**U.S.
        SECURITIES AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20429**
 
 **FORM
          10-QSB**
 (Mark
        One)
  x
              QUARTERLY
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                  EXCHANGE ACT OF 1934
  For
        the quarterly
        period ended June 30, 2006
  OR
  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 small business issuer as specified in its charter)
 
 **Colorado**
              **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)**(858)
                  375-2030**(Issuer's telephone
                  number)
 
 (Former
        name, former address and former fiscal year, if changed since last
        report)
 
 Check
        whether the issuer (1) has filed all reports required to be filed by Sections
        13
        or 15(d) of the Exchange Act during the past 12 months (or for such shorter
        period that the registrant was required to file such reports), and (2) has
        been
        subject to such filing requirements for the past 90 days. Yes x No o
 
 Indicate
        by checkmark whether the registrant is a shell company (as defined in Rule
        12b-2
        of the Exchange Act. Yes o No x
 
 State
        the
        number of shares outstanding of each of the issuer's classes of common equity,
        as of the latest practicable date: **28,890,070** shares
        of
        Issuer's voting common stock were outstanding on July 20, 2006.
 
 Transitional
        Small Business Disclosure Format (check one): Yes o No x












**Form
      10 QSB**




Table of
      Contents




PART
                    I -- FINANCIAL INFORMATIONITEM
                    1. FINANCIAL STATEMENTS
                1Consolidated
                    Balance Sheets
                1Consolidated
                    Balance Sheets
                2Consolidated
                    Statements of
                    Operations
                3Consolidated
                    Statements of Cash
                    Flows
                4NOTES
                    TO CONSOLIDATED FINANCIAL
                    STATEMENTS
                6ITEM
                    2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
                    OPERATION
                15Overview
                15Selection
                    of Significant
                    Contracts
                17Results
                    of Operations
                18Liquidity
                    and Capital Resources
                24Critical
                    Accounting
                    Standards
                24Recent
                    Accounting Pronouncements
                25Risk
                    Factors
                25ITEM
                    3. CONTROLS AND PROCEDURES
                36PART
                    II -- OTHER INFORMATIONITEM
                    1. LEGAL PROCEEDINGS
                37ITEM
                    2. UNREGISTERED SALES OF EQUTIY SECURITIES AND USE OF
                    PROCEEDS
                37ITEM
                    3. DEFAULTS UPON SENIOR SECURITIES
                37ITEM
                    4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
                37ITEM
                    5. OTHER INFORMATION
                37ITEM
                    6. EXHIBITS
                38SIGNATURES
                38


**PART
        I --FINANCIAL INFORMATION**
 **ITEM
          1.**  **FINANCIAL
          STATEMENTS**
 **SpaceDev,
            Inc. and Subsidiaries**
 **Consolidated
            Balance Sheets**
 **(Unaudited)**
 *At
                      June 30,*
                  
                  
                  **2006**
                  
                  
                  2005**Assets****Current
                      Assets**Cash
                  
                  **$**
                  **1,253,371**
                  
                  $
                  5,443,052Accounts
                      receivable
                  
                  
                  **6,244,819**
                  
                  
                  845,181Inventory
                      (Note 2(b))
                  
                  
                  **2,762,675**
                  
                  
                  54,729Other
                      current assets
                  
                  
                  **414,189**
                  
                  
                  -**Total
                      Current Assets**
                  
                  
                  **10,675,054**
                  
                  
                  6,342,962**Fixed
                      Assets - Net**
                  
                  
                  **3,864,761**
                  
                  
                  586,562**Goodwill
                      (Note 5)**
                  
                  
                  **12,246,362**
                  
                  
                  -**Other
                      Assets**
                  
                  
                  **783,018**
                  
                  
                  170,249**$**
                  **27,569,195**
                  
                  $
                  7,099,773
 *The
            accompanying notes are an integral part of these consolidated financial
            statements.*
 Table
                of Contents
 1
 **SpaceDev,
                  Inc. and
                  Subsidiaries**
 Consolidated
                Balance Sheets
 **(Unaudited)**
 *At
                          June 30,*
                      
                      
                      **2006**
                      
                      
                      2005**Liabilities
                          and Stockholders’ Equity****Current
                          Liabilities**Accounts
                          payable and accrued expenses
                      
                      **$**
                      **3,091,509**
                      
                      $
                      494,989Accrued
                          payroll, vacation and related taxes
                      
                      
                      **1,665,794**
                      
                      
                      224,281Billings
                          in excess of costs incurred and estimated earnings (Note
                          2(a))
                      
                      
                      **1,581,574**
                      
                      
                      -Other
                          accrued liabilities (Note 2(a))
                      
                      
                      **2,098,094**
                      
                      
                      300,998**Total
                          Current Liabilities**
                      
                      
                      **8,436,971**
                      
                      
                      1,020,268**Capitalized
                          Lease Obligations, Less Current Maturities**
                      
                      
                      **171,570**
                      
                      
                      -**Deferred
                          Gain - Assets Held For Sale (Note 3(a))**
                      
                      
                      **772,041**
                      
                      
                      889,313**Other
                          Long Term Liabilities**
                      
                      
                      **15,266**
                      
                      
                      -**Total
                          Liabilities**
                      
                      
                      **9,395,848**
                      
                      
                      1,909,581**Commitments
                          and Contingencies****Stockholders’
                          Equity**Convertible
                          preferred stock, $.001 par value, 10,000,000shares
                          authorized, and 253,535 and 250,000 sharesissued
                          or outstanding, respectivelySeries
                          C Convertible preferred stock (Note 4(a))
                      
                      
                      **249**
                      
                      
                      250Series
                          D-1 Convertible preferred stock (Note 4 (b))
                      
                      
                      **5**
                      
                      
                      -Common
                          stock, $.0001 par value; 100,000,000 and 50,000,000 sharesauthorized,
                          and 28,877,702 and 22,186,446 shares issuedand
                          outstanding, respectively (Note 4)
                      
                      
                      **2,887**
                      
                      
                      2,218Additional
                          paid-in capital
                      
                      
                      **32,998,424**
                      
                      
                      19,466,281Additional
                          paid-in capital - stock options
                      
                      
                      **-**
                      
                      
                      750,000Deferred
                          compensation
                      
                      
                      **-**
                      
                      
                      (250,000
                      )Accumulated
                          deficit
                      
                      
                      **(14,828,218**
                      **)**
                      
                      (14,778,557
                      )**Total
                          Stockholders’ Equity**
                      
                      
                      **18,173,347**
                      
                      
                      5,190,192**Total
                          Liabilities and Stockholders’ Equity**
                      
                      **$**
                      **27,569,195**
                      
                      $
                      7,099,773
 *The
          accompanying notes are an integral part of these consolidated financial
          statements.*
  Table
              of Contents
 2
  **SpaceDev,
          Inc. and Subsidiaries**
 **Consolidated
          Statements of Operations**
 **(Unaudited)**
 *Three
                              Months Ending*******
                          **
                          ***Six Months
                              Ending****At
                              June 30,*
                          
                          
                          2006
                          
                          
                          2005
                          
                          
                          2006
                          
                          
                          2005**Net
                              Sales**
                          
                          **$**
                          **8,631,165**
                          
                          $
                          1,901,659
                          
                          **$**
                          **15,805,943**
                          
                          $
                          3,708,548**Total
                              Cost of Sales***
                          
                          
                          **6,329,932**
                          
                          
                          1,465,593
                          
                          
                          **11,595,039**
                          
                          
                          2,862,428**Gross
                              Margin**
                          
                          
                          **2,301,233**
                          
                          
                          436,066
                          
                          
                          **4,210,904**
                          
                          
                          846,120**Operating
                              Expenses**Marketing
                              and sales
                          
                          
                          **691,136**
                          
                          
                          159,673
                          
                          
                          **1,334,695**
                          
                          
                          304,689Research
                              and development
                          
                          
                          **123,062**
                          
                          
                          639
                          
                          
                          **204,839**
                          
                          
                          9,112General
                              and administrative
                          
                          
                          **1,476,941**
                          
                          
                          201,073
                          
                          
                          **2,707,674**
                          
                          
                          392,071**Total
                              Operating Expenses***
                          
                          
                          **2,291,139**
                          
                          
                          361,385
                          
                          
                          **4,247,208**
                          
                          
                          705,872**Income/(Loss)
                              from Operations**
                          
                          
                          **10,094**
                          
                          
                          74,681
                          
                          
                          **(36,304**
                          **)**
                          
                          140,248**Non-Operating
                              Income/(Expense)**Interest
                              income
                          
                          
                          **7,137**
                          
                          
                          36,823
                          
                          
                          **40,752**
                          
                          
                          44,783Interest
                              expense
                          
                          
                          **(5,346**
                          **)**
                          
                          (609
                          )
                          
                          **(10,629**
                          **)**
                          
                          (1,830Gain
                              on building sale (Note 3(a))
                          
                          
                          **29,319**
                          
                          
                          29,318
                          
                          
                          **58,637**
                          
                          
                          58,636Non-Cash
                              loan fee - equity conversions (Note 3(c))
                          
                          
                          **-**
                          
                          
                          (28,875
                          )
                          
                          **-**
                          
                          
                          (28,875**Total
                              Non-Operating Income**
                          
                          
                          **31,110**
                          
                          
                          36,657
                          
                          
                          **88,760**
                          
                          
                          72,714**Income
                              Before Taxes**
                          
                          
                          **41,204**
                          
                          
                          111,338
                          
                          
                          **52,456**
                          
                          
                          212,962**Income
                              tax provision**
                          
                          
                          **5,000**
                          
                          
                          400
                          
                          
                          **9,235**
                          
                          
                          800**Net
                              Income**
                          
                          **$**
                          **36,204**
                          
                          $
                          110,938
                          
                          **$**
                          **43,221**
                          
                          $
                          212,162**Net
                              Income Per Share:**Net
                              income
                          
                          **$**
                          **0.00**
                          
                          $
                          0.01
                          
                          **$**
                          **0.00**
                          
                          $
                          0.01Weighted-Average
                              Shares Outstanding
                          
                          
                          **28,818,403**
                          
                          
                          21,792,987
                          
                          
                          **28,047,709**
                          
                          
                          21,541,549**Fully
                              Diluted Net Income Per Share:**Net
                              income
                          
                          **$**
                          **0.00**
                          
                          $
                          0.00
                          
                          **$**
                          **0.00**
                          
                          $
                          0.01Fully
                              Diluted Weighted-Average Shares Outstanding
                          
                          
                          **49,604,151**
                          
                          
                          30,593,912
                          
                          
                          **47,598,736**
                          
                          
                          30,515,291*
                            The following table shows how the Company's stock option
                            expense would be
                            allocated to all expenses.Cost
                              of Sales
                          
                          $
                          -
                          
                          $
                          -
                          
                          $
                          -
                          
                          $
                          -Marketing
                              and sales
                          
                          
                          -
                          
                          
                          -
                          
                          
                          -
                          
                          
                          -Research
                              and development
                          
                          
                          -
                          
                          
                          -
                          
                          
                          -
                          
                          
                          -General
                              and administrative
                          
                          
                          24,992
                          
                          
                          -
                          
                          
                          115,693
                          
                          
                          -$
                          24,992
                          
                          $
                          -
                          
                          $
                          115,693
                          
                          $
                          -
 The
          accompanying notes are an integral part of
          these consolidated financial statements.
  Table
              of Contents
 3
  **SpaceDev,
            Inc. and Subsidiaries**
 **Consolidated
            Statements of Cash Flows**
 **(Unaudited)**
 *Six-Months
                      Ending June 30,*
                  
                  
                  **2006**
                  
                  
                  2005**Cash
                      Flows From Operating Activities**Net
                      income
                  
                  **$**
                  **43,221**
                  
                  $
                  212,162Adjustments
                      to reconcile net income to net cashused
                      in operating activities:Depreciation
                      and amortization
                  
                  
                  **372,500**
                  
                  
                  64,137Gain
                      on disposal of building sale
                  
                  
                  **(58,637**
                  **)**
                  
                  (58,636
                  )Stock
                      Option Expense
                  
                  
                  **117,868**
                  
                  
                  -Non-cash
                      interest expense - Warrants
                  
                  
                  **-**
                  
                  
                  28,875Change
                      in operating assets and liabilities
                  
                  
                  **(2,770,637**
                  **)**
                  
                  (75,437
                  )**Net
                      Cash (Used In)/Provided By Operating Activities**
                  
                  
                  **(2,295,685**
                  **)**
                  
                  171,101**Cash
                      Flows From Investing Activities**Other
                      assets, capitalized acquisition costs
                  
                  
                  **(1,066,564**
                  **)**
                  
                  -Purchases
                      of fixed assets
                  
                  
                  **(1,075,688**
                  **)**
                  
                  (371,318
                  )**Net
                      Cash Used in Investing Activities**
                  
                  
                  **(2,142,252**
                  **)**
                  
                  (371,318
                  )**Cash
                      Flows From Financing Activities**Principal
                      payments on notes payable
                  
                  
                  **(4,675,832**
                  **)**
                  
                  (18,106
                  )Principal
                      payments on capitalized lease obligations
                  
                  
                  **(10,537**
                  **)**
                  
                  (1,808
                  )Dividend
                      payments on Series C and Series D-1 Preferred
                  
                  
                  **(197,684**
                  **)**
                  
                  -Employee
                      stock purchase plan
                  
                  
                  **89,510**
                  
                  
                  24,734Proceeds
                      from issuance of preferred stock
                  
                  
                  **4,602,956**
                  
                  
                  -Proceeds
                      from issuance of common stock
                  
                  
                  **132,857**
                  
                  
                  569,848**Net
                      Cash (Used In)/Provided by Financing Activities**
                  
                  
                  **(58,730**
                  **)**
                  
                  574,668**Net
                      (Decrease)/Increase in Cash**
                  
                  
                  **(4,496,667**
                  **)**
                  
                  374,451**Cash
                      at Beginning of Period**
                  
                  
                  **5,750,038**
                  
                  
                  5,068,601**Cash
                      at End of Period**
                  
                  **$**
                  **1,253,371**
                  
                  $
                  5,443,052
 The
          accompanying notes are an integral part of
          these consolidated financial statements.
  Table
              of Contents
 4
 **SpaceDev,
            Inc. and Subsidiaries**
 **Consolidated
            Statements of Cash Flows, Cont'd.**
 **(Unaudited)**
 *Six-Months
                        Ending June 30,*
                    
                    
                    **2006**
                    
                    
                    2005**Supplemental
                        Disclosures of Cash Flow Information:**Cash
                        paid during the period for:Interest
                    
                    **$**
                    **10,629**
                    
                    $
                    1,830Taxes
                    
                    
                    **21,000**
                    
                    
                    1,600
 **Noncash
                            Investing and Financing Activities:**During
                            the six-months ending June 30, 2006 the Company entered
                            into capital
                            leases in the amount of approximately
                            $184,000.During
                            the six-months ending June 30, 2006 and 2005 the Company
                            converted $34,516
                            and $11,303 of
                            employee stock purchase plan contributions into 24,885
                            and 7,915 shares of
                            common stock, respectively.During
                            the six-months ending June 30, 2006 and 2005 the Company
                            declared
                            dividends payable of
                            $84,398 and $84,922, repectively to the holders of its
                            Series C preferred
                            stock.During
                            the six-months ending June 30, 2005 the Company paid
                            dividends valued at
                            $117,268
                            in the form of 76,148 shares of common stock to the holders
                            of its Series
                            C preferred stock.During
                            the six-months ending June 30, 2006 the Company declared
                            dividends payable
                            of
                            $211,551 to the holders of its Series D-1 preferred stock
                            and paid $98,774
                            of these dividends.
 *The
                    accompanying notes are an integral part of these consolidated
                    financial
                    statements.*
  Table
                        of Contents
 5
 **NOTESTO
                        CONSOLIDATED FINANCIAL
                        STATEMENTS**


**1.
          Basis of Presentation**
 
 The
          accompanying consolidated financial statements of SpaceDev, Inc., a Colorado
          corporation ("the Company") include the accounts of the Company and its
          subsidiary, Starsys, Inc., a Colorado corporation, and its inactive subsidiary
          SpaceDev Oklahoma, an Oklahoma corporation. In the opinion of management,
          the
          consolidated financial statements reflect all normal and recurring adjustments,
          which are necessary for a fair presentation of the Company's financial
          position,
          results of operations and cash flows as of the dates and for the periods
          presented. The consolidated financial statements have been prepared in
          accordance with generally accepted accounting principles for interim financial
          information. Consequently, these statements do not include all disclosures
          normally required by generally accepted accounting principles of the United
          States of America for annual financial statements nor those normally made
          in an
          Annual Report on Form 10-KSB. Accordingly, reference should be made to
          the
          Company's Form 10-KSB filed on March 28, 2006 and other reports the Company
          filed with the U.S. Securities and Exchange Commission for additional
          disclosures, including a summary of the Company's accounting policies,
          which
          have been modified, as a result of the Company's acquisition of Starsys
          Research
          Corporation, to include a "percentage-of-completion" method of revenue
          recognition and inventory policies. The consolidated results of operations
          for
          the six-months ended June 30, 2006 are not necessarily indicative of results
          that may be expected for the fiscal year ended December 31, 2006 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 revenues for the six months
          ended June 30, 2006 were derived from United States government cost plus
          fixed
          fee (CPFF) contracts, fixed price contracts and some commercial sales of
          component and subsystem products that the Company acquired in its acquisition
          of
          Starsys, which is compared to primarily CPFF contracts for the same six
          month
          period in 2005. Revenues from the CPFF contracts during the first six months
          ended June 30, 2006 and 2005 were recognized as expenses were incurred.
          Estimated contract profits are taken into earnings in proportion to revenues
          recorded. Time and material revenues are recognized as services are performed
          and costs incurred. Certain fixed price contracts were prepared according
          to the
          "percentage-of-completion" method of accounting for long-term contracts.
          The
          amount of revenues recognized is that portion of the total contract amount
          that
          the actual cost expended bears to the anticipated final total cost based
          on
          current estimates of cost to complete the project (cost-to-cost method).
          Recognition of profit commences on an individual project only when cost
          to
          complete the project can reasonably be estimated and after there has been
          some
          meaningful performance achieved on the project. Recognition of losses on
          projects are taken as soon as the loss is reasonably determinable and accrued
          on
          the balance sheet in other accrued liabilities. The current accrual for
          potential losses on existing projects represents approximately $1.0 million.
          As
          projects are completed, the accrual is adjusted as projects move toward
          completion and more accurate estimates are established. Changes in job
          performance, job conditions, and estimated profitability, including those
          arising from contract penalty provisions (when applicable), and final contract
          settlements may result in revisions to costs and income and are recognized
          in
          the period in which the revisions are determined. Contract costs include
          all
          direct material, direct labor and 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.
   Table
              of Contents
 6
 *(b)
            Inventory*
 
 Inventory
            is valued based on the lower-of-cost-or-market method and is disbursed
            on a FIFO
            (First-In, First-Out) basis, unless required by customer contract to
            be
            distributed by specific identification for lot control purposes. Inventory
            includes raw material inventory, finished goods inventory and work-in-process
            inventory (which includes "costs and estimated earnings in excess of
            billings on
            uncompleted contracts" and represents revenues recognized in excess of
            amounts
            billed, which represents approximately $2.3 million at June 31, 2006).
            Actual
            results of contracts may differ from management's estimates and such
            differences
            could be material to the consolidated financial statements. Professional
            fees
            are billed to customers on a time and materials basis. Time and material
            revenues are recognized as services are performed and costs
            incurred.
 
 **3.
            Long Term Liabilities**
 
 *a)
            Building and Deferred Gain.*
 
 In
            December 2002, the Company entered an agreement to sell its interest
            in its
            Poway, California headquarters facility. The transaction closed in January
            2003.
            The transaction included the sale of the land and building. Net fixed
            assets
            were reduced by approximately $1.9 million and notes payable were reduced
            by
            approximately $2.4 million while a deferred gain was recorded. In conjunction
            with the sale, the Company entered into a lease agreement with the buyer
            to
            leaseback its facilities. The Company's then Chief Executive Officer
            provided a
            guarantee for the leaseback. The gain on the sale of the facility was
            deferred
            and amortized in proportion to the gross rental charged to expense over
            the
            lease term. Deferred gain of $1,172,720 is being amortized at the rate
            of
            $117,272 per year for ten (10) years ending in January 2013. As of June
            30,
            2006, the deferred gain was $772,041. This amortization is included in
            the
            Company's non-operating expenses/(income) and totaled $58,637 and $58,636
            for
            the six months ended June 30, 2006 and 2005, respectively.
 
 *b)
            Revolving Credit Facility.*
 
 On
            June
            3, 2003, the Company entered into a Security Agreement, Secured Convertible
            Note, Registration Rights Agreement and Common Stock Purchase Warrant,
            with the
            Laurus Master Fund, Ltd. ("Laurus"). Pursuant to the agreements, the
            Company
            received a $1 million revolving credit facility in the form of a three-year
            Convertible Note secured by its assets subject to the amount of eligible
            accounts receivables. On August 25, 2004, after the initial $1 million
            was
            converted, the revolving credit facility was increased to $1.5 million
            with an
            additional $1.5 million in the form of two Secured Convertible Notes.
            The net
            proceeds from the Convertible Notes were used for general working capital
            purposes. Advances on the Convertible Notes were repaid at the Company's
            option,
            in cash or through the issuance of the Company's shares of common stock.
            The
            Convertible Notes carried an interest rate of Wall Street Journal Prime
            plus
            0.75% on any outstanding balance. In addition, the Company was required
            to pay a
            collateral management payment of 0.55% of the average aggregate outstanding
            balance during the month plus an unused line payment of 0.20% per annum.
            Availability of funds under the revolving credit facility was based on
            the
            Company's accounts receivable. Laurus exercised its conversion rights
            from
            time-to-time on outstanding balances. Laurus converted a total of 3,406,417
            shares to satisfy an aggregate of $2.5 million of revolving debt since
            the
            inception of the revolving credit facility. There was no outstanding
            balance on
            the revolving credit facility at June 30, 2005 and there were no conversions
            during the first six months of 2006 and 2005. The
            Company's revolving credit facility with Laurus expired on June 3, 2006.
 
 In
            conjunction with this transaction, Laurus was paid a fee of $20,000 for
            the
            first year, which was expensed as additional interest expense in 2003.
            The
            Company was required to pay a continuation fee of $10,000 each year thereafter.
            In addition, Laurus received a warrant to purchase 200,000 shares of
            the
            Company's common stock for the initial $1 million revolving credit facility,
            as
            stated herein. The warrant exercise price was computed as follows: $0.63
            per
            share for the purchase of up to 125,000 shares; $0.69 per share for the
            purchase
            of an additional 50,000 shares; and $0.80 per share for the purchase
            of an
            additional 25,000 shares. The warrant exercise price may be paid in cash,
            in
            shares of the Company's common stock, or by a combination of both. The
            warrant
            expiration date is June 3, 2008. In addition to the initial warrant,
            the Company
            issued two additional warrants: 1) to purchase 50,000 shares at an exercise
            price of $1.0625 per share in relation to the August 25, 2004 $500,000
            revolving
            credit facility expansion, which warrant was exercised by Laurus on April
            19,
            2005; and, 2) to purchase 50,000 shares at an exercise price of $1.925
            per share
            in relation to the August 25, 2004 $1 million in added convertible debt,
            which
            warrant's expiration date is August 25, 2009.
   Table
                of Contents
 7
  **4.
            Stockholder's Equity - Preferred Stock, Common Stock and
            Warrants**
 
 **Preferred
            Stock**
 
 *a)
            Series C Preferred Stock.*
 
 On
            August
            25, 2004, the Company entered into a Securities Purchase Agreement with
            Laurus,
            whereby the Company issued 250,000 shares of its Series C Non-Redeemable
            Convertible Preferred Stock, par value $0.001 per share (the "Series
            C Preferred
            Shares"), to Laurus for an aggregate purchase price of $2,500,000 or
            $10.00 per
            share (the "Stated Value"). The Series C Preferred Shares are convertible
            into
            shares of the Company's common stock at a rate of $1.54 per share, and
            accrue
            quarterly, cumulative dividends at a rate of 6.85%. The first payment
            was due on
            January 1, 2005. As of June 30, 2006 and 2005, approximately $42,000
            and $29,000
            has been accrued for dividends and are payable in cash or shares of our
            common
            stock at the holder's option with the exception that dividends must be
            paid in
            shares of our common stock for up to 25% of the aggregate dollar trading
            volume
            if the fair market value of the Company's common stock for the 20-days
            preceding
            the conversion date exceeds 120% of the conversion rate. On January 11,
            2005,
            $60,967 of accrued dividends were paid in the form of 39,589 shares of
            the
            Company's common stock. Also, on May 5, 2005, $56,301 of accrued dividends
            were
            paid in the form of 36,559 shares of the Company's common stock, on September
            28, 2005, $57,708 of accrued dividends were paid in the form of 37,473
            shares of
            the Company's common stock and on April 1, 2006, $98,911 of accrued dividends
            were paid in cash. The Series C Preferred Shares are redeemable by the
            Company
            in whole or in part at any time after issuance for (a) 115% of the Stated
            Value
            if the average closing price of the common stock for the 22 days immediately
            preceding the date of conversion does not exceed $1.48 per share or (b)
            the
            Stated Value if the average closing price of our common stock for the
            22 days
            immediately preceding the date of conversion exceeds the Stated Value.
            The
            Series C Preferred Shares have a liquidation right equal to the Stated
            Value
            upon the Company's dissolution, liquidation or winding-up. The Series
            C
            Preferred Shares have no voting rights, except as required by law.
 
 In
            conjunction with the Series C Preferred Shares, the Company issued a
            five-year
            common stock warrant to Laurus for the purchase of 487,000 shares of
            the
            Company's common stock at an exercise price of $1.77 per share.
 
 *b)
            Series D-1 Preferred Stock.*
 
 On
            January 12, 2006, the Company entered into a Securities Purchase Agreement
            with
            a limited number of institutional accredited investors, including Omicron
            Capital, Tailwind Capital, Bristol Capital Management, Nite Capital and
            Laurus.
            On January 13, 2006, the Company issued and sold to these investors 5,150
            shares
            of our Series D-1 Amortizing Convertible Perpetual Preferred Stock, par
            value
            $0.001 per share, for an aggregate purchase price of $5,150,000, or $1,000
            per
            share. As
            of
            June 30, 2006, 5,075 shares of our Series D-1 Amortizing Convertible
            Perpetual
            Preferred Stock remain outstanding since 75 were converted in May 2006
            into
            50,676 shares of the Company's common stock. The Company also issued
            various
            warrants to these investors as described below. The Company paid cash
            fees and
            expenses of $119,209 to a finder for the introduction of potential investors
            in
            this financing, and paid $60,000 to the lead investor's counsel for legal
            expenses incurred in the transaction. The preferred shares are convertible
            into
            shares of the Company's common stock at a rate of $1.48 per share and
            accrue
            quarterly, cumulative dividends at a rate of LIBOR plus 4% on the first
            day of
            the applicable quarter with the first payment due on April 1, 2006. As
            of June
            30, 2006, the Company had paid approximately $99,000 of accrued Series
            D-1
            dividends in cash.
 
 Table
                of Contents
 8
  Under
            the
            purchase agreement, from the date of the effectiveness of the initial
            registration statement filed pursuant to the registration rights agreement
            (February 15, 2006), until the one-year anniversary of that date, if:
            (1) on any
            trading day during such period the volume weighted average price of the
            Company's common stock for each of the 20 trading days immediately prior
            to such
            date exceeds $1.63; and, (2) the average daily trading volume of the
            Company's
            common stock exceeds $100,000 on each of those days, then the Company
            has the
            option, subject to a number of additional conditions, to put to the investors
            "units" at $1,000 per unit for an aggregate purchase price of up to $2,000,000
            (or a lesser amount to the extent the preferred stock warrants issued
            at the
            initial closing of the financing, which are described below, have been
            exercised
            to purchase these units). Each "unit" consists of one share of Series
            D-1
            Preferred Stock and a common stock warrant, which entitles the holders
            to
            purchase up to an aggregate of 440,829 shares of common stock at an exercise
            price of $1.51 and otherwise has the same terms as the warrants described
            in the
            following paragraph.
 
 Certain
            warrants the Company issued to the Series D-1 investors at the closing
            entitle
            the investors to purchase up to an aggregate of 1,135,138 shares of the
            Company's common stock at an exercise price of $1.51 per share. The warrants
            are
            exercisable for five years following the date of grant. The warrants
            have
            "ratchet" anti-dilution provisions reducing the warrant exercise price
            if the
            Company issues equity securities (other than in specified exempt transactions)
            at an effective price below the warrant exercise price to such lower
            exercise
            price.
 
 The
            Company also issued certain other warrants to the Series D-1 investors
            at the
            closing (the "preferred stock warrants"). These warrants entitle the
            holder to
            purchase an aggregate number of 2,000 "units", which are identical to
            the
            "units" described above, at an exercise price of $1,000 per unit. The
            preferred
            stock warrants are exercisable from the effective date (February 15,
            2006) until
            the one-year anniversary of that date. If any units subject to the preferred
            stock warrants remain unsold after (1) their expiration date and (2)
            the
            exercise of the Company's put option, if applicable, and any holder of
            a
            preferred stock warrant issued in the financing has exercised the warrant
            in
            full, then the preferred stock warrant would supplementally grant that
            holder
            the right to purchase 440,829 shares of common stock, times the number
            of
            "units" which the holder's preferred stock warrant initially overlaid,
            with a
            strike price of $1.51 per share, and the warrant, as so supplemented,
            would have
            a five year term from January 12, 2006 to January 11, 2011.
 
 *Other
            Provisions* .
 
 The
            purchase agreement contains a number of covenants by the Company, which
            include:
 
 ·
                  A
                      grant of preemptive rights to the investors to participate
                      in future
                      financings until January 12, 2007;
 
 ·
                  An
                      agreement not to issue any shares of the Company's common stock
                      or
                      securities or other rights to acquire shares of common stock
                      until August
                      15, 2006, except under specified conditions intended to ensure
                      the terms
                      are no less favorable to the Company than the terms of this
                      financing;
                      and,
 
 ·
                  An
                      agreement not to effect any transaction involving the issuance
                      of
                      securities convertible, exercisable or exchangeable for the
                      Company's
                      common stock at a price per share or rate which may change
                      over time,
                      which the Company refers to as a variable-rate transaction,
                      so long as any
                      shares of Series D-1 Preferred Stock are
                      outstanding.
 
 In
            connection with this financing, Laurus consented to and waived certain
            contractual rights. The Company paid Laurus Capital Management, L.L.C.,
            and the
            manager of Laurus, $87,000 in connection with Laurus' delivery of the
            consent
            and waiver,
            and paid $1,000 to Laurus' counsel for their related fees.
  Table
                of Contents
 9
  **Common
            Stock and Warrants**
 
 The
            Company adopted SFAS 123(R) to account for its stock-based compensation
            beginning January 1, 2006. Previously, the Company elected to account
            for its
            stock-based compensation plans under APB 25. The Company computed, for
            pro forma
            disclosure purposes, the value of all options granted during the six
            months
            ended June 30, 2005 using the minimum value method as prescribed by SFAS
            123 and
            amended by SFAS 148. Under this method, the Company used the risk-free
            interest
            rate at the date of grant, the expected volatility, the expected dividend
            yield
            and the expected life of the options to determine the fair value of options
            granted. The risk-free interest rates ranged from 6.0% to 6.5%, expected
            volatility was 117%, the dividend yield was assumed to be zero, and the
            expected
            life of the options was assumed to be three to five years based on the
            average
            vesting period of options granted.
 
 If
            the
            Company had accounted for its options in accordance with SFAS 123(R)
            in 2005,
            the total value of options granted during the six month period ended
            June 30,
            2005 would have been amortized over the vesting period of the options.
            Thus, the
            Company's consolidated net income (loss) would have been as
            follows:
 
 **Net
                            Income (Loss)**
                        
                        
                        **2005**As
                            reported
                        
                        **$**
                        **212,162**Add:
                            Stock based employee compensation expense included in
                            reported net income
                        
                        **$**
                        **-**Deduct:
                            Stock based employee compensation expense determined
                            under the fair value
                            based method for all awards
                        
                        **$**
                        **395,347**Pro
                            forma
                        
                        **$**
                        **(183,185**
                        **)**Net
                            Income (Loss) Per Share:As
                            reported
                        
                        **$**
                        **0.01**Pro
                            forma
                        
                        **$**
                        **(0.01**
                        **)**
 For
            the
            six months ended June 30, 2006, the Company expensed approximately $116,000
            of
            stock option expenses due to SFAS 123(R) in its financial
            statements.
 
 **5.
            Goodwill**
 
 On
            January 31, 2006, the
            Company acquired Starsys Research Corporation and in accordance with
            U.S.
            generally accepted accounting principles, the merger was accounted for
            using the
            purchase method of accounting. Under the purchase method of accounting,
            the
            total estimated purchase price was allocated to Starsys' net tangible
            assets and
            identifiable intangible assets based on their fair values as of the date
            of
            completion of the merger. The excess of the purchase price over those
            fair
            values was recorded as goodwill. Goodwill is not amortized but is tested
            for
            impairment at least annually. The combined company will incur additional
            amortization expense based on the identifiable amortizable intangible
            assets
            acquired pursuant to the merger agreement and their relative useful lives.
            Additionally, to the extent the value of goodwill or identifiable intangible
            assets or other long-lived assets become impaired, the combined company
            may be
            required to record material charges relating to the impairment. The goodwill
            balance as of June 30, 2006 was approximately $12.2 million.
  Table
                of Contents
 10
  The
            following is a schedule of the goodwill incurred in the Starsys
            acquisition.
 
 Starsys
                        Total Assets
                    
                    $
                    (7,851,494
                    )Starsys
                        Total Liabilities
                    
                    
                    13,054,140Cash
                        to Starsys Stockholders
                    
                    
                    410,791Equity
                        to Starsys Stockholders
                    
                    
                    5,576,846Fees
                        Associated with Acquisition
                    
                    
                    1,056,079$
                    12,246,362
 **6.
            New Accounting Pronouncements**
 
 There
            were no recent Accounting Pronouncements that affected the Company during
            the
            second quarter of 2006. For past pronouncements, please refer the Company's
            Form
            10-KSB filed on March 28, 2006.
 
 **7.
            Change in Accounting Principle and Accounting for Share-Based
            Compensation**
 
 The
            Company adopted Financial Accounting Standards Board (FASB) Statement
            of
            Financial Accounting Standards (SFAS) No. 123 (revised 2004) (123(R))
            on January
            1, 2006. Upon the adoption of SFAS 123(R), compensation costs associated
            with
            share-based compensation and stock option awards will be recorded to
            expense
            over the requisite period(s) associated with the stock or options. Prior
            to the
            adoption of SFAS 123(R), the Company accounted for share-based compensation
            and
            stock option awards issued to employees, directors and officers under
            the
            recognition and measurement principles of Accounting Principles Board
            (APB) No.
            25, *Accounting
            for Stock Issued to Employees* ,
            and
            related interpretations. Generally, no share-based employee compensation
            expense
            was recognized for stock option grants, as all options granted had an
            exercise
            price equal to the fair market value of the underlying common stock at
            the date
            of grant. Similarly, no compensation expense had been recognized under
            the
            Company's 1999 Employee Stock Purchase Plan (ESPP).
 
 As
            noted
            above, on January 1, 2006, the Company adopted SFAS 123(R), which requires
            companies to measure an equity instrument based on the grant-date fair
            value of
            the award and expense the value. The Company uses the Black-Scholes pricing
            model to determine the fair value of its options on the measurement date.
            The
            cost is recognized over the requisite period (usually the vesting period).
            During the first six months of 2006, the Company had stock option expense
            of
            approximately $116,000 related to an executive stock option award coincident
            with the Starsys merger. Without the adoptions of SFAS 123(R), the Company's
            operating income, net income and net income per share would have been
            increased
            to the pro forma non-GAAP amounts indicated below:
  Table
                of Contents
 11
 *Three
                            Months
                            Ending*
                        
                        *Six
                            Months Ending**At
                            June 30,*
                        
                        
                        2006
                        
                        
                        2005
                        
                        
                        2006
                        
                        
                        2005**GAAP
                            Operating Income**
                        
                        **$**
                        **10,094**
                        
                        $
                        74,681
                        
                        **$**
                        **(36,304**
                        **)**
                        $
                        140,248SFAS
                            123(R) stock -based compensation
                        
                        
                        **24,992**
                        
                        
                        -
                        
                        
                        **115,693**
                        
                        
                        -**Non-GAAP
                            Operating Income**
                        
                        
                        **35,086**
                        
                        
                        74,681
                        
                        
                        **79,389**
                        
                        
                        140,248**Non-Operating
                            Income/(Expense)**Interest
                            income
                        
                        
                        **7,137**
                        
                        
                        36,823
                        
                        
                        **40,752**
                        
                        
                        44,783]Interest
                            expense
                        
                        
                        **(5,346**
                        **)**
                        
                        (609
                        )
                        
                        **(10,629**
                        **)**
                        
                        (1,830Gain
                            on building sale
                        
                        
                        **29,319**
                        
                        
                        29,318
                        
                        
                        **58,637**
                        
                        
                        58,636Non-Cash
                            loan fee - equity conversions (Note 3(c))
                        
                        
                        **-**
                        
                        
                        (28,875
                        )
                        
                        **-**
                        
                        
                        (28,875**Total
                            Non-Operating Income**
                        
                        
                        **31,110**
                        
                        
                        36,657
                        
                        
                        **88,760**
                        
                        
                        72,714**Non-GAAP
                            Net Income Before Taxes**
                        
                        **$**
                        **66,196**
                        
                        $
                        111,338
                        
                        **$**
                        **168,149**
                        
                        $
                        212,962**Income
                            tax provision**
                        
                        
                        **5,000**
                        
                        
                        400
                        
                        
                        **9,235**
                        
                        
                        800**Non-GAAP
                            Net Income**
                        
                        **$**
                        **61,196**
                        
                        $
                        110,938
                        
                        **$**
                        **158,914**
                        
                        $
                        212,162**Net
                            Income Per Share:**Non-GAAP
                            Net Income Per Share
                        
                        **$**
                        **0.00**
                        
                        $
                        0.01
                        
                        **$**
                        **0.01**
                        
                        $
                        0.01Weighted-Average
                            Shares Outstanding
                        
                        
                        **28,818,403**
                        
                        
                        21,792,987
                        
                        
                        **28,047,709**
                        
                        
                        21,541,549**Fully
                            Diluted Net Income Per Share:**Non-GAAP
                            Fully Diluted Income Per Share
                        
                        **$**
                        **0.00**
                        
                        $
                        0.00
                        
                        **$**
                        **0.00**
                        
                        $
                        0.01Fully
                            Diluted Weighted-Average Shares Outstanding
                        
                        
                        **49,604,151**
                        
                        
                        30,593,912
                        
                        
                        **47,598,736**
                        
                        
                        30,515,291
 The
            Company believes that evaluating its ongoing operating results with these
            non-GAAP measurements may be useful as a supplement to its standard GAAP
            financial measurement presentation. Accordingly, the Company has chosen
            certain
            non-GAAP financial information to evaluate its ongoing operations and
            for
            internal planning and forecasting purposes. The Company believes that
            non-GAAP
            financial measures should be considered in addition to, and not a substitute
            for, financial information prepared in accordance with GAAP. The Company
            presents such non-GAAP financial measures in reporting its financial
            results to
            provide additional and supplemental disclosure to evaluate operating
            results.
            Whenever the Company uses a non-GAAP financial measurement, it provides
            a
            reconciliation of the non-GAAP financial measure to the most closely
            applicable
            GAAP financial measurement.
 
 **8.
            Unaudited Pro Forma Combined Consolidated Statements of
            Operations**
 
 The
            following unaudited pro forma combined statements of operations give
            effect to
            the merger of SpaceDev and Starsys using the purchase method of accounting,
            as
            required by Statement of Financial Accounting Standard No. 141, "Business
            Combinations." The Company acquired Starsys Research Corporation on January
            31,
            2006 and is the
            "accounting acquirer" for accounting purposes. Under this method of accounting,
            the combined company will allocate the purchase price to the fair value
            of
            assets of Starsys deemed to be acquired, including identifiable intangible
            assets and goodwill. The purchase price allocation is subject to revision
            when
            the combined company obtains additional information regarding asset valuation.
            The unaudited pro forma combined statements of operations are based on
            respective historical consolidated financial statements and the accompanying
            notes of the Company, and those of Starsys included herein.
  The
            unaudited pro forma combined statements of operations for the six months
            ended
            June 30, 2006 assume the merger took place on January 1, 2006 and combines
            SpaceDev's historical statement of operations for the year ended December
            31,
            2005 with Starsys' historical statement of operations for the year ended
            December 31, 2005 as if the merger took place on January 1, 2005. The
            unaudited
            pro forma combined statements of operations should be read in conjunction
            with
            the related notes included in this Form 10-QSB and the consolidated audited
            financial statements of SpaceDev, Inc. The unaudited pro forma combined
            statements of operations are not necessarily indicative of what the actual
            results of operations and financial position would have been had the
            merger
            taken place on January 1 of each period presented and do not indicate
            future
            results of operations.
   Table
                of Contents
 12
 **Pro
            Forma Combined Consolidated Statement of Operations**
 **(Unaudited)**
  ***For
                            the Six Months Ended******June
                            30, 2006*****Poway**
                        
                        
                        **Boulder**
                        
                        
                        **Pro
                            Forma Adjustments**
                        
                        
                        **Consolidated
                            Pro Forma****Net
                            Sales**
                        $
                        6,369,577
                        
                        $
                        11,236,928
                        
                        $
                        (216,223
                        )
                        $
                        17,390,282**Cost
                            of Sales ***
                        
                        4,562,882
                        
                        
                        8,388,495
                        
                        $
                        (80,758
                        )
                        $
                        12,870,619**Gross
                            Margin**
                        
                        1,806,695
                        
                        
                        2,848,433
                        
                        $
                        (135,465
                        )
                        $
                        4,519,663**Operating
                            Expenses**Marketing
                            and sales expense
                        
                        937,438
                        
                        
                        600,731
                        
                        $
                        (135,465
                        )
                        
                        1,402,705Research
                            and development
                        
                        158,932
                        
                        
                        40,624
                        
                        
                        -
                        
                        
                        199,556General
                            and administrative
                        
                        687,753
                        
                        
                        2,330,398
                        
                        
                        -
                        
                        
                        3,018,152**Total
                            Operating Expenses ***
                        
                        1,784,123
                        
                        
                        2,971,753
                        
                        
                        (135,465
                        )
                        
                        4,620,412**Income/(Loss)
                            from Operations**
                        
                        22,572
                        
                        
                        (123,320
                        )
                        
                        -
                        
                        
                        (100,749
                        )**Non-Operating
                            Income/(Expense)**Interest
                            income
                        
                        40,626
                        
                        
                        28,432
                        
                        
                        -
                        
                        
                        69,058Interest
                            expense
                        
                        (360
                        )
                        
                        (32,752
                        )
                        
                        -
                        
                        
                        (33,112
                        )Gain
                            on Building Sale
                        
                        58,637
                        
                        
                        -
                        
                        
                        -
                        
                        
                        58,637**Total
                            Non-Operating Income/(Expense)**
                        
                        98,903
                        
                        
                        (4,320
                        )
                        
                        -
                        
                        
                        94,583**Income
                            (Loss) Before Income Taxes**
                        
                        121,475
                        
                        
                        (127,640
                        )
                        
                        -
                        
                        
                        (6,166
                        )Income
                            tax provision
                        
                        9,200
                        
                        
                        35
                        
                        
                        -
                        
                        
                        9,235**Net
                            Income (Loss)**
                        $
                        112,275
                        
                        $
                        (127,675
                        )
                        $
                        -
                        
                        
                        (15,401
                        )*
                            The following table shows how the Company's amortization
                            expense of stock
                            options would be allocated to all
                            expenses.Cost
                            of Sales
                        $
                        -
                        
                        $
                        -
                        
                        $
                        -
                        
                        
                        -Marketing
                            and sales
                        
                        -
                        
                        
                        -
                        
                        
                        -
                        
                        
                        -Research
                            and development
                        
                        -
                        
                        
                        -
                        
                        
                        -
                        
                        
                        -General
                            and administrative
                        
                        -
                        
                        
                        115,693
                        
                        
                        -
                        
                        
                        115,693$
                        -
                        
                        $
                        115,693
                        
                        $
                        -
                        
                        
                        115,693
 Table
                of Contents
 13
 **Pro
            Forma Combined Consolidated Statement of Operations**
 **(Unaudited)**
 
 ***For
                            the year ended December 31, 2005*****SpaceDev**
                        
                        
                        **Starsys**
                        
                        
                        **Pro
                            Forma Adjustments**
                        
                        
                        **Pro
                            Forma****Net
                            Sales**
                        
                        $
                        9,005,011
                        
                        $
                        17,762,730
                        
                        $
                        -
                        
                        $
                        26,767,741**Cost
                            of sales**
                        
                        
                        6,905,902
                        
                        
                        14,721,176
                        
                        
                        -
                        
                        $
                        21,627,078**Gross
                            Margin**
                        
                        
                        2,099,109
                        
                        
                        3,041,554
                        
                        
                        -
                        
                        $
                        5,140,663**Operating
                            Expenses**Marketing
                            and sales expense
                        
                        
                        673,636
                        
                        
                        
                        
                        
                        -
                        
                        
                        673,636General
                            and administrative
                        
                        
                        1,113,973
                        
                        
                        6,000,676
                        
                        
                        -
                        
                        
                        7,114,649**Total
                            Operating Expenses**
                        
                        
                        1,787,609
                        
                        
                        6,000,676
                        
                        
                        -
                        
                        
                        7,788,285**Income/(Loss)
                            from Operations**
                        
                        
                        311,500
                        
                        
                        (2,959,122
                        )
                        
                        -
                        
                        
                        (2,647,622
                        )**Non-Operating
                            Income/(Expense)**Interest
                            income
                        
                        
                        105,840
                        
                        
                        **-**
                        
                        
                        **-**
                        
                        
                        105,840Rental
                            income
                        
                        
                        **-**
                        
                        
                        88,146
                        
                        
                        
                        
                        
                        88,146Interest
                            expense
                        
                        
                        (2,873
                        )
                        
                        (506,525
                        )
                        
                        -
                        
                        
                        (509,398
                        )Gain
                            on building sale
                        
                        
                        117,272
                        
                        
                        -
                        
                        
                        -
                        
                        
                        117,272Loan
                            fee - equity compensation
                        
                        
                        (28,875
                        )
                        
                        -
                        
                        
                        -
                        
                        
                        (28,875
                        )**Total
                            Non-Operating Income/(Expense)**
                        
                        
                        191,364
                        
                        
                        (418,379
                        )
                        
                        -
                        
                        
                        (227,015
                        )**Income/(Loss)
                            Before Income Taxes**
                        
                        
                        502,864
                        
                        
                        (3,377,501
                        )
                        
                        -
                        
                        
                        (2,874,637
                        )Income
                            tax provision
                        
                        
                        1,600
                        
                        
                        -
                        
                        
                        -
                        
                        
                        1,600**Net
                            Income/(Loss)**
                        
                        $
                        501,264
                        
                        $
                        (3,377,501
                        )
                        $
                        -
                        
                        
                        (2,876,237
                        )**Net
                            Income/(Loss) Per Share:**Net
                            Income/(Loss)
                        
                        $
                        0.02
                        
                        $
                        (6.49
                        )
                        
                        
                        
                        $
                        (0.08
                        )Shares
                            Outstanding
                        
                        
                        29,030,858
                        
                        
                        520,447
                        
                        
                        5,357,143
                        
                        
                        34,388,001
 Table
                of Contents
 14
  **9.
            Subsequent Events**
  O n
            August
            10, 2006 the Board of Directors agreed to grant to certain Starsys employees
            an
            aggregate of 161,000 stock options with a strike price of $1.33 per share,
            the
            closing price of the Company's common stock on the date of grant. The
            options
            will vest over the next three years and expire on August 10, 2010. SpaceDev
            granted these options in conjunction with the merger agreement with Starsys.
            These options were issued as part of SpaceDev's equity incentive plan
            to
            executives, managers, employees and consultants of Starsys.
 
 **ITEM
            2.** **MANAGEMENT'S
            DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**
 
 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 our fiscal year 2005 Form 10-KSB and quarterly Form
            10-QSB
            filings.
 
 In
            addition to historical information, the following discussion and other
            parts of
            this document may contain forward-looking statements. These statements
            relate to
            future events or our future financial performance. In some cases, you
            can
            identify forward-looking statements by terminology such as "may," "will,"
            "should," "expect," "plan," "anticipate," "believe," "estimate," "predict,"
            "potential," or "continue," the negative of such terms or other comparable
            terminology. These statements are only predictions. Although we believe
            that the
            expectations reflected in the forward-looking statements are reasonable,
            we
            cannot guarantee future results, levels of activity, performance or
            achievements. Moreover, neither we nor any other person assume responsibility
            for the accuracy and completeness of the forward-looking statements.
            Except as
            may be required by law, we undertake no obligation to publicly update
            any of the
            forward-looking statements after the date of this report to conform such
            statements to actual results or to changes in our expectations.
 
 Actual
            results could differ materially from those anticipated by such forward-looking
            statements. Factors that could cause or contribute to such differences
            include,
            but are not limited to those identified in the "Risk Factors" subsection
            below.
 
 **Overview**
  We
            are
            engaged in the conception, design, development, manufacture, integration
            and
            operations of space technology systems, products and services. Our historic
            SpaceDev operations are currently focused on the commercial and military
            development of low-cost microsatellites, nanosatellites and related subsystems,
            hybrid rocket propulsion for space, launch and human flight vehicles
            as well as
            associated engineering and technical services primarily to government
            agencies,
            and specifically the Department of Defense. Our products and solutions
            are sold,
            mainly on a project basis, directly to these customers and include sophisticated
            micro- and nanosatellites, hybrid rocket-based launch vehicles, Maneuvering
            and
            orbital Transfer Vehicles as well as safe sub-orbital and orbital hybrid
            rocket-based propulsion systems. Although we believe there will be a
            commercial
            market for our microsatellite and nanosatellite products and services
            in the
            long-term, the early adopters of this technology appears to be the military
            and
            our "products" are considered to be the outcome of specific projects.
            We are
            also developing commercial hybrid rocket motors for possible use in small
            launch
            vehicles, targets and sounding rockets and small high-performance space
            vehicles
            and subsystems for commercial customers.
 
 Table
                of Contents
 15
  We
            acquired Starsys Research Corporation on January 31, 2006 in a tax-free
            forward
            triangular merger, renamed the company Starsys, Inc., and now hold it
            as a
            wholly-owned subsidiary of SpaceDev. Starsys is engaged in the design
            and
            manufacture of mechanical and electromechanical subsystems and components
            for
            spacecraft. Starsys' subsystems enable critical spacecraft functions
            such as
            pointing solar arrays and communication antennas and restraining, deploying
            and
            actuating moving spacecraft components. Starsys manufactures a wide range
            of
            products that include bi-axis gimbals, flat plate gimbals, solar array
            pointing
            mechanisms, deployable booms, separation systems, thermal louvers, actuators,
            restraint devices and cover systems. Starsys' products are sold both
            as
            "off-the-shelf" catalog products, which represent previously qualified
            devices
            with spaceflight history, and as custom systems that are developed for
            specific
            applications. Starsys' products are typically sold directly to spacecraft
            manufacturers. Starsys' customer base is segregated into three major
            segments:
            (1) domestic and international commercial spacecraft (communication and
            imaging satellites), (2) civil spacecraft (NASA) that are primarily
            scientific in nature and (3) defense spacecraft that support the United
            States' military capability. Starsys also offers products to non-space
            customers, including aerospace, maritime, and industrial customers.
  Starsys'
            engineering and manufacturing capabilities position the company to provide
            both
            mechanical and electromechanical subsystems for spacecraft. Starsys'
            strategy is
            to identify opportunities to develop products from custom mechanical
            and
            electromechanical subsystems. To extend the product life cycle, Starsys
            has
            developed and expanded a "product platforms" business model. Product
            platforms
            are subsystems for which non-recurring and development engineering have
            been
            completed and for which there is continued customer demand. Starsys'
            product
            offerings also
            currently include High Output Paraffin ("HOP") actuators, hinges, battery
            bypass
            switches, thermal louvers, bi-axial gimbals and solar array drives, among
            others. The product life cycle for this type of product within the space
            industry is approximately 15 years.
  The
            acquisition of Starsys fundamentally changed our profile. Starsys is
            a mature
            operating company with 2005 revenues of approximately $18 million and
            2005
            losses of approximately $3.4 million. We believe there are numerous potential
            synergies between the historic SpaceDev business and Starsys' business,
            including but not limited to providing SpaceDev with a production capability
            as
            its technologies migrate from advanced systems to products, access to
            quality
            facilities and a strong market of aerospace engineers, a diversification
            of
            customers and revenues, and the ability to bid on larger and more vertically
            integrated programs and projects.
 
 Our
            historic SpaceDev business approach is to provide smaller spacecraft
            - generally
            250 kg (550 pounds) mass and less - and cleaner, safer hybrid propulsion
            systems
            to commercial, government, university and limited international customers.
            We
            are developing smaller spacecraft and miniaturized subsystems using proven,
            lower cost, high-quality off-the-shelf components. Our space products
            are
            modular and reproducible, which allows us to create affordable space
            solutions
            for our customers. By utilizing our innovative technology and experience,
            and
            space-qualifying commercial industry-standard hardware, software and
            interfaces,
            we provide increased reliability with reduced costs and risks.
 
 We
            have
            been awarded, have successfully concluded or are successfully concluding
            contracts from such esteemed government, university and commercial customers
            as
            the Air Force Research Laboratory, Boeing, the California Space Authority,
            the
            Defense Advanced Research Projects Agency, NASA's Jet Propulsion Laboratory,
            Lockheed Martin, Lunar Enterprise Corporation, Malin Space Science Systems,
            the
            Missile Defense Agency (formerly the "Ballistic Missile Defense Organization"),
            the National Reconnaissance Office, Scaled Composites and the University
            of
            California at Berkeley via NASA.
 
 During
            the first six months of 2006, 45% of our net sales were generated from
            direct
            government contracts, 49% were generated from government-related work
            through
            subcontracts with others, and 6% were generated from commercial contracts.
            For
            the same six month period in 2005, approximately 93% of our net sales
            were
            generated by government or government-related work. We will continue
            to seek
            both government and commercial business and anticipate that net sales
            from
            government sources will continue to represent in excess of 80% of our
            net sales
            for the next several years. Currently, we are focusing on the domestic
            United
            States government market, which we believe is only about one-half of
            the global
            government market for our technology, products and services. Although
            we are
            interested in exploring increased international revenue and contract
            opportunities, we are restricted by export control regulations, including
            International Traffic in Arms Regulations, which may limit our ability
            to
            develop market opportunities outside the United States on some of our
            products.
 
 Table
                of Contents
 16
 
 At
            this
            time, over 85% of our forecasted sales for 2006 are under contract or
            near
            contract award. We may not be able to win enough new business to achieve
            our
            targeted growth projection or to maintain a positive cash flow position.
            During
            the first six months of 2006 we submitted approximately twenty-five bids
            for
            government or commercial programs ranging from $25,000 to $350 million
            and
            continued our work with the United States Congress to identify directed
            funding
            for our programs.
 
 In
            order
            to perform the Missile Defense Agency contract (described below) on schedule
            and
            successfully execute other existing and new business opportunities, we
            must
            substantially increase our staff and hire new engineers or subcontract
            the work
            to third parties. We are actively seeking to hire spacecraft and propulsion
            engineers, and we are investigating various partnership arrangements
            to increase
            resource availability.
 
 **Selection
            of Significant Contracts**
 On
            July
            18, 2005, we were awarded a subcontract to provide scientific, engineering,
            development and programmatic support to the development and demonstration
            of
            innovative SSA (space situational awareness) nanosatellite (<15kg)
            spacecraft. SSA is the ability to search, identify and monitor spacecrafts
            for
            the purpose of obtaining space superiority. The subcontract covers the
            conceptual/preliminary phase of development and includes all aspects
            of
            potential systems from the platforms and associated payloads to the links
            and
            nodes and ground support. The cost plus fixed fee subcontract resulted
            in
            revenues of approximately $120,000. We completed this subcontract in
            December
            2005. In January 2006, we submitted a proposal for the next phase subcontract
            and, in March 2006, we were awarded the subcontract in the amount of
            approximately $1.2 million and began work on this phase. Revenues through
            June
            30, 2006 totaled approximately $720,000.
 
 On
            February 28, 2006, we were awarded two important Boom Technology contracts
            for
            advance research and development of a self-deployed articulated boom
            for
            approximately $950,000 and a jack screw deployed boom for approximately
            $1.5
            million by the Air Force Research Laboratory.  AFRL placed these contracts
            with Starsys which will leverage the significant technical talent and
            advances
            Starsys engineers have already made in this critical space
            technology.
 
 On
            March
            31, 2004, we were awarded a five-year, cost-plus-fixed fee indefinite
            delivery/indefinite quantity contract for up to $43,362,271 to conduct
            a
            microsatellite distributed sensing experiment in support of the Advanced
            Systems
            Deputate of the Missile Defense Agency, which contract was originally
            awarded on
            March 31, 2004. The microsatellite distributed sensing experiment is
            now
            intended to analyze, design, develop, fabricate, integrate, test, operate
            and
            support a networked cluster of three formation-flying boost phase and
            midcourse
            tracking microsatellites to support national missile defense. This overall
            contract is proceeding under a phased approach. The first phase, executed
            under
            Task Order I for approximately $1.1 million was completed on September
            30, 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 on March 31, 2006. Task Order
            II
            resulted in a detailed mission and microsatellite design, as exemplified
            by a
            successful Critical Design Review in March 2006. Task Order III, the
            first of
            several task orders expected during the third phase, was awarded to us
            on April
            1, 2006 for a total of approximately $1.5 million, which was later amended
            to
            approximately $2.5 million and ran through June 30, 2006. Task Order
            IV was
            awarded by the Missile Defense Agency in July 2006, with initial funding
            of
            approximately $4 million through November 30, 2006. We expect continued
            modifications to the current phase with additional task orders throughout
            2006
            and 2007.
 
 In
            addition to the three networked microsats under our second Task Order,
            the $43
            million contract also originally envisioned an option for a second cluster
            of
            three microsats using laser communication technology.  We were informed in
            2005 that the Missile Defense Agency had re-routed the laser communications
            experiment to another program and that they would not be exercising their
            option
            for the additional microsats at that time; however, the contract vehicle
            remained at $43 million and left open the opportunity for some other
            purchase to
            take its place. The
            IDIQ
            (indefinite delivery, indefinite quantity) nature of the contract allows
            for
            replenishment of funds by MDA within the same contract vehicle, as work
            is
            performed and we recognize revenue. We estimated that the second cluster
            would
            have represented approximately $10 million of the $43.3 million contract,
            and we
            reduced our current backorder accordingly.  We believe the remaining
            unbilled contract backlog amount of approximately $20.0 million to be
            secure.  We have recognized approximately $13.4 million in revenue under
            this contract through June 30, 2006.
 
 Table
                of Contents
 17
  **Results
            of Operations**
  Please
            refer to the consolidated financial statements, which are a part of this
            report,
            for further information regarding the results of operations. Due to our
            January
            2006 acquisition of Starsys, all 2006 -vs.- 2005 comparisons are of limited
            meaningfulness and usefulness.
 
 ***Six-Months
            Ending June 30, 2006 -vs.- Six-Months Ending June 30,
            2005***
 
 During
            the six-months ending June 30, 2006, we net sales of approximately $15.8
            million
            as compared to net sales of approximately $3.7 million for the same six
            month
            period in 2005. Sales increased primarily due to our acquisition of Starsys
            on
            January 31, 2006, which generated revenues of approximately $9.6 million
            which
            include approximately $200,000 of inter-company sales. Sales also increased
            due
            to revenues of approximately $6.4 million from our existing government
            contracts, including our contract with the Missile Defense Agency which
            generated revenues of approximately $4.9 million. For the six-months
            ended June
            30, 2006, revenue from government and government related work was approximately
            $14.1 million and revenue from commercial customers was approximately
            $1.7
            million. Our government customers include but are not limited to the
            Missile
            Defense Agency, the Air Force Research Laboratory, NASA, and the U.S.
            Army. Our
            government related work customers include but are not limited to General
            Dynamics, Northrop Grumman and Raytheon. Commercial customers include
            Lockheed
            Martin and Sumitomo. Revenue for the six-months ended June 30, 2005 primarily
            represented approximately $2.7 million of work on the second Task Order
            for the
            Missile Defense Agency contract. Small Business Innovation Research contracts
            with the Air Force Research Laboratory represented sales of approximately
            $1.0
            million in the six-months ended June 30, 2005.
 
 For
            the
            six-months ended June 30, 2006, we had costs of sales (direct and allocated
            costs associated with individual contracts) of approximately $11.6 million
            or
            73.4% of net sales, as compared to approximately $2.9 million, or 77.2%
            of net
            sales, during the same period in 2005. The increase in cost of sales
            and the
            improved gross margin percentage were both due to the higher margin contracts
            and products sold by Starsys. We continue to focus efforts on managing
            our
            growth including but not limited to recruiting new talented engineers,
            developing and acquiring project management skills and creating or expanding
            systems to assist in the efficient and effective management of our projects.
 
 We
            experienced an increase of approximately $3.5 million in operating expenses
            from
            approximately $706,000, or 19.0% of net sales, for the six-months ending
            June
            30, 2005 to approximately $4.2 million, or 26.9% of net sales, for the
            six-months ending June 30, 2006. Operating expenses include general and
            administrative expenses, research and development expenses, marketing
            and sales
            expenses, and stock option expenses under SFAS 123(R).
 
 ·
                  General
                      and administrative expenses increased approximately $2.3 million
                      from
                      approximately $392,000, or 10.6% of net sales, for the six-months
                      ending
                      June 30, 2005 to approximately $2.7 million, or 17.1% of net
                      sales, for
                      the same six-month period in 2006. This increase is attributed
                      mainly to
                      the assumption of general and administrative costs from Starsys
                      and the
                      addition of our new Chief Executive Officer. We expect to recognize
                      some
                      cost saving and efficiencies as the companies eliminate redundancies
                      in
                      certain general and administrative functions.
  ·
                  Research
                      and development expenses increased during the second quarter
                      of 2006, from
                      approximately $9,000, or 0.2% of net sales, for the six-months
                      ending June
                      30, 2005, to approximately $205,000, or 1.3% of net sales,
                      during the same
                      period in 2006. The total dollar value increased by approximately
                      $196,000, mainly due to an investment in new technologies and
                      the addition
                      of a Chief Technology Officer. Most of our scientific work
                      is performed
                      under contracts and therefore is accounted for as costs of
                      sales, rather
                      than as R&D expenses.
   Table
                of Contents
 18
 ·
                  Marketing
                      and sales expenses increased during the second quarter of 2006,
                      from
                      approximately $305,000, or 8.2% of net sales, for the six-months
                      ended
                      June 30, 2005, to approximately $1.3 million, or 8.4% of net
                      sales, during
                      the same period in 2006. The total dollar increase of approximately
                      $1.0
                      million was mainly due to costs related to bidding certain
                      large
                      proposals, including our NASA COTS proposal, during the first
                      six-months
                      of 2006 as well as absorbing a larger marketing and sales organization
                      as
                      part of the merger with Starsys.
 
 ·
                  Our
                      stock option expense is based on a calculation using the minimum
                      value
                      method as prescribed bySFAS
                      123(R), otherwise known as the Black-Scholes method. Under
                      this method, we
                      used a risk-free interest rate at the date of grant, an expected
                      volatility, an expected dividend yield and an expected life
                      of the options
                      to determine the fair value of options granted. The risk-free
                      interest
                      rate was estimated at 4.0%, expected volatility was 86.7%,
                      the dividend
                      yield was assumed to be zero, and the expected life of the
                      options was
                      assumed to be three years based on the average vesting period
                      of options
                      granted. The total expense for the six-months ended June 30,
                      2006 was
                      approximately $116,000 as compared to no expense during the
                      same period in
                      2005, as we adopted SFAS 123(R) on January 1,
                      2006.
  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. Non-operating gain and income exceeded non-operating expenses
            beginning in 2005, and since then, we have recorded non-operating income.
 
 Interest
            expense for the six-months ending June 30, 2006 and 2005 was approximately
            $11,000 and $2,000, respectively, as we incurred no interest expense
            on our
            now-expired revolving credit facility, which had a zero balance for the
            six-months ending June 30, 2006 and 2005. We generated interest income
            in the
            six-months ended June 30, 2006 and 2005 of approximately $41,000 and
            $45,000,
            respectively, due to our cash management practices.
 
 We
            recognized approximately $59,000 of the deferred gain on the 2003 sale
            of our
            Poway headquarters building during each of the six-month periods ended
            June 30,
            2006 and 2005, and we will continue to amortize the remaining deferred
            gain of
            approximately $772,000 into non-operating income over the remainder of
            the
            leaseback, which expires in January 2013.
  During
            the six-months ending June 30, 2006, we generated net income of approximately
            $43,000, or 0.3% of net sales, despite recognizing over $116,000 in non-cash
            charges related to expensing stock options under SFAS 123(R), compared
            to net
            income of approximately $212,000, or 5.7% of net sales, for the same
            six-month
            period in 2005. During the six-months ended June 30, 2006, we incurred
            a
            positive EBITDA (earnings before interest, taxes depreciation and amortization)
            of approximately $452,000, or 2.8% of net sales, compared to a EBITDA
            of
            approximately $204,000, or 5.5% of net sales, for the six-months ended
            June 30,
            2005.
 
 Table
                of Contents
 19
 
 The
            following table reconciles Earnings Before Interest, Taxes, Depreciation
            and
            Amortization (EBITDA) to net income for the six-months ended June 30,
            2006 and
            2005, respectively:
 ***For
                        the six months ending***
                    
                    
                    **June
                        30, 2006**
                    
                    
                    June
                         30, 2005**(Unaudited)**
                    
                    
                    (Unaudited)**Net
                        Income**
                    
                    ***$***
                    ***43,221***
                    
                    $
                    212,162Interest
                        Income
                    
                    
                    ***(40,752***
                    ***)***
                    
                    (44,783
                    )Interest
                        Expense
                    
                    
                    ***10,629***
                    
                    
                    1,830Non-Cash
                        Interest exp. (Debt Discount)
                    
                    
                    ***-***
                    
                    
                    28,875Gain
                        on Building Sale
                    
                    
                    ***(58,637***
                    ***)***
                    
                    (58,636
                    )Stock
                        Option Expense
                    
                    
                    ***115,693***
                    
                    
                    -Provision
                        for income taxes
                    
                    
                    ***9,235***
                    
                    
                    800Depreciation
                        and Amortization
                    
                    
                    ***372,500***
                    
                    
                    64,193**EBITDA***
                    
                    ***$***
                    ***451,889***
                    
                    *$*
                    204,441
 *
              Earnings Before Interest, Taxes, Depreciation and Amortization.
 EBITDA
            should not be considered as an alternative to net income (as an indicator
            of
            operating performance) or as an alternative to cash flow (as a measure
            of
            liquidity or ability to service debt obligations). We believe that EBITDA
            provides an important additional perspective on our operating results,
            our
            ability to service our long-term obligations, our ability to fund continuing
            growth, and our ability to continue as a going concern. Beginning in
            2003
            through the current quarter in 2006, we showed continued progress in
            total
            revenue as well as in EBITDA.
 
 Beginning
            in 2003 through the current quarter in 2006, we showed continued progress
            in
            total revenue as well as in EBITDA.
 
 Table
                of Contents
 20
 ***For
                            the three months ending***
                        
                        
                        3/31/04
                        
                        
                        6/30/04
                        
                        
                        9/30/04
                        
                        
                        12/31/04
                        
                        
                        3/31/05
                        
                        
                        **6/30/05**
                        
                        
                        **9/30/05**
                        
                        
                        **12/31/05**
                        
                        
                        **3/31/06**
                        
                        
                        **6/30/06**(Unaudited)
                        
                        
                        (Unaudited)
                        
                        
                        (Unaudited)
                        
                        
                        (Unaudited)
                        
                        
                        (Unaudited)
                        
                        
                        **(Unaudited)**
                        
                        
                        **(Unaudited)**
                        
                        
                        **(Unaudited)**
                        
                        
                        **(Unaudited)**
                        
                        
                        **(Unaudited)****Net
                            Income (Loss)**
                        
                        $
                        (442,549
                        )
                        $
                        (1,286,866
                        )
                        $
                        (602,888
                        )
                        $
                        (694,750
                        )
                        $
                        101,223
                        
                        **$**
                        **110,938**
                        
                        **$**
                        **136,251**
                        
                        **$**
                        **152,851**
                        
                        **$**
                        **7,017**
                        
                        **$**
                        **36,204**Interest
                            Income
                        
                        
                        -
                        
                        
                        -
                        
                        
                        (5,619
                        )
                        
                        (13,386
                        )
                        
                        (7,960
                        )
                        
                        **(36,824**
                        **)**
                        
                        **(24,848**
                        **)**
                        
                        **(36,208**
                        **)**
                        
                        **(33,615**
                        **)**
                        
                        **(7,137**
                        **)**Interest
                            Expense
                        
                        
                        19,788
                        
                        
                        19,736
                        
                        
                        23,110
                        
                        
                        (6,707
                        )
                        
                        1,222
                        
                        
                        **609**
                        
                        
                        **452**
                        
                        
                        **590**
                        
                        
                        **5,283**
                        
                        
                        **5,346**Non-Cash
                            Interest exp. (Debt Discount)
                        
                        
                        464,000
                        
                        
                        1,329,313
                        
                        
                        663,481
                        
                        
                        797,636
                        
                        
                        -
                        
                        
                        **28,875**
                        
                        
                        **-**
                        
                        
                        **-**
                        
                        
                        **-**
                        
                        
                        **-**Gain
                            on Building Sale
                        
                        
                        (29,318
                        )
                        
                        (29,318
                        )
                        
                        (29,318
                        )
                        
                        (29,318
                        )
                        
                        (29,318
                        )
                        
                        **(29,318**
                        **)**
                        
                        **(29,318**
                        **)**
                        
                        **(29,318**
                        **)**
                        
                        **(29,318**
                        **)**
                        
                        **(29,317**
                        **)**Stock
                            Option Expense
                        
                        
                        -
                        
                        
                        -
                        
                        
                        -
                        
                        
                        -
                        
                        
                        -
                        
                        
                        **-**
                        
                        
                        **-**
                        
                        
                        **-**
                        
                        
                        **90,701**
                        
                        
                        **24,992**Provision
                            for income taxes
                        
                        
                        -
                        
                        
                        -
                        
                        
                        -
                        
                        
                        1,600
                        
                        
                        400
                        
                        
                        **400**
                        
                        
                        **400**
                        
                        
                        **400**
                        
                        
                        **4,235**
                        
                        
                        **5,000**Depreciation
                            and Amortization
                        
                        
                        15,954
                        
                        
                        16,533
                        
                        
                        22,749
                        
                        
                        28,250
                        
                        
                        29,061
                        
                        
                        **35,077**
                        
                        
                        **44,078**
                        
                        
                        **83,708**
                        
                        
                        **147,370**
                        
                        
                        **225,130****EBITDA**
                        
                        $
                        27,874
                        
                        $
                        49,398
                        
                        $
                        71,515
                        
                        $
                        83,325
                        
                        $
                        94,628
                        
                        **$**
                        **109,758**
                        
                        **$**
                        **127,015**
                        
                        **$**
                        **172,023**
                        
                        **$**
                        **191,673**
                        
                        **$**
                        **260,218**
  Table
                of Contents
 21
 ***Three-Months
            Ended June 30, 2006 -vs.- Three-Months Ended June 30,
            2005***
 
 In
            the
            three-months ended June 30, 2006, we had our fourteenth consecutive quarter
            of
            revenue growth with net sales of approximately $8.6 million as compared
            to net
            sales of approximately $1.9 million for the same three month period in
            2005.
            Sales increased primarily due to our acquisition of Starsys on January
            31, 2006
            which has generated revenues of approximately $5.2 million. Sales also
            increased
            due to revenues of approximately $3.4 million from our existing contract
            with
            the Missile Defense Agency which generated revenues of approximately
            $2.4
            million as well as other new and ongoing government business. For the
            three-months ended June 30, 2006, revenue from government and government
            related
            work was approximately $7.6 million and revenue from commercial customers
            was
            approximately $1.0 million. Revenue for the three-months ended June 30,
            2005
            primarily represented $1.2 million of work on the second Task Order for
            the
            Missile Defense Agency contract. Small Business Innovation Research contracts
            with the Air Force Research Laboratory represented sales of approximately
            $662,000 in the three-months ending June 30, 2005.
 
 For
            the
            three-months ended June 30, 2006, we had costs of sales (direct and allocated
            costs associated with individual contracts) of approximately $6.3 million
            or
            73.3% of net sales, as compared to approximately $1.5 million, or 77.1%
            of net
            sales, during the same period in 2005. The increase in cost of sales
            and the
            improved gross margin percentage were both due to the higher margin contracts
            and products sold by Starsys. We continue to focus efforts on managing
            our
            growth including but not limited to recruiting new talented engineers,
            developing and acquiring project management skills and creating or expanding
            systems to assist in the efficient and effective management of our projects.
 
 We
            experienced an increase of approximately $1.9 million in operating expenses
            from
            approximately $361,000, or 19.0% of net sales, for the three-months ending
            June
            30, 2005 to approximately $2.3 million, or 26.5% of net sales, for the
            three-months ended June 30, 2006. Operating expenses include general
            and
            administrative expenses, research and development expenses, marketing
            and sales
            expenses, and stock option expenses under SFAS 123(R).
 
 ·
                  General
                      and administrative expenses increased approximately $1.3 million
                      from
                      approximately $201,000, or 10.6% of net sales, for the three-months
                      ending
                      June 30, 2005 to approximately $1.5 million, or 17.1% of net
                      sales, for
                      the same three-month period in 2006. This increase is attributed
                      mainly to
                      the assumption of general and administrative costs from Starsys
                      and the
                      addition of our new Chief Executive Officer. We expect to recognize
                      some
                      cost saving and efficiencies as the companies eliminate redundancies
                      in
                      certain general and administrative functions.
  ·
                  Research
                      and development expenses increased during the second quarter
                      of 2006, from
                      approximately $1,000, or 0.0% of net sales, for the three-months
                      ending
                      June 30, 2005, to approximately $123,000, or 1.4% of net sales,
                      during the
                      same period in 2006. The total dollar value increased by approximately
                      $122,000, mainly due to an investment in new technologies and
                      the addition
                      of a Chief Technology Officer.
 
 ·
                  Marketing
                      and sales expenses increased during the first quarter of 2006,
                      from
                      approximately $160,000, or 8.4% of net sales, for the three-months
                      ending
                      June 30, 2005, to approximately $691,000, or 8.0% of net sales,
                      during the
                      same period in 2006. The total dollar increase of approximately
                      $531,000
                      was mainly due to costs related to bidding certain large proposals,
                      including our NASA COTS proposal, as well as absorbing a larger
                      marketing
                      and sales organization as part of the merger with
                      Starsys.
 
 ·
                  Our
                      stock option expense is based on a calculation using the minimum
                      value
                      method as prescribed bySFAS
                      123(R), otherwise known as the Black-Scholes method. Under
                      this method, we
                      used a risk-free interest rate at the date of grant, an expected
                      volatility, an expected dividend yield and an expected life
                      of the options
                      to determine the fair value of options granted. The risk-free
                      interest
                      rate was estimated at 4.0%, expected volatility was 86.7%,
                      the dividend
                      yield was assumed to be zero, and the expected life of the
                      options was
                      assumed to be three years based on the average vesting period
                      of options
                      granted. The total expense for the three-months ended June
                      30, 2006 was
                      approximately $25,000 as compared to no expense during the
                      same period in
                      2005, as we adopted SFAS 123(R) on January 1,
                      2006.
   Table
                of Contents
 22
 
  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. Non-operating gain and income exceeded non-operating expenses
              beginning in 2005, and since then, we have recorded non-operating income.
 
 Interest
            expense for the three-months ended June 30, 2006 and 2005 was approximately
            $5,000 and $1,000, respectively, as we incurred no interest expense on
            various
            capital leases. We generated interest income in the three-months ended
            June 30,
            2006 and 2005 of approximately $7,000 and $37,000, respectively, due
            to our cash
            management practices, as our funds available for investment
            declined.
  We
            recognized approximately $29,000 of the deferred gain on 2003 the sale
            of our
            Poway headquarters building during each of the three-months ending June
            30, 2006
            and 2005, and we will continue to amortize the remaining deferred gain
            of
            approximately $772,000 into non-operating income over the remainder of
            the
            leaseback, which expires in January 2013.
 
 During
            the three-months ended June 30, 2006, we generated net income of approximately
            $36,000, or 0.4% of net sales, despite recognizing approximately $25,000
            in
            non-cash charges related to expensing stock options under SFAS 123(R),
            compared
            to net income of approximately $111,000, or 5.8% of net sales, for the
            same
            three-month period in 2005. During the three-months ended June 30, 2006,
            we
            incurred a positive EBITDA (earnings before interest taxes depreciation
            and
            amortization) of approximately $260,000, or 3.0% of net sales, compared
            to a
            EBITDA of approximately $110,000, or 5.8% of net sales, for the three-months
            ended June 30, 2005.
 
 The
            following table reconciles EBITDA to net income for the three-months
            ending June
            30, 2006 and 2005, respectively. The 2006 second quarter represents our
            eleventh
            consecutive quarter of positive EBITDA:
  ***For
                          the three months ending***
                      
                      
                      **June
                          30, 2006**
                      
                      
                      June
                          30, 2005**(Unaudited)**
                      
                      
                      (Unaudited)**Net
                          Income**
                      
                      ***$***
                      ***36,204***
                      
                      $
                      110,938Interest
                          Income
                      
                      
                      ***(7,137***
                      ***)***
                      
                      (36,823
                      )Interest
                          Expense
                      
                      
                      ***5,346***
                      
                      
                      609Non-Cash
                          Interest exp. (Debt Discount)
                      
                      
                      ***-***
                      
                      
                      28,875Gain
                          on Building Sale
                      
                      
                      ***(29,317***
                      ***)***
                      
                      (29,318
                      )Stock
                          Option Expense
                      
                      
                      ***24,992***
                      
                      
                      -Provision
                          for income taxes
                      
                      
                      ***5,000***
                      
                      
                      400Depreciation
                          and Amortization
                      
                      
                      ***225,130***
                      
                      
                      35,077**EBITDA***
                      
                      ***$***
                      ***260,218***
                      
                      $
                      109,758
 *
              Earnings Before Interest, Taxes, Depreciation and
              Amortization.
  EBITDA
            should not be considered as an alternative to net income (as an indicator
            of
            operating performance) or as an alternative to cash flow (as a measure
            of
            liquidity or ability to service debt obligations). We believe that EBITDA
            provides an important additional perspective on our operating results,
            our
            ability to service our long-term obligations, our ability to fund continuing
            growth, and our ability to continue as a going concern.
 
 Table
                of Contents
 23
 **Liquidityand
            Capital Resources**
 
 ***Cash
            Position for Six-Months Ended June 30, 2006 -vs.- Six-Months Ended June
            30,
            2005***
 
 Net
            decrease in cash during the six-months ending June 30, 2006 was approximately
            $4.5 million compared to a cash increase of $374,000 for the same six-month
            period in 2005, primarily due to the acquisition of Starsys Research
            Corporation
            and related debt repayment and transaction costs. These items were partially
            offset by the sale of our Series D-1 Preferred Stock to a small group
            of
            institutional investors in January 2006. Net cash used in operating activities
            totaled approximately $2.3 million for the six-months ended June 30,
            2006, a
            decrease of approximately $2.5 million, as compared to approximately
            $171,000
            provided by operating activities during the same six-month period in
            2005,
            primarily due to the increase in accounts receivable which we received
            upon the
            acquisition of Starsys.
 
 Net
            cash
            used in investing activities totaled approximately $2.1 million for the
            six-months ended June 30, 2006, compared to approximately $371,000 used
            in
            investing activities during the same six-month period in 2005. The increase
            in
            cash used in investing activities is primarily due to the need to provide
            working capital for the operations of Starsys, which was insolvent at
            the time
            we acquired it, as well as an increase in the purchases of fixed assets.
 
 Net
            cash
            provided by financing activities totaled approximately $40,000 for the
            six-months ended June 30, 2006, which is a decrease of approximately
            $535,000
            from the approximately $575,000 provided by financing activities during
            the same
            six-months in 2005. This is primarily attributable to the sale of our
            Series D-1
            Preferred Stock in January 2006, which was then used to fund the merger
            with
            Starsys and pay off the secured debt.
  At
            June
            30, 2006, our cash, which included cash reserves and cash available for
            investment, was approximately $1.3 million, as compared to approximately
            $5.4
            million at June 30, 2005, a decrease of approximately $4.1 million mainly
            due to
            the use of cash to fund our acquisition of Starsys in January 2006 and
            to
            provide working capital for the combined company in the first half of
            2006.
 
 As
            of
            June 30, 2006, our backlog of funded and non-funded business was approximately
            $41 million, compared to approximately $44 million as of June 30, 2005.
  As
            of
            June 30, 2006 there has been no material changes in the Company's utilization
            of
            net operating carryforwards or effective tax rate from those reported
            on the
            10KSB issued March 28, 2006.  Pursuant to Internal Revenue Code Section 382
            and 383, our use of net operating loss and credit carry forwards may
            be limited
            as a result of the cumulative changes in the ownership of more than 50%
            over a
            three year period.
 
 Our
            ability to increase cash generation from operations and thereby continue
            as a
            going concern without the need to raise additional capital depends upon
            our
            ability to ultimately implement our business plan, which includes (but
            is not
            limited to) our ability
            to effectively integrate operations with Starsys, manage the uncertainties
            in
            the government budgeting process, implement cost controls and limit the
            possibility of further cost overruns on fixed-price contracts, and generate
            substantial new revenue from customers, including but not limited to,
            the
            Missile Defense Agency.
  **CriticalAccounting
            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
            estimable (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. Professional
            fees
            are billed to customers on a time-and-materials basis, a fixed-price
            basis or a
            per-transaction basis. Time-and-materials revenues are recognized as
            services
            are performed. Deferred revenue represents amounts collected from customers
            for
            services to be provided at a future date. Research and development costs
            are
            expensed as incurred.
 
 Table
                of Contents
 24
 In
            October 1995, the Financial Accounting Standards Board (FASB) issued
            Statement
            of Financial Accounting Standards (SFAS) No. 123, *Accounting
            for Stock-Based Compensation.* We
            adopted SFAS No. 123 in 1997. Through December 31, 2005, we have elected
            to
            measure compensation expense for our stock-based employee compensation
            plans
            using the intrinsic value method prescribed by APB Opinion No. 25, *Accounting
            for Stock Issued to Employees* and
            provided pro forma disclosures as if the fair value based method prescribed
            in
            SFAS No. 123 had been utilized. (See Note 4 to our Consolidated Financial
            Statements.)
 
 SFAS
            No.
            148, *Accounting
            for Stock-Based Compensation - Transition and Disclosure* ,
            which
            amends SFAS No. 123, *Accounting
            for Stock-Based Compensation* ,
            was
            published by the FASB on December 31, 2002. The effective date of SFAS
            No. 148
            was December 15, 2002. SFAS No. 123 prescribes a "fair value" methodology
            to
            measure the cost of stock options and other equity awards. Companies
            may elect
            either to recognize fair value stock-based compensation costs in their
            financial
            statements or to disclose the pro forma impact of those costs in the
            footnotes.
            Through December 31, 2005, we had chosen the latter approach.
  In
            December 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based
            Payment* (SFAS
            123(R)), which replaces SFAS No. 123 and supersedes APB Opinion No. 25.
            SFAS
            123(R) requires all share-based payments to employees, including grants
            of
            employee stock options, to be recognized in the financial statements
            based on
            their fair values. In addition, the adoption of SFAS 123(R) requires
            additional
            accounting related to the income tax effects and additional disclosure
            regarding
            the cash flow effects resulting from share-based payment arrangements.
            SFAS
            123(R) is effective January 1, 2006 for calendar year companies. Accordingly,
            we
            implemented the revised standard in the first quarter of 2006. [See Note
            4 to
            our consolidated financial statements for additional information.]
  On
            December 20, 2005, in response to SFAS 123(R), our Board of Directors
            approved
            accelerating the vesting of all unvested stock options held by current
            employees, including executive officers, and members of the Board of
            Directors.
            The accelerated vesting was effective as of December 20, 2005.
 
 **Recent
            Accounting Pronouncements**
 There
            were no recent Accounting Pronouncements that affected the Company during
            the
            second quarter of 2006. For past pronouncements, please refer to our
            Form 10-KSB
            filed on March 28, 2006.
 
 **RiskFactors**
 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.
 
 **Risks
            Related to** **our
            Company**
 
 ***SpaceDev
            and Starsys have experienced losses from operations in prior periods
            and have
            been required to seek additional financing to support their
            businesses.***
 
 In
            prior
            years, both SpaceDev and Starsys have experienced operating losses and,
            in some
            periods, revenues from operations have not been sufficient to fund their
            respective operations. On a pro forma basis, the combined company would
            have had
            a net loss from operations of approximately $5.0 million for the year
            ended
            December 31, 2004 and $2.9 million for the year ended December 31, 2005,
            assuming the merger had occurred on January 1, 2004. The success of the
            combined
            company's business depends upon our ability to generate revenue from
            existing
            contracts, to execute programs cost-effectively, to attract and complete
            successfully additional government and commercial contracts, and 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.
 
 Table
                of Contents
 25
 ***If
            we are unable to raise capital, we may be unable to fund operating cash
            shortfalls and future growth opportunities.***
 
 In
            the
            past, both SpaceDev and Starsys have relied upon cash from financing
            activities
            to fund part of the cash requirements of their respective businesses.
            We may
            need additional financing to fund our projected operations or expansion
            plans.
            Additional financing may not be available to us on acceptable terms,
            or at all.
            Any financing may cause additional dilution to existing shareholders.
            Any debt
            financing or other issuance of securities senior to common stock likely
            will
            include financial and other covenants that will restrict our operating
            flexibility and our ability to pay dividends to common shareholders.
            SpaceDev
            has not paid dividends on its common stock in the past and does not anticipate
            paying dividends on its common stock in the foreseeable future.
 
 ***Some
            of our government contracts, including our large Missile Defense Agency
            contract, are staged and we cannot guarantee that all stages of the contracts
            will be awarded to us.***
 
 Some
            of
            our government contracts are phased contracts in which the customer may
            determine to terminate the contract between phases for any reason. Accordingly,
            the entire contract amount may not be realized by us. In the event that
            subsequent phases of some of our government contracts, including but
            not limited
            to the Missile Defense Agency contract, are not awarded to us, it could
            have a
            material adverse effect on our financial position and results of operations.
            For
            example, approximately $10 million of potentially available work under
            the
            Missile Defense Agency contract was re-routed in 2005.
 
 ***We
            provide our products and services primarily through fixed-price and cost
            plus
            fixed fee contracts. Starsys has experienced significant losses on fixed-price
            contracts. Cost overruns may result in further losses and, if significant,
            could
            impair our liquidity position.***
 
 Under
            fixed-price contracts, our customers pay us for work performed and products
            shipped without adjustment for the costs we incur in the process. Therefore,
            we
            generally bear all or a significant portion of the risk of losses as
            a result of
            increased costs on these contracts. Starsys has experienced significant
            cost
            overruns on development projects under its fixed-price contracts, resulting
            in
            estimated losses on uncompleted contracts of $2.7 million for Starsys'
            fiscal
            2004, and an additional $2.5 million for the twelve months ended December
            31,
            2005. As of December 31, 2005, based on a formal evaluation process,
            Starsys
            reserved approximately $1.5 million for potential risks on these remaining
            development projects, which has been reduced to approximately $1.0 million
            as of
            June 30, 2006. Fixed-price contracts may provide for sharing of unexpected
            costs
            incurred or savings realized within specified limits and may provide
            for
            adjustments in price depending on actual contract performance other than
            costs.
            We bear the entire risk of cost overruns in excess of the negotiated
            maximum
            amount of unexpected costs to be shared. Any significant overruns in
            the future
            could materially impair our liquidity and operations.
 
 Under *cost
            plus fixed fee contracts* ,
            we are
            reimbursed for allowable incurred costs plus a fee, which may be fixed
            or
            variable. There is no guarantee as to the amount of fee we will be awarded
            under
            a cost plus fixed fee contract with a variable fee. The price on a cost
            plus
            fixed fee reimbursable contract is based on allowable costs incurred,
            but
            generally is subject to contract funding limitations. Therefore, we could
            bear
            the amount of costs in excess of the funding limitation specified in
            the
            contract, and we may not be able to recover those cost overruns.
 
 ***If
            we fail to integrate our operations effectively, the combination of SpaceDev
            and
            Starsys will not realize all the potential benefits of the merger and
            may be
            counterproductive.***
 
 The
            integration of SpaceDev and Starsys is ongoing and may be time consuming
            and
            expensive and may disrupt the combined company's operations if it is
            not
            completed in a timely and efficient manner. If this integration effort
            is not
            successful, the combined company's results of operations could be harmed.
            In
            addition, the combined company may not achieve anticipated synergies
            or other
            benefits of the merger. The combined company may encounter difficulties,
            costs
            and delays involved in integrating their operations, including but not
            limited
            to the following:
   Table
                of Contents
 26
 ·
                  failure
                      to successfully manage relationships with customers and other
                      important
                      relationships;
 ·
                  failure
                      of customers to accept new services or to continue using the
                      products and
                      services of the combined company;
 ·
                  difficulties
                      in successfully integrating the management teams and employees
                      of the two
                      companies;
 ·
                  potential
                      incompatibility of business cultures;
 ·
                  challenges
                      encountered in managing larger, more geographically dispersed
                      operations;
 ·
                  the
                      loss of key employees;
 ·
                  diversion
                      of the attention of management from other ongoing business
                      concerns;
 ·
                  potential
                      incompatibilities of processes, technologies and systems;
                      and
 ·
                  potential
                      difficulties integrating and harmonizing financial reporting
                      systems.
 
 If
            the
            combined company's operations do not meet the expectations of existing
            customers
            of either company, these customers may reduce the amount of business
            or cease
            doing business with the combined company altogether, which would harm
            the
            results of operations and financial condition of the combined company.
 
 If
            the
            anticipated benefits of the merger are not realized or do not meet the
            expectations of financial or industry analysts, the market price of SpaceDev
            common stock may decline. This could occur if, among other reasons:
 ·
                  the
                      integration of the two companies is unsuccessful;
 ·
                  the
                      combined company does not achieve the expected benefits of
                      the merger as
                      quickly as anticipated or the costs of or operational difficulties
                      arising
                      from the merger are greater than anticipated;
 ·
                  the
                      combined company's financial results after the merger are not
                      consistent
                      with the expectations of management or financial or industry
                      analysts;
 ·
                  the
                      anticipated operating and product synergies of the merger are
                      not
                      realized;
 ·
                  the
                      combined company experiences the loss of significant customers
                      or
                      employees as a result of the merger; or
 ·
                  Starsys
                      business continues to incur major cost overruns or remains
                      unprofitable
                      for other reasons.
 
 ***If
            we fail to integrate Starsys, Inc., our new wholly owned subsidiary,
            our cash
            flow and operating results could be adversely
            affected.***
 
 We
            recently acquired Starsys, Inc., as a subsidiary of SpaceDev. Starsys
            which was
            insolvent at the time of the merger and we have begun making post-acquisition
            cash investments into Starsys. As stated previously, SpaceDev and Starsys
            have
            experienced losses from operations in prior periods, requiring that we
            seek
            additional financing to support our businesses. Our operating plans assume
            revenue and cash growth from SpaceDev and Starsys. If we are unable to
            effectively integrate our new subsidiary, or if we are unable to create
            positive
            cash flow within SpaceDev or Starsys, our cash flow and operating results
            could
            be adversely affected.
 
 ***A
            substantial portion of our net sales are generated from government contracts,
            which makes us susceptible to the uncertainties inherent in the government
            budgeting process. In addition, many of our contracts can be terminated
            by the
            customer.***
 
 Our
            concentration of government work makes us susceptible to government budget
            cuts
            and policy changes, which may impact the award of new contracts or future
            phases
            of existing contracts. Government budgets (both in general and as to
            space and
            defense projects) are subject to the prevailing political climate, which
            is
            subject to change at any time. Additionally, awarded contracts could
            be altered
            or terminated prior to the time we recognize our projected revenue. Many
            contracts are awarded in phases where future phases are not guaranteed
            to us. In
            addition, obtaining contracts and subcontracts from government agencies
            is
            challenging, and contracts often include provisions that are not standard
            in
            private commercial transactions. For example, government contracts
            may:
 
 Table
                of Contents
 27
 ·
                  include
                      provisions that allow the government agency to terminate the
                      contract
                      without penalty under some circumstances;
 ·
                  be
                      subject to purchasing decisions of agencies that are subject
                      to political
                      influence;
 ·
                  contain
                      onerous procurement procedures; and
 ·
                  be
                      subject to cancellation if government funding becomes unavailable.
 
 Securing
            government contracts can be a protracted process involving competitive
            bidding.
            In many cases, unsuccessful bidders may challenge contract awards, which
            can
            lead to increased costs, delays and possible loss of the contract for
            the
            winning bidder.
 
 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.
 
 ***SpaceDev
            common shareholders will experience dilution if our preferred stock is
            converted
            or our outstanding warrants and options are
            exercised.***
 
 As
            of
            August 10, 2006, SpaceDev is obligated to issue 9,756,751 shares of SpaceDev
            common stock if all of SpaceDev's outstanding warrants are exercised
            and shares
            of preferred stock converted.  In addition, as of August 10, 2006, SpaceDev
            has outstanding stock options to purchase an aggregate of 10,961,700
            shares of
            SpaceDev common stock, of which 10,261,700 are currently vested.  The total
            number of shares, issuable upon the exercise or conversion of currently
            vested
            warrants, options and preferred stock (20,018,451 shares) represents
            approximately 69% of SpaceDev's issued and outstanding shares of common
            stock as
            of August 10, 2006.
 
 ***Our
            historic SpaceDev business' limited operating history and lack of experience
            in
            our new or proposed lines of business make it difficult to predict our
            future
            prospects.***
 
 SpaceDev
            has a limited operating history and, as a result, our historical financial
            information is of limited value in projecting our future success in these
            markets. We launched our first microsatellite, CHIPSat, in January 2003
            and, in
            June, September and October, 2004, our hybrid rocket technology was first
            utilized in connection with SpaceShipOne. We hope to sell an increasing
            percentage of SpaceDev's products and services in commercial markets,
            but
            virtually all of SpaceDev's historical work has been from government
            contracts
            and government-related work. We recently announced our intention to enter
            the
            launch services market by providing a microsat bus, integration services,
            and a
            launch vehicle as a package. We will be dependent on the performance
            of Space
            Exploration Technologies, a small company with limited operating history
            which
            has not yet had a successful launch, for our first launch vehicle. Our
            microsatellites, nanosatellites and launch services may not achieve market
            acceptance, and our future prospects are therefore difficult to evaluate.
 
 ***We
            may not successfully or timely develop products.***
 
 Many
            of
            our products and technologies are currently 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. Our ongoing and future product
            development will depend, in part, on the ability to timely complete our
            projects
            within estimated cost parameters and ultimately deploy the product in
            a
            cost-effective manner. In addition, Starsys has contracted to execute
            development programs under fixed price contracts. Under these contracts,
            even if
            our costs begin to exceed the amount to be paid by the customer under
            the
            contract, we are required to complete the contract without receiving
            any
            additional payments from the customer. It is difficult to predict accurately
            the
            total cost of executing these programs. If the costs to complete these
            programs
            significantly exceed the payments from the customers under the contracts,
            our
            results of operations will be harmed.
   Table
                of Contents
 28
 ***The
            marketplace for our technology and products is
            uncertain.***
 
 The
            demand for our technology, products and services is uncertain and we
            may not
            obtain a sufficient market share to sustain our business or to increase
            profitability. Our business plan assumes that near-term revenues will
            be
            generated largely from government contracts for microsatellites and
            electromechanical systems for spacecraft with a long-term commercial
            market
            developing for private manned and unmanned space exploration. Microsatellites
            and commercial space exploration are still relatively new concepts, and
            it is
            difficult to predict accurately the ultimate size of the market. In addition,
            we
            are developing new product areas such as large deployable structures,
            solar
            array drives, slip rings and precision scanning assemblies for spacecraft.
            Many
            of our products and services are new and unproven, and the true level
            of
            customer demand is uncertain. Lack of significant market acceptance of
            our
            products and services, delays in such acceptance, or failure of our markets
            to
            develop or grow could negatively affect our business, financial condition,
            and
            results of operations.
 
 ***Our
            operating results could fluctuate on a quarterly and annual basis, which
            could
            cause our stock price to fluctuate or decline.***
 
 Our
            operating results may fluctuate from quarter-to-quarter and year-to-year
            for a
            variety of reasons, many of which are beyond our control. Factors that
            could
            affect our quarterly and annual operating results include those listed
            below as
            well as others listed in this "Risk Factors" section:
 ·
                  we
                      may not be awarded all stages of existing or future contracts;
 ·
                  the
                      timing of new technological advances and product announcements
                      or
                      introductions by us and our competitors;
 ·
                  changes
                      in the terms of our arrangements with customers or suppliers;
 ·
                  our
                      current reliance on a few customers for a significant portion
                      of our net
                      sales;
 ·
                  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;
 ·
                  delays
                      or failures to satisfy our obligations under our contracts
                      on a timely
                      basis;
 ·
                  the
                      failure of our products to successfully launch or operate;
 ·
                  the
                      uncertain market for our technology and products;
 ·
                  the
                      availability and cost of raw materials and components for our
                      products;
                      and
 ·
                  the
                      potential loss of or inability to hire key personnel.
 
 As
            a
            result of these factors, period-to-period comparisons of our operating
            results
            may not be meaningful, and you should not rely on them as an indication
            of our
            future performance. In addition, our operating results may fall below
            the
            expectations of public market analysts or investors. In this event, our
            stock
            price could decline significantly.
 
 ***We
            face significant competition and many of our competitors have greater
            resources
            than we do.***
 
 We
            face
            significant competition for our government and commercial contracts.
            Many of our
            competitors have greater resources than we do and may be able to devote
            greater
            resources than us to research and development and marketing. Given the
            sophistication inherent in our operations, larger competitors may have
            a
            significant advantage and may be able to more efficiently adapt and implement
            technological advances. In addition, larger and financially stronger
            corporations have advantages over us in obtaining space and defense contracts
            due to their superior marketing (lobbying) resources and the perception
            that
            they may be a better choice than smaller companies for mission-critical
            projects
            because of the higher likelihood that they will be able to continue in
            business
            for the necessary future period. Furthermore, it is possible that other
            domestic
            or foreign companies or governments, some with greater experience in
            the space
            industry and many with greater financial resources than we possess, could
            seek
            to produce products or services that compete with our products or services,
            including new mechanisms and electromechanical subsystems using new technology
            which could render our products less viable. Some of our foreign competitors
            currently benefit from, and others may benefit in the future from, subsidies
            from or other protective measures implemented by their home countries.
 
 Table
                of Contents
 29
 ***Our
            products and services may not function well under certain conditions.***
 
 Most
            of
            our products are technologically advanced and tested, but sometimes are
            not
            space qualified for performance under demanding operating conditions.
            Our
            products may not be successfully launched or operated, or perform as
            intended.
            Like most organizations that have launched satellite programs, we have
            experienced and in the future will likely experience some product and
            service
            failures, cost overruns, schedule delays, and other problems in connection
            with
            our products. Our products and services are and will continue to be subject
            to
            significant technological change and innovation. Our success will generally
            depend on our ability to continue to conceive, design, manufacture and
            market
            new products and services on a cost-effective and timely basis. We anticipate
            that we will incur significant expenses in the design and initial manufacture
            and marketing of new products and services.
 
 ***Launch
            failures or delays could have serious adverse effects on our business.***
 
 Launch
            failures or delays of our microsatellites could have serious adverse
            effects on
            our business. Microsatellite launches are subject to significant risks,
            the
            realization of which can cause disabling damage to or total loss of a
            microsatellite, as well as damage to our reputation among actual and
            potential
            customers. Delays in the launch could also adversely affect our net sales.
            Delays could be caused by a number of factors, including:
 ·
                  designing,
                      constructing, integrating, or testing the microsatellite, microsatellite
                      components, or related ground
                      systems;
 ·
                  delays
                      in receiving the license necessary to operate the microsatellite
                      systems;
 ·
                  delays
                      in obtaining the customer's payload;
 ·
                  delays
                      related to the launch vehicle;
 ·
                  weather;
                      and
 ·
                  other
                      events beyond our control.
 
 Delays
            and the perception of potential delay could negatively affect our marketing
            efforts and limit our ability to obtain new contracts and projects.
 
 ***Our
            U.S. government contracts are subject to audits that could result in
            a material
            adverse affect on our financial condition and results of operations if
            a
            material adjustment is required.***
 
 The
            accuracy and appropriateness of our direct and indirect costs and expenses
            under
            our contracts with the U.S. government are subject to extensive regulation
            and
            audit by the Defense Contract Audit Agency, by other agencies of the
            U.S.
            government or prime contractors. These entities have the right to audit
            our cost
            estimates and/or allowable cost allocations with respect to certain contracts.
            From time to time we may in the future be required to make adjustments
            and
            reimbursements as a result of these audits. Responding to governmental
            audits,
            inquiries or investigations may involve significant expense and divert
            management attention. Also, an adverse finding in any such audit, inquiry
            or
            investigation could involve contract termination, suspension, fines,
            injunctions
            or other sanctions.
 
 ***Our
            success depends on our ability to retain our key personnel. The December
            20,
            2005 acceleration of vesting all outstanding stock options, in anticipation
            of
            the January 2006 implementation of SFAS 123(R), reduced the effectiveness
            of the
            stock options as a retention device.***
 
 Our
            success will be dependent upon the efforts of key members of our management
            and
            engineering team, including our chairman and chief technology officer,
            James W.
            Benson, our chief executive officer and vice-chairman, Mark N. Sirangelo,
            our
            president and chief financial officer, Richard B. Slansky, our vice president
            of
            engineering, Frank Macklin, our vice president of programs and new business
            development, Randall K. Simpson, the managing director of SpaceDev, Scott
            Tibbitts, the president of Starsys, Inc., Robert Vacek, and certain other
            SpaceDev personnel. The loss of any of these persons, or other key employees,
            including personnel with security clearances required for classified
            work and
            highly skilled technicians and engineers, could have a material adverse
            effect
            on us. Our future success is likely to depend substantially on our continued
            ability to attract and retain highly qualified personnel. The competition
            for
            such personnel is intense, and our inability to attract and retain such
            personnel could have a material adverse effect on us. At this time we
            do not
            maintain key man life insurance on any of our key personnel.
 
 Table
                of Contents
 30
 One
            device we have historically used to enhance our ability to retain and
            incent key
            personnel is the grant of stock options which are subject to vesting.
            If the
            employee leaves us before the vesting period has been completed, the
            employee
            must forfeit a portion of the stock options. In December 2005, in order
            to avoid
            adverse financial reporting effects in future years under SFAS 123(R),
            a new
            accounting standard, we eliminated all future vesting requirements on
            all of our
            8,031,036 stock options then outstanding in the hands of employees, officers,
            and directors.
 
 ***If
            we grow but do not effectively manage the growth, our business could
            suffer as a
            result.***
 
 Even
            if
            we are successful in obtaining new business, failure to manage the growth
            could
            adversely affect our operations. We may experience extended periods of
            very
            rapid growth, which could place a significant strain on our management,
            operating, financial and other resources. Our future performance will
            depend in
            part on our ability to manage growth effectively. We must develop management
            information systems, including operating, financial, and accounting systems,
            improve project management systems and processes and expand, train, and
            manage
            our workforce to keep pace with growth. Our inability to manage growth
            effectively could negatively affect results of operations and the ability
            to
            meet obligations as they come due.
 
 ***We
            may not address successfully the problems encountered in connection
            with*** ***potential future acquisitions.***
 
 We
            expect
            to consider opportunities to acquire or make investments in other technologies,
            products and businesses that could enhance our capabilities, complement
            our
            current products or expand the breadth of our markets or customer base.
            We have
            limited experience in acquiring other businesses and technologies; the
            Starsys
            acquisition was our first major acquisition. Potential and completed
            acquisitions and strategic investments involve numerous risks,
            including:
 ·
                  problems
                      assimilating the purchased technologies, products or business
                      operations;
 ·
                  problems
                      maintaining uniform standards, procedures, controls and policies;
 ·
                  unanticipated
                      costs associated with the acquisition;
 ·
                  diversion
                      of management's attention from our core business;
 ·
                  adverse
                      effects on existing business relationships with suppliers and
                      customers;
 ·
                  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 newly adopted
                      rules and
                      regulations related to the Sarbanes-Oxley Act of
                      2002.
 
 ***If
            our key suppliers fail to perform as expected, our reputation may be
            damaged. We
            may experience delays, lose customers and experience declines in revenues,
            profitability, and cash flow.***
 
 We
            purchase a significant percentage of our product components and subassemblies
            from third parties. If our subcontractors fail to perform as expected
            or
            encounter financial difficulties, we may have difficulty replacing them
            or
            identifying qualified replacements in a timely or cost effective manner.
            As a
            result, we may experience performance delays that could result in additional
            program costs, contract termination for default or damage to our customer
            relationships which may cause our revenues, profitability and cash flow
            to
            decline. In addition, negative publicity from any failure of one of our
            products
            or sub-systems as a result of a supplier failure could damage our reputation
            and
            prevent us from winning new contracts.
 
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                of Contents
 31
 ***Our
            limited insurance may not cover all risks inherent in our
            operations.***
 
 We
            may
            find it difficult to insure certain risks involved in our operations,
            including
            our launch vehicle and satellite operations, accidental damage to high
            value
            customer hardware during the manufacturing process and damages to customer
            spacecraft caused by our products not working to specification. Insurance
            market
            conditions or factors outside of our control at the time insurance is
            purchased
            could cause premiums to be significantly higher than current estimates.
            Additionally, the U.S. Department of State has published regulations
            which could
            significantly affect the ability of brokers and underwriters to insure
            certain
            launches. These factors could cause other terms to be significantly less
            favorable than those currently available, may result in limits on amounts
            of
            coverage that we can obtain, or may prevent us from obtaining insurance
            at all.
            Furthermore, proceeds from insurance may not be sufficient to cover losses.
 
 ***Several
            years of low demand and overcapacity in the commercial satellite market
            have
            resulted in slow growth in demand for space products.***
 
 The
            commercial satellite market has experienced pricing pressures due to
            excess
            capacity in the telecommunications industry and weakened demand over
            the past
            several years. Satellite demand, and thus subsystem and component orders,
            have
            also been impacted by the business difficulties encountered by the commercial
            satellite services industry. This has resulted in a reduction in the
            total
            market size in the near term. While the market appears to be making a
            recovery,
            growth in the demand for our products may be limited.
 
 ***Our
            competitive position will be seriously damaged if we cannot protect intellectual
            property rights in our technology.***
 
 Our
            success, in part, depends on our ability to obtain and enforce intellectual
            property protection for our technology. We rely on a combination of patents,
            trade secrets and contracts to establish and protect our proprietary
            rights in
            our technology. However, we may not be able to prevent misappropriation
            of our
            intellectual property, and the agreements we enter into may not be enforceable.
            In addition, effective intellectual property protection may be
            unavailable or limited in some foreign countries.
 
 There
            is
            no guarantee any patent will be issued on any patent application that
            we have
            filed or may file. Further, any patent that we may obtain will expire,
            and it is
            possible that it may be challenged, invalidated or
            circumvented.  If we do not secure and maintain patent protection
            for our technology and products, our competitive position will be significantly
            harmed because it will be much easier for competitors to sell products
            similar
            to ours. Alternatively, a competitor may independently develop or patent
            technologies that  design around
            our  patented technology.  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 product line or develop new uses for our products, these products
            or
            uses may be outside the scope of our current patent applications, issued
            patents,  and other intellectual property rights. In addition, if we
            develop new products or enhancements to existing products, there is no
            guarantee
            that we will be able to obtain patents to protect them. Even if we do
            receive
            patents for our existing or new products, these patents may not provide
            meaningful protection. In some countries outside of the United States,
            effective
            patent protection is not available. Moreover, some countries that do
            allow
            registration of patents do not provide meaningful redress for violations
            of
            patents. As a result, protecting intellectual property in these countries
            is
            difficult and our competitors may successfully sell products in those
            countries
            that have functions and features that infringe on our intellectual property.
 
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                of Contents
 32
 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
            proprietary rights against our products or products using our technologies
            or
            other technologies used in our industry. These claims may result in our
            involvement in litigation. We may not prevail in such litigation given
            the
            complex technical issues and inherent uncertainties in intellectual property
            litigation. If any of our products were found to infringe on another
            company's
            intellectual property rights, we could be required to redesign our products
            or
            license such rights and/or pay damages or other compensation to such
            other
            company. If we were unable to redesign our products or license such intellectual
            property rights used in our products, we could be prohibited from making
            and
            selling such products.
 
 Other
            companies or entities also may commence actions seeking to establish
            the
            invalidity of our patents. In the event that one or more of our patents
            are
            challenged, a court may invalidate the patent or determine that the patent
            is
            not enforceable, which could harm our competitive position. If any of
            our key
            patents are invalidated, or if the scope of the claims in any of these
            patents
            is limited by court decision, we could be prevented from licensing the
            invalidated or limited portion of such patents. Even if such a patent
            challenge
            is not successful, it could be expensive and time consuming to address,
            divert
            management attention from our business and harm our reputation.
 
 ***We
            are subject to substantial regulation, some of which prohibits us to
            sell
            internationally. Any failure to comply with existing regulations, or
            increased
            levels of regulation, could have a material adverse effect on us.***
 Our
            business activities are subject to substantial regulation by various
            agencies
            and departments of the United States government and, in certain circumstances,
            the governments of other countries. Several government agencies, including
            NASA
            and the U.S. Air Force, maintain Export Control Offices to ensure that
            any
            disclosure of scientific and technical information complies with the
            Export
            Administration Regulations and the International Traffic in Arms Regulations,
            or
            "ITAR." Exports of our products, services and technical information require
            either Technical Assistance Agreements, manufacturing license agreements
            or
            licenses from the U.S. Department of State depending on the level of
            technology
            being transferred. This includes recently published regulations restricting
            the
            ability of U.S.-based companies to complete offshore launches, or to
            export
            certain satellite components and technical data to any country outside
            the
            United States. The export of information with respect to ground-based
            sensors,
            detectors, high-speed computers, and national security and missile technology
            items are controlled by the Department of Commerce. Failure to comply
            with the
            ITAR and/or the Commerce Department regulations may subject guilty parties
            to
            fines of up to $1 million and/or up to 10 years imprisonment per
            violation.
  In
            addition, the space industry has specific regulations with which we must
            comply.
            Command and telemetry frequency assignments for space missions are regulated
            internationally by the International Telecommunications Union, which
            we refer to
            as the ITU. In the United States, the Federal Communications Commission,
            which
            we refer to as the FCC, and the National Telecommunications Information
            Agency,
            which we refer to as NTIA, regulate command and telemetry frequency assignments.
            All launch vehicles that are launched from a launch site in the United
            States
            must pass certain launch range safety regulations that are administered
            by the
            U.S. Air Force. In addition, all commercial space launches that we would
            perform
            require a license from the Department of Transportation. Satellites that
            are
            launched must obtain approvals for command and frequency assignments.
            For
            international approvals, the FCC and NTIA obtain these approvals from
            the ITU.
            These regulations have been in place for a number of years to cover the
            large
            number of non-government commercial space missions that have been launched
            and
            put into orbit in the last 15 to 20 years. Any commercial deep space
            mission
            that we would perform would be subject to these regulations.
 
 We
            are
            also subject to laws and regulations regulating the formation, administration
            and performance of, and accounting for, U.S. government contracts. With
            respect
            to such contracts, any failure to comply with applicable laws could result
            in
            contract termination, price or fee reductions, penalties, suspension
            or
            debarment from contracting with the U.S. government.
 
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                of Contents
 33
 We
            are
            also required to obtain permits, licenses, and other authorizations under
            federal, state, local and foreign laws and regulations relating to the
            environment. Our failure to comply with applicable law or government
            regulations, including any of the above-mentioned regulations, could
            have
            serious adverse effects on our business.
 
 ***SpaceDev's
            stock price has been and may continue to be volatile, which could result
            in
            substantial losses for investors purchasing shares of our common
            stock.***
 
 The
            market prices of securities of technology-based companies like ours,
            particularly in industries (also like ours) where substantial value is
            ascribed
            to a hope for future increase in the size of the total market, are often
            highly
            volatile. The market price of 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 from
                      estimates;
 ·
                  changes
                      in estimates of our financial
                      performance;
 ·
                  changes
                      in our markets, including decreased government spending or
                      the entry of
                      new competitors;
 ·
                  our
                      inability to obtain financing necessary to operate our
                      business;
 ·
                  changes
                      in technology;
 ·
                  potential
                      loss of key personnel;
 ·
                  short
                      selling;
 ·
                  changes
                      in market valuations of similar companies and stock market
                      price;
 ·
                  the
                      Starsys merger; and
 ·
                  volume
                      fluctuations generally, including resales by former Starsys
                      stockholders
                      or by Laurus.
 
 ***Changes
            in stock option accounting rules may adversely affect our reported operating
            results prepared in accordance with generally accepted accounting principles,
            our stock price and our efforts in recruiting additional employees.***
  Technology
            companies, in general, and our company in particular, depend upon and
            use broad
            based employee stock option programs to hire, incent and retain employees
            in a
            competitive marketplace. Through fiscal 2005, we did not recognize compensation
            expense for stock options issued to employees or directors, except in
            limited
            cases involving modifications of stock options, and we instead disclosed
            in the
            notes to our financial statements information about what such charges
            would be
            if they were expensed. An accounting standard setting body adopted SFAS
            123(R),
            a new accounting standard that will require us to record equity-based
            compensation expense for stock options and employee stock purchase plan
            rights
            granted to employees based on the fair value of the equity instrument
            at the
            time of grant. We are now recording these expenses beginning with the
            first
            quarter of 2006. The change in accounting rules will lead to a decrease
            in
            reported earnings, if we have earnings, or an increased loss, if we do
            not have
            earnings. This may negatively impact our future stock price. In addition,
            this
            change in accounting rules could impact our ability to utilize broad
            based
            employee stock plans to reward employees and could result in a competitive
            disadvantage to us in the employee marketplace.
 
 ***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
            August 10, 2006, our executive officers and directors together beneficially
            owned approximately 50.16% of the issued and outstanding shares of our
            common
            stock. As a result, these persons could have the ability to exert significant
            influence over matters concerning us, including the election of directors,
            changes in the size and composition of the board of directors, and mergers
            and
            other business combinations involving us. In addition, through control
            of the
            board of directors and voting power, our officers and directors may be
            able to
            control certain decisions, including decisions regarding the qualification
            and
            appointment of officers, dividend policy, access to capital (including
            borrowing
            from third-party lenders and the issuance of additional equity securities),
            and
            the acquisition or disposition of our assets. In addition, the concentration
            of
            voting power in the hands of those individuals could have the effect
            of delaying
            or preventing a change in control of our company, even if the change
            in control
            would benefit our shareholders. A perception in the investment community
            of an
            anti-takeover environment at our company could cause investors to value
            our
            stock lower than in the absence of such a perception.
 
 Table
                of Contents
 34
 ***We
            have not paid dividends on our common stock in the past and do not anticipate
            paying dividends on our common stock in the foreseeable
            future.***
 
 We
            have
            not paid common stock dividends since our inception and do not anticipate
            paying
            dividends in the foreseeable future. Our current business plan provides
            for the
            reinvestment of earnings in an effort to complete development of our
            technologies and products, with the goal of increasing sales and long-term
            profitability and value. In addition, the terms of our preferred stock
            currently
            restrict, and any other credit or borrowing arrangements that we may
            enter into
            may in the future restrict or limit, our ability to pay common stock
            dividends
            to our shareholders.
  ***Our
            expansion into other new lines of business may divert management's attention
            from our existing operations and prove to be too
            costly.***
 
 Our
            current business plan contemplates the migration of SpaceDev's technology
            from
            projects into products for microsatellites and hybrid rocket motors over
            the
            next several years. In the meantime, we are investigating other applications
            of
            our technology and other markets for our technologies and prospective
            products.
            Our expansion into new lines of business may be difficult for us to manage
            because they may involve different disciplines and require different
            expertise
            than our core business. Consequently, this expansion may divert management's
            time and attention away from our core business, and we may need to incur
            significant expenses in order to develop the expertise, and reputation
            we
            desire. Any revenues generated by new lines of business may not be significant
            enough to offset the expenditures required to enter such business, or
            provide
            the anticipated return on investment.
 
 ***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 will be required
            to
            include management and independent registered public accounting firm
            reports on
            internal controls as part of our annual report for the year ended
            December 31, 2007 pursuant to Section 404 of the Sarbanes-Oxley Act. We are
            in the process of evaluating our control structure and processes to help
            ensure
            that we will be able to comply with Section 404 of the Sarbanes-Oxley
            Act. We
            cannot assure you that we will be able to fully comply with these laws,
            rules
            and regulations that address corporate governance, internal control reporting
            and similar matters. Failure to comply with these laws, rules and regulations
            could materially adversely affect our reputation, financial condition
            and the
            value of our securities.
 
 ***The
            terms of our outstanding shares of preferred stock, and any shares of
            preferred
            stock issued in the future, may reduce the value of your common stock.***
 
 We
            have
            authorized to issue up to 10,000,000 shares of preferred stock in one
            or more
            series. We currently have outstanding 248,460 shares of our Series C
            Convertible
            Preferred Stock and 5,075 shares of our Series D-1 Preferred Stock. Our
            board of
            directors may determine the terms of future preferred stock offerings
            without
            further action by our shareholders. If we issue additional preferred
            stock, it
            could affect your rights or reduce the value of your common stock. In
            particular, specific rights granted to future holders of preferred stock
            could
            be used to restrict our ability to merge with or sell our assets to a
            third
            party. These terms may include voting rights, preferences as to dividends
            and
            liquidation, conversion and redemption rights, and sinking fund provisions.
            Our
            Series C Preferred Stock and Series D-1 Preferred Stock rank senior to
            the
            common stock with respect to dividends and liquidation and have other
            important
            preferred rights.
 
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                of Contents
 35
 ***Because
            SpaceDev common stock is subject to the SEC's penny stock rules, broker-dealers
            may experience difficulty in completing customer transactions and trading
            activity in SpaceDev securities may be adversely affected.***
 
 Transactions
            in SpaceDev common stock are currently subject to the "penny stock" rules
            promulgated under the Securities Exchange Act of 1934. Under these rules,
            broker-dealers who recommend SpaceDev securities to persons other than
            institutional accredited investors must:
 ·
                  make
                      a special written suitability determination for the purchaser;
 ·
                  receive
                      the purchaser's written agreement to a transaction prior to
                      sale;
 ·
                  provide
                      the purchaser with risk disclosure documents which identify
                      certain risks
                      associated with investing in "penny stocks" and which describe
                      the market
                      for these "penny stocks" as well as a purchaser's legal remedies;
                      and
 ·
                  obtain
                      a signed and dated acknowledgment from the purchaser demonstrating
                      that
                      the purchaser has actually received the required risk disclosure
                      document
                      before a transaction in a "penny stock" can be completed.
 
 As
            a
            result of these rules, broker-dealers may find it difficult to effectuate
            customer transactions and trading activity in SpaceDev securities may
            be
            adversely affected. As a result, the market price of SpaceDev securities
            may be
            depressed, and you may find it more difficult to sell our
            securities.
 
 **ITEM
            3.**  **CONTROLS
            AND PROCEDURES**
 Mark
            N.
            Sirangelo, our chief executive officer, and Richard B. Slansky, our chief
            financial officer, after evaluating the effectiveness of our disclosure
            controls
            and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the
            Securities
            Exchange Act of 1934, as amended) have concluded that, as of June 30,
            2006, our
            disclosure controls and procedures are effective.
 
 There
            have been no changes in our internal control over financial reporting
            (as
            defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange
            Act of
            1934, as amended) during the quarter ended June 30, 2006 that have materially
            affected, or are reasonably likely to materially affect, our internal
            control
            over financial reporting.
 
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                of Contents
 36
  **PART
            II -- OTHER INFORMATION**
 
 **ITEM
            1.**  **LEGAL
            PROCEEDINGS**
 None.
 
 **ITEM
            2.**  **UNREGISTERED
            SALES OF EQUTIY SECURITIES AND USE OF PROCEEDS**
 
 None.
 
 **ITEM
            3.**  **DEFAULTS
            UPON SENIOR SECURITIES**
 None.
 
 **ITEM
            4.**  **SUBMISSION
            OF MATTERS TO A VOTE OF SECURITY HOLDERS**
  The
            annual meeting of the shareholders of SpaceDev, Inc. was held at 13855
            Stowe
            Drive, Poway, California 92064, on August 10, 2006, at 9:00 A.M. Out
            of a total
            of 28,877,702  shares
            outstanding on the date of record, June
            19,
            2006  shares,
            or approximately 74%, were voted in person or by proxy. The following
            proposals
            were presented and passed by the amounts indicated below:
 
 PROPOSAL
            1: To elect nine directors to hold office until the 2007 Annual Meeting
            of
            Stockholders:
  **Issue**
                  
                  **For**
                  **Against**
                  **Abstain**Sirangelo,
                      Mark
                  Total
                  21,215,854
                  -
                  166,094Benson,
                      Jim
                  Total
                  21,197,185
                  -
                  184,763Slansky,
                      Richard
                  Total
                  21,217,416
                  -
                  164,532Blake,
                      Curt
                  Total
                  21,216,854
                  -
                  165,094Estes,
                      Howell
                  Total
                  21,215,554
                  -
                  166,394Huntress,
                      Wesley
                  Total
                  21,215,454
                  -
                  166,494McClendon,
                      Scott
                  Total
                  21,214,359
                  -
                  167,589Tibbitts,
                      Scott
                  Total
                  21,203,234
                  -
                  178,714Walker,
                      Robert
                  Total
                  21,216,354
                  -
                  165,594
 
 PROPOSAL
            2: To approve the appointment of PKF, Certified Public Accountants, as
            our
            independent public accountants for the fiscal year ending December 31,
            2006:
 
 **Issue**
                  
                  **For**
                  **Against**
                  **Abstain**Accountants
                  Total
                  21,295,886
                  49,148
                  36,914
 
 
 **ITEM
            5.**  **OTHER
            INFORMATION**
  None.
   Table
                of Contents
 37
  **ITEM
            6.** **EXHIBITS** ****
 
 Exhibit
                      No.
                  Description
                  Filed
                      Herewith
                  Incorporated
                      by Reference
                  Form
                  Date
                      Filed with SEC
                  Exhibit
                      No.3.1
                  Articles
                      of Incorporation dated December 20, 1996
                  
                  X
                  10-SB
                  Jan.
                      18, 2000
                  2.13.2
                  Articles
                      of Amendment to Articles of Incorporation dated November 4,
                      1997
                  
                  X
                  10-SB
                  Jan.
                      18, 2000
                  2.23.3
                  Articles
                      of Amendment to Articles of Incorporation dated December 17,
                      1997
                  
                  X
                  10-SB
                  Jan.
                      18, 2000
                  2.33.4
                  Articles
                      of Amendment to Articles of Incorporation dated February 1,
                      2006
                  
                  X
                  10-KSB
                  Mar.
                      28, 2006
                  3.431.1
                  Rule
                      13a-14(a) certification of Chief Executive Officer
                  X31.2
                  Rule
                      13a-14(a) certification of Chief Financial Officer
                  X32.1
                  Section
                      1350/Rule 13a-14(b) certifications
                  X
 
 
 
 
 **SIGNATURES**
 
 
 In
            accordance with the requirements of the Exchange Act, the Registrant
            caused this
            report to be signed on its behalf by the undersigned thereunto duly
            authorized.
 
 **SpaceDev,
            Inc.**
 Registrant
 
 
 Dated:
            August 14, 2006  By:
            /s/ Mark N. Sirangelo
 Mark
            N.
            Sirangelo
 Chief
            Executive Officer
 
 
 
 Dated:
            August 14, 2006  By:
            /s/ Richard B. Slansky
 Richard
            B. Slansky
 President
            & Chief Financial Officer
  
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