sierra Nevada Corporation a $1.5 million termination fee.
 
 The merger transaction with Sierra
Nevada is subject to the satisfaction of closing conditions, and we cannot
assure you that the merger will be successfully completed. In the event that the
merger is not completed, we may be subject to a number of risks,
including:
 
 ·
                the
      price of our common stock may decline to the extent that the market price
      of our common stock reflected a market assumption that the merger would be
      completed;
 
 ·
                we
      could suffer the loss of customers, revenues and employees due to
      uncertainties resulting from an uncompleted merger;
  and
 
 ·
                our
      costs related to the merger, such as legal and advisory fees, must be paid
      even if the merger is not completed. Such costs would reduce our reported
      earnings or increase our reported loss, for the period when it was
      determined that the merger would not be consummated. We estimate that we
      will incur aggregate direct transaction costs of between $1.5 million and
      $2.0 million associated with the Sierra Nevada merger transaction
      including legal fees, and investment banking
  costs.
 
 We
have been sued in connection with the Sierra Nevada transaction.
 
 On
October 30, 2008 and again on November 5, 2008, plaintiffs filed in California
and Delaware two purported class action lawsuits related to the proposed
transaction with Sierra Nevada Corporation. These lawsuits seek to prevent the
proposed transaction as well as damages. The Company is obligated to commit
resources to defending such litigation.  If the plaintiffs are
successful, the court could potentially temporarily or permanently prevent the
merger from taking place.
 If
we remain independent, our size might tend to limit our business
opportunities.
 
 If the
acquisition transaction with Sierra Nevada Corporation does not close, we will
continue to be considered a relatively small company.  Our size is
determined by revenues, work force and capabilities. As a small company, our
ability to compete successfully for a large amount of desirable business may be
limited because customers perceive that larger suppliers are more dependable,
have the resources to successfully execute larger programs and, therefore, are
more stable.  Yet, if we cannot win such business, it may be difficult
for us to rapidly grow our business through organic growth.  Prime
contracts in our industry may be large in dollar amount and critical to national
interests. As a practical matter, smaller companies are at a disadvantage when
competing to be awarded such large contracts as the prime contractor, due to
customer perception that larger companies might be more stable. For this
purpose, we would currently be considered a "smaller company."
 
 30
 Our
success depends on our ability to retain our key personnel.
 
 Our
success will be dependent upon the efforts of key members of our management and
engineering team, including our Chairman and Chief Executive Officer, Mark N.
Sirangelo, our President and Chief Financial Officer, Richard B. Slansky whose
employment contracts currently expire in December 2008 and certain other key
personnel.  The loss of either of these persons, or other key
employees, including personnel with security clearances required for classified
work and highly skilled technicians and engineers, could have a material adverse
effect on us.  Our future success is likely to depend substantially on
our continued ability to attract and retain highly qualified
personnel.  The competition for such personnel is intense, and our
inability to attract and retain such personnel could have a material adverse
effect on us.  At this time, we do not maintain key man life insurance
on any of our personnel.
 
 We
have experienced losses from operations in prior periods and have been required
to seek additional financing to support our businesses.
 
 In prior
years, we have experienced operating losses and, in some periods, revenue from
operations was not sufficient to fund our operations.  Historically,
our operating activities have used cash rather than provided
cash.  The success of our Company depends upon our ability to generate
revenue from existing contracts, to execute programs cost-effectively, to price
fixed price contracts accurately, to attract and successfully complete
additional government and commercial contracts, and possibly to obtain
additional financing.  The likelihood of our success must be
considered in light of the expenses, difficulties and delays frequently
encountered in connection with developing businesses, those historically
encountered by us, and the competitive environment in which we
operate.
 
 If
we remain independent and if we are unable to raise capital, we may be unable to
fund operating cash shortfalls, necessary capital expenditures, and future
growth opportunities.
 
 In the
past, we have relied upon cash from financing activities to fund part of the
cash requirements of our business.  We may need additional financing
to fund our projected operations, capital expenditures or expansion plans
(including acquisitions).  Additional financing may not be available
to us on acceptable terms, or at all.  Any equity financing may cause
additional dilution to existing stockholders.  Any debt financing or
other issuance of securities senior to common stock likely will include
financial and other covenants that will restrict our operating flexibility and
payment of dividends to common stockholders.
 
 Some
of our contracts are staged and we cannot guarantee that all stages of the
contracts will be awarded to us or fully funded.
 
 Some of
our contracts are phased contracts in which the customer may determine to
terminate the contract between phases for any reason.  Accordingly,
the entire contract amount may not be realized by us.  In the event
that subsequent phases of these contracts are not awarded to us, or if they are
awarded to us but not fully funded, it could have a material adverse effect on
our financial position and results of operations.  For example, we
were informed in 2007 that there were not going to be any GFY 2008 funds from
the Missile Defense Agency to support our microsatellite distributed sensing
experiment.  We were able to replace some, but not all, of the Missile
Defense Agency funding support with funding from the Office of Operationally
Responsive Space.
 
 31
 We
provide our products and services primarily through fixed price and cost-plus-
fixed-fee contracts. We have experienced significant losses on fixed price
contracts, especially those requiring significant development. Cost overruns may
result in further losses and could impair our liquidity position.
 
 Under
fixed price contracts, our customers pay us for work performed and products
shipped without adjustment for the costs we incur in the process. Therefore, we
generally bear all or a significant portion of the risk of losses as a result of
increased costs on these contracts, unless we can obtain voluntary relief from
our customer, which relief (or additional consideration) cannot be assured.
Although we have taken significant steps to try to limit our risk on fixed price
contracts going forward, we have experienced significant cost overruns on
certain development projects under fixed price contracts.  Although we
anticipate contract modifications to cover overruns, there can be no assurance
that such contract modifications will be successfully negotiated or, if
negotiated, sufficient to cover our expended costs.  These costs
significantly affected our gross margin and impaired our liquidity position and
operations.
 
 When
contract provisions produce unfavorable results for us, or fixed price
development contracts result in losses, we generally do not have the legal or
economic leverage needed to easily obtain renegotiated terms. Our customers
generally would not fear any threat we might make to withhold future business
and our financial and business position make litigation an unfavorable option
for us. On the other hand, the reverse might be true of our customers, who tend
to be large aerospace companies with significant resources. In the case of two
major fixed price contracts on which we have experienced significant cost
overruns, the customers were willing to work with us and negotiations resulted
in contract amendments providing additional incentive payments based on
performance. However, there can be no assurance that future attempts to
renegotiate contracts will be successful.
 
 To
mitigate risks of this kind, we have made a business decision to:
 
 ·
              limit
      the number of new fixed price development
  contracts;
 ·
              offer
      our customers alternative contract structures that better protect
      us;
 ·
              establish
      additional costing reviews;
 ·
              improve
      our contract review process and hire contract professionals to review
      contracts; and
 ·
              increase
      senior management involvement to scrutinize proposal efforts related to
      fixed price contracts.
 
 This
decision could limit our ability to obtain new business.
 
 Under
cost-plus contracts, we are reimbursed for allowable incurred costs plus a fee,
which may be fixed or variable. This type of contract structure passes much of
the risk to the buyer; however, it also limits our ability to generate
profit.  We normally try to negotiate a cost-plus contract for high
risk development-type programs. Most customers prefer a fixed-fee arrangement
but variable fee arrangements are possible.  There is no guarantee as
to the fee amount we will be awarded under a cost-plus contract with a variable
fee. The price on a cost-plus fixed-fee reimbursable contract is based on
allowable costs incurred, but generally is subject to contract funding
limitations. Therefore, we could bear the amount of costs in excess of the
funding limitation specified in the contract, and we may not be able to recover
those cost overruns.  Generally, cost-plus contracts are the best way
to mitigate risks related to development-type programs and other higher risk
opportunities. However, there can be no assurance that any type of contract
vehicle can protect us from cost overruns and significant cost overruns could
impair our liquidity position.
 
 32
 If
we fail to operate our multi-location business effectively, we may have
disappointing business results.
 
 Even if
we are successful in obtaining new business, failure to manage the growth could
adversely affect our operations. We may experience acute periods of very rapid
growth (for example, if we were to win a major contract), which could place a
significant strain on our management, operating, financial, and other resources.
Our future performance will depend in part on our ability to manage growth
effectively. We must develop management information systems, including
operating, financial, and accounting systems, improve project management systems
and processes and expand, train, and manage our workforce to keep pace with
growth. Our inability to manage growth effectively could negatively affect
results of operations and the ability to meet obligations as they come
due.  We may encounter difficulties, costs, and delays involved in
operating our multi-location business, including but not limited to the
following:
 
 ·
              challenges
      encountered in managing larger, more geographically dispersed
      operations;
 ·
              the
      loss of key employees;
 ·
              diversion
      of the attention of management from other ongoing business
      concerns;
 ·
              potential
      incompatibilities of processes, technologies and
  systems;
 ·
              potential
      difficulties integrating and harmonizing financial reporting systems;
      and,
 ·
              potential
      failure to implement systems to properly price and manage the execution of
      fixed price contracts.
 
 We will
not meet the expectations of investors and financial or industry analysts
if:
 
 ·
              the
      operations of our multi-site company does not result in the anticipated
      synergies and benefits;
 ·
              the
      costs savings from operational improvements is not greater than
      anticipated;
 ·
              the
      combined financial results are not consistent with
      expectations;
 ·
              management
      is unable to successfully manage a multi-location
  business;
 ·
              the
      anticipated operating and product synergies of our business areas are not
      realized; or,
 ·
              the
      fixed price development contracts, or new fixed price contracts, incur
      major cost overruns or remain unprofitable for any
  reasons.
 
 We
relocated to a new Colorado facility and North Carolina facility in 2007,
increasing our rental costs.
 
 The move
of our Boulder, Colorado and Durham, North Carolina operations to new and larger
nearby facilities in 2007 was time consuming and expensive and partially
disrupted operations.  In addition, we may not achieve anticipated
efficiencies or other benefits of these moves.  For example, if our
business does not develop as expected, the new facilities may be larger than
what we require, resulting in rent payments for some unneeded
space.  Our rental costs at the new facilities are approximately 72%
higher than we had paid at the prior facilities.
 
 33
 A
substantial portion of our net sales are generated from government contracts,
which makes us susceptible to the uncertainties inherent in the government
budgeting process.  In addition, many of our contracts can be
terminated by our customer.
 
 Our
concentration of government work makes us susceptible to government budget cuts
and policy changes, which may impact the award of new contracts or future phases
of existing contracts.  Government budgets (both in general and as to
space and defense projects) are subject to the prevailing political climate,
which is subject to change at any time, and particularly when a new presidential
administration comes into office.  Additionally, awarded contracts
could be altered or terminated before we recognize our projected revenue. Many
contracts are awarded in phases where future phases are not guaranteed to
us.  Delays in government budget appropriations may delay the award or
start date of current funded programs.  In addition, obtaining
contracts and subcontracts from government agencies is challenging, and
contracts often include provisions that are not standard in private commercial
transactions. For example, government contracts may:
 
 ·
              include
      provisions that allow the government agency to terminate the contract
      without penalty;
 ·
              be
      subject to purchasing decisions of agencies that are subject to political
      influence;
 ·
              contain
      onerous procurement procedures;
and,
 ·
              be
      subject to cancellation if government funding becomes
      unavailable.
 
 Securing
government contracts can be a protracted process involving competitive
bidding.  In many cases, unsuccessful bidders may challenge contract
awards, which can lead to increased costs, delays, and possible loss of the
contract for the winning bidder.
 
 In
addition, major contracts are often awarded to teams of companies. Therefore,
our ability to win contracts may depend not only on our own merits, but also
those of our bid team members. Also, if we do not lead the bid team as the prime
contractor, we will have limited control over the contract bid and award
processes.
 
 Our
common stockholders will experience dilution if our preferred stock is converted
or our outstanding warrants and options are exercised.
 
 As of
September 30, 2008, we have outstanding non-stock option derivative securities
which could obligate us to issue 6,935,169 shares of our common stock, of which
1,690,888 underlie outstanding warrants and 5,244,281 are issuable upon
conversion of our outstanding Series C and Series D-1 preferred
stock.  In addition, as of September 30, 2008, we had outstanding
stock options to purchase an aggregate of 11,889,393 shares of our common stock,
of which 7,970,502 are currently vested.  The total number of shares
issuable upon the exercise or conversion of vested warrants, options and
preferred stock (14,905,671 shares as of September 30, 2008) represents
approximately 34% of our issued and outstanding shares of common stock as of
September 30, 2008.
 
 If
we remain independent, we face significant competition and many of our
competitors have greater resources and market status than we do.
 
 We face
significant competition for our government and commercial
contracts.  Many of our competitors have greater resources than we do
and may be able to devote greater resources than us to research and development,
marketing, and lobbying efforts.  Given the sophistication inherent in
any space company's operations, larger competitors may have a significant
advantage and may be able to more efficiently adapt and implement technological
advances. In addition, larger and financially stronger corporations have
advantages over us in obtaining space and defense contracts due to their
superior marketing (lobbying) resources and the perception that they may be a
better choice than smaller companies for mission-critical projects because of
the higher likelihood that they will be able to continue in business for the
necessary future period.
 
 34
 Furthermore,
it is possible that other domestic or foreign companies or governments, some
with greater experience in the space industry and many with greater financial
resources than we possess, could seek to develop mission solutions or produce
products or services that compete with us, including new mechanisms and
electromechanical subsystems using new technology which could render our mission
solutions and products less viable.  Some of our foreign competitors
currently benefit from, and others may benefit in the future from, subsidies
from or other protective measures implemented by their home
countries.
 
 Our
level of business may be difficult to predict.
 
 We hope
to sell an increasing percentage of our mission solutions, products and services
on a recurring basis, but most of our revenue is derived from government
contracts and government-related work, which may not be recurring or may be
terminated.  (See Risk Factor:  A substantial portion of our net
sales are generated from government contracts, which makes us susceptible to the
uncertainties inherent in the government budgeting process.  In addition,
many of our contracts can be terminated by our
customer.)  Government contracts can be defunded or terminated
by the Government for convenience. Also, some of our mission solutions, products
and services may not achieve market acceptance, and our future prospects may
therefore be difficult to evaluate.
 
 We
may not develop products successfully or in a timely manner.
 
 Many of
our mission solutions, products, services and technologies are currently in
various stages of development.  Further development and testing of our
products and technologies will be required to prove additional performance
capability beyond current levels and to confirm commercial
viability.  Additionally, the final cost of development cannot be
determined until development is complete.  Most of our development
work is in fact performed under contracts from our customers.  In the
past, we have contracted to execute development programs under fixed price
contracts.  Under these contracts, even if our costs begin to exceed
the amount to be paid by the customer under the contract, we are required to
complete the contract without receiving any additional payments from our
customer.  It is difficult to accurately predict the total cost of
executing these programs.  If the costs to complete these programs
significantly exceed the payments from our customers under the contracts, our
results of operations will be harmed. These contracts are inherently risky, and
in the past have had material adverse effects to us.  We intend to
significantly reduce our acceptance of this sort of contract. This may limit our
opportunity to develop products at a customer's expense.
 
 Our
mission solutions, products, services and technologies are, and will continue to
be, subject to significant technological change and innovation. Our success will
generally depend on our ability to continue to conceive, design, manufacture,
and market new products and services on a cost-effective and timely basis. We
anticipate that we will incur significant expenses in the design and initial
manufacture and marketing of new products and services.  Some of these
costs may be covered by our customers or partnership arrangements. However,
there can be no assurance that significant costs will not be incurred by
us.
  The
marketplace for our technology and products is uncertain.
 
 The
demand for all space-related goods and services in general, and for our mission
solutions, products, services and technologies in particular, is uncertain and
we may not obtain a sufficient market share to sustain our business or to
increase profitability. Our business plan assumes that near-term revenues will
be generated largely from government contracts for our mission solutions,
including, but not limited to, small satellites and electromechanical systems
for spacecraft.  A long-term commercial market may not develop for
private manned and unmanned space exploration.  Small satellites and
commercial space exploration are still relatively new concepts, and it is
difficult to accurately predict the ultimate size of the market. In addition, we
are working to develop new ways to enhance our mission solutions, such as large
deployable structures, solar array drives, slip rings, precision scanning
assemblies for spacecraft, and now services such as turnkey launch
solutions.  Many of our products and services are new and unproven,
and the true level of customer demand is uncertain. Lack of significant market
acceptance of our mission solutions, products, services and technologies, delays
in such acceptance, or failure of our markets to develop or grow could
negatively affect our business, financial condition, and results of
operations.
 
 35
 Our
operating results could fluctuate on a quarterly and annual basis, which could
cause our stock price to decline.
 
 Our
operating results may fluctuate from quarter-to-quarter and year-to-year for a
variety of reasons, many of which are beyond our control. Factors that could
affect our quarterly and annual operating results include those listed below as
well as others listed in this "Risk Factors" section:
 
 ·
              we
      may not be awarded all stages of existing or future
    contracts;
 ·
              significant
      contracts may be awarded to our competitors rather than to
    us;
 ·
              the
      timing of new technological advances and mission solution announcements or
      introductions by us and our
competitors;
 ·
              changes
      in the terms of our arrangements with customers or
    suppliers;
 ·
              reliance
      on a few customers for a significant portion of our
    revenue;
 ·
              the
      failure of our key suppliers to perform as
  expected;
 ·
              general
      or particular political conditions that could affect spending for the
      products that we offer;
 ·
              changes
      in perception of the safety of space
travel;
 ·
              cost
      overruns or other delays or failures to satisfy our obligations under our
      contracts on a timely basis;
 ·
              the
      failure of our mission solution to conduct a successful
      mission;
 ·
              the
      uncertain market for our mission solutions, products, services and
      technologies;
 ·
              the
      availability and cost of raw materials and components;
  and,
 ·
              the
      potential loss of or inability to hire key
  personnel.
 
 Our
operating results may fall below the expectations of public market analysts or
investors.  In this event, our stock price could decline
significantly.
 
 Our
products and services may not function well under certain
conditions.
 
 Most of
our mission solutions and related products are technologically advanced and
tested, but sometimes are not space qualified for performance under demanding
operating conditions. Many of our customers conduct extensive testing during the
extensive pre-launch period, while the hardware is on the
ground.  Depending on the contract terms, we could incur additional
costs related to rework.  Although we have never had a failure of our
mission solutions or products in space, it is possible that our mission solution
or products may not successfully launch or operate, or perform or operate as
intended in space. Like most organizations that have designed space missions or
launched space qualified hardware, we may experience some failures, cost
overruns, schedule delays, and other problems.
 
 36
 Launch
failures or delays, due to no fault of our own, could have serious adverse
effects on our business.
 
 Launch
failures or delays could have serious adverse effects on our
business.  Launches are subject to significant risks, the realization
of which can cause disabling damage to, or total loss of, our mission solution
and/or products, as well as damage to our reputation among actual and potential
customers. Delays in the launch could also adversely affect our revenues. Delays
could be caused by a number of factors related to the launch vehicle and outside
of our control.  Delays and the perception of potential delays could
negatively affect our marketing efforts and limit our ability to obtain new
contracts and projects.
 
 In
addition to many other risks involving our business, until we develop our own
launch vehicle, we may be dependent on the performance of third party companies
like United Launch Alliance (ULA), a large company, or Space Exploration
Technologies (SpaceX), a small company with limited operating history, which had
its first successful launch in 2008.
 
 Our
U.S. government contracts are subject to audits that could result in a material
adverse effect on our financial condition and results of operations if a
material adjustment is required.
 
 The
accuracy and appropriateness of our direct and indirect costs and expenses under
our contracts with the U.S. government are subject to extensive regulation and
audit by the Defense Contract Audit Agency, by other agencies of the U.S.
government, or by prime contractors.  These entities have the right to
audit our cost estimates and/or allowable cost allocations with respect to
certain contracts.  From time to time we may in the future be required
to make adjustments and reimbursements as a result of these
audits.  Responding to governmental audits, inquiries, or
investigations may involve significant expense and divert management
attention.  Also, an adverse finding in any such audit, inquiry, or
investigation could involve contract termination, suspension, fines, injunctions
or other sanctions.
 
 We
reduced the use of stock options, in part due to SFAS 123(R), which reduced the
effectiveness of stock options as a retention device.
 
 Historically,
we have used vesting stock options to enhance our ability to retain key
personnel.  Technology companies, in general, and our company in
particular, depends upon and uses broad based employee stock option programs to
hire, incentivize, and retain employees in a competitive marketplace. If the
employee leaves us before the vesting period has been completed, the employee
must forfeit any unvested portion of the stock options.  To the extent
vesting stock options were operating as a retention device, the reduced use of
vesting stock options, in part due to SFAS 123(R), and the elimination of the
vesting requirements on pre-2006 issued stock options, eliminated the retention
benefit.  An accounting standard setting body adopted SFAS 123(R), an
accounting standard that requires us to record equity-based compensation expense
for stock options and employee stock purchase plan rights granted to employees
based on the fair value of the equity instrument at the time of grant. We began
recording these expenses in 2006. The change in accounting rules lead to a
decrease in reported earnings, if we have earnings, or an increased loss, if we
do not have earnings. We continue to use vesting stock options as an incentive;
however, as a result of SFAS 123(R) and other issues, the number of options
being granted has been significantly reduced. By doing so, we may have lost the
advantage of a valuable incentive tool and could be placed at a competitive
disadvantage by other potential employers who were more willing to grant stock
options and incur the related expense.
 
 37
 We
may not successfully address the problems encountered in connection with
potential future acquisitions.
 
 We may
consider opportunities to acquire or make investments in other technologies, and
businesses that could enhance our capabilities, complement our current business,
or expand the breadth of our markets or customer base.  Acquisitions
may be necessary to enable us to quickly achieve the size needed for some
potential customers to seriously consider entrusting us with mission solutions,
mission-critical contracts or subcontracts. As a company, we have limited
experience in acquiring other businesses and technologies: the Starsys Research
Corporation acquisition was our first major acquisition.  Potential
and completed acquisitions and strategic investments involve numerous risks,
including:
 
 ·
              problems
      assimilating the purchased technologies, products, or business
      operations;
 ·
              problems
      maintaining uniform standards, procedures, controls, and
      policies;
 ·
              unanticipated
      costs associated with the
acquisition;
 ·
              diversion
      of management's attention from core
businesses;
 ·
              adverse
      effects on existing business relationships with suppliers and
      customers;
 ·
              incompatibility
      of business cultures;
 ·
              risks
      associated with entering new markets in which we have no or limited prior
      experience;
 ·
              dilution
      of common stock and shareholder value as well as adverse changes in stock
      price;
 ·
              potential
      loss of key employees of acquired businesses;
  and
 ·
              increased
      legal and accounting costs as a result of the rules and regulations
      related to the Sarbanes-Oxley Act of
2002.
 
 If
our key suppliers fail to perform as expected, our reputation may be
damaged.  We may experience delays, lose customers, and experience
declines in revenues, profitability, and cash flow.
 
 We
purchase a significant percentage of our product components and subassemblies
from third parties. If our subcontractors fail to perform as expected or
encounter financial difficulties, we may have difficulty replacing them or
identifying qualified replacements in a timely or cost effective
manner.  As a result, we may experience performance delays that could
result in additional program costs, contract termination for default, or damage
to our customer relationships which may cause our revenues, profitability, and
cash flow to decline.  In addition, negative publicity from any
failure of one of our missions, products or sub-systems as a result of a
supplier failure could damage our reputation and prevent us from winning new
contracts.
 
 Our
limited insurance may not cover all risks inherent in our
operations.
 
 We may
find it difficult to insure certain risks involved in our operations, including
our mission solutions and satellite operations, accidental damage to high value
customer hardware during the manufacturing process, and damages to customer
spacecraft caused by us not working to specification. Insurance market
conditions or factors outside of our control at the time insurance is purchased
could cause premiums to be significantly higher than current estimates.
Additionally, the U.S. Department of State has published regulations which could
significantly affect the ability of brokers and underwriters to insure certain
missions or launches. These factors could cause other terms to be significantly
less favorable than those currently available, may result in limits on amounts
of coverage that we can obtain, or may prevent us from obtaining insurance at
all. Furthermore, proceeds from insurance may not be sufficient to cover
losses.
 
 Our
competitive position may be seriously damaged if we cannot protect intellectual
property rights in our technology.
 
 Our
success, in part, depends on our ability to obtain and enforce intellectual
property protection for our technologies.  We rely on a combination of
patents, trade secrets and contracts to establish and protect our proprietary
rights in our technologies.  However, we may not be able to prevent
misappropriation of our intellectual property, and the agreements we enter into
may not be enforceable.  In addition, effective intellectual property
protection may be unavailable or limited in some foreign countries.
 
 38
 There is
no guarantee any patent will be issued on any patent application that we have
filed or may file.  Further, any patent that we may obtain will
expire, and it is possible that it may be challenged, invalidated, or
circumvented.  If we do not secure and maintain patent protection for
our technologies, our competitive position may be significantly harmed because
it may be much easier for competitors to copy our mission solutions or sell
products similar to ours.  Alternatively, a competitor may
independently develop or patent technologies designed around our patented
technologies.  In addition, it is possible that any patent that we may
obtain may not provide adequate protection and our competitive position could be
significantly harmed.
 
 As we
expand our mission solution offerings or develop new uses for our products,
these offerings or uses may be outside the scope of our current patent
applications, issued patents, and other intellectual property
rights.  In addition, if we develop new mission solutions or
enhancements to existing products, there is no guarantee that we will be able to
obtain patents to protect them.  Even if we do receive patents, these
patents may not provide meaningful protection.  In some countries
outside of the United States, effective patent protection is not
available.  Moreover, some countries that do allow registration of
patents do not provide meaningful redress for violations of
patents.  As a result, protecting intellectual property in these
countries is difficult and our competitors may successfully develop mission
solution offerings and sell products in those countries that have functions and
features that infringe on our intellectual property.
 
 We may
initiate claims or litigation against third parties in the future for
infringement of our proprietary rights or to determine the scope and validity of
our proprietary rights or the proprietary rights of
competitors.  These claims could result in costly litigation and
divert the efforts of our technical and management personnel.  As a
result, our operating results could suffer and our financial condition could be
harmed, regardless of the outcome of the case.
 
 Claims
by other companies that we infringe on their intellectual property or that
patents on which we rely are invalid could adversely affect our
business.
 
 From time
to time, companies may assert patent, copyright and other intellectual property
rights against our mission solutions, or products using our technologies, or
other technologies used in our industry.  These claims may result in
our involvement in litigation.  We may not prevail in such litigation
given the complex technical issues and inherent uncertainties in intellectual
property litigation, as well as the possible need to devote our finite resources
to priorities other than expensive litigation.  If any of our products
were found to infringe on another company's intellectual property rights, we
could be required to redesign our mission solution or product, or license such
rights and/or pay damages or other compensation to such other
company.  If we were unable to redesign our mission solution or
product, or license such intellectual property rights used in our products, we
could be prohibited from using such mission solution, or making and selling such
products.
 
 Other
companies or entities also may commence actions seeking to establish the
invalidity of our patents.  In the event that one or more of our
patents is challenged, a court may invalidate the patent or determine that the
patent is not enforceable, which could harm our competitive
position.  If any of our key patents are invalidated, or if the scope
of the claims in any of these patents is limited by court decision, we could be
prevented from licensing the invalidated or limited portion of such
patents.  Even if such a patent challenge is not successful, it could
be expensive and time consuming to address, divert management attention from our
business, and harm our reputation.
 
 39
 We
are subject to substantial regulations, some of which prohibit us from selling
internationally.  Any failure to comply with existing regulations, or
increased levels of regulation, could have a material adverse effect on
us.
 
 Our
business activities are subject to substantial regulations by various agencies
and departments of the United States government and, in certain circumstances,
the governments of other countries.  Several government agencies,
including NASA and the U.S. Air Force, maintain Export Control Offices to ensure
that any disclosure of scientific and technical information complies with the
Export Administration Regulations and the International Traffic in Arms
Regulations (ITAR).  Exports of our mission solutions, products,
services, and technical information require Technical Assistance Agreements,
manufacturing license agreements, or licenses from the U.S. Department of State
depending on the level of technology being transferred.  This includes
recently published regulations restricting the ability of U.S.-based companies
to complete offshore launches, or to export certain satellite components and
technical data to any country outside the United States.  The export
of information with respect to ground-based sensors, detectors, high-speed
computers, and national security and missile technology items are controlled by
the Department of Commerce. Failure to comply with the ITAR and/or the Commerce
Department regulations may subject guilty parties to fines of up to $1 million
and/or up to 10 years imprisonment per violation.  The practical
effect of ITAR is to limit our opportunities or increase the costs of our
proposals in the international marketplace.
 
 In
September 2007, we sold to OHB Technology AG, a leading German space technology
company, and MT Aerospace AG, a subsidiary of OHB Technology AG and an
established supplier in the aeronautic, aerospace and defense sectors, common
stock amounting to 19% of our then total outstanding shares.  In
December 2007, after an additional investment by Loeb Partners, a New York based
investment firm, we sold additional shares of our common stock to OHB Technology
AG and MT Aerospace AG, when they exercised their pre-emptive rights to maintain
19% ownership of our total outstanding shares.  Because they are
foreign companies, we could possibly be at risk of losing new and ongoing
business if we do not have the proper procedures in place to delineate and
inform employees and visitors, and also stockholders like OHB, regarding our
controls necessary to ensure that no transfer of classified defense information
or controlled unclassified information occurs unless authorized.
 
 In
addition, the space industry has specific regulations with which we must
comply.  Command and telemetry frequency assignments for space
missions are regulated internationally by the International Telecommunications
Union (ITU). In the United States, the Federal Communications Commission (FCC)
and the National Telecommunications Information Agency (NTIA), regulate command
and telemetry frequency assignments.  All launch vehicles that are
launched from a launch site in the United States must pass certain launch range
safety regulations that are administered by the U.S. Air Force. In addition, all
commercial space launches that we would perform require a license from the
Department of Transportation. Satellites that are launched must obtain approvals
for command and frequency assignments.  For international approvals,
the FCC and NTIA obtain these approvals from the ITU.  These
regulations have been in place for a number of years to cover the large number
of non-government commercial space missions that have been launched and put into
orbit in the last 15 to 20 years. Any commercial deep space mission that we
would perform would be subject to these regulations.
 
 We are
also subject to laws and regulations placed on the formation, administration and
performance of, and accounting for, U.S. government contracts.  With
respect to such contracts, any failure to comply with applicable laws could
result in contract termination, price or fee reductions, penalties, suspension,
or debarment from contracting with the U.S. government.
 
 We are
also required to obtain permits, licenses, and other authorizations under
federal, state, local, and foreign laws and regulations relating to the
environment.  Our failure to comply with applicable law or government
regulations, including any of the above-mentioned regulations, could have
serious adverse effects on our business.
 
 40
 Our
stock price has been and may continue to be volatile, which could result in
substantial losses for investors purchasing shares of our common
stock.
 
 The
market prices of securities of technology-based companies like ours,
particularly in industries (also like ours) where substantial value is ascribed
to a hope for future increase in the size of the total market, are often highly
volatile. The market price of our common stock has fluctuated significantly in
the past. Our market price may continue to exhibit significant fluctuations in
response to a variety of factors, many of which are beyond our control,
including:
 
 ·
              deviations
      in our results of operations;
 ·
              changes
      in our financial performance or in analyst coverage
    decisions;
 ·
              changes
      in our markets, including decreased government spending or the entry of
      new competitors;
 ·
              awards
      of significant contracts to competitors rather than to
  us;
 ·
              our
      inability to obtain financing necessary to operate our
      business;
 ·
              changes
      in technology;
 ·
              potential
      loss of key personnel;
 ·
              short
      selling;
 ·
              perceptions
      about the effect of possible dilution arising from the issuance of large
      numbers of shares of common stock underlying outstanding stock options,
      warrants, and preferred stock:
 ·
              changes
      in market valuations of similar companies and of stocks
      generally;
 ·
              volume
      fluctuations generally; and,
 ·
              other
      factors listed above in our Risk Factor: "Our operating results could
      fluctuate on a quarterly and annual basis, which could cause our stock
      price to fluctuate or
decline."
 
 The
concentration of ownership of our common stock gives a few individuals
significant control over important policy decisions and could delay or prevent
changes in control.
 
 As of
October 20, 2008, our Directors together beneficially owned approximately 25.7%
of our common stock.  (Note: The beneficial ownership calculations are
different from a straight percentage of outstanding ownership
calculation.  The beneficial ownership calculation takes into
consideration derivative securities, such as stock options and warrants, which
are vested or will vest within 60 days from October 20, 2008.  OHB
Technology AG and MT Aerospace AG collectively beneficially own approximately
18.3% of our common stock. Susan C. Benson beneficially owns approximately 16.5%
of our common stock.  Loeb Partners Corporation owns approximately
11.0% of our common stock.  Together, all these persons and
individuals beneficially owned 62.8% of our common stock.  As a
result, Directors and/or significant stockholders (i.e., OHB Technology AG, MT
Aerospace AG, Loeb Partners and Ms. Benson) could have the ability to exert
significant influence over matters concerning us, including the election of
directors, changes in the size and composition of the Board of Directors, and
mergers and other business combinations involving us.  Our foreign
stockholders are contractually limited for a period of two years from their
stock purchase date and Loeb Partners is contractually limited for a period of
one year from their stock purchase date in their ability to exert significant
influence over us by voting of shares.  In addition, the concentration
of voting power in the hands of those individuals and entities could have the
effect of delaying or preventing a change in control of our company, even if the
change in control would benefit our stockholders.  A perception in the
investment community of an anti-takeover environment at our company could cause
investors to value our stock lower than in the absence of such a
perception.
 
 41
 We
have not paid dividends on our common stock in the past and do not anticipate
paying dividends on our common stock in the foreseeable future. In addition,
other securities may restrict payment of common stock dividends.
 
 We have
not paid common stock dividends since our inception and do not anticipate paying
dividends in the foreseeable future. Our current business plan provides for the
reinvestment of any earnings in an effort to complete development of our
technologies and products, with the goal of increasing sales and long-term
profitability and value.  In addition, the terms of our preferred
stock currently restrict, and any other credit or borrowing arrangements that we
may enter into may in the future restrict or limit, our ability to pay common
stock dividends to our shareholders.
 
 We
are subject to new corporate governance and internal control reporting
requirements, and our costs related to compliance with, or our failure to comply
with existing and future requirements, could adversely affect our
business.
 
 We face
new corporate governance requirements under the Sarbanes-Oxley Act of 2002, as
well as new rules and regulations subsequently adopted by the SEC, the Public
Company Accounting Oversight Board and any stock exchange on which our stock may
be listed in the future. These laws, rules and regulations, which are already
known to be burdensome and costly, continue to evolve and may become
increasingly stringent in the future. In particular, we are required to include
a management report on internal control over financial reporting as part of our
Form 10-K and 10-Q annual and quarterly reports pursuant to Section 404 of the
Sarbanes-Oxley Act.  We are continually evaluating our internal
controls and processes to help ensure that we will be able to comply with
Section 404 of the Sarbanes-Oxley Act.  We cannot assure you that we
will be able to fully maintain compliance with these laws, rules and regulations
that address corporate governance, internal control reporting, and similar
matters.  Failure to comply with these laws, rules, and regulations,
may be viewed negatively by investors and could materially adversely affect our
reputation, financial condition, and the value of our securities.
 
 The
terms of our outstanding shares of preferred stock, and any shares of preferred
stock issued in the future, may reduce the value of our common
stock.
 
 We have
up to 10,000,000 shares of authorized preferred stock in one or more series. We
currently have outstanding 248,460 shares of our Series C Preferred Stock and
approximately 1,649 shares of our Series D-1 Preferred Stock, as of October 20,
2008.  Our Board of Directors may determine the terms of future
preferred stock offerings without further action by our
stockholders.  If we issue additional preferred stock, it could affect
the rights of stockholders or reduce the value of common stock.  In
particular, specific rights granted to future holders of preferred stock could
be used to restrict our ability to merge with or sell our assets to a third
party.  These terms may include voting rights, preferences as to
dividends and liquidation, conversion and redemption rights, and sinking fund
provisions.  Our Series C Preferred Stock and Series D-1 Preferred
Stock rank senior to the common stock with respect to dividends and liquidation
and have other important preferred rights.
 
 Our
available secured debt financing is expensive and carries restrictive
conditions.
 
 On
September 29, 2006, we entered into a secured revolving credit facility with
Laurus Master Fund.  Although the maximum size of the facility is $5.0
million, actual borrowings are limited by a formula based on our eligible
accounts receivable and eligible inventory.  We currently have nothing
drawn on the revolving credit facility.  We paid a loan fee at
inception in the form of 310,009 shares of common stock valued at $0.35 million,
plus a cash loan fee.  On September 30, 2007, we issued an additional
283,286 restricted shares to Laurus, equivalent to a $0.2 million fee upon the
first anniversary of the facility.  In addition, we will be required
to pay Laurus an additional loan fee in the form of common stock valued at $0.2
million in January 2009, if the facility remains in place.  Any
outstanding balance on the facility bears interest at a floating rate of prime
plus 2%, and the maximum life of the facility is three years.  The
facility is collateralized by substantially all of our assets.  The
facility contains certain default provisions.  In the event of a
default by us, we will be required to pay an additional fee per month until the
default is cured.  Laurus has the option of accelerating the entire
principal balance and requiring us to pay a premium in the event of an uncured
default.
 
 42
 Any
further debt financing, if available at all when needed, might require further
expensive and onerous financial terms, security provisions and restrictive
covenants.  If we cannot repay or refinance our debt when it comes
due, we would be materially adversely affected.
 
 Because
our common stock is not listed on a national stock exchange and is subject to
the SEC's penny stock rules, broker-dealers may experience difficulty in
completing customer transactions and trading activity in our securities may be
adversely affected.
 
 Transactions
in our common stock are currently subject to the "penny stock" rules promulgated
under the Securities Exchange Act of 1934. Under these rules, broker-dealers who
recommend our securities to persons other than institutional accredited
investors must:
 
 ·
              make
      a special written suitability determination for the
    purchaser;
 ·
              receive
      the purchaser's written agreement to a transaction prior to
      sale;
 ·
              provide
      the purchaser with risk disclosure documents which identify certain risks
      associated with investing in "penny stocks" and which describe the market
      for these "penny stocks" as well as a purchaser's legal remedies;
      and,
 ·
              obtain
      a signed and dated acknowledgment from the purchaser demonstrating that
      the purchaser has actually received the required risk disclosure document
      before a transaction in a "penny stock" can be
  completed.
 
 As a
result of these rules, broker-dealers may find it difficult to effectuate
customer transactions and trading activity in our securities may be adversely
affected.  As a result, the market price of our securities may be
depressed, and it may be more difficult to sell our securities. In addition,
having a common stock traded on the OTC Bulletin Board with a low trading price
may result in a negative image which hinders our commercial initiatives and our
future capital-raising activities.
 
 43
 ITEM
4.  CONTROLS AND PROCEDURES
  Evaluation
of Disclosure Controls and Procedures
  We
maintain a set of disclosure controls and procedures designed to reasonably
ensure that information we are required to disclose in reports filed under the
Securities Exchange Act is recorded, processed, summarized and reported within
the time periods specified by the Securities and Exchange Commission’s rules and
forms and that such information is accumulated and communicated to our
management, including Mark N. Sirangelo, our Chief Executive Officer, and
Richard B. Slansky, our Chief Financial Officer, as appropriate, to allow for
timely decisions regarding required disclosure.  In designing and
evaluating the disclosure controls and procedures, management recognizes that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management is required to apply its reasonable judgment in evaluating the
cost-benefit relationship of possible controls and procedures, in light of the
limited resources which it has at its disposal at the time.
  As
required by SEC Rule 13a-15(b), and as defined in Rule 13a-15(e) under the
Securities Exchange Act, we carried out an evaluation, under the supervision and
with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this Report.  Based
on the foregoing, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective for a
company of our size, maturity and financial level.
  Changes
in Internal Control over Financial Reporting
  During
the most recent fiscal quarter, no change in our internal control over financial
reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act)
was identified that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
  44
 PART
II -- OTHER INFORMATION
 
 ITEM
1.  LEGAL PROCEEDINGS
  None.
 
 ITEM
2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
 
 None.
 
 ITEM
3.  DEFAULTS UPON SENIOR SECURITIES
  None.
 
 ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  None.
 
 ITEM
5.  OTHER INFORMATION
  On July
15, 2008, we entered into a Release Agreement with the Shareholder Agent for the
former shareholders of Starsys Research Corporation.  We agreed to pay
the former shareholders $116,667 in cash and 833,333 shares of Company common
stock in exchange for a release of claims, including claims related to their
alleged entitlement to earnout merger consideration in connection with our 2006
acquisition of Starsys.
 
 On
October 20, 2008, we signed an Agreement and Plan of Merger with Sierra Nevada
Corporation and its subsidiary.  Under this agreement, we would be
acquired for cash.
  Peterson v. Sirangelo et al.
- San Diego Super. Ct. Case No. 37-2008-00060178-CU-MC-NC
 On
October 30, 2008, John Peterson, a SpaceDev stockholder, filed a complaint
against us, our ten directors individually, Sierra Nevada Corporation and Merger
Sub in the San Diego (California) County Superior Court.  The complaint,
which purports to be a class action, alleges that our directors breached their
fiduciary duties by approving the merger agreement and that each of the
defendants conspired and aided and abetted in the breaches of fiduciary
duties.  The theory of the complaint appears to be that the merger
agreement does not maximize our value.  The complaint’s requested relief
includes damages in an unspecified amount, a preliminary and permanent
injunction against the merger, and (if the merger is consummated)
rescission.
 
 Becker v. SpaceDev et al. -
Delaware Chancery Ct. Case No. 4145
 
 
 45
 ITEM
6.  EXHIBITS
  Exhibit
      No.
              Description10.1
              Release
      entered into as of July 15, 2008 by and between SpaceDev, Inc. and the
      Shareholder Agent of Starsys Research Corporation31.1
              Rule
      13a-14(a) certification of Principal Executive Officer31.2
              Rule
      13a-14(a) certification of Principal Financial Officer32.1
              Rule
      13a-14(b) certification of Chief Executive Officer32.2
              Rule
      13a-14(b) certification of Chief Financial
  Officer
 
 
 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
 
 SpaceDev,
Inc.
 Registrant
 
 
 
 Dated:  November
13,
2008                                                          By:  /s/ Mark N.
Sirangelo
 Mark N.
Sirangelo
 Chief
Executive Officer
 
 
 
 Dated:  November
13,
2008                                                          By:  /s/ Richard
B. Slansky
 Richard
B. Slansky
 President
& Chief Financial Officer
 
 46