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

                                  FORM 10-KSB/A

     |X| ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
                                   ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

   |_| TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
                                   ACT OF 1934

        FOR THE TRANSITION PERIOD FROM ______________ TO________________

                          COMMISSION FILE NO. 333-46424

                           CYBER DEFENSE SYSTEMS, INC.

                 (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)

     A FLORIDA CORPORATION                              55-0610380
     ---------------------                              ----------
     (STATE OR OTHER JURISDICTION                       (IRS EMPLOYER
     OF INCORPORATION OR ORGANIZATION)                  IDENTIFICATION NUMBER)


                            10901 ROOSEVELT BOULEVARD
                          ST. PETERSBURG, FLORIDA 33716
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                                 (727) 577-0878

                           (ISSUER'S TELEPHONE NUMBER)

    Securities registered under Section 12(b) of the Securities Exchange Act
                   of 1934, as amended ("Exchange Act"): NONE.

               Title of each class name of each exchange on which
                 registered Securities registered under Section
                           12(g) of the Exchange Act:

                CLASS A COMMON STOCK, PAR VALUE $0.001 PER SHARE.
                CLASS B COMMON STOCK, PAR VALUE $0.001 PER SHARE.
                CLASS C COMMON STOCK, PAR VALUE $0.001 PER SHARE.

    Check whether the issuer (1) filed all reports required to be filed under

Section 13 or 15(d) of the Exchange Act, during the past 12 months (or for such
shorter period that the Issuer was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. |X| Yes |_| No

<PAGE>



Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure by reference in Part
III of this Form 10-KSB or any amendment to this Form 10-KSB/A. |X| Yes |_| No

Indicate by check mark whether the registrant is a shell company (as defined in
rule 12b-2 of the Exchange Act). Yes |_| No |X|

The Issuer's revenues for the fiscal year ended December 31, 2005 were $461,244.
The aggregate market value of the voting stock held by non-affiliates of the
Issuer computed by reference to the price at which the stock was sold, or the
average bid and ask prices of such stock as of April 13, 2006, was approximately
$7,014,771.

Number of shares outstanding of Issuer's Class A common stock, $0.001 par value,
outstanding on April 17, 2006: 56,912,893.

Documents Incorporated by Reference: NONE

Transitional Small Business Disclosure Format (Check one): Yes |_|; No |X|

                                      - 2 -

<PAGE>




                                TABLE OF CONTENTS


                                     PART I

Item 1. Business ........................................................... 01
Item 2. Description of Property ............................................ 10
Item 3. Legal Proceedings .................................................. 10
Item 4. Submission of Matters to a Vote of Security Holders ................ 10

                                     PART II

Item 5. Market for Common Equity and Related Stockholder

Matters..................................................................... 11
Item 6. Management's Discussion and Analysis of Financial Condition
        or Plan of Operations............................................... 13
Item 7. Financial Statements ............................................... 17
Item 8. Changes in and Disagreements With Accountants on
        Accounting and Financial Disclosure ................................ 17
Item 8A. Controls and Procedures ........................................... 18
Item 8B. Other Information ................................................. 18

                                    PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons;
        Compliance With Section 16(a) of the Exchange Act .................. 19
Item 10. Executive Compensation ............................................ 23
Item 11. Security Ownership of Certain Beneficial Owners and
         Management and Related Stockholder Matters ........................ 24
Item 12. Certain Relationships and Related Transactions .................... 25
Item 13. Exhibits and Reports on Form 8-K .................................. 27
Item 14. Principal Accountant Fees and Services ............................ 32

Signatures ................................................................. 33

                                      - 3 -


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                                     PART I

ITEM 1. BUSINESS

Organization and Background

Cyber Defense Systems, Inc. ("Cyber Defense", the "Company", "we", "us" and
"our") was incorporated in the State of Florida on August 19, 2004 and is the
successor company of E-City Software, Inc. ("E-City"), a Nevada corporation,
pursuant to a change of domicile merger which became effective on September 1,
2004. The change of domicile merger was preceded by another merger by means of
which an entity known as On Alert Systems, Inc. ("On Alert") was also merged
into Cyber Defense. On Alert was incorporated on March 17, 2003 in the State of
Nevada and subsequently acquired a control position in our majority-owned
subsidiary, Cyber Aerospace Corp. ("Cyber Aero") in March 2004. As a result of
the foregoing, we became the successor to E-City and as of September 7, 2004 our
stock is quoted on the OTC Bulletin Board under the symbol "CYDF". On March 31,
2005, our majority owned subsidiary, Cyber Aero, was merged into the Company in
order to consolidate operations into one company, with one name, and one group
of shareholders. On September 19, 2005 we acquired all the shares of Techsphere
Systems International, Inc., ("TSI") a Georgia Corporation for 23,076,923 Class
A common shares and 245,455, or 45%, of the issued and outstanding shares of
Class B common stock.

Proxity, Inc. ("Proxity"), a publicly traded company (under the symbol "PRXT" on
the OTC:BB) and Cherokee Raiders, a partnership, ("Cherokee") respectively own
31% and 17% of the Class A common shares of the Company. Cherokee owns 300,000,
or 55% of the Class B shares, which allow for 1,000 votes per share. Cherokee
and Proxity each own one share of the two shares of Class C common stock issued
and outstanding, which have certain liquidation preference rights. As a result
of the Class B voting tights, Cherokee is the controlling shareholder of the
Company.

Overview

Cyber Defense was formed following the consolidation of several companies in
September of 2004. On Alert Systems, Inc., a security systems company, and its
subsidiary, Cyber Aerospace Corp., were both merged into the publicly traded
company E-City Software, Inc. Following a financial restructuring and a name
change, Cyber Defense Systems, Inc was born. Cyber Defense is headquartered in
St Petersburg, Florida with sales offices located near major customers
throughout North America. Additionally, the Company and its key production
partners have facilities in Georgia, Virginia and Florida.

As a result of the global war on terror that has re-defined need for security
protection both at home and abroad, Cyber Defense is focusing on developing
affordable and efficient tools and equipment. As of today our existing products
include the TSI SA 60A airship the SA 90MA and the scalable CyberBugTM a
small-unmanned air vehicle (UAV) and the developmental CyberScoutTM, M.A.R.S.TM
MAA and HAA airships. The airships and UAV's are used primarily to provide
persistent surveillance 24/7 and have been updated to include the latest
tracking devices for troop and weapon movement. These proposed airships have
unique capabilities such as the SA 60A Low Altitude Airship (LAA) with
capabilities of up to 10,000 feet, the ability to carry equipment of up to 500
lbs and the ability to fly up to 10 hours. The Mid Altitude Airship SA90MA has
specifications including remaining stationary for up to 48 hours, carrying
equipment up to 1,000 lbs, and maintaining stationary keeping at altitudes up to
20,000 feet. The U.S. Navy Naval Air Systems Command (NAVAIR) awarded a series
of technology-proof of concept contracts to CYBER. NAVAIR, along with additional
government agencies, consider the airship CYBER purchased from TSI one that
offers capabilities that are becoming an important part of the United States
Department Of Defense ("DoD") and Intelligence Agencies strategy; many of these
were tested on the first operational prototype the TSI SA 60.

Additionally, sensor and communication enhancements under development by outside
contractors are tested and ultimately fielded by Cyber Defense under joint
ventures with external strategic partners to provide a fully integrated network
from the ground to satellite.

Recent developments and early testing results for the SA 60 as a low altitude
"advertising" airship were satisfactory and have provided the Company with a new
potential source of revenue. The SA 60A has a scheduled deployment for late
2006. With less than 50 advertising airships operating in the world the
potential market could generate a reoccurring revenue stream of millions in a
very short period of time. The ability to operate at elevations of over 5000
feet and the unique shape and maneuvering characteristics give the SA 60A a
distinct market advantage.

                                      - 4 -

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Sierra Nevada Corp. ("Sierra") has the exclusive government integration rights
and the first right of refusal on all commercial airships. Currently Cyber
Defense, TSI and Sierra have been co-developing technologies that will be
utilized on both the SA 60 and SA 90 airships.

Our initial focus was to market our existing products to the DoD homeland
defense and intelligence agencies, as this is a substantial market.
Understanding our future technology needs requires on-going analysis, and Cyber
Defense is poised to address those needs. We intend to further expand into other
market segments that require enhanced security, mobile communication platforms
and increased surveillance capabilities. Examples of market segments include,
but are not limited to: industrial plants, chemical plants, nuclear sites, oil
rigs, oil pipelines, and ports.

Cyber Defense intends to provide a suite of integrated security products that
can be deployed quickly at a cost effective and secured fashion. Moreover, the
Company intends to build and develop other products and sell marketing airships
support similar to the advertisement blimps seen at sporting events, targeting
various industries and broadening its sources of income.

Management anticipates, but cannot guarantee, that existing technology developed
by Cyber Defense, along with future planned innovations, will be able to meet
these security challenges with cost effective solutions.

Nevertheless, our products represent new technology being developed by a new
enterprise with limited resources, and like any such new technology, no
assurance can be given that it will function in a cost-conscious manner, if at
all, in the uses for which it is designed. In that regard, most of our products
have not been tested in either simulated or real combat conditions.

Furthermore, we face competition from entities with far more substantial
financial and manpower resources, together with stronger access to procurement
personnel in the military and the security industries.

In addition, the opinion of Hansen, Barnett & Maxwell, the Company's Independent
Registered Public Accounting Firm, raises substantial doubt about our ability to
continue as a going concern.

The Use of Unmanned Aerial Vehicles

UAV's have been referred to in many ways: RPV's (remotely piloted vehicle),
drones, robot planes, and pilot-less aircraft. The DoD defines UAV's as powered,
aerial vehicles that do not carry to a human operator, use aerodynamic forces to
provide vehicle lift, are able to fly autonomously or be piloted remotely, can
be expendable or recoverable, with the ability to carry a lethal or non-lethal
payload. Ballistic or semi-ballistic vehicles, such as cruise missiles, and
artillery projectiles are not considered UAV's by the DoD.

UAV's differ from RPV's in that some UAV's can fly autonomously. UAV's are
either described as a single air vehicle (with associated surveillance sensors),
or a UAV System, which usually consists of three to six air vehicles, a ground
control station, and support equipment.

UAV's are thought to offer two main advantages over manned aircraft: they are
arguably cheaper to procure, and they eliminate the risk to a pilot's life.
UAV's protect the lives of pilots by performing the "3-D" missions - those that
are "dull, dirty, or dangerous" and do not require a pilot in the cockpit.
Furthermore, for those certain missions that require a very small aircraft, only
a UAV can be deployed because there is no equivalent manned system small enough
for the task.

Design and Development of the Company's UAV's

In March of 2004, Cyber Aero began assembling a team of military experts,
aeronautical, and composite engineers to design and build a new generation of
UAV's. Cyber Aero engaged Mr. James Alman, an Aeronautical Engineer with an
extensive background in experimental aerial vehicles and airline operations, to
design what came to be known as the CyberBugTM, a lightweight low-cost,
micro-mini UAV, and the CyberScoutTM, a heavier, more sophisticated UAV.

                                      - 5 -

<PAGE>

To provide the technology and know-how for the venture we determined that it
would be in the best interest of Cyber Aero to acquire certain designs,
technology, and equipment owned by Mr. Alman. Accordingly, in March of 2004,
Cyber Aero entered into an agreement (the "Original Alman Asset Purchase
Agreement") pursuant to which Cyber Aero purchased from Mr. Alman the right to
manufacture and sell UAV's designed by Mr. Alman, in consideration of a
promissory note from Cyber Aero to Mr. Alman for $100,000 due on December 5,
2005, the issuance of 1,000,000 shares of Cyber Aero's common stock, par value
$0.0001 per share, to Mr. Alman, and the undertaking to pay as a royalty to Mr.
Alman a sum of money equal to 5% of the gross invoiced selling price of each
CyberBugTM and CyberScoutTM unit sold less sales tax and commissions. On January
11, 2005, the Original Alman Asset Purchase Agreement was modified (the "Amended
Alman Asset Purchase Agreement"), so that Mr. Alman would receive as a royalty,
a sum of money equal to 5% of the gross profit of each CyberBugTM and
CyberScoutTM sold during the life of any patent covering the intellectual
property, provided, however, it did not exceed twenty (20) years from January
11, 2005, less sales taxes, shipping and commissions.

The CyberBugTM is a low cost UAV solution, affordable to local law enforcement
and the Military, providing the capability to better monitor routine
surveillance and communication in crowded or remote locations. The system
control station is based upon the Windows XP operating system allowing practical
access to any authorized user. The CYBER system provides the owner with the
ability to control the camera and UAV from areas remote to the plane. The
observer could monitor activities from a remote location from inside the US with
the ability to notify forces on the ground. Recently, the CyberBug was used in
demonstrations with the Maryland State police, Houston TX law enforcement and
Atlantic Strike II and III training exercises. The training exercise was hosted
by USCENTAF and held at Avon Park Air Force Range, FL.

The product is scalable and provides camera solution on both the small 2.6 pound
platform as well as significant cameras solutions for day and night vision on
the larger platform 14 pound platform which also has the capability to fly on
station in a programmed or manual mode for up to an hour, traveling at speeds of
30 MPH with a camera foot print of 300 x 300 depending on day or night view.

Cyber has recently completed the following two flying prototype UAV's:

o The low-cost CyberBugTM.

This scalable, unmanned aircraft is available in two versions. The smaller
CyberBugTM weighs 2.6 pounds or more depending on type of mission. The larger
CyberBugTM weighs approximately five pounds and is capable of lifting a larger
payload depending on each type of mission. On board options include, but are not
limited to, high power day and night vision capable of carrying explosive
payloads for defense and military use. In-house testing indicates that the
CyberBugTM can be assembled and launched in remote areas in approximately 30
seconds by an individual and are easily recoverable in winds up to approximately
20 MPH. We intend to include in future models an autopilot function as well as
datalink with GPS overlay.

The CyberBugTM has two basic uses: (i) short flight, which is intended for
surveillance in areas of concern when troops are in dangerous situations; and
(ii) long-term flight for the surveillance of patrol areas up to approximately
four hours. The smaller CyberBugTM is encased in a cylindrical tube which will
allow easy transport. The basic smaller CyberBugTM has a base price of
approximately $28,500.00.

o The CyberScoutTM

The CyberScout(TM) is the first in a series of planned vehicles by Cyber Defense
that employ a VTOL technique. Cyber Defense has recently completed a series of
controlled flight tests with the CyberScout, and its propulsion technology is
evolving from utilizing gas power to a planned three-turbine, jet-fueled
aircraft-less than 10 feet in overall dimensions and weighing in at under 80
pounds fully fueled with payload-which is considered unique among its peers in
the industry.

The CyberBugTM and CyberScoutTM will be marketed by Cyber Defense and we have
filed patents with the United States Patent and Trademark Office to protect
their unique features.

A competitor of Cyber Defense is attempting to develop a UAV which
replicates/copies the CyberBug(TM), and we served this organization with notice
requesting such competitor ceases and desists from its activities.

                                      - 6 -

<PAGE>

Use of Airships

The use of Airships to provide high altitude surveillance is not a new concept.
For over one hundred years, balloons have been used by battlefield commanders to
get a "big picture" perspective. However, it is anticipated that a new
generation of airship design will bring an enhanced potential to the field by
integrating advanced communications with mobile platform stability. The physical
configuration of these Airships will allow the system to remain airborne in a
set location longer than previously possible. Furthermore, in addition to
providing "hovering" ability, the engines of the new generation of Airships are
designed to rotate, allowing the ship to fly, versus float, to its station. This
design also permits the Airship to spin on its axis permitting greater mobility.

Airships have significant potential military and security applications:

o Surveillance (the military, Drug Enforcement Agency/Customs, the Coast Guard,
etc.) of movements 24 hours a day/ seven days a week in multiple environments.

o Quick replacement of obscure/destroyed technology infrastructures with
on-board wireless communication capability.

o Command and control of ground and airborne communications.

In addition, Airships have civilian applications, such as providing wireless
solutions in the growing U.S. broadband market. We believe a byproduct of this
technology will be the formation of mobile "Cell Towers" for remote locations or
overloaded systems. Used both for planned and unplanned occurrences (Super Bowl,
New Year's, and other major events), we believe that positioning one of these
Airships above a city or area of interest could provide a mobile communications
platform which would allow for cell, microwave, broadband and video technology.
High above the area of concern or service, this platform could be put into place
within three hours of an event and maintained for a long period of time to
support core systems. Although we have had discussions with several large
telecoms, no firm agreements to purchase an Airship materialized.

Competition

A number of UAV's presently exist, both domestically and internationally. Their
payload weight carrying capability, accommodations (i.e., volume, environment,
etc.), mission profile (i.e., altitude, range, duration, etc.) and their
command, control and data acquisition capabilities vary significantly.

A buildup of domestic UAV configurations, promoted by the DoD occurred in the
late 1980s and well into the 1990s. During this time, the DoD sought UAV's to
satisfy their mission unique surveillance requirements in either a Close Range,
Short Range or Endurance category of vehicle. Close Range was defined to be
within approximately 50 kilometers; Short Range was defined as within
approximately 200 kilometers and Endurance was anything beyond 200 kilometers.

With the advent of newer technology, and with the demonstrated performance of
the UAV's provided to the DoD by industry, the Close and Short Range categories
have since been combined and a later separate Shipboard category has been added.
The current classes or combinations of these type vehicles are presently called
Tactical UAV followed by the Endurance category.

Within these three categories of vehicles (LOCAL, REGIONAL, and ENDURANCE),
approximately twenty-two companies within the U.S. are or have been involved and
represent approximately 45 different UAV configurations. See UAV characteristics
chart for base platforms. Their known performance capabilities and payload
accommodations are presented below. They range in size from hand-held to much
larger vehicles with payload weight capabilities ranging from a few pounds to
approximately 2000 pounds.

UAV CHARACTERISTICS AVAILABLE

   UNMANNED AERIAL    ENDURANCE      PAYLOAD WEIGHT        ALTITUDE CAPABILITY
   VEHICLE             (HOURS)          (POUNDS)                   FEET
   -------             -------          --------                   ----
   Aerosonde           40 hrs.          2.2 lbs.                20,000 ft.
   Altus2              24 hrs.          330 lbs.                65,000 ft.
   BQM-34              1.25 hrs.        470 lbs.                60,000 ft.
   Exdrone             2.5 hr.          25 lbs                  10,000 ft.
   Global Hawk         42 hrs.          1,960 lbs.              65,000 ft.
   Gnat 750            48 hrs.          140 lbs.                25,000 ft.
   Pioneer             5.5 hrs.         75 lbs.                 12,000 ft.
   Shadow 200          4 hrs.           50 lbs.                 15,000 ft.

                                      - 7 -

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Principal competitors include, but are not limited to: AAI Corporation and its
Shadow System (developed) and Lockheed Martin, which has recently instituted a
Skunk Works project with the Jet Propulsion Laboratory (JPL). Raytheon also
recently announced a UAV Program named Bike Shop.

We do not believe either CyberBugTM and CyberScoutTM will face competition in
the near future. Large multinational companies frequently require a substantial
return on investment prior to commencing any development efforts - both
CyberBugTM and CyberScoutTM are relatively inexpensive units - and in our
opinion will likely not be able to generate the types of returns necessary for
competitors to even consider entering the market.

Design and Development of the Airships

Pursuant to the acquisition of TSI the Company benefits from TSI's exclusive
worldwide right and license to manufacture Airships which it acquired from 21st
Century Airships, Inc., a Canadian corporation ("C-21"). TSI, in turn, is under
contract with C-21 to purchase one Airship from C-21, pursuant to an Agreement
of Purchase and Sale of Airship, dated December 4, 2003, between TSI and C-21
(the "TSI/ C-21 Purchase Agreement"). Prior to the acquisition , TSI executed an
agreement providing Sierra Nevada with the exclusive integration contract for
government end users of TSI's Airships. The principals of Sierra Nevada have
substantial experience in DoD procurement, and it is anticipated by management
that they will be of great assistance in marketing Airships.

Accordingly, the amendment was undertaken to adjust the price of the AeroSphere
SA-60 which Cyber Aero had agreed to purchase, as follows: Cyber Aero allowed
TSI to sell the Airship to Sierra Nevada, and in turn, Cyber Aero was the
designated seller of the Airship. The purchase price was $2,700,000. We further
agreed to order a new 76 Airship conditioned upon the specifications being
approved by both parties. The sale of the AeroSphere SA-60 was completed;
however, the specifications of the new Airship are still under negotiations,
because, as at this date, the future needs of potential clients call for a
larger Airship to be built. TSI is currently building the new generation SA 90
which is designed to fly up to approximately 25,000 feet and stay on station up
to 2 days.

The balance due TSI by Sierra Nevada was credited to the original amount owed of
$2,200,000 with the difference credited to the new Airship. On July 15, 2004, an
additional $675,000 was paid to TSI as a security deposit for the new Airship.
In addition, as a result of this resale by Cyber Aero, Cyber Aero was relieved
of its debt obligations to each of TSI and GTRI under the Original TSI Asset
Purchase Agreement and the TSI/GTRI Research Project Agreement, respectively.

One Airship (the AeroSphere SA-60) has been field-tested on various occasions.
Although representatives of DoD were present and expressed interest in utilizing
the Airships, no purchase order has yet been received, and we are unable to
predict if one will ever be issued by DoD. There has been continued interest in
the use of Airships.

The Airships represent new technology being developed by a new enterprise with
limited resources, and like any such new technology, no assurance can be given
that it will function in a cost-conscious manner. In addition, our existing
airship has not been tested in either simulated or real combat conditions.
Moreover, we face competition from entities with far more substantial financial
and manpower resources, together with far more access to procurement personnel
in the military and the security industries.

Business Operations of Cyber Defense - Distributorships

In addition to direct sales, Cyber Defense plans on selling its line of UAV's
through agreements with exclusive and non-exclusive distributorships both in the
United States and internationally. We seek to include in our annual
distributorship agreements commitments by the dealers to purchase 10 units (two
upfront) for non-exclusive territories to purchasing as many as 100 units for
exclusive territories. Cyber Defense will provide protection for territory
owners as well as product marketing/sales training. Exclusive international
dealerships and reseller agreements will also be available.

                                      - 8 -

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Business Operations of Cyber Defense - Reseller Arena

At the time of the acquisition by On Alert of its controlling position in
E-City, it was contemplated by the management of On Alert that the E-City
computer mapping technology could be put to a different use. On Alert was
originally organized in March of 2003 to engage in the marketing of the "On
Alert Gunshot Detection System"TM ("GDS") being developed by Synchros
Technologies, Inc. ("Synchros").

As a result of the merger with On Alert into Cyber Defense, we are presently the
sub-licensee (from Proxity, Inc., a public company listed on the Pink Sheets,
LLC under the symbol, "PRXT" ("Proxity") a beneficial owner of approximately 31%
of our capital stock. Our Chief Executive Officer is also the Chief Executive
Officer of Proxity and owns or has voting control of approximately 35% of the
outstanding and issued shares of capital stock of Proxity.

The original exclusive marketing and distribution rights were obtained from
Synchros by Proxity. Proxity paid $40,000.00 to obtain the gun shot license for
a period of 15 years from Synchros, and Proxity was to receive 50% of the
profits from sales. After organizing On Alert, Proxity sub-licensed the
technology to On Alert. In consideration, (i) On Alert agreed to pay $13,900 to
Proxity and to assume all costs relating to the research and development
completed to date, and (ii) Proxity purchased 16,000,000 (and, subsequently, an
additional 2,750,000) shares of the common stock of On Alert for par value
(i.e., for a total of $18,750.00).

Cyber Defense has re-seller arrangements with Traptec Security Systems, Inc.
("Traptec"). Traptec develops systems that use acoustical and ultrasonic means
to sense and evaluate activity pertinent to law enforcement, security, and
defense industries. These systems are specifically tailored to identify the
acoustical and ultrasonic signatures of weapons discharge, bombs, explosions,
spray cans, tire leaks, intrusion sounds, and voice-initiated alarms. Once
identified, it is the intent that the system will promptly reports event details
to appropriate personnel through dynamic links to the Internet, global
positioning systems, pagers, cell phones, or other surveillance and
communications equipment.

On November 10, 2003, On Alert entered in to an agreement with Traptec (the
"Original Traptec Licensing Agreement") pursuant to which On Alert licensed to
Traptec the right to market certain technology related to gunshot detection. The
parties modified the Original Traptec Licensing Agreement to grant Cyber Defense
the right to represent Traptec as a marketing representative of Traptec to
market certain products under Traptec's distributorship agreement with World
Wide Eyes, LLC. Subsequently, the Original Traptec Licensing Agreement was
amended to extend its term and to modify the fees required to be paid by us to
Traptec.

The gun-shot technology represents new technology being developed by a new
enterprise with limited resources, and like any such new technology, no
assurance can be given that it will function in a cost-conscious manner, if at
all, in the uses for which it is designed. None of our products has been tested
in either simulated or real combat conditions.

Recent Developments

On September 19, 2005, the Company consummated a transaction (:This "Merger")
with Techsphere Systems International, Inc. ("TSI") which resulted in TSI
becoming the Company's wholly owned subsidiary. Pursuant to a plan of
reorganization and agreement of merger Cyber Acquisition Sub, Inc (the "Sub")
merged into TSI, the separate existence of Sub ceased and TSI became the
surviving corporation. In connection with the Merger, the Company issued to the
shareholders of TSI a total of 23,076,923 shares of its Class A Common Stock and
245,455 shares of its Class B Common Stock for all of the issued and outstanding
stock of TSI.

On April 1, 2005, Cyber Defense entered into a Securities Purchase Agreement
((the "SPA"), by and among Cyber Defense Systems, Inc., and AJW Partners, LLC.
("Partners"), AJW Offshore, Ltd. ("Offshore"), AJW Qualified Partners and New
Millenium Capital Partners, II, LLC ("Millenium"). Partners, Offshore, Qualified
and Millenium are collectively referred to as the "Purchasers". Under the SPA
the Company agreed to issue and sell to the Purchasers Secured Convertible Term
Notes in the aggregate principal amount of Four Million Dollars ($4,000,000).

                                      - 9 -

<PAGE>

In July, 2005 TSI amended the 21st Century Airship License agreement that
restricted the use of Airships for the purposes of commercial advertising,
sightseeing, heavy lifting or used as personal "flying (air) yachts", was
amended to remove the exclusion in Section 2 for "commercial advertising"
described in the Exclusive License Agreement, so that TSI is hereby granted the
Exclusive License to manufacture and sell or lease the Airships as described in
the Exclusive License Agreement for the purpose of "commercial advertising". It
further stated that TSI shall pay 21st Century Airships, Inc. a royalty payment
of Four Hundred Thousand Dollars ($400,000.00 USD) for each Low Altitude Airship
manufactured by TSI for the purpose of "commercial advertising". Since September
19, 2005, pursuant to the acquisition of TSI, all rights and duties have been
integrated by the Company.

ITEM 2. DESCRIPTION OF PROPERTY

Cyber Defense Systems, Inc. owns no real property. We are located at 10901
Roosevelt Boulevard Suite 100D in St. Petersburg, Florida. This facility is over
3,500 square feet and houses our corporate headquarters, R&D facilities and is
being readied for final assembly of our CyberBugTM and CyberScout product. We
currently pay rent of $3,510 per month. Techsphere rents office space in
Atlanta, GA and such lease expires in June 2006. at which point the personnel
will relocate to either new premises or will share tenancy in Columbus.
Techsphere also leases warehouse and manufacturing space in Columbus, GA for
$7,800 per month and that lease expires in August, 2006.

We believe the premises leased are adequate for our current and near term
requirements.

We do not have any investment policies with respect to investments in (i) real
estate or interests in real estate, (ii) investments in real estate mortgages
and (iii) securities of or interests in persons primarily engaged in real estate
activities.

ITEM 3. LEGAL PROCEEDINGS

We are not currently involved in any real or threatened legal proceedings.

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

There were no matters submitted for stockholders' vote during the fiscal period
covered by this report.

                                     - 10 -


<PAGE>



                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

As of April 13, 2006, there were approximately 225 record owners of our common
stock, which is traded on the OTC Bulletin Board under the symbol "CYDF". Set
forth below are the range of high and low bid quotations for the periods
indicated as reported by the OTC Bulletin Board. The market quotations reflect
interdealer prices, without retail mark-up, mark-down or commissions and may not
necessarily represent actual transactions.

                  Quarter Ending        High                   Low

                  3/31/02               $3.30                  $0.35
                  6/30/02               $0.35                  $0.04
                  9/30/02               $0.10                  $0.01
                  12/31/02              $0.01                  $0.01
                  3/31/03               $0.01                  $0.00
                  6/30/03               $0.04                  $0.01
                  9/30/03               $0.20                  $0.01
                  12/31/03              $0.15                  $0.06
                  3/31/04               $0.10                  $0.04
                  6/30/04               $0.06                  $0.02
                  9/30/04*              $0.01                  $1.81
                  12/31/04              $2.50                  $1.50
                  3/30/05               $3.65                  $2.00
                  6/30/05               $0.52                  $0.27
                  9/30/05               $0.52                  $0.22
                  12/31/05              $0.60                  $0.27
                  3/31/06               $0.60                  $0.27

      ---------


* Reverse stock split 1:30 effected on September 1, 2004.

The Company currently has no compensation plans or employee benefit plans.

                                     - 11 -

<PAGE>

Recent Sales of Unregistered Securities

On October 19, 2005, the Company issued 20,465 shares to William Robinson,
73,553 shares to Cherokee Raiders, LLC and 25,000 shares to Proxity, Inc of
Class A common stock for the extension of loans made by the respective parties
to the Company.

On October 19, 2005 the Company issued 3,000,000 shares of Class A common stock
to Cherokee Raiders, LLC for the conversion of $600,000 in loans made to the
Company. Also, the Company issued 250,000 shares of Class A common stock to
James Alman for the conversion of $50,000 in loans made to the Company.

On October 19, 2005, the Company issued 300,000 shares of Class A common stock
to Equipment Depot, Inc. for services rendered.

On October 19, 2005, the Company issued 50,000 shares of Class A common stock to
David Barnes, its CFO for services rendered.

On December 21, 2005 the Company issued a Secured Commercial Promissory Note for
$25,000 in exchange for cash received from Equipment Depot, Inc. of $25,000.

On December 31, 2005 the Company issued a Convertible Promissory Note in the
amount of $331,250 to Mayo Hadden. Also on December 31, 2005 the Company issued
Convertible Promissory Notes in the amount of $822,094 to CMG Tech. These notes
are convertible into the Company's Class A common stock at a price of $0.30 per
share.

At December 31, 2005 the Company issued Convertible Promissory Notes aggregating
$263,266 to four executive employees of the Company in lieu of deferred
salaries. The notes are convertible into the Company's Class A common stock at a
price of $0.30 per share.

At December 31, 2005 the Company issued Mr. Robinson a Convertible Promissory
Note in the amount of $460,851. The note is convertible into the Company's Class
A common stock at a price of $0.30 per share.

At December 31, 2005 the Company issued Proxity a Convertible Promissory Note in
the amount of $351,600. The note is convertible into the Company's Class A
common stock at a price of $0.30 per share.

At December 31, 2005 the Company issued Cherokee a Convertible Promissory Note
in the amount of $312,255. The note is convertible into the Company's Class A
common stock at a price of $0.30 per share. At December 31, 2005 the Company
issued James Alman a Convertible Promissory Note in the amount of $50,000. The
note is convertible into the Company's Class A common stock at a price of $0.30
per share.

At December 31, 2005 the Company issued Convertible Promissory Notes aggregating
$124,343 to Frank Lively, a director of the Company in lieu of deferred salaries
and for working capital advances made to the Company. The notes are convertible
into the Company's Class A common stock at a price of $0.30 per share.

All securities described above were issued in reliance upon the exemption set
forth of Section 4(2) of the Securities Act of 1933.

                                     - 12 -


<PAGE>

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF
OPERATIONS

General

The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and notes thereto appearing elsewhere in this
Report. In addition, at December 31, 2004 and 2005, our auditors, Hansen,
Barnett & Maxwell, the Company's Independent Registered Public Accounting Firm,
raised substantial doubt about our ability to continue as a going concern.
Notwithstanding the foregoing, subject to realization of the Millennium
financing and the financing available from Commerce Funding Corporation, if we
generate eligible receivables to finance, we will be in a position to fund the
anticipated level of operations for at least one year.

Results of Operations

General

The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and notes thereto appearing elsewhere in this
Report. In addition, at December 31,2004 and 2005, our auditors, Hansen, Barnett
& Maxwell, the Company's Independent Registered Public Accounting Firm, raised
substantial doubt about our ability to continue as a going concern.
Notwithstanding the foregoing, subject to realization of the Millennium
financing and the financing available from Commerce Funding Corporation, if we
generate eligible receivables to finance, we will be in a position to fund the
anticipated level of operations for at least one year.

Results of Operations

The Year Ended December 31, 2005 as compared to December 31, 2004

Revenues in 2005 were $461,244 in 2005 as compared to $3,026,287 in 2004. Sales
in 2005 included sales of TSI in the aggregate amount of $323,988 for which no
prior year comparable amount exists. Prior year revenues include the sale of an
airship in the amount of $2,700,000. There were no airship sales in 2005.

Cost of sales for 2005 totaled $449,995 as compared to $2,200,000 in 2004. Cost
of sales in 2005 include TSI's cost of sales in the amount of $332,447 for which
no prior year comparable amount exists. Cost of sales for 2004 consisted of the
cost related to the airship discussed above.

Research and development costs for 2005 were $691,660 and are primarily related
to development of airships and Unmanned Aircraft Vehicles, for which no prior
year comparable expense exists.

General and administrative expenses totaled $4,132,422 for the year ended
December 31, 2005 as compared to $1,090,153 for the year ended December 31,
2004, a net increase of $3,042,269. The net increase is primarily due to
$928,755 of expenses of TSI for which no prior year comparable amount exist and
salary and related expense increases of $778,974 in 2005 due to increases in
personnel and wage rates. In 2005 there was also an increase in amortization
expense related to loan costs and intangible assets in the amount of $335,983;
an increase in travel expenditures of $105,157, an increase in stock option
expense of $101,186 for which no comparable prior year expenses exist and an
increase in engineering related costs of $149,804. The Company also had
additional legal expenses of $58,671. The remainder of the increase is due to
general increases in activity in 2005 versus 2004.

The impairment of goodwill and licenses increased $4,557,877 in 2005 of which
$4,577,068 is the impairment loss related to acquisition of Cyber Aerospace in
2005. The 2004 amount of $19,192 represents the impairment loss related to the
write off of the GDS and Traptec licenses.

Interest income in 2005 totaled $4,689 for which no comparable prior year amount
exists.

Interest expense in 2005 increased $2,360,460 to $2,459,269 from $98,809 in
2004. The increase is primarily due to non cash interest expense related to the
discount on the convertible notes issued to AJW in the aggregate amount of
$1,237, 667 and the beneficial conversion feature related to three additional
convertible notes in the aggregate amount of $517,000 that were converted during
2005. In addition, a total of $180,060 was recorded as interest expense related
to the AJW Notes. Also, an aggregate of $149,166 pertains to interest expense
for TSI for which no prior year comparable expense exists. The remainder of the
increase in 2005 is attributable to higher debt levels in 2005 versus 2004.

                                     - 13 -

<PAGE>

The derivative valuation loss of $6,182,166 represents the year end valuation of
the embedded derivatives associated with the issuance of $4,000,000 of
convertible notes and warrants to purchase 4,000,000 shares of Class A common
stock issued in conjunction with the AJW funding transaction in 2005 for which
no prior year amount exists.

Legal Contingencies

We may be subject to proceedings, lawsuits and other claims, including
proceedings under laws and government regulations related to the environment,
labor, product and other matters. We are required to assess the likelihood of
any adverse judgments or outcomes to these matters, as well as potential ranges
of probable losses. A determination of the amount of reserves required, if any,
for these contingencies is based on a careful analysis of each individual issue
with the assistance of outside legal counsel. The required reserves may change
in the future due to new developments in each matter or changes in approach such
as a change in settlement strategy in dealing with these matters. On December
31, 2005, there are no outstanding legal proceedings, nor are there any reserves
established.

Liquidity and Capital Resources

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

The Company's cash and cash equivalents of $476 as of December 31, 2005 are not
sufficient to support current levels of operations for the next twelve months
and it will be necessary for the Company to seek additional financing.

Subsequent to year end, on March 15, 2006, the Company entered into a Securities
Purchase Agreement, whereby the Company agreed to issue and sell an aggregate of
$2,000,000 of 6% Callable Secured Convertible Notes and warrants to purchase
2,000,000 shares of common stock for a total offering price of $2,000,000. The
$2,000,000 is to be funded in three tranches ($1,000,000 on March 15, 2006,
$500,000 upon filing the Registration Statement and $500,000 upon effectiveness
of the Registration Statement). The Notes are convertible into common stock of
the Company at a 40% discount to market pursuant to the terms of the Secured
Convertible Note agreements. In connection with the offering, the Company will
issue an aggregate of 2,000,000 warrants to purchase Class A common stock at a
price of $1.25 per share. The warrants are exercisable for a period of five
years from the date of issuance. The conversion of the Notes is subject to an
effective Registration Statement. The Notes are secured by all of the Company's
assets, except for its accounts receivable and proceeds of inventory. In
addition, the lenders have agreed to subordinate to an institutional lender. On
March 15, 2006 the Company received $1,000,000 and issued warrants for 1,000,000
shares of common stock.

On February 16, 2005 the Company and Commerce Funding Corporation (CFC) executed
a Working Capital Financing Proposal relative to a potential secured financing
of up to $3,000,000 for a two year term. All borrowings under this financing
would be collateralized by a first security UCC-1 filing on all assets related
to accounts receivable and a Cross Corporate Guaranty by Proxity, Inc., a major
shareholder of the Company. In addition, CFC requires a Limited Guaranty of
certain provisions in the loan agreement by the Company's Chief Executive
Officer. The interest rate on borrowings would be Prime, as quoted in the Wall
Street Journal, plus 1/2 % and there will be a one time facility fee of 1% of
the total credit line payable out of the first funding. In addition, all
borrowings are subject to eligibility of accounts receivable, as defined and
determined by CFC, and the advance rate on eligible receivables, as defined, is
90% for direct Government accounts and 80% for Commercial Accounts. In March
2005, the Company was informed that it could begin to use the credit line by
submitting all the required documentation relative to the receivables to be
financed and upon approval of eligibility, funds would be transferred in
accordance with the applicable advance rate.

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

Subject to the realization of certain financings as described above and the
financing available from Commerce Funding Corporation, if we generate eligible
receivables to finance, we should be in a position to fund the anticipated level
of operations for at least one year. However, there can be no assurances that
this will be the case.

                                     - 14 -

<PAGE>

Critical Accounting Policies

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

Accounting for Income Taxes

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

Impairment of Investments

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

On March 31, 2005, the Company acquired the 6.19% minority interest in its
majority owned subsidiary, Aerospace, and merged Aerospace into Cyber Defense.
As part of the acquisition, the goodwill arising from the required purchase
accounting in the amount of $4,577,069 was impaired and recorded in the
financial statements for the year ended December 31, 2005.

The Company purchased the rights to two licensing agreements - the GDS license
on April 7, 2003 and the Traptec license on November 10, 2003 from Proxity
Digital Networks, a related party. The GDS license is an exclusive license for
the Company to sell licensed equipment throughout the world. The Traptec license
gives the Company the right to represent Traptec Corporation as a marketing
representative on the exclusive basis to sell surveillance and security
equipment and other such products to the military and other federal agencies.
The licensing agreements have been recorded at the historical cost to Proxity.
As of December 31, 2004, the Company determined that the effort and resources
required to be spent in order to utilize these licenses were more than the
Company was able to spend and, therefore, the future cash flows relating to the
ownership of the licenses would be negligible. As a result, the licenses are
considered impaired in full. The impairment loss recorded in the December 31,
2004 financial statements is $19,192.

Derivative Securities

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

                                     - 15 -

<PAGE>

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, which is
an amendment to SFAS No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This
new standard eliminates the ability to account for share-based compensation
transactions using Accounting Principles Board (APB) No. 25, Accounting for
Stock Issued to Employees (APB 25) and requires such transactions to be
accounted for using a fair-valued-based method, with the resulting cost
recognized in the Company's financial statements. This new standard is effective
for annual periods beginning after June 15, 2005. The Company will adopt this
pronouncement effective January 1, 2006 and anticipates that the impact on their
financial statements will be material due to the 11,379,900 options granted in
September, 2005 with a fair value of $2,617,377 of which 50% will vest in 2006
and the remainder in 2007.

In December 2004, the FASB issued SFAS No. 153, "Exchange of Non-monetary
Assets". SFAS No. 153 amends APB Opinion No. 29, "Accounting for Non-monetary
Transactions", to eliminate the exception for non-monetary exchanges of similar
productive assets. The Company will be required to apply this statement to
non-monetary exchanges after December 31, 2005. The adoption of this standard is
not expected to have a material effect on the Company's financial position or
results of operations.

In May 2005, FASB issued FASB Statement 154, "Accounting Changes and Error
Corrections -- a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("FAS 154"). FAS 154 changes the requirements for the accounting for and
reporting of a change in accounting principle. The provisions of FAS 154
require, unless impracticable, retrospective application to prior periods'
financial statements of (1) all voluntary changes in principles and (2) changes
required by a new accounting pronouncement, if a specific transition is not
provided. FAS 154 also requires that a change in depreciation, amortization, or
depletion method for long-lived, non-financial assets be accounted for as a
change in accounting estimate, which requires prospective application of the new
method. FAS 154 is effective for all accounting changes made in fiscal years
beginning after December 15, 2005.

In June 2005, the FASB Emerging Issues Task Force ("EITF") reached a consensus
on Issue No. 05-6, "Determining the Amortization Period for Leasehold
Improvements." The guidance requires that leasehold improvements acquired in a
business combination or purchased subsequent to the inception of a lease be
amortized over the lesser of the useful life of the assets or a term that
includes renewals that are reasonably assured at the date of the business
combination or purchase. The guidance is effective for periods beginning after
June 29, 2005. The adoption of EITF No. 05-6 is not expected to have a material
effect on the Company's financial position or results of operations.

In February 2006, the FASB issued Statement of Financial Accounting Standards
No. 155, "Accounting for Certain Hybrid Financial Instruments," referred to as
SFAS No. 155. This statement amends SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" and SFAS No. 140 "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No.
155 permits fair value remeasurement for hybrid financial instruments that
contain embedded derivatives that would require separate accounting. In
addition, the statement establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain embedded
derivatives. SFAS No. 155 is effective for all financial instruments acquired or
issued beginning after an entity's fiscal year beginning on September 15, 2006
with earlier adoption permitted. Management is evaluating the statement and does
not believe that it will have a material impact on our financial statements.

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

                                     - 16 -

<PAGE>

Forward Looking Statements

The Company is including the following cautionary statement in this Annual
Report of Form 10-KSB/A to make applicable and take advantage of the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995 for any
forward-looking statements made by, or on behalf of, the Company.
Forward-looking statements include statements concerning plans, objectives,
goals, strategies, future events or performance and underlying assumptions and
other statements which are other than statements of historical facts. Certain
statements contained herein are forward-looking statements and accordingly
involve risks and uncertainties which could cause actual results or outcomes to
differ materially from those expressed in the forward-looking statements. The
Company's expectations, beliefs and projections are expressed in good faith and
are believed by the Company to have a reasonable basis, including without
limitation, management's examination of historical operating trends, data
contained in the Company's records and other data available from third parties,
but there can be no assurance that management's expectation, beliefs or
projections will result or be achieved or accomplished. In addition to other
factors and matters discussed elsewhere herein, the following are important
factors that, in the view of the Company, could cause actual results to differ
materially from those discussed in the forward-looking statements: technological
advances by the Company's competitors, changes to regulatory requirements
relating to DoD approvals, capital needs to fund any delays or extensions of
development programs, delays in the manufacture of new and existing products by
the Company or third party contractors, the loss of any key employees, the
outcome of existing litigations, delays in obtaining federal, state or local
regulatory clearance for new installations and operations, changes in
governmental regulations, and availability of capital on terms satisfactory to
the Company. The Company disclaims any obligation to update any forward-looking
statements to reflect events or circumstances after the date hereof.

ITEM 7. FINANCIAL STATEMENTS

The Consolidated Financial Statements are included after the Exhibit Index.

                           CYBER DEFENSE SYSTEMS, INC.

                                      INDEX
      PART II.

      Report of Independent Registered Public Accounting Firm...........     F-1

      Consolidated Balance Sheets as of
      December 31, 2005 and 2004........................................     F-2

      Consolidated Statements of Operations for the Years Ended
      December 31, 2005 and December 31, 2004...........................     F-3

      Consolidated Statements of Stockholders' Deficit for the
      Years Ended December 31, 2005 and December 31, 2004...............     F-4

      Consolidated Statements of Cash Flows for the Years Ended
      December 31, 2005 and December 31, 2004...........................     F-5

      Notes to the Consolidated Financial Statements....................  F-7-25

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.


                                     - 17 -

<PAGE>

ITEM 8A. CONTROLS AND PROCEDURES

The Company's principal executive officer and principal financial officer, based
on their evaluation of the Company's disclosure controls and procedures (as
defined in Rules 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934,
as amended) as of December 31, 2005 have concluded that the Company's disclosure
controls and procedures are adequate and effective to ensure that material
information relating to the Company are recorded, processed, summarized and
reported within the time periods in which this Annual Report has been prepared.

The Company's principal executive officer and principal financial officer, have
concluded that there were no significant changes in the Company's internal
controls or in other factors that could significantly affect these controls for
the year ended December 31, 2005, the date of their most recent evaluation of
such controls, and that there were no significant deficiencies or material
weaknesses in the Company's internal controls.

ITEM 8B. OTHER INFORMATION

NONE


                                     - 18 -

<PAGE>

                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.

Directors and Executive Officers

As of April 17, 2006, the Directors and executive officers of the Company are
presented below.

NAME                                 AGE   TITLE

William C. Robinson                  50    Chairman, CEO
David Barnes                         63    CFO
James Alman                          45    Vice President and Director
Keith Vierela                        43    Director and Chief Operating Officer
Joseph A. Grace, Jr.                 47    Director
Frank Lively                         70    Director
Mike Lawson                          49    Director
Marinko Vekovic                      52    Director
Stephen I. Johnson RADM USN (ret.)   58    Director

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


The principal occupations and brief summary of the background of each Director
and executive officer of Cyber Defense during the past five years is as follows:

William C. Robinson - Founder, CEO, and Chairman of the Board of Directors

Mr. Robinson has more than 20 years experience in the public equity markets,
including management positions at Paine Webber, and Prudential Securities. Mr.
Robinson has performed as a successful start-up entrepreneur, and as a corporate
officer and director of eight public companies. He brings seasoned operational,
fund-raising, and merger and acquisition skills to the Cyber Defense team. As a
principal, he has been responsible for initiating and negotiating more than
$100,000,000 worth of merger and acquisition transactions and has developed,
bought, and sold more than 20 companies, eight of which were from inception to
full public company status. From April 2000 until October 2003, Mr. Robinson was
CEO/CFO/President of Trivia Group, Inc. From April 2001 until October 2003, Mr.
Robinson was CEO/CFO/President of Computer Support Associates, Inc. From March
2003 until April 2005, Mr. Robinson was CEO/CFO of Cyber Aero, our former
subsidiary.

In addition, prior to its merger into Cyber Defense, Mr. Robinson was the
CEO/CFO and sole Director of On Alert.

Mr. Robinson is also the CEO/CFO and Chairman of the Board of Directors of
Proxity. Proxity specializes in the deployment and integration of security
protection technology and government contract fulfillment. Trading in the Common
Stock of Proxity is reported in the inter-dealer quotation system maintained by
the National Quotation Bureau, Inc. and the Pink Sheets under the symbol "PRXT."
Mr. Robinson is also /President of the wholly owned subsidiary Techsphere
Systems International, Inc. and the General Partner of Cherokee Raiders, L.P., a
family limited partnership.

Both Proxity and Cherokee are affiliates of the Company.

David M. Barnes

Mr. Barnes was appointed as the Chief Financial Officer of Cyber in August 2005.
Mr. Barnes has also been Chief Financial Officer and a director of American
United Global Inc. (AUGB) since May 1996 and sits on the board of Searchhelp,
Inc. (SHLP) , Thinkpath Inc. (THPHF), MDWerks, Inc. (MDWK) and Roadhouse Foods,
(RHSE) and is Chairman of the Audit committee and Compensation committee of SHLP
and MDWK

                                     - 19 -

<PAGE>

Mr. Jim Alman - Founder/Vice-President/Director

Mr. Alman has a Bachelor of Science degree in Aerospace Engineering from Boston
University. Before joining Cyber Defense, He served as the Director of
Engineering for AirTran Airways and led a group of engineers in the technical
support of AirTran. Mr. Alman was responsible for directing technical matters
for the airline as well as new aircraft introduction projects. As a test
engineer for the NASA Langley Research Center, Mr. Alman designed various types
of wind tunnel research hardware. He was a team member on the Daedalus Project,
a MIT-based group that designed, built and flew three 114-foot span composite
human powered aircraft that holds three world records for human powered distance
flying.

Keith Vierela - Chief Operating Officer/Director

Mr. Vierela had over 20 years of experience in advanced technologies and
business development. He served as and Avionics Navigation Systems Specialist in
the United States Air Force, attached to the 320th Bombardment Wing of the
Strategic Air Command in Sacramento, CA. In this role, Mr. Vierela received
training on numerous Avionics Systems and Radar Systems such as: Search and
Weather Radar and Radar Beacon Systems, Instrument Landing Systems, Tactical
Navigation Systems, Radar Altimeters and IFF (Identification, Friend or Foe)
Systems. Mr. Vierela was Honorably Discharged in 1986.

Joseph A. Grace, Jr. - Founder/Director

A 1980 graduate of the United States Naval Academy. He received his MBA from the
University of New Orleans. After serving almost nine years as a nuclear
submarine officer, he left the active duty Navy to take a position with a
Fortune 500 Electronics firm in California, where he held various positions in
sales and sales management. He came home to Louisiana in November of 1994 to
become the founding President of the LTC, a technical trade association
committed to transforming the Louisiana Technology Industry. During his tenure
as President, the LTC emerged as a technology leader for Louisiana and the
Southern States. He has been actively involved in raising Millions in venture
capital funds; has participated in the start up of over 150 companies; and has
personally formed over 20 companies. He is nationally recognized for his
innovative marketing and business strategies. In Mr. Grace has remained active
as a Captain in the United States Naval Reserve. In 2001 Captain Grace assumed
the Reserve position of Special Projects officer and spokesperson for the Navy's
$8Billion enterprise rollout of the Navy Marine Corps Intranet. He has since
been fully recalled to Active Duty in support of Operation Enduring Freedom, as
the hand selected Chief Information Officer for Navy Medicine. His
responsibilities include all operational Information Management and Information
Technology in support of the Bureau of Medicine and Surgery for the Surgeon
General. He is active on many Boards and Committees and is a recognized leader
of the business community of Louisiana

Frank Lively-Director

Mr.Lively received a Bachelor of Arts Degree from the University of Richmond in
1956. He went to work for as maintenance Repair Specialist at General Electric
Co in 1956. In 1958, he became a Property Claims Adjuster for Federated Mutual
Implement and Hardware Insurance Co. In Richmond, VA. He was promoted to Claims
Supervisor in 1960. In 1967, he accepted a job to open a new office for Western
Salvage and Appraisal Co., in Atlanta, GA. Frank began as a field rep for that
company until in 1974 he was promoted to the position of Manager of the
Southeastern Region. During that period of time, from 1974 until 1980, and with
the growth of the company, there were three satellite offices opened in the
Southeastern Region.

In 1981, Frank was offered and he accepted a position with Underwriters Salvage
Co., of Chicago, as Regional Vice President. Underwriters Salvage was the
largest salvage company in the nation owned by a cartel of insurance companies.
In 1983, Frank was offered a position with Blackmon Mooring Co., as a V P of
Marketing and Sales for their catastrophe company. In 1984, M. F. Bank Co.
(formerly Western Salvage). In 1985, Mr. Lively founded the Restoration Company
(TRC), which was to be headquartered in Atlanta.

                                     - 20 -

<PAGE>

Frank served as President and CEO of TRC from 1985 until 1994 when he sold his
partnership in TRC. During that period of time, TRC grew from a start-up to
sales of $20 million and had three branch offices. The company was called to
serve the insurance industry all over the world, including Italy, the UK, Fiji
Islands, Australia, Singapore, Canada, Mexico, and others. The largest
restoration job ever in the USA was the restoration of the World Trade Center in
New York in 1993 when terrorists attacked it. Because of the company's
reputation the port authority hired TRC, immediately without the job going out
for bid. TRC with 110 supervisors worked 3,400 laborers 24 hours per day and
completed the job in 16 days.

Mike Lawson - Director

Mr. Lawson has been involved with the international aerospace community for 15
years. In 1989, Mr. Lawson founded Space Marketing, Inc., which successfully
worked with the NASA and Russian Space Agency on commercialization of space
program initiatives. SMI was responsible for creating a national promotion for
the Pepsi-Cola Company in a 1990 "Take Flight with Ideas" campaign with NASA.
Mr. Lawson also participated in President George Bush's Outreach Program to
evaluate the return to the Moon and ultimately a manned landing on Mars. Mr.
Lawson was involved with the Lunar Prospector project that landed on the Moon in
mid 1997. In 1992, Mr. Lawson's company created two International Space
Exhibits, a Space Station Tour with NASA exhibits and a full scale Lunar
Habitat. The two exhibits toured 50 cities throughout the United States and
Canada and was visited by more than 20 million people between 1992 and 1996. Mr.
Lawson was responsible for executing a contract with Pepsi-Cola to film the
first commercial in space outside the Mir Space Station. Pepsi and Mr. Lawson's
success led to other promotional space campaigns with corporations such as
Frito-Lay and MTV.

Marinko Vekovic - Director

Mr. Vekovic is the President of the management consulting company Alpha Medicals
in Irvine, California. Was Senior VP Marketing and Sales at ICN (NYSE: VRX),
President of MVC Consulting, Over ten years with Eli Lilly (NYSE: LLY) from US
to Latin America and Europe / Director of Operations Europe Middle East Africa
region /; Over 25 years of multidimensional expertise, both domestic and
international, in General management, Business development, Strategic planning,
Marketing and Sales. Experience with Global and start up companies. Managed
businesses from $3 million to $850 million. Started Companies on London Stock
Exchange and NYSE and NASDAQ. Proven record of success leading turnarounds and
high-growth operations worldwide. An MBA in General Management from IMD
-Lausanne Switzerland and B.S. in Economics from London University UK,
complement a history of outstanding results.

Rear Admiral Stephen I. Johnson, U.S. Navy (Retired) - Director

Rear Admiral Johnson's 30-year Navy career included command of the Nuclear Fast
Attack Submarine U.S. CITY OF CORPUS CHRISTI (SSN-705); service as Major
Acquisition Program Manager for Submarine Electronic Systems (PMS-401), Naval
Sea Systems Command (NAVSEA); Program Director, Information Support Systems
(PD-15), Space and Naval Warfare Systems Command (SPAWAR); and Project Director,
Navy Year 2000 Project (CNO-N6Y). Subsequent to his naval service, Admiral
Johnson has served commercial industry, government program offices, and
educational institutions as a senior management consultant. Admiral Johnson is a
Managing Director of Source Companies LLC, an investment banking and value
growth consulting company providing debt capitalization and growth advisory
services to medium-sized, closely held businesses. He is the founder of SBS
Consulting, Inc., providing strategic planning, senior program management,
subject matter expert, and sales and marketing consulting services to commercial
customers, government organizations, and educational institutions. Admiral
Johnson also serves as a Technology and Business Advisor to the William J. von
Liebig Center for Entrepreneurism and Technology Advancement at the Jacobs
School of Engineering, University of California, San Diego. Admiral Johnson is a
graduate of Duke University (Physics) and the Major Program Managers Course,
Defense Systems Management College. He is certified and served as a Department
of Defense Major Acquisition Program Manager (Level III). He resides in
Spartenburg, South Carolina

Compensation of Directors

50,000 shares of common stock as an initial award for being a Board Member,
Minimum of 1 year term that is renewable. Shares will vest 50% on the first
annual anniversary of the date hereof and the balance will vest on the second
annual anniversary thereof.

o Vesting of the one time issuance of shares immediately for existing board
only.

o $1,000 per day for Board meetings, $500 per day of travel with all reasonable
expenses related to Cyber business and travel being reimbursed by the Company.

                                     - 21 -

<PAGE>

o $175 per hour for committee time not to include the board meeting, phone
conferences or other required duties as defined by the Board or at the request
of the CEO.

o $5,000 per year to be the Chair of a committee. Each Member is a Chair of at
least one Committee.

* 500,000 options in the initial year of service for being a Board Member.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934 requires our directors,
executive officers and any person who owns more than 10% of our common stock
(the "Reporting Persons") to file with the Securities and Exchange Commission
reports of ownership and reports of changes in ownership of our common stock.
Under Securities and Exchange Commission rules, we receive copies of all Section
16(a) forms that these Reporting Persons file. We have reviewed copies of these
reports and written representations from the Reporting Persons. We believe all
Reporting Persons complied with their Section 16(a) reporting obligations during
2005.

CODE OF ETHICS

We have adopted a Code of Ethics within the meaning of Item 406(b) of Regulation
S-B. This Code of Ethics applies to our principal executive officer, our
principal financial officer and principal accounting officer, as well as all
other employees, and is filed herewith. If we make substantive amendments to
this Code of Ethics or grant any waiver, including any implicit waiver, we will
disclose the nature of such amendment or waiver on our website or in a report on
Form 8-K within five days of such amendment or waiver.

                                     - 22 -


<PAGE>

ITEM 10. EXECUTIVE COMPENSATION

The following table sets forth the aggregate cash compensation paid by the
Company to: (i) its Chief Executive Officer, Chairman and Chief Financial
Officer; and (ii) its most highly compensated officers whose cash compensation
exceeded $100,000 for services performed during the year ended December 31,
2005.

<TABLE>
<CAPTION>

                         ANNUAL COMPENSATION                                              LONG TERM COMPENSATION
                         -------------------                                              ----------------------
                                                                                    Awards                           Payouts
                                                                                    ------                           -------
                                                                           Restricted    Securities
                                                            Other Annual      Stock      Underlying
Name and Principal                                          Compensation     Award(s)      Options        LTIP        All Other
Position              Year         Salary ($)     Bonus ($)     ($)             ($)        SARs(#)     Payouts ($)  Compensation ($)
------------------    ----         ----------     --------- ------------     --------      -------     -----------  ----------------
<S>                   <C>                 <C>           <C>           <C>           <C>           <C>       <C>           <C>
                      2005          245,000             0             0       275,000     1,250,000         0             0
William Robinson      2004                0             0             0             0             0         0             0
President and CEO     2003                0             0             0             0             0         0             0


                      2005          115,000             0             0        75,000       750,000         0             0
James Alman           2004                0             0      $ 65,000             0             0         0             0
Vice-President        2003                0             0             0             0             0         0             0


                      2005           86,886             0             0        40, 000      600,000         0             0
Barry Nelsen (5)      2004                0             0      $129,000             0             0         0             0
Vice-President        2003                0             0             0             0             0         0             0

David Barnes          2005                0             0        59,000        59,000       750,000         0             0
CFO                   2004                0             0             0             0             0         0             0
                      2003                0             0             0             0             0         0             0
</TABLE>


The Company does not have any annuity, retirement, pension or deferred
compensation plan or other arrangements under which an executive officer is
entitled to participate without similar participation by other employees.

The company currently has an option plan subject to shareholder approval.

                                     - 23 -


<PAGE>

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.

As of April 14, 2006, there were (i) 56,912,893 shares of our Class A Common
Stock issued and outstanding; (ii) 545,455 shares of our Class B Common Stock
issued and outstanding; and (iii) 2 shares of our Class C Common Stock issued
and outstanding.

The following table sets forth certain information as of December 31, 2005,
regarding (i) each person known by the Company to be the beneficial owner of
more than 5% of the outstanding shares of our common stock, (ii) each director,
and named executive officer of the Company, and (iii) all officers and directors
as a group:

<TABLE>
<CAPTION>

                                                                                       Amount and Nature
                                                                                       of Beneficial           Percentage of
                                                        Position with                  Ownership of Class      Securities(1)
  Name/Address of Beneficial                            Company                        A Common Stock
  Owner*                                                                               (1)(2)
  ------------------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>                             <C>                            <C>
  William C. Robinson(3)(4)                             Chairman and CEO               10,119,018                     17.8%

  James Alman                                           Vice President and              1,325,000                      2.3%
                                                        Director

  David M. Barnes                                       Chief Financial Officer            50,000                      0.1%

  Michael Lawson                                        Director                        4,488,461                      7.9%

  Frank Lively                                          Director, Secretary             3,627,885                      6.4%
                                                         and Treasurer

  Keith Vierela                                         Director and COO                3,602,885                      6.3%

  Stephen I.                                            Director                           25,000                      0.0%
  Johnson RADM USN (ret.)

  Joseph A. Grace, Jr.                                  Director                           25,000                      0.0%

  Marinko Vekovic                                       Director                           25,000                      0.0%

  Cherokee Raiders, L.P.                                                                9,823,553                     17.3%
  5146 South Harvard Ave.
  Suite 138
  Tulsa, OK 74135

  Proxity, Inc.(4)                                                                     17,728,217                    31.1%
  1600 Canal St., Suite 1418
  New Orleans, LA 70112

  All executive officers and Directors as a                                            23,288,249                    40.8%
  group (5 persons)

</TABLE>


* Address of all holders is c/o Cyber Defense Systems, Inc., 10901 Roosevelt
Boulevard, St. Petersburg, Florida 33716.

(1) Pursuant to the rules of the Securities and Exchange Commission, a person is
deemed to "beneficially own" shares of common stock over which the person has or
shares investment or voting power, or has the right to acquire such power within
60 days. The percentage of common stock owned is calculated based on the number
of shares of common stock outstanding, plus in the case of each person the
number of shares of common stock issuable only to such person upon the exercise
of options or warrants and the conversion of convertible debt securities.

(2) 55% of the Class B Common Stock is held by Cherokee Raiders, LP (300,000
shares) and 45% is held by the prior shareholders of TSI (245,455). One each of
the 2 issued and outstanding shares of our Class C Common Stock are held by
Cherokee Raiders, LP and by Proxity.

(3) Includes all of the shares held by Cherokee Raiders, L.P., a family limited
partnership, which is controlled by Mr. Robinson.

(4) Mr. Robinson, the CEO and CFO of Proxity, and his family affiliates own and
have voting control of approximately 33% of the outstanding shares of capital
stock of Proxity.

                                     - 24 -

<PAGE>

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

As of December 31, 2003, Proxity owned 100% of the stock of On Alert. On Alert
also purchased the GDS technology and Traptec licenses from Proxity at Proxity's
cost. In addition, On Alert has accounts and notes payable to Proxity of
$184,506 and $107,011, respectively. As of December 31, 2004, the Company has
accounts payable to Proxity of $468,176, respectively. The technology was never
funded and Traptec has not continued the development process so all activities
related to this technology have been curtailed.

Cherokee's general partner is William C. Robinson. As of December 31, 2003, As
of December 31, 2004, the Company had notes payable to Cherokee in the amount of
$927,768. As of December 31, 2005 the balance owed to Cherokee was $312,254 plus
accrued interest if $185,015. Cherokee is the controlling shareholder of the
Company.

William C. Robinson has a controlling interest in Proxity and Cherokee. He is
also the CEO of the Company.

On September 19, 2005, the Company consummated a transaction with TSI which
resulted in TSI becoming the Company's wholly owned subsidiary. Pursuant to a
plan of reorganization and agreement of merger, dated September 19, 2005 Cyber
Acquisition Sub, Inc (the "Sub") merged into TSI and the separate existence of
Sub ceased, and TSI became the surviving corporation. In connection with the
Merger, the Company issued a total of 23,076,923 shares of its Class A Common
Stock and 245,455 shares of its Class B Common Stock for all of the issued and
outstanding stock of TSI. The Class B shares have 1,000 votes each.

On December 31, 2005 the Company entered into a Loan Agreement with Mr. Robinson
in the amount of $460,851. The new note bears interest at the rate of 12%, is
unsecured and convertible into the Company's Class A common stock at a price of
$0.30 per share. The notes are due on December 31, 2007 and provide for pro-rata
acceleration of payment from proceeds in excess of $7,000,000 should the Company
raise more than $7,000,000 in any kind of financing.

During the year ended December 31, 2005, Cherokee converted a $600,000 portion
of their debt to Class A common shares at the rate of $0.20 per share into
3,000,000 Class A common shares. In addition, the Company issued a Convertible
Promissory Note in the amount of $312,255 to Cherokee which replaced the two
notes outstanding at December 31, 2004. The new note bears interest at the rate
of 12%, is unsecured and convertible into the Company's Class A common stock at
a price of $0.30 per share. The notes are due on December 31, 2007 and provide
for pro-rata acceleration of payment from proceeds in excess of $7,000,000
should the Company raise more than $7,000,000 in any kind of financing. As
additional consideration for extending the due date of the loans, the Company
issued 73,553 shares of its Class A common stock valued at $102,974 to Cherokee.

During the year ended December 31, 2005, Proxity loaned the Company funds to be
used for working capital purposes which were payable on demand. The Company
issued Proxity a Convertible Promissory Note in the amount of $351,600. The note
bears interest at the rate of 12%, is unsecured and convertible into the
Company's Class A common stock at a price of $0.30 per share. The notes are due
on December 31, 2007 and have the same acceleration provision as described in
the above paragraph. As additional consideration for extending the due date of
the loan, the Company issued 25,000 shares of its Class A common stock valued at
$35,000 to Proxity.

                                     - 25 -

<PAGE>

During the year ended December 31, 2005, Jim Alman converted $50,000 of the
balance of his loan at December 31, 2004 to Class A common shares at the rate of
$0.20 per share and received 250,000 Class A common shares. In addition, the
Company issued a Convertible Promissory Note to Mr. Alman in the amount of
$50,000.The note bears interest at the rate of 12%, is unsecured and convertible
into the Company's Class A common stock at a price of $0.30 per share. The note
is due on December 31, 2007.

At December 31, 2005 the Company issued Convertible Promissory Notes aggregating
$263,266 to four executive employees of the Company in lieu of deferred
salaries. The notes bear interest at the rate of 12%, are unsecured and
convertible into the Company's Class A common stock at a price of $0.30 per
share. The notes are due on December 31, 2007.

At December 31, 2005 the Company issued Convertible Promissory Notes aggregating
$124,343 to Frank Lively, a director of the Company in lieu of deferred salaries
and for working capital advances made to the Company. The notes were subject to
a 10% loan transaction fee and bear interest at the rate of 12%, are unsecured
and convertible into the Company's Class A common stock at a price of $0.30 per
share. The notes are due on December 31, 2007.

The notes discussed above to Cherokee, Proxity, Billy Robinson, Jim Alman, the
four executive employees, and Frank Lively all provide for acceleration of
payment from amounts in excess of a minimum of $7,000,000 that are raised in any
type of financing. Such prepayments would be made on a pro rata basis among the
Noteholders.

On March 31, 2006 the Company issued an additional Convertible Promissory Note
to Mr. Lively for working capital advances in the amount of $13,056. The note
bears interest at the rate of 12% and an origination fee of 10%; is unsecured
and convertible into the Company's Class A common stock at a price of $0.30 per
share. The note is due on December 31, 2007 and provides for acceleration of
payment from amounts in excess of a minimum of $7,000,000 that are raised in any
type of financing on a pro rata basis with other Noteholders.

                                     - 26 -


<PAGE>

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

All references to the Company's Forms 8-K, 10-K, 10-QSB and 10-KSB include
reference to File No. 333-46424.

(a) Exhibits

Exhibit No.    Document
-----------    --------

3.1            Articles of Incorporation of Cyber Defense Systems, Inc.
               (incorporated by reference to Exhibit 3.1 filed with Company's
               Form 8-K on February 23, 2005 ("February 2005 Form 8-K")).

4.1(a)         $242,216.00 Corporate Promissory Note from On Alert to 9145-6442
               Quebec, Inc (incorporated by reference to Exhibit 10.8(a) filed
               with the February 2005 Form 8-K).

4.1(a)(1)      Addendum dated February 9, 2005, to the Note dated August 23,
               2004 (incorporated by reference to Exhibit 10.8(a)(1) filed with
               the February 2005 Form 8-K).

4.2            Intercreditor Agreement between On Alert, Equipment Depot, Inc.
               and 9145-6442 Quebec, Inc., dated September 21, 2004
               (incorporated by reference to Exhibit 10.8(d) filed with the
               February 2005 Form 8-K).

4.3(a)         $100,000.00 Corporate Promissory Note from On Alert (Maker) to
               Proxity (Holder) dated March 13, 2004; due on or before November
               30, 2004 (incorporated by reference to Exhibit 10.11(a) filed
               with the February 2005 Form 8-K).


4.3(b)         Re-stated $100,000.00 Corporate Promissory Note from On Alert
               (Maker) to Proxity (Holder) Originally dated March 13, 2004 due
               on or before November 30, 2004 - Now dated February 1, 2005, and
               due November 30, 2005 (incorporated by reference to Exhibit
               10.11(b) filed with the February 2005 Form 8-K).

4.4            $500,000.00 Corporate Promissory Note from Cyber Aero (Maker) to
               On Alert (Holder) dated March 10, 2004; due on or before November
               30, 2005 (incorporated by reference to Exhibit 10.12 filed with
               the February 2005 Form 8-K).

4.5            Notice of Conversion dated September 1, 2004 Cherokee (Holder)
               elects to be issued 6,750,000 shares of Common Stock of On Alert
               (Maker) in satisfaction of $400.000.00 in debt evidenced by
               Convertible Corporate Promissory Note from On Alert in the amount
               of $400,425.00 (incorporated by reference to Exhibit 10.13 filed
               with the February 2005 Form 8-K).

4.6            $400,000.00 Corporate Promissory Note from On Alert (Maker) to
               Cherokee (Holder) dated March 13, 2004 due on or before November
               30, 2004 (incorporated by reference to Exhibit 10.14 filed with
               the February 2005 Form 8-K).

4.7            $675,000.00 Corporate Promissory Note from On Alert (Maker) to
               Cherokee (Holder) dated July 15, 2004 due on or before November
               30, 2005 (incorporated by reference to Exhibit 10.15 filed with
               the February 2005 Form 8-K).

4.8            $675,000.00 Corporate Promissory Note from Cyber Aero (Maker) to
               On Alert (Holder) dated July 15, 2004 due on or before November
               30, 2005 (incorporated by reference to Exhibit 10.16 filed with
               the February 2005 Form 8-K).

4.9            $374,169.30 Corporate Promissory Note from On Alert (Maker) to
               Proxity (Holder) dated March 13, 2004 due on or before November
               30, 2004 (incorporated by reference to Exhibit 10.17 filed with
               the February 2005 Form 8-K).

                                     - 27 -

<PAGE>



4.10           Notice of Conversion dated April 12, 2003 Proxity (Holder) elects
               to be issued 18,750,000 shares of Common Stock of On Alert
               (Maker) in satisfaction of $18,750.00 in debt evidenced by
               Convertible Corporate Promissory Note from On Alert in the amount
               of $18,750.00 (incorporated by reference to Exhibit 10.18 filed
               with the February 2005 Form 8-K).

4.11           $194,200.00 Corporate Promissory Note from On Alert (Maker) to
               Cherokee (Holder) dated September 28, 2004 due on or before
               November 30, 2005 (incorporated by reference to Exhibit 10.19
               filed with the February 2005 Form 8-K).

4.12           Form of Secured Convertible Term Note issued to AJW Partners,
               LLC, dated as of April 1, 2005 (incorporated by reference to
               Exhibit 10.1 filed with the Company's Form 8-K on April 6, 2005
               (the "April 2005 Form 8-K")).

4.13           Security Agreement in favor of AJW Partners, LLC, dated as of
               April 1, 2005 (incorporated by reference to Exhibit 10.3 filed
               with the April 2005 Form 8-K).

4.14           Intellectual Property Security Agreement with AJW Partners, LLC,
               dated as of April 1, 2005 (incorporated by reference to Exhibit
               10.4 filed with the April 2005 Form 8-K).


4.15           Guaranty and Pledge Agreement in favor of AJW Partners, LLC,
               dated as of April 1, 2005 (incorporated by reference to Exhibit
               10.5 filed with the April 2005 Form 8-K).

4.16           Amended Convertible Promissory Note Issued to Joseph Theismann in
               the Amount of $117,000 due September 30, 2005.

4.17           Form of Subscription Agreement dated November 4, 2005 by and
               between the Company and Equipment Depot Inc. incorporated by
               reference to Exhibit 10.23 filed with the November 10, 2005 on a
               Form 8-K)

10.1(a)        Original Traptec Licensing Agreement between On Alert and the
               Traptec Corporation, dated November 10, 2003, with subsequent
               modifications (incorporated by reference to Exhibit 10.1(a) filed
               with the February 2005 Form 8-K).

10.1(b)        First Modification to Traptec Licensing Agreement (incorporated
               by reference to Exhibit 10.1(b) filed with the February 2005 Form
               8-K).

10.1(c)        Second Modification Traptec Licensing Agreement (incorporated by
               reference to Exhibit 10.1(c) filed with the February 2005 Form
               8-K).

10.2(a)        Asset Purchase Agreement Between Cyber Aero And James Alman,
               dated March 5, 2004 (incorporated by reference to Exhibit 10.2(a)
               filed with the February 2005 Form 8-K).

                                     - 28 -


<PAGE>


10.2(b)        Amendment dated January 11, 2005 to Alman Asset Purchase
               Agreement dated March 5, 2004 (incorporated by reference to
               Exhibit 10.2(b) filed with the February 2005 Form 8-K).

10.3           Original TSI Asset Purchase Agreement between Cyber Aero and
               Techsphere Systems International, LLC, dated as of March 10, 2004
               with addendum (incorporated by reference to Exhibit 10.3 filed
               with the February 2005 Form 8-K).

10.4           Marketing and Sales Agreement between On Alert and Techsphere
               Systems International, LLC, dated May 1, 2004 (incorporated by
               reference to Exhibit 10.4 filed with the February 2005 Form 8-K).

10.5           Modification of the Original TSI Asset Purchase Agreement between
               Cyber Aero and Techsphere Systems International, LLC, Dated June
               15, 2004 (incorporated by reference to Exhibit 10.5 filed with
               the February 2005 Form 8-K).

10.6(a)        Equipment Purchase Agreement between On Alert Systems, Inc, and
               Equipment Depot, Inc., dated as of May 31, 2004, with Addendums
               And Subordination Agreement (incorporated by reference to Exhibit
               10.6(a) filed with the February 2005 Form 8-K).

10.6(a)(1)     Addendum dated June 30, 2004, to the Equipment Purchase Agreement
               between On Alert Systems, Inc, and Equipment Depot, Inc., dated
               as of May 31, 2004 (incorporated by reference to Exhibit
               10.6(a)(1) filed with the February 2005 Form 8-K).

10.6(a)(2)     Amendment #1 of August 6, 2004 to the Addendum dated June 30,
               2004 (incorporated by reference to Exhibit 10.6(a)(2) filed with
               the February 2005 Form 8-K).

10.6(a)(3)     Addendum dated September 28, 2004, to the Equipment Purchase
               Agreement between On Alert Systems, Inc, and Equipment Depot,
               Inc., dated as of May 31, 2004 (incorporated by reference to
               Exhibit 10.6(a)(3) filed with the February 2005 Form 8-K).

10.6(a)(4)     Amendment dated February 8, 2005, to the Equipment Purchase
               Agreement between On Alert Systems, Inc, and Equipment Depot,
               Inc., dated as of May 31, 2004 (incorporated by reference to
               Exhibit 10.6(a)(4) filed with the February 2005 Form 8-K).

10.6(b)        Money Purchase Contract between On Alert Systems, Inc, and
               Equipment Depot, Inc., dated as of May 31, 2004 (incorporated by
               reference to Exhibit 10.6(b) filed with the February 2005 Form
               8-K).

10.6(b)(1)     Addendum dated July 28, 2004, to Money Purchase Contract dated
               May 31, 2004 (incorporated by reference to Exhibit 10.6(b)(1)
               filed with the February 2005 Form 8-K).

10.6(c)        Registration Rights Agreement between On Alert Systems, Inc, and
               Equipment Depot, Inc., dated as of May 31, 2004 (incorporated by
               reference to Exhibit 10.6(c) filed with the February 2005 Form
               8-K).

10.7(a)        Stock Purchase Agreement between On Alert Systems. Inc. and
               Allstars Marketing, Inc., dated as of August 19, 2004
               (incorporated by reference to Exhibit 10.7(a) filed with the
               February 2005 Form 8-K).

10.7(a)(1)     Amendment #1 dated August 30, 2004 to the Stock Purchase
               Agreement between On Alert and Allstars Marketing, Inc., dated
               August 19, 2004 (incorporated by reference to Exhibit 10.7(a)(1)
               filed with the February 2005 Form 8-K).

                                     - 29 -


<PAGE>

10.7(a)(2)     Amendment #2 dated September 28, 2004 to the Stock Purchase
               Agreement between On Alert and Cyber Defense and Allstars, dated
               as of August 19, 2004 (incorporated by reference to Exhibit
               10.7(a)(2) filed with the February 2005 Form 8-K).

10.7(a)(3)     Amendment #3 dated February 8, 2005, to the Stock Purchase
               Agreement between On Alert and Cyber Defense and Allstars, dated
               as of August 19, 2004 (incorporated by reference to Exhibit
               10.7(a)(3) filed with the February 2005 Form 8-K).

10.7(b)        Registration Rights Agreement between On Alert Systems. Inc. and
               Allstars Marketing, Inc., dated as of August 19, 2004
               (incorporated by reference to Exhibit 10.7(b) filed with the
               February 2005 Form 8-K).

10.8(a)        Assignment of Loan Proceeds (incorporated by reference to Exhibit
               10.8(a) filed with the February 2005 Form 8-K).

10.8(b)        Assignment of Funding Proceeds to Repay Loan (incorporated by
               reference to Exhibit 10.8(b) filed with the February 2005 Form
               8-K).


10.9           Plan of Merger between On Alert and Cyber Defense Systems, dated
               August 24, 2004 (incorporated by reference to Exhibit 10.9 filed
               with the February 2005 Form 8-K).

10.10          Plan of Merger between On Alert Cyber and E-City Software, Inc.,
               dated August 24, 2004 (incorporated by reference to Exhibit 10.10
               filed with the February 2005 Form 8-K).

10.20(a)       Employment Agreement between Cyber Defense and James Alman
               (incorporated by reference to Exhibit 10.20(a) filed with the
               February 2005 Form 8-K).

10.20(b)       Employment Agreement between Cyber Defense and Andrea Facchinetti
               (incorporated by reference to Exhibit 10.20(b) filed with the
               February 2005 Form 8-K).

10.20(c)       Employment Agreement between Cyber Defense and Barry Nelsen
               (incorporated by reference to Exhibit 10.20(c) filed with the
               February 2005 Form 8-K).

10.20(d)       Employment Agreement between Cyber Defense and William C.
               Robinson (incorporated by reference to Exhibit 10.20(d) filed
               with the February 2005 Form 8-K).

10.20(e)       Employment Agreement between Cyber Defense and Jaffray Stephens
               (incorporated by reference to Exhibit 10.20(e) filed with the
               February 2005 Form 8-K).

10.21          $110,000.00 Corporate Promissory Note from Cyber Defense to
               Joseph Theismann dated December 10, 2004; due on or before
               February 28, 2005 (incorporated by reference to Exhibit 10.21
               filed with the February 2005 Form 8-K).

10.22          Agreement between Cyber Defense and Cyber Aero and Brayton
               Energy, LLC, dated September 27, 2004 (incorporated by reference
               to Exhibit 10.22 filed with the February 2005 Form 8-K).

10.23          $2,000,000 Form of Subscription Agreement dated November 4, 2005
               by and between the Company and Equipment Depot Inc. (incorporated
               by reference to Exhibit 10.23 filed with the November 2005 on
               Form 8-K).

                                     - 30 -


<PAGE>

10.24          Securities Purchase Agreement, dated as of April 1, 2005, by and
               among Cyber Defense Systems, Inc. (the "Company"), and AJW
               Partners, LLC.("Partners"), AJW Offshore, Ltd. ("Offshore"), AJW
               Qualified Partners ("Qualified") and New Millenium Capital
               Partners, II, LLC ("Millenium") (incorporated by reference to
               Exhibit 10.24 filed with the March 20, 2005 on Form 8-K).


21             List of Company's subsidiaries

31.1*          Rule 13a-14(a)/15d-14(a) Certification

31.2*          Rule 13a-14(a)/15d-14(a) Certification

32.1*          Section 1350 - Certification

32.2*          Section 1350 - Certification

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


* Filed herewith.

(b) Reports on Form 8-K:

The Company filed a Current Report on Form 8-K on February 23, 2005 regarding
the execution of the $250,000 principal amount convertible note issued to
Bedlington Securities, Ltd. (the "Bedlington Note").

The Company filed a Current Report on Form 8-K on March 1, 2005 amending our
Current Report on Form 8-K filed on February 23, 2005, whereby the Bedlington
Note was repaid with the issuance of 217,391 shares of our Class A Common Stock.

The Company filed a Current Report on Form 8-K on March 3, 2005 regarding a
press release concerning the Company's participation in the Warfare in Low
Intensity Conflict Conference in Tel Aviv, Israel.

The Company filed a Current Report on Form 8-K on March 11, 2005 regarding the
payment in full of the convertible promissory note issued to Joseph Theismann,
in the amount of $117,000, with the issuance of 100,000 shares of the Company's
Class A Common Stock.

The Company filed a Current Report on Form 8-K on April 1, 2005 regarding the
acquisition of the 6.19% minority interest in Cyber Aerospace Corporation.

The Company filed a Current Report on Form 8-K on April 6, 2005 relative to the
sale of Secured Convertible Term Notes in the aggregate amount of $4,000,000 to
AJW Partners, LLP and other affiliated purchasers.

The Company filed a Current Report on Form 8-K on April 25, 2005 regarding a
Joint Venture arrangement between the Company and TSI to purchase and then lease
certain Airships.

The Company filed a Current Report on Form 8-K on May 25, 2005 regarding the
execution of an option to merge with TSI, a secured loan to TSI and a license
fee arrangement with 21st Century Airships, Inc.

                                     - 31 -

<PAGE>

The Company filed a Current Report on Form 8-K on June 6, 2005 regarding an
additional secured loan to TSI and the execution of a Promissory Note to 21st
Century Airships, Inc. in payment of license fees on behalf of TSI and the
Company.

The Company filed a Current Report on Form 8-K on August 22, 2005 relative to
the appointment of David M. Barnes as Vice President and Chief Financial Officer
of the Company.

The Company filed a Current Report on Form 8-K on September 19, 2005 regarding
the exercise of the option to acquire TSI whereby TSI became a wholly owned
subsidiary of the Company.

The Company filed a Current Report on Form 8-K on September 28, 2005 regarding
the Investrend "Spotlight Coverage" analysis of the Company.

The Company filed a Current Report on Form 8-K/A on December 7, 2005 regarding
the merger of TSI and the Company.

The Company filed a Current Report on Form 8-K on February 1, 2006 regarding the
departure of Directors or Principal Officers, the election of Directors and the
appointment of Principal Officers.

The Company filed a Current Report on Form 8-K on March 15, 2006 regarding the
Company entering into a Securities Purchase Agreement with AJW Partners, LLC,
AJW Offshore, Ltd., AJW Qualified Partners, and new Millenium Partners, II, LLC.

The Company filed a Current Report on Form 8-K on April 11, 2006 regarding a
press release about the financial results of the year ended December 31, 2005.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

     Year ended December 31,

                                          2005                          2004
                                          ----                          ----

     Audit Fees                          $ 80,560                       $78,785
     Audit Related Fees                  $ 17,633                       $     0
     Tax Fees                            $  3,500                       $     0
     Other Fees                          $      0                       $     0
     Total Fees                          $101,693                       $78,785


                                     - 32 -

<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Company has duly caused this amended report to be
signed on its behalf by the undersigned, thereunto duly authorized on the 7th
day of February, 2007.

                                   CYBER DEFENSE SYSTEMS, INC.

                                   By: /s/ William C. Robinson
                                       ----------------------------------------
                                       William C. Robinson, Chairman, CEO
                                       and Principal Executive Officer


Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this amended report has been signed by the following persons in the capacities
and on the dates indicated.

<TABLE>
<CAPTION>

        Signature                                                     Title                                   Date
        ---------                                                     -----                                   ----
<S>                                                         <C>                                         <C>
   /s/ William C. Robinson                                  Chairman, Chief Executive Officer,           February 7, 2007
   -----------------------                                  Principal Executive Officer
   William C. Robinson

   /s/ David M. Barnes                                      Chief Financial Officer                      February 7, 2007
   --------------------------------------
   David M. Barnes

   /s/ Stephen I. Johnson RADM USN (ret.)                   Director                                     February 7, 2007
   --------------------------------------
   Stephen I. Johnson RADM USN (ret.)

   /s/ Joseph A. Grace, Jr.                                 Director                                     February 7, 2007
   --------------------------------------
   Joseph A. Grace, Jr.

   /s/ Marinko Vekovic                                      Director                                     February 7, 2007
   --------------------------------------
   Marinko Vekovic

   /s/ Frank Lively                                         Director                                     February 7, 2007
   --------------------------------------
   Frank Lively

   /s/ Mike Lawson                                          Director                                     February 7, 2007
   --------------------------------------
   Mike Lawson

</TABLE>

                                     - 33 -

<PAGE>


                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY

                                      INDEX

                                                                        Page
                                                                       Number
                                                                       ------

PART II.

Report of Independent Registered Public Accounting Firm...........       F-1

Consolidated Balance Sheets as of
December 31, 2005 and 2004........................................       F-2

Consolidated Statements of Operations for the Years Ended
December 31, 2005 and December 31, 2004...........................       F-3

Consolidated Statements of Stockholders' Deficit for the Years
Ended December 31, 2005 and December 31, 2004.....................       F-4

Consolidated Statements of Cash Flows for the Years Ended
December 31, 2005 and December 31, 2004...........................       F-5

Notes to the Consolidated Financial Statements....................    F-7 - F-25

<PAGE>


[LETTERHEAD - HANSEN, BARNETT & MAXWELL]      Registered with the Public Company
                                                  Accounting Oversight Board

                                               [LOGO] an independent member of
                                                           BAKER TILLY
                                                          INTERNATIONAL

                           A Professional Corporation
                          CERTIFIED PUBLIC ACCOUNTANTS
                            5 Triad Center, Suite 750
                          Salt Lake City, UT 84180-1128
                              Phone: (801) 532-2200
                               Fax: (801) 532-7944
                                 www.hbmcpas.com


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders Cyber Defense Systems, Inc.
St. Petersburg, Florida

We have audited the consolidated balance sheets of Cyber Defense Systems, Inc.
and Subsidiary as of December 31, 2005 and 2004, and the related consolidated
statements of operations, stockholders' deficit and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Cyber Defense Systems,
Inc. and Subsidiary as of December 31, 2005 and 2004, and the results of their
operations and their cash flows for the years then ended in conformity with U.S.
generally accepted accounting principles.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. The Company had losses and
working capital deficits for 2005 and 2004. As discussed in Note 1 to the
financial statements, there is substantial doubt about the Company's ability to
continue as a going concern. Management's plans concerning these matters are
also described in Note 1. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.

                            HANSEN, BARNETT & MAXWELL

Salt Lake City, Utah
April 12, 2006

                                       F-1


<PAGE>



                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>

                                                                  DECEMBER 31,   DECEMBER 31,
                                                                      2005          2004
                                                                  -----------    -----------
                                         ASSETS
<S>                                                               <C>            <C>
CURRENT ASSETS:

 CASH AND CASH EQUIVALENTS ....................................   $       476    $   206,270
 ACCOUNT RECEIVABLE ...........................................       364,299        747,155
 INVENTORIES ..................................................       336,523             --
 PREPAID INTEREST..............................................        32,580             --
                                                                  -----------    -----------
 TOTAL CURRENT ASSETS .........................................       733,878        953,425
                                                                  -----------    -----------
OTHER ASSETS

PROPERTY AND EQUIPMENT, NET OF ACCUMULATED DEPRECIATION
  OF $10,173 AND $2,138 RESPECTIVELY ..........................        91,973          5,603
DEPOSITS ON EQUIPMENT .........................................       150,976        150,976
DEPOSITS ON AIRSHIPS ..........................................            --      1,175,000
LOAN COSTS, NET OF ACCUMULATED AMORTIZATION
OF $364,697 AND $5,292, RESPECTIVELY...........................     1,228,897         12,849
SECURITY DEPOSITS .............................................         7,371          7,156
AIRSHIP MANUFACTURING LICENSE, NET OF ACCUMULATED
AMORTIZATION OF $230,993  .....................................    14,024,656             --
INTANGIBLE ASSETS, NET OF ACCUMULATED AMORTIZATION
OF $61,113 AND $27,777, RESPECTIVELY .........................         38,887        506,252

                                                                  -----------    -----------
TOTAL ASSETS ..................................................   $16,276,638    $ 2,811,261
                                                                  ===========    ===========

                         LIABILITIES AND SHAREHOLDERS' DEFICIT

CURRENT LIABILITIES:

ACCOUNTS PAYABLE AND ACCRUED LIABILITIES.......................   $ 2,996,827    $ 1,319,772
ACCRUED INTEREST ..............................................       329,626             --
ACCOUNTS PAYABLE - RELATED PARTIES ............................        53,337        468,176
DEFERRED REVENUE ..............................................       450,000             --
ASSUMED DEBT OF SUBSIDIARY ....................................            --         33,337
NOTES PAYABLE - RELATED PARTIES ...............................     1,562,315      1,137,768
NOTES PAYABLE - UNRELATED PARTIES .............................     1,728,075        242,216
EMBEDDED DERIVATIVE LIABILITY..................................    10,057,733             --
                                                                  -----------    -----------
TOTAL CURRENT LIABILITIES .....................................   $17,177,913    $ 3,201,269
                                                                  -----------    -----------
LONG-TERM NOTES PAYABLE NET OF DISCOUNT OF $2,762,333..........       655,358             --
DEFERRED TAXES ................................................       217,325             --
                                                                  -----------    -----------
TOTAL LIABILITIES .............................................    18,050,596      3,201,269
                                                                  -----------    -----------
MINORITY INTEREST IN CYBER AEROSPACE, CORP. (6.2% in 2004).....            --         26,581

COMMITMENTS AND CONTINGENCIES

SHAREHOLDERS' DEFICIT:

CLASS A PREFERRED STOCK, $0.001 PAR VALUE; 100,000,000 SHARES
AUTHORIZED; NONE ISSUED AND OUTSTANDING .......................            --             --
COMMON STOCK:
CLASS A, $0.001 PAR VALUE; 200,000,000 SHARES AUTHORIZED;
56,912,893 AND 25,921,562 SHARES ISSUED AND
OUTSTANDING RESPECTIVELY ......................................        56,913         25,921
CLASS B, $0.001 PAR VALUE; 200,000,000 SHARES AUTHORIZED;
545,455 AND 150,000 SHARES ISSUED
AND OUTSTANDING RESPECTIVELY ..................................           545            150
CLASS C, $0.001 PAR VALUE; 200,000,000 SHARES AUTHORIZED;
2 SHARES ISSUED AND OUTSTANDING ...............................            --             --
ADDITIONAL PAID-IN CAPITAL ....................................    14,644,966        461,762
ACCUMULATED OTHER COMPREHENSIVE LOSS ..........................            --         (7,064)
ACCUMULATED DEFICIT ...........................................   (16,476,382)      (897,358)
                                                                  -----------    -----------
TOTAL SHAREHOLDERS' DEFICIT ...................................    (1,773,958)      (416,589)
                                                                  -----------    -----------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT ...................   $16,276,638    $ 2,811,261
                                                                  ===========    ===========


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

</TABLE>

                                       F-2


<PAGE>


                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

                                                    YEAR ENDED       YEAR ENDED
                                                   ------------    ------------
                                                   DECEMBER 31,     DECEMBER 31,
                                                       2005            2004
                                                   ------------    ------------

<S>                                                     <C>           <C>
Revenues .......................................        461,244       3,026,287

Cost of product sold ...........................        449,995       2,200,000
                                                   ------------    ------------

Gross profit ...................................         11,249         826,287
                                                   ------------    ------------

Research and development .......................        691,660              --
General and administrative expenses ............      4,132,422       1,090,153
Impairment of goodwill and licenses.............      4,577,069          19,192
                                                   ------------    ------------
Total Expenses .................................      9,401,151       1,109,345
                                                   ------------    ------------
Loss from Operations ...........................     (9,389,902)       (283,058)

Other Income (Expense)

Interest income ................................          4,689              --
Interest expense ...............................     (2,459,269)        (98,809)
Derivative valuation loss ......................     (6,182,166)            --
Write off of equipment .........................             --         (12,205)
                                                   ------------    ------------
Other Income (Expense), Net ....................     (8,636,746)       (111,014)
                                                   ------------    ------------
Net Loss Before Income Tax and Minority
  Interest                                          (18,026,648)       (394,072)

Income tax benefit .............................      2,447,624              --
Minority interest ..............................             --         (26,581)
                                                   ------------    ------------
Net loss .......................................   $(15,579,024)   $   (420,653)
                                                   ============    ============

Basic and diluted loss per share ...............   $      (0.47)   $      (0.02)
                                                   ============    ============

Weighted average number of Class A
  common shares outstanding ....................     33,397,028      21,125,176
                                                   ============    ============

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

</TABLE>

                                       F-3

<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

                   DECEMBER 31, 2003 THROUGH DECEMBER 31, 2005

<TABLE>
<CAPTION>

                                  Class A            Class B         Class C                  Accumulated
                               Common Stock       Common Stock    Common Stock                   Other     Additional    Total
                           -------------------  --------------  --------------  Accumulated  Comprehensive  Paid-in    Stockholders'
                             Shares    Amount   Shares  Amount  Shares  Amount    Deficit         Loss       Capital     Deficit
                           ---------- --------  ------- ------  ------  ------  -----------  ------------- ---------- -------------
<S>                        <C>        <C>       <C>      <C>    <C>     <C>     <C>               <C>      <C>          <C>
Balance at
December 31, 2003          18,750,000 $ 18,750       --     --      --      --  $  (476,705)      $(6,540)              $  (464,495)

Issuance of 2 Class
C Common Shares in
exchange for on
Alert Shares                                                         2      --

Issuance of 150,000
Class B Common shares
in exchange for note
payable conversion                              150,000    150                                                                  150

Issuance of 6,750,000
Class A common shares
for conversion of
Note payable                6,750,000    6,750                                                                398,322       405,072

Stock Option
Compensation                                                                                                   63,440        63,440

Issuance of 421,562
Class A common
shares pursuant to
the acquisition of
E-City Software               421,562      421                                                                                  421

Net loss for the year                                                              (420,653)                               (420,653)

Currency translation
adjustments                                                                                          (524)                     (524)
                                                                                            -------------                ----------
Comprehensive
loss                                                                                                                       (421,177)
                                                                                                                         ----------
Balance at                 ---------- --------  ------- ------  ------  ------  -----------  ------------  ----------    ----------
December 31, 2004          25,921,562 $ 25,921  150,000 $  150       2  $   --  $  (897,358) $     (7,064)  $ 461,762    $ (416,589)
                           ---------- --------  ------- ------  ------  ------  -----------  ------------  ----------    ----------
Class A common shares
 Issued for services        1,101,017    1,101                                                                667,648       668,749

Class A and B shares
 issued for acquisitions   24,726,923   24,728  395,455    395                                              9,918,754     9,943,877

Class A shares issued
 to convert notes payable   4,858,000    4,858                                                              1,494,659     1,499,517

Exercise of stock options      88,000       88                                                                  5,121         5,209

Conversions of derivative
   securities                                                                                               1,746,053     1,756,053

Issuance of shares for
 cash                         217,391      217                                                                249,783       250,000

Stock option
compensation                                                                                                  101,186       101,186

Net loss for the year                                                           (15,579,024)                            (15,579,024)

Currency translation
 adjustment                                                                                         7,064                     7,064
                                                                                             ------------               -----------
Comprehensive
loss                                                                                                                    (15,571,960)
                                                                                                                        -----------
Balance at                 ---------- --------  ------- ------  ------  ------  -----------  ------------  ----------   -----------
December 31, 2005          56,912,893 $ 56,913  545,455 $  545       2      --  $(16,476,382)         --  $14,644,966   $(1,773,958)
                           ========== ========  ======= ======  ======  ======  ===========  ============  ==========   ===========

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

</TABLE>

                                       F-4

<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>

                                                              YEAR ENDED       YEAR ENDED
                                                             DECEMBER 31,      DECEMBER 31,
                                                                 2005             2004
                                                             ------------     ------------
<S>                                                          <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES
   Net loss ...............................................  $(15,579,024)     $ (420,653)
   Adjustments to reconcile net loss to net
   cash from operating activities:
     Stock Option Compensation.............................       101,186          63,440
     Minority interest ....................................            --          26,581
     Depreciation and amortization ........................       694,265         121,392
     Impairment of goodwill and licenses...................     4,577,069          19,192
     Loss from derivative .................................     6,182,866              --
     Interest expense from loan discount amortization......     1,774,667              --
     Income tax benefit....................................    (2,447,624)             --
     Issuance of stock for services........................       818,750              --
     Loss on currency adjustment ..........................            --            (524)
     Write off of intangible assets .......................         5,543              --
     Write off of property and equipment ..................            --          12,205
     Gain on sale of airship ..............................            --        (500,000)
     Changes in assets and liabilities:
       Accounts receivable ................................       620,634        (747,155)
       Inventories ........................................      (255,002)             --
       Prepaid interest ...................................       (27,173)             --
       Security deposits ..................................          (215)         (7,156)
       Accounts payable ...................................      (256,701)      1,039,653
       Accrued liabilities ................................       171,111         197,931
       Deferred revenue ...................................       (16,667)             --

                                                              -----------    ------------
NET CASH FROM OPERATING ACTIVITIES ........................    (3,636,315)       (195,094)
                                                              -----------    ------------
CASH FLOWS FROM INVESTING ACTIVITIES
    Deposits on equipment .................................            --        (150,096)
    Purchase of equipment .................................       (12,000)         (5,668)
    Change in related party receivables/payables ..........      (420,246)        283,670
    Cash received in acquisition ..........................        25,010              --
                                                              -----------    ------------
NET CASH FROM INVESTING ACTIVITIES ........................      (407,236)        127,026
                                                              -----------    ------------

CASH FLOWS FROM FINANCING ACTIVITIES
    Payments on loan costs ................................      (290,833)        (18,141)
    Proceeds from notes payable ...........................     4,275,000         543,330
    Proceeds from notes payable - related parties .........     1,426,764         638,166
    Principal payments on notes payable ...................      (347,342)       (389,008)
    Principal payments on notes payable - related parties .      (373,542)       (439,911)
    Payments on debt assumed from subsidiary ..............       (33,337)        (65,635)
    Issuance of common stock ..............................       250,000           5,218
    Proceeds from exercise of stock options................         5,209              --
    Loan to TSI ...........................................    (1,074,162)             --
                                                              -----------    ------------
NET CASH FROM FINANCING ACTIVITIES ........................     3,837,757         274,019
                                                              -----------    ------------
Net (decrease) increase in cash and cash equivalents ......      (205,794)        205,951
Cash and cash equivalents, beginning ......................       206,270             319
                                                              -----------    ------------
Cash and cash equivalents, ending .........................     $     476      $  206,270
                                                              ===========    ============

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

</TABLE>

                                       F-5

<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY

                CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

<TABLE>
<CAPTION>

                                                              YEAR ENDED       YEAR ENDED
                                                             -------------   ------------
                                                             DECEMBER 31,    DECEMBER 31,
                                                                 2005            2004
                                                             ------------    -------------
Supplemental disclosure of cash flow information:

<S>                                                          <C>             <C>
Cash paid for interest                                       $  217,484      $       9,316
Cash paid for income taxes                                           --                 --

Supplemental disclosure of non-cash investing and financing
  information:

Issued stock for debt                                         $1,499,517           400,425
Accounts payable paid by related party                               --             24,655
Retirement of fully depreciated assets                               --             29,513
Deposits for purchase of airship                                     --            675,000
Subsidiary minority shareholders' stock issued for
  subscriptions receivable                                           --                166
Licenses purchased with debt                                         --            500,000
Plans and designs purchased with debt                                --            100,000
Capital restructuring                                                --                355


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

</TABLE>

                                       F-6

<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION, ACQUISITIONS AND MERGERS AND CONTROLLING SHAREHOLDERS --Cyber
Defense Systems, Inc. ("the Registrant" or "Cyber Defense" or "the Company") was
incorporated on August 19, 2004 in Florida. E-City Software, Inc. ("E-City") was
organized in Nevada on May 12, 2000. On Alert Systems, Inc. ("On Alert") was
incorporated on March 17, 2003 in Nevada and acquired a control position in
E-City in May of 2003 and in Cyber Aerospace Corp. ("Cyber Aerospace") in March
2004. On Alert was merged with and into Cyber Defense on September 1, 2004. On
September 1, 2004 E-City was also merged with and into Cyber Defense following
the On Alert merger. As a result of the aforementioned, Cyber Defense became the
successor to E-City and its shares of class A common stock began trading on the
Over the Counter Bulletin Board ("OTC:BB") under the symbol CYDF on September 7,
2004. Due to the nature of the mergers, the fiscal year end of the Company was
changed to December 31 effective for Fiscal 2003 and the historical financial
statements of the Company are now those of On Alert and will include results of
operations for Cyber Aerospace from its date of inception in March 2004, as it
was previously a subsidiary of On Alert, and will also include the results of
operations of E-City from it's date of merger, September 1, 2004. Cyber
Aerospace was merged with and into Cyber Defense effective March 31, 2005. In
addition, on September 19, 2005, the Company acquired Techsphere Systems
International, Inc. ("TSI") for 23,076,923 Class A common shares and 245,455
Class B common shares (see Note 3).

The controlling shareholders of the company are Proxity, Inc. ("Proxity"), a
publicly traded company (under the symbol OTC:BB "PRXT") and Cherokee Raiders, a
partnership, ("Cherokee") owning 31% and 17% of the Class A common shares of the
Company, respectively. In addition, the former shareholders of TSI also own
245,455 or 45%, of the issued and outstanding shares of Class B common stock and
Cherokee owns 300,000, or 55% of such class B shares which allow for 1,000 votes
per share and as a result of which Cherokee is the controlling shareholder of
the Company. Cherokee and Proxity each own one share of the two shares of Class
C common stock issued and outstanding which have certain liquidation preference
rights. The Chief Executive Officer of both Proxity and Cherokee is Mr.
Robinson, the Chief Executive Officer of the Company. As a result of the above,
Cherokee is the controlling shareholder of the Company.

CONSOLIDATION - The accompanying consolidated financial statements include the
accounts and transactions of Cyber Defense Systems, Inc. for all periods
presented and the accounts and transactions of Cyber Defense, and its TSI wholly
owned subsidiary from its date of acquisition on September 19, 2005,
(collectively the "Company"). Intercompany accounts and transactions have been
eliminated in consolidation. At December 31, 2004, the minority interest of
$26,581 shown on the balance sheet represents the shareholdings of stockholders
of Cyber Aerospace other than Cyber Defense, of approximately 6.2% multiplied by
the then cumulative net income of the Cyber Aerospace subsidiary. The
acquisition of the minority interest by the Company was effective as of March
31, 2005 and such minority interest was therefore eliminated at that date (see
Note 3).

On May 23, 2003, the Company paid $40,000 for 35,000,000 shares of common stock
of E-city Software, Inc. ("E-city"), representing 77.6% of the total shares
outstanding. The purchase included current assets of $71,020 and current
liabilities of $152,323, resulting in goodwill of $121,303. Management
determined that the value of the goodwill was impaired and the total amount was
written off. The accompanying consolidated financial statements include the
accounts and transactions of On Alert Systems, Inc. for all periods presented
and the accounts and transactions of E-City from the date of its acquisition
until it was merged into Cyber on September 1, 2004. Intercompany accounts and
transactions have been eliminated in consolidation.

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

                                       F-7

<PAGE>

                   CYBER DEFENSE SYSTEMS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

BUSINESS CONDITION - The accompanying financial statements have been prepared on
a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in the
financial statements for the period ended December 31, 2004, the Company
recorded revenue of $3,026,287 but incurred a net loss of $420,653. For the year
ended December 31, 2005, the Company recorded revenues of $461,244 and incurred
a net loss of $15,579,024. As of December 31, 2005 and 2004 the net working
capital deficit was $16,444,035 and $2,247,844, respectively. The lack of
sufficient revenues and the loss from operations raise substantial doubt about
the Company's ability to continue as a going concern for a reasonable period of
time. The financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets or the amount and
classification of liabilities which might be necessary should the Company be
unable to continue as a going concern. The Company's continuation as a going
concern is dependent upon its ability to generate sufficient cash flows to meet
its obligations on a timely basis, to obtain additional financing as may be
required, and ultimately to attain successful operations (see Note 6).

CASH AND CASH EQUIVALENTS -- Cash equivalents include highly liquid short-term
investments with original maturities of three months or less, readily
convertible to known amounts of cash. At December 31, 2005 and 2004 the Company
had cash of zero and $106,270, respectively, in excess of federally insured
limits.

ACCOUNTS RECEIVABLE -- The Company does not have an allowance for doubtful
accounts receivables as management believes that all receivables will be
collected.

INVENTORY -- Inventories consist primarily of supplies and parts used for
manufacturing and are valued at the lower of average cost or market.

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

Long-lived assets are reviewed for impairment quarterly or when events or
changes in circumstances indicate that the carrying amount may not be
recoverable. Recoverability of assets to be held and used is measured by
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount that the carrying amount
of the assets exceeds the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to sell.
Based on the evaluation, an impairment loss for goodwill related to the
acquisition of Cyber Aerospace Corp. of $4,577,069 was recorded in the fiscal
2005. In fiscal 2004 the Company recorded a reduction in the value of certain
equipment of $12,205 and an impairment in the value of licenses of $19,192.

MANUFACTURING LICENSE -- The Company acquired an exclusive manufacturing license
valued at $14,255,649 with the acquisition of TSI in September, 2005 as
described in Note 3. Amortization totaled $230,993 as of December 31, 2005. The
Company evaluated the carrying value of the license to determine if the carrying
amount warranted revision or may not be recoverable. In management's opinion, an
adjustment is not required at December 31, 2005.

REVENUE RECOGNITION -- Service revenues are recognized when the services are
performed and the customer is billed. Airship construction revenue is recognized
on the percentage of completion method of accounting. Airship sales are
recognized when substantially all contract specifications have been met and
title passes to the customer.

                                       F-8

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

COSTS AND EARNINGS IN EXCESS OF BILLINGS AND BILLINGS IN EXCESS OF COSTS AND
ESTIMATED EARNINGS -- In instances when services are performed on fixed price
agreements of a very short duration, the completed contract method of accounting
is used whereby revenue is recognized when the work is completed. Where fixed
price contracts are for an extended duration, the percentage of completion
method of accounting is used whereby revenue is recognized as the work
progresses based on actual cost to date to total projected contract cost. Billed
amounts in excess of recognized revenue are recorded as Billings in Excess of
Cost and Estimated Earnings and billed amounts under recognized revenue are
recorded as Costs and Estimated Earnings in Excess of Billings.

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

STOCK BASED COMPENSATION - The Company utilizes the intrinsic-value method as
provided by Accounting Principles Board Opinion ("APB") No. 25 in accounting for
its stock options and restricted stock plans and provides pro forma disclosure
of the compensation expense determined under the fair value provisions of SFAS
No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), as amended by
SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure.

The following table illustrates the effect on net loss if the fair-value-based
method had been applied to all outstanding and unvested awards in each period:

<TABLE>
<CAPTION>

                                                       Year ended                  Year ended
                                                    December 31, 2005           December 31, 2004
                                                    -----------------           -----------------
<S>                                                  <C>                         <C>
Net loss, as reported                                $   (15,579,024)            $      (420,653)
Add (deduct) stock-based
 compensation expense included
 in reported net loss                                        101,186                          --
Deduct total stock-based
 compensation expense determined
 under fair-value-based method for all awards               (775,754)                         --
                                                     ----------------            ----------------
Pro forma net loss                                   $   (16,243,592)            $      (420,653)
                                                     ================            ================
Pro forma basic and diluted net loss per share       $         (0.49)            $         (0.02)
                                                     ================            ================
Weighted average number of class A
common shares outstanding                                 33,397,028                  21,125,176
                                                     ================            ================
</TABLE>

                                       F-9

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ADVERTISING COSTS -- The Company expenses advertising costs as incurred. These
costs amounted to $42,482 and $4,458 in 2005 and 2004, respectively.

CONCENTRATIONS OF RISK -- At December 31, 2005, a total of 94% of accounts
receivable is due from one customer. In addition, 2 customers comprised 61% and
21% of sales, respectively for the year ended December 31, 2005. During the year
ended December 31, 2004, there was one airship sale to one customer.

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

LOSS PER SHARE --Basic loss per share is calculated by dividing loss available
to Class A common shareholders by the weighted-average number of Class A common
shares outstanding during each period. Fully diluted loss per share in 2004 and
2005 is anti dilutive due to net losses incurred by the Company. In 2005,
potentially dilutive securities include an aggregate of 11,379,900 Class A
common shares subject to stock options issued under the 2005 Option Plan
resulting and 10,307,886 Class A common shares issuable upon conversion of
Convertible Notes Payable, resulting in a weighted average of 3,560,468 shares
that would be added to the weighted average shares used to calculate basic
earnings per share. Potentially dilutive securities would exclude Class A common
shares issuable upon exercise of 4,400,000 warrants issued in connection with
the financing received from AJW Partners, LLP and affiliates as discussed in
Note 6, since the exercise price of the warrants exceeds the average market
price of the Class A Common Stock in 2005. In 2004, potentially dilutive
securities include 88,000 shares subject to a stock option held by All- Stars
Marketing since August 9, 2004 resulting in 34,716 additional shares that would
be added to the weighted average shares used to calculate basic earnings per
share.

FAIR VALUES OF FINANCIAL INSTRUMENTS -- The carrying amounts reported in the
balance sheet for notes payable approximate their fair values because the
interest rates approximate current interest rates to be charged on similar
borrowings.

RECENT ACCOUNTING PRONOUNCEMENTS -- In December 2004, the FASB issued SFAS No.
123(R), Share-Based Payment, which is an amendment to SFAS No. 123, "Accounting
for Stock-Based Compensation" and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. This new standard eliminates the ability to account
for share-based compensation transactions using Accounting Principles Board
(APB) No. 25, Accounting for Stock Issued to Employees (APB 25) and requires
such transactions to be accounted for using a fair-valued-based method, with the
resulting cost recognized in the Company's financial statements. This new
standard is effective for annual periods beginning after June 15, 2005. The
Company will adopt this pronouncement effective January 1, 2006 and anticipates
that the impact on their financial statements will be material due to the
11,379,900 options granted in September, 2005 with a fair value of $2,617,377 of
which 50% will vest in 2006 and the remainder in 2007.

In December 2004, the FASB issued SFAS No. 153, "Exchange of Non-monetary
Assets". SFAS No. 153 amends APB Opinion No. 29, "Accounting for Non-monetary
Transactions", to eliminate the exception for non-monetary exchanges of similar
productive assets. The Company will be required to apply this statement to
non-monetary exchanges after December 31, 2005. The adoption of this standard is
not expected to have a material effect on the Company's financial position or
results of operations.

                                      F-10

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In May 2005, FASB issued FASB Statement 154, "Accounting Changes and Error
Corrections -- a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("FAS 154"). FAS 154 changes the requirements for the accounting for and
reporting of a change in accounting principle. The provisions of FAS 154
require, unless impracticable, retrospective application to prior periods'
financial statements of (1) all voluntary changes in principles and (2) changes
required by a new accounting pronouncement, if a specific transition is not
provided. FAS 154 also requires that a change in depreciation, amortization, or
depletion method for long-lived, non-financial assets be accounted for as a
change in accounting estimate, which requires prospective application of the new
method. FAS 154 is effective for all accounting changes made in fiscal years
beginning after December 15, 2005.

In June 2005, the FASB Emerging Issues Task Force ("EITF") reached a consensus
on Issue No. 05-6, "Determining the Amortization Period for Leasehold
Improvements." The guidance requires that leasehold improvements acquired in a
business combination or purchased subsequent to the inception of a lease be
amortized over the lesser of the useful life of the assets or a term that
includes renewals that are reasonably assured at the date of the business
combination or purchase. The guidance is effective for periods beginning after
June 29, 2005. The adoption of EITF No. 05-6 is not expected to have a material
effect on the Company's financial position or results of operations.

In February 2006, the FASB issued Statement of Financial Accounting Standards
No. 155, "Accounting for Certain Hybrid Financial Instruments," referred to as
SFAS No. 155. This statement amends SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" and SFAS No. 140 "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No.
155 permits fair value remeasurement for hybrid financial instruments that
contain embedded derivatives that would require separate accounting. In
addition, the statement establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain embedded
derivatives. SFAS No. 155 is effective for all financial instruments acquired or
issued beginning after an entity's fiscal year beginning on September 15, 2006
with earlier adoption permitted. Management is evaluating the statement and does
not believe that it will have a material impact on our financial statements.

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

NOTE 2 - RELATED PARTY TRANSACTIONS

Proxity, Inc. ("Proxity") - Proxity owned 100% of the stock of On Alert Systems,
Inc. at December 31, 2003. On Alert purchased the GDS and Traptec licenses from
Proxity at Proxity's cost.

On Alert Systems - On Alert was incorporated on March 17, 2003 in Nevada and
acquired a control position in E-City in May of 2003 and in Cyber Aerospace in
March 2004. On Alert was merged with and into Cyber Defense on September 1,
2004.


                                      F-11

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

E-City Software - On May 23, 2003, the Company paid $40,000 for 35,000,000
shares of common stock of E-city Software, Inc., representing 77.6% of the total
shares outstanding. On September 1, 2004, the Company issued 333,562 shares of
Cyber Defense Common Stock Class A for the remaining shares of E-City. E-City
Software, Inc. was a public company incorporated in Nevada on May 12, 2000. The
Company acquired E-City for its status as a public entity.

Cyber Aerospace - Prior to March 31, 2005, Cyber Aerospace ("Aerospace") had
previously been consolidated with the Company as it was a 93.8% owned
subsidiary. All transactions and account balances between the Company and
Aerospace were eliminated during consolidation. On March 31, 2005, the Company
purchased the minority interest so that Aerospace became a wholly owned
subsidiary and was then merged with and into the Company (see Note 3).

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

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

Through March 31, 2006 Frank Lively advanced $13,056 to the Company for working
capital.

See Note 7 - Related Party Notes for additional related party disclosure.

NOTE 3 - ACQUISITIONS

Acquisition of Minority Interest in Subsidiary

On March 31, 2005, the Company acquired the 6.19% minority interest in its
majority owned subsidiary, Aerospace, and merged Aerospace into Cyber Defense.
The merger was accounted for by the purchase method of accounting and was
completed in order to consolidate operations into one company, with one name,
and one group of shareholders, as well as to avoid what had become unnecessary
bookkeeping expenses associated with maintaining Aerospace as a separate entity.
For each share of Aerospace, the beneficial owner received one share of Cyber
Defense. As a result, 1,650,000 shares of class A common stock were issued for
the 6.19% ownership, along with 150,000 shares of class B common stock.

Aerospace had been a majority owned subsidiary of On Alert from the date of its
inception in March 2004 through September 1, 2004 at which time it became a
majority owned subsidiary of Cyber Defense pursuant to the Domicile merger
between Cyber Defense, On Alert and E-City.

The purchase price for the acquisition of the Cyber Aerospace minority interest
was $4,603,650, comprised of 1,650,000 shares of common stock valued at $2.79
per share. The share price was determined by the average price for shares sold
in the market for the months of February and March discounted at 10% for a block
sale. A nominal value was given to the 150,000 Class B shares issued.

The purchase price was accounted for in accordance with FAS 141, "Business
Combinations". Subsequent to the acquisition and merger, the goodwill was
impaired. Cyber allocated all but $24,593 of the purchase price to goodwill,
which was impaired on the date of acquisition. As a result of the losses
incurred through March 31, 2005, the minority interest had been eliminated.
There were no net assets attributable to the minority shareholders. All shares
of Class A common stock and Class B common stock that comprised the purchase
price were treated as if they were issued at March 31, 2005.



                                      F-12

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


The assets acquired and liabilities assumed were as follows:

      Assets Acquired:

      Accounts receivable                               $    13,386
      Deposits on airships for resale                        21,051
      Intangible assets:
                Plans & designs                               1,145
                Techsphere marketing rights                   7,403
                                                        -----------
      Net Intangibles                                         8,548

      Goodwill                                            4,577,069
                                                        -----------
      Total Assets Acquired                             $ 4,620,054
                                                        -----------
      Liabilities Assumed:
      Accounts payable & accrued expenses                   $14,168
      Notes payable - related parties                         2,236
                                                        -----------
      Total Liabilities Assumed                              16,404
                                                        -----------

      Net Assets Acquired                               $ 4,603,650
                                                        ===========


Acquisition of TSI

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

At September 19, 2005, the purchase price was allocated to the assets acquired
and the liabilities assumed as follows:

      Assets Acquired
      Cash                                         $      25,010
      Accounts receivable                                236,028
      Miscellaneous receivable                             1,750
      Inventory                                           81,521
      Prepaid expenses                                     5,407
      Property, plant & equipment, net                    82,405
      21st Century manufacturing license              14,255,649
      Liabilities assumed                             (6,682,456)
      Deferred Taxes                                  (2,665,088)
                                                   --------------
      Net assets acquired                          $   5,340,226
                                                   ==============



                                      F-13

<PAGE>


                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following pro-forma combined condensed statements of operations present what
such results of operations would have been had the acquisition of TSI been
consummated on January 1, 2004.

<TABLE>
<CAPTION>

                         -------------- Year ended December 31, 2004 -------------

                             TSI           Cyber     Adjustments        Combined
                         -----------    -----------  ------------    -------------
<S>                      <C>            <C>          <C>             <C>
Revenues                 $ 2,618,844    $ 3,026,287  $(2,200,000)(a) $   3,445,131

Expenses

Cost of Sales              2,036,369      2,200,000   (2,200,000)(a)     2,036,369
General & administrative   2,490,264(b)   1,090,153           --         3,580,417
Impairment loss                   --             --           --                --

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

Total expenses             4,526,633      3,290,153   (2,200,000)(a)     5,616,786

Loss from operations      (1,907,789)      (263,866)          --        (2,171,655)

Other expense               (359,554)      (156,787)          --          (516,341)

Derivative Valuation
  Loss                            --             --           --                --

Income taxes                      --             --           --                --

                         -----------    -----------  -----------     -------------
Net loss                 $(2,267,343)   $  (420,653) $        --     $  (2,687,996)
                         ===========    ===========  ===========      =============

Basic and diluted loss
  per share                                                          $       (0.06)
                                                                     =============
Weighted average shares
  outstanding                                                           44,202,099
                                                                     =============
<CAPTION>

                        -------------Year ended December 31, 2005------------------

                             TSI            Cyber     Adjustments        Combined
                        ------------    ------------  -----------       -----------
<S>                     <C>             <C>           <C>              <C>
Revenues                $  2,272,108    $    137,256  $  (128,467)(c)  $  2,280,897

Expenses

Cost of Sales              2,151,684         117,548           --         2,269,202
General & administrative   2,223,396(b)    3,895,278     (128,467)(c)     5,990,207
Impairment loss                   --       4,577,069           --         4,577,069
                        ------------    ------------  -----------      ------------

Total expenses             4,375,050       8,589,895     (128,467)       12,836,478

Loss from operations      (2,102,942)     (8,452,639)          --       (10,555,581)

Other expense               (399,818)     (2,305,153)          --        (2,704,971)

Derivative Valuation
  Loss                            --      (6,182,166)          --        (6,182,166)

Income taxes              (1,615,116)      4,062,740           --         2,447,624
                        ------------    ------------  -----------      ------------

Net loss                $ (4,117,876)   $(12,877,218)                  $(16,995,094)
                        ============    ============                   ============

Basic and diluted
  loss per share                                                       $      (0.33)
                                                                       ============
Weighted average
  shares outstanding                                                     51,858,567
                                                                       ============
</TABLE>

                                      F-14

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Footnotes to Pro Forma Condensed Statement of Operations

(a) - Eliminates intercompany sales and cost of sales for the purchase and sale
of an airship.

(b) - Includes the adjustment for amortization of the value of the license with
21st Century Airships, Inc. of $417,301 and $600,305 for fiscal 2005 and 2004,
respectively, as if the transaction had occurred as of January 1, 2004

(c) - To eliminate the inter-company transaction related to the sale of the
license for marketing and integration rights of Airships by TSI to Cyber.

NOTE 4 - PROPERTY AND EQUIPMENT

Property and equipment consists of the following at December 31, 2005 and 2004:

                                      Year Ended              Year Ended
                                   December 31, 2005       December 31, 2004
                                   -----------------       -----------------
Machinery and Equipment            $          90,146       $          7,741

Automobile                                    12,000
                                   -----------------       -----------------
Total cost                                   102,146                  7,741

Less Accumulated Depreciation                (10,173)                (2,138)
                                   -----------------       -----------------
Net Fixed Assets                   $          91,973       $          5,603
                                   =================       =================


Depreciation expense for the years ended December 31, 2005 and 2004 was $6,748
and $2,138 respectively. During the year ended December 31, 2005, the Company
purchased an automobile for $12,000. In addition, the Company acquired machinery
and equipment valued at $82,405 as part of the acquisition of TSI.

NOTE 5 - INTANGIBLE ASSETS AND LICENSE AGREEMENT

As discussed in Note 3, the Company acquired the exclusive, worldwide license
for the manufacture of its airships with 21st Century Airships, Inc. with the
acquisition of TSI. The value recorded for the license was $14,255,649. The cost
is being amortized over the life of the license of 18 years, resulting in
monthly amortization of $65,99. Accumulated amortization as of December 31, 2005
and 2004 was $230,933 and $0, respectively. The agreement calls for royalty
payments relating to the sales of airships ranging from $450,000 for a low
altitude airship, $600,000 for a medium altitude airship, 10% of the gross sales
price of a high altitude airship and $400,000 for the manufacture of a low
altitude airship used for commercial advertising purposes. Payments are to be
made on any royalties due upon receipt of payment from the customer on a
proportionate basis as defined in the agreement and in full within 120 days of
completion of the manufacturing process.

The agreement calls for a minimum royalty payment of $1,000,000 for the period
of January 17, 2005 through January 16, 2006. The Company has accrued $955,578
related to this royalty in the balance sheet as of December 31, 2005. The
Company has executed an amendment to the license agreement in April, 2006
providing payment terms of $200,000 each on May 15 and July 15, 2006, and
$150,000 each for four months on the fifteenth of each month ending November 15,
2006.


                                      F-15

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In 2004, the Company purchased designs and plans for unmanned air vehicles
(UAVs) which have a useful life of 3 years. The cost was $100,000 and the
monthly amortization is $2,777. Accumulated amortization at December 31, 2005
and 2004 was $61,113 and $27,777, respectively.

The Company purchased the rights to two licensing agreements - the GDS license
on April 7, 2003 and the Traptec license on November 10, 2003 from Proxity
Digital Networks, a related party. The GDS license is an exclusive license for
the Company to sell licensed equipment throughout the world. The Traptec license
gives the Company the right to represent Traptec Corporation as a marketing
representative on the exclusive basis to sell surveillance and security
equipment and other such products to the military and other federal agencies.
The licensing agreements have been recorded at the historical cost to Proxity.
As of December 31, 2004, the Company determined that the effort and resources
required to be spent in order to utilize these licenses were more than the
Company was able to spend and, therefore, the future cash flows relating to the
ownership of the licenses would be negligible. As a result, the licenses were
considered impaired in full. The impairment loss recorded in the December 31,
2004 financial statements was $19,192.


NOTE 6 - NOTES PAYABLE

On April 1, 2005, the Company entered into a Securities Purchase agreement with
AJW Partners, LLC, AJW Offshore, Ltd., AJW Qualified Partners, LLC, and New
Millennium Capital Partners II, LLC ("AJW") to issue up to $4,000,000 of 8%
Callable Secured Convertible Notes (the "Notes") with warrants to purchase
4,000,000 shares of common stock at $4.25 per share (the "Warrants") for a total
offering price of $4 million. Between April and August, 2005, under the terms of
the agreement, the Company issued the Notes and the Warrants. The Company
incurred $1,575,453 in fees as part of the offering which consisted of cash
payments of $270,833, as well as issuing 61,538 shares of common stock valued at
$200,000 and warrants to purchase 400,000 shares of common stock at $4.25 per
share valued at $1,104,620. Each Note entitles the holder to convert the Note
into the number of shares of common stock resulting from dividing the amount of
the Note to be converted by the conversion price. The conversion price is the
lesser of $3.65 or 60% of the average of the lowest three intra-day trading
prices for the Company's common stock during the 20 trading days immediately
preceding the conversion date. The Warrants and the exercise price are subject
to equitable adjustment in connection with a stock split, stock dividend or
similar transaction. The Warrants have a term of five years from the date of
issuance. In connection with that sale, the Company also entered into a
Registration Rights Agreement with AJW, requiring it to file a registration
statement with the Securities and Exchange Commission registering the shares of
common stock issuable upon conversion of the Notes and exercise of the Warrants.

The Notes are secured by all of the Company's assets, except for its accounts
receivable and proceeds of inventory.

The Notes described above contain embedded derivatives in the form of the
Warrants and the beneficial conversion feature. The Warrants were valued at
$11,046,200 on the dates of issuance and was recorded as a derivative liability.
An aggregate of $1,104,620 was recognized as loan costs and $9,941,950 was
recognized as a derivative valuation loss on issuance of the warrants. The
beneficial conversion feature was valued at $7,313,576, which was recorded as a
derivative liability. An aggregate of $4,000,000 was allocated to discounts on
the individual notes, representing 100% of the face value of the notes, with the
remaining $3,313,576 recognized as a derivative valuation loss.

The Company valued the derivatives using the Black Scholes method. There are
multiple methods of valuation available and the choice of any individual method
may result in significant valuation variances. An analysis of the individual
tranches issued during fiscal 2005 and the significant assumptions used to value
the warrants and the beneficial conversion feature are contained in the
following table:

                                      F-16

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<CAPTION>

                                                           Tranche 1      Tranche 2       Tranche 3        Total
                                                           ---------      ---------       ---------        -----
<S>                                                        <C>            <C>            <C>            <C>
Issue date                                                    4/1/2005      5/25/2005       8/3/2005
Aggregate note amounts                                     $ 1,500,000    $ 1,300,000    $ 1,200,000    $ 4,000,000
Conversion price on issue dates                            $      1.95    $      1.69    $     0.966
Term of notes at issuance                                      3 years        3 years        3 years
Shares issuable upon conversion                                769,231        769,231      1,242,236
Warrants issued                                              1,650,000      1,430,000      1,320,000      4,400,000
Exercise price of warrants                                 $      4.25    $      4.25    $      4.25
Term of warrants at issuance                                   5 years        5 years        5 years
Market Price on issue dates                                $      3.60    $      2.75    $      2.10
Risk free interest rate on issuance date                         3.90%          3.68%          4.07%
Volatility on date of issuance                                 255.05%        240.63%        234.17%
Fair value per share of conversion shares                       3.5321         2.6750         2.0438
Beneficial conversion feature fair value                   $ 2,717,000    $ 2,057,693    $ 2,538,883    $ 7,313,576
Note discount amount                                       $ 1,500,000    $ 1,300,000    $ 1,200,000    $ 4,000,000
Fair value of derivative allocated to beneficial
conversion feature                                         $ 1,217,000    $   757,693    $ 1,338,883    $ 3,313,576
Warrant fair value per share at issuance                   $    3.5000    $    2.6304    $    1.9805
Fair values of warrants at issuance dates                  $ 5,775,000    $ 3,761,472    $ 2,614,260    $12,150,732
Value of warrants allocable to loan costs                  $   525,000    $   341,960    $   237,660    $ 1,104,620
Fair value of derivative related to warrants               $ 5,250,000    $ 3,419,512    $ 2,376,600    $11,046,112
Aggregate fair value allocated to derivative instruments   $ 6,992,000    $ 4,519,165    $ 3,953,143    $14,359,688

</TABLE>


On August 10, 2005, AJW converted $500,000 of the Notes for 500,000 Shares of
Class A common stock of the Company and through September 30, 2005 an additional
$62,300 was converted into 700,000 shares of class A common stock. On October 4,
2005 an additional $6,867 was converted into 58,000 shares of Class A common
stock and on October 20, 2005 an additional $13,350 was converted into 150,000
shares of Class A Common Stock. Such conversions were made at a 40% discount to
market pursuant to the terms of the Secured Convertible Note agreements. As a
result of the conversions, $1,229,053 of the derivative liability was
reclassified to additional paid-in capital.



                                      F-17

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


An analysis of the individual conversions of the AJW Notes during fiscal 2005
and the significant assumptions used to value the beneficial conversion feature
recognized upon conversion are contained in the following table:

<TABLE>
<CAPTION>

Conversion date              8/10/2005         9/16/2005         9/22/2005         10/4/2005       10/20/2005          Total
                           ---------------    ------------      ------------     ------------     --------------    ------------
<S>                         <C>               <C>               <C>               <C>              <C>              <C>
Original proceeds from
note                        $  1,500,000      $  1,500,000      $  1,500,000      $  1,500,000     $  1,500,000
Note amount converted       $    500,000      $     31,150      $     31,150      $     13,350     $      6,867     $    582,517
Principal remaining
after conversion            $  1,000,000      $    968,850      $    937,700      $    924,350     $    917,483
Conversion price                              $      1.000      $      0.089      $      0.089            0.089           0.1184
Term of notes at
December 31, 2005             2.64 years        2.54 years        2.52 years        2.49 years       2.45 years
Shares issued on
conversion                       500,000           350,000           350,000           150,000           58,000
Potential remaining
conversion shares              1,000,000        10,885,955        10,535,955        10,385,955        7,749,015
Common stock price on
conversion date             $       2.00      $       0.40      $       0.23              0.27             0.25
Risk free interest rate             4.18%             4.00%             3.96%             4.22%            4.29%
Volatility on
conversion dates                  232.59%           251.54%           254.69%           254.89%          253.00%
Fair value per share of
conversion shares                 1.9227            0.3923      $      0.219            0.2637           0.2423
Fair value of derivative    $  1,922,700      $  4,270,560      $  2,311,589      $  2,738,776     $  1,877,586
Derivative liability
reclassified to
Additional Paid in
Capital upon conversion     $    961,350      $    137,305      $     76,790      $     39,555     $     14,053     $  1,229,053
Derivative valuation
gain (loss) recognized
on conversion               $    (77,975)     $    (82,271)     $    (21,756)     $      8,910     $     10,875     $   (162,217)

</TABLE>


                                      F-18

<PAGE>


                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


The carrying value of these Notes as of December 31, 2005 was $655,358 net of
discount. The carrying value will be increased each quarter over the three year
period as the accretion of the discount related to the embedded derivatives is
recorded until the carrying value equals the face value of $4,000,000 less any
amounts converted. As of December 31, 2005, the derivative instruments had a
fair value of $10,057,733. An analysis of the valuation of the individual
tranches as of December 31, 2005 and the significant assumptions used to value
the warrants and the beneficial conversion feature are contained in the
following table:


<TABLE>
<CAPTION>

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





The derivative valuation loss reported in the accompanying consolidated
statements of operations results from the revaluation to fair value of the
beneficial conversion feature and attached warrants associated with the above
notes. As the fair value of the derivative changes, a gain or a loss is
recognized. The components of the derivative valuation loss for the year ended
December 31, 2005 and 2004 consisted of the following:

<CAPTION>

                                                                       Year ended         Year ended
                                                                      December 31,       December 31,
                                                                          2005               2004
                                                                    -----------------   -----------------
<S>                                                                     <C>               <C>
Derivative valuation loss on issuance of notes - AJW                    $ (3,313,576)     $         --

Derivative valuation loss on issuance of warrants -AJW                   (11,046,112)               --

Derivative valuation loss on conversions of debt - AJW                      (162,217)               --

Derivative valuation gain - warrant revaluation - AJW                      9,530,348                --

Derivative valuation loss - beneficial conversion revaluation - AJW       (1,190,609)               --
                                                                        ------------      ------------
Total derivative valuation loss                                         $ (6,182,166)     $         --
                                                                        ============      ============
</TABLE>


                                      F-19

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Subsequent to year end on March 15, 2006, the Company entered into a Securities
Purchase Agreement, dated as of March 14, 2006 with whereby the Company
authorized the sale of an aggregate of $2,000,000 of 6% Callable Secured
Convertible Notes and warrants to purchase 2,000,000 shares of common stock for
a total offering price of $2,000,000. The $2,000,000 is to be funded in three
tranches ($1,000,000 on March 15, 2006, $500,000 upon filing the Registration
Statement and $500,000 upon effectiveness of the Registration Statement). The
Notes are convertible into common stock of the Company at a 50% discount to
market pursuant to the terms of the Secured Convertible Note agreements. In
connection with the offering, the Company will issue an aggregate of 2,000,000
warrants to purchase Class A common stock at a price of $1.25 per share. The
warrants are exercisable for a period of five years from the date of issuance.

The conversion of the Notes is subject to an effective Registration Statement.
The Notes are secured by all of the Company's assets, except for its accounts
receivable and proceeds of inventory. In addition, the lenders have agreed to
subordinate to an institutional lender. On March 15, 2006 the Company received
$1,000,000 and issued warrants for 1,100,000 shares of common stock valued at
$542,190 on the date of issuance which will be recorded as a derivative
liability. An aggregate of $49,290 will be recognized as loan costs and $492,900
will be recognized as a derivative valuation loss on issuance of the warrants.
The beneficial conversion feature was valued at $2,599,655 which will be
recorded as a derivative liability. An aggregate of $1,000,000 was allocated to
discounts on the individual notes, representing 100% of the face value of the
notes, with the remaining $1,599,655 to be recognized as a derivative valuation
loss. These transactions related to this issuance will be recorded in the first
quarter of fiscal 2006.

An analysis of the March 14, 2006 issuance and the significant assumptions used
to value the warrants and the beneficial conversion feature are contained in the
following table:


                                                      March 14,
                                                        2006
                                                      Agreement
                                                      Tranche 1
                                                   --------------
Aggregate note amounts                               $1,000,000
Conversion price                                     $     0.19
Term of notes                                           3 years
Shares issuable upon conversion                       5,172,414
Warrants issued                                       1,100,000
Exercise price of warrants                           $     1.25
Term of warrants                                        5 years
Common stock price on issue date                     $     0.51
Risk free interest rate on issuance date                   4.00%
Volatility on date of issuance                           261.79%
Fair value per share of conversion shares                0.5026
Beneficial conversion feature fair value             $2,599,655
Note discount amount                                 $1,000,000
Warrant fair value per share at issuance             $   0.4929
Fair values of warrants at issuance dates            $  542,190
Value of warrants allocable to loan costs            $   49,290
Fair value of derivative related to warrants         $  492,900
Fair value of derivative allocated to beneficial
conversion feature                                   $1,599,655
Aggregate fair value allocated to derivative
instruments                                          $2,141,845


                                      F-20

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On February 18, 2005, the Company and Bedlington Securities, Ltd. ("Bedlington")
executed a Convertible Promissory Note (the "Bedlington Note") for the principal
amount of $250,000 at the rate of 18% per annum. The conversion price was
calculated at 50% of the average closing price of the Class A common shares for
the 30 days preceding the date of conversion. All amounts so converted were not
subject to any accrual of interest. The proceeds of the notes were allocated
between the fair value of the beneficial conversion feature and to the note
payable based upon their relative fair values. This resulted in a discount on
the note of $250,000 which was credited to additional paid-in capital. The
Company exercised its right to pay amounts due under the Bedlington Note and
upon receipt of the funds issued 217,391 shares of its Class A common stock and
the discount of $250,000 was recorded as interest expense.

On March 24, 2005, the Company issued a Convertible Promissory Note to Guy K.
Stewart, Jr., its former corporate counsel for the principal amount of $150,000
for unpaid legal fees. Interest accrued on the note at the rate of 18% per
annum. Mr. Stewart had the right to convert the outstanding amount of his note
into shares of the Class A Common Stock at any time upon five days notice at
$1.50 per share. The proceeds of the notes were allocated between the fair value
of the beneficial conversion feature and to the note payable based upon their
relative fair values. This resulted in a discount on the note of $150,000 which
was credited to additional paid-in capital. We subsequently issued 100,000
shares of our Class A Common Stock to Mr. Stewart in satisfaction of his note
and the discount of $150,000 was recorded as interest expense.

The following table reflects amounts credited to additional paid-in capital upon
the conversion of notes payable with beneficial conversion features to common
stock:

<TABLE>
<CAPTION>
                                                                                           December 31
                                                                                   -------------------------
                                                                                      2005           2004
                                                                                   ----------     ----------
<S>                                                                                <C>
Beneficial conversion feature associated with notes payable issued to:
  Bedlington Securities                                                            $  250,000             --
  Guy Stewart                                                                         150,000             --
  Joe Theisman (Note 7)                                                               117,000             --

Beneficial conversion feature associated with convertible notes payable to AJW
  Partners, et al reclassified as additional paid-in capital
  upon conversion of notes payable                                                  1,229,053             --
                                                                                   ----------     ----------


Total beneficial conversion of derivative securities                               $1,746,053     $       --
                                                                                   ==========     ==========
</TABLE>


On December 31, 2005, the Company issued unsecured Demand Notes in the aggregate
amount of $154,888 to four of its vendors for goods and services previously
provided. The Demand Notes bear interest at the rate of 12% per annum, and are
due in four monthly installments beginning March 5, 2006. The payments for March
and April, 2006 have not been paid as of the date of this filing and the notes
are therefore currently in default.

On December 21, 2005 the Company issued a Secured Commercial Promissory Note for
$25,000 in exchange for cash received from Equipment Depot, Inc. of $25,000. The
note is secured by 100,000 shares of Company Class A common stock pledged by
Cherokee to the lender. The note bears interest at the rate of 9.0% per annum
and is due June 19, 2006 with a conditional extension for 60 additional days.
The note contains acceleration provisions for payment of the balance plus all
accrued interest from any funding of at least $1,000,000.



                                      F-21

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


On August 23, 2004, the Company and Quebec, Inc., ("Quebec") executed a
promissory note pursuant to which the Company borrowed $242,216 bearing interest
at an annual rate of 24%. The note was secured by securities owned by Mr.
Robinson and was paid in full during 2005 with the proceeds from sales of such
securities. For the year ended December 31, 2005 and 2004, amortization expense
of the loan costs was $12,849 and $5,292, respectively.

The Note payable to 21st Century is in payment of the balance of the license fee
for Techsphere. The Company loaned Techsphere $1,000,000 which was paid to 21st
Century and the total license fee was $3,000,000. This note was paid in full
subsequent to year end.

The Note payable to Mayo Hadden, was assumed as part of the acquisition of TSI.
The note originally was due on December 31, 2005. On December 31, 2005, in
exchange for the original note and all related accrued interest aggregating
$331,250, the Company issued Promissory Notes bearing interest at a rate of 10%
per annum. The note is convertible into the Company's Class A common stock at a
price of $0.30 per share and are due on February 25, 2007. The note is callable
in the event the Company obtains in excess of a minimum of $7,000,000 that is
raised in any type of financing.

The Note payable to CMG Tech was assumed as part of the acquisition of TSI. The
note originally was due on December 31, 2005. On December 31, 2005, in exchange
for the original note and all related accrued interest aggregating $822,094, the
Company issued Promissory Notes bearing interest at a rate of 10% per annum. The
note is convertible into the Company's Class A common stock at a price of $0.30
per share and are due on February 25, 2007. The note is callable in the event
the Company obtains in excess of a minimum of $7,000,000 that is raised in any
type of financing.

The Note payable to Charles McClure is in default as of December 31, 2005. The
Company is currently in negotiations regarding extending and amending the terms
of the Note with Mr. McClure.



                                      F-22

<PAGE>


                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

                                                                                           December 31,        December 31,
                                                                                              2005                 2004
                                                                                           ------------        ------------
<S>                                                                                        <C>                 <C>
Current - Unrelated parties

Note payable - Quebec, Inc. - interest accrued at 24% and the note
was due upon sale of securities held as collateral......................                   $         --        $    242,216

Note payable - 21st Century Airship, Inc. - interest accrues at 12%
per annum. The Note was due on August 24, 2005 and is in default at
December 31, 2005, paid in full in March, 2006..........................                        144,844

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

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

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

Demand  Notes to Vendors - unsecured, interest accrues at 12% per
annum due in 4 equal payments from March 5, 2006 to June 5, 2006........                        154,887                  --

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

                                                                                           ------------        ------------
                                                                                            $ 1,728,075        $    242,216

Long-term - unrelated parties

Notes payable - AJW Partners, LLP and
affiliates, callable secured convertible
notes bearing interest at 8% per annum,
$917,691 due April 4, 2008; $1,300,000 due
May 25, 2008 and $1,200,000
due August 4, 2008 less total discount of $2,762,333 ...................                        655,358                  --
                                                                                           ------------        ------------
NOTES PAYABLE UNRELATED.................................................                    $ 2,383,433         $   242,216
                                                                                           ============        ============
</TABLE>


On March 10, 2005 the Company and Commerce Funding Corporation (CFC) executed a
Working Capital Financing Agreement relative to a potential secured financing of
up to $3,000,000 for a two year term. All borrowings under this potential
financing would be collateralized by a first security UCC-1 filing on all assets
related to accounts receivable and a Cross Corporate Guaranty by Proxity, Inc.,
the Company's majority shareholder. In addition, CFC requires a Limited Guaranty
of certain provisions in the loan agreement by the Company's Chief Executive
Officer. The interest rate on borrowings would be Prime plus 1/2 % and there
will be a one time facility fee of 1% of the total credit line payable out of
the first funding. In addition, all borrowings are subject to eligibility and
the advance rate on eligible receivables, as defined. The Company did not
utilize this facility in 2005.

                                      F-23

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 7 - NOTES PAYABLE - RELATED PARTIES

During the year ended December 31, 2005, Cherokee converted a $600,000 portion
of their debt to Class A common shares at the rate of $0.20 per share into
3,000,000 Class A common shares. The conversion rate was determined based on the
fair value of the common stock on the date of the note of September 16, 2005 of
$0.18 per share. On August 12, 2005 Cherokee agreed to extend their note and, as
additional consideration for extending the due date of the loans, the Company
issued 73,553 shares of its Class A common stock valued at $102,974 to Cherokee
based on the bid price as of that date. The Company recorded the value of the
shares as additional interest expense related to the note. In addition, on
December 31, 2005 the Company issued a Convertible Promissory Note in the amount
of $312,255 to Cherokee which replaced the two notes outstanding at December 31,
2004. The new note bears interest at the rate of 12%, is unsecured and
convertible into the Company's Class A common stock at a price of $0.30 per
share. The conversion price approximated the market price on the date of the
note. The notes are due on December 31, 2007.

During the year ended December 31, 2005, Proxity loaned the Company funds to be
used for working capital purposes which were payable on demand. On August 12,
2005 Proxity agreed to extend their note and, as additional consideration for
extending the due date of the loans, the Company issued 25,000 shares of its
Class A common stock valued at $35,000 to Cherokee based on the bid price as of
that date. The Company recorded the value of the shares as additional interest
expense related to the note. The Company issued Proxity a Convertible Promissory
Note in the amount of $351,600 on December 31, 2005. The note bears interest at
the rate of 12%, is unsecured and convertible into the Company's Class A common
stock at a price of $0.30 per share. The conversion price approximated the
market price on the date of the note. The note is due on December 31, 2007.

During the year ended December 31, 2005, Billy Robinson loaned the Company funds
to be used for working capital purposes which were payable on demand. On August
12, 2005 Mr. Robinson agreed to extend their note and, as additional
consideration for extending the due date of the loans, the Company issued 20,465
shares of its Class A common stock valued at $28,631 to Mr. Robinson based on
the bid price as of that date. The Company recorded the value of the shares as
additional interest expense related to the note. The Company issued Mr. Robinson
a Convertible Promissory Note in the amount of $460,851 on December 31, 2005.
The note bears interest at the rate of 12%, is unsecured and convertible into
the Company's Class A common stock at a price of $0.30 per share. The conversion
price approximated the market price on the date of the note. The note is due on
December 31, 2007.

 During the year ended December 31, 2005, Jim Alman converted $50,000 of the
balance of his loan at December 31, 2004 to Class A common shares at the rate of
$0.20 per share and received 250,000 Class A common shares. The conversion rate
was determined based on the fair value of the common stock on the date of the
note of September 16, 2005 of $0.18 per share. In addition, the Company issued a
Convertible Promissory Note to Mr. Alman in the amount of $50,000.The note bears
interest at the rate of 12%, is unsecured and convertible into the Company's
Class A common stock at a price of $0.30 per share. The conversion price
approximated the market price on the date of the note. The note is due on
December 31, 2007.

At December 31, 2005 the Company issued Convertible Promissory Notes aggregating
$263,266 to four executive employees of the Company in lieu of deferred
salaries. The notes bear interest at the rate of 12%, are unsecured and
convertible into the Company's Class A common stock at a price of $0.30 per
share. The conversion price approximated the market price on the date of the
note. The notes are due on December 31, 2007.

At December 31, 2005 the Company issued Convertible Promissory Notes aggregating
$124,343 to Frank Lively, a director of the Company in lieu of deferred salaries
and for working capital advances made to the Company. The notes were subject to
a 10% loan transaction fee and bear interest at the rate of 12%, are unsecured
and convertible into the Company's Class A common stock at a price of $0.30 per
share. The conversion price approximated the market price on the date of the
note. The notes are due on December 31, 2007.

                                      F-24

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The notes discussed above to Cherokee, Proxity, Billy Robinson, Jim Alman, the
four executive employees, and Frank Lively all provide for acceleration of
payment from amounts in excess of a minimum of $7,000,000 that are raised in any
type of financing. Such prepayments would be made on a pro rata basis among the
noteholders. As a result of this acceleration provision, the notes have all been
treated as current liabilities.

On December 10, 2004 the Company entered into a loan transaction for $110,000
pursuant to which a promissory note was issued to Joe Theisman, a shareholder
and a Company spokesperson. Interest accrued on the note at the rate of 18% per
annum. The repayment terms were amended and added unpaid accrued interest of
$6,000 to the note and a beneficial conversion feature, allowing Mr. Theismann
to convert the principal into common stock at $1.17 per share. The proceeds of
the note were allocated between the fair value of the beneficial conversion
feature and to the note payable based upon their relative fair values. This
resulted in a discount on the note of $117,000, which was recorded as additional
paid in capital. Such note was converted into 100,000 common shares and the
discount of $117,000 was recorded as interest expense.

<TABLE>
<CAPTION>

                                                                               December 31,    December 31,
                                                                                   2005            2004
                                                                               ------------    -----------
<S>                                                                           <C>             <C>
Current - Related Parties

Note payable - Cherokee Raiders - interest accrues at 12%
per annum, due on demand, unsecured .....................................      $         --    $    58,993

Convertible Promissory Note - Cherokee Raiders, interest at 12%
per annum, due December 31, 2007, unsecured .............................           312,255             --

Note payable - Cherokee Raiders - interest accrues at 12%
per annum, due December 31, 2007 and is unsecured .......................                --        868,775

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

Convertible Promissory Note - Billy Robinson, interest at 12%
per annum, due December 31, 2007, unsecured .............................           460,851             --

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

Note payable - Jim Alman - interest accrues at 8% per
annum, due December 5, 2005, unsecured ...................................               --        100,000

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

Convertible Promissory Notes - Frank Lively - interest at 12% per
annum, unsecured, due December 31, 2007 .................................           124,343             --

Note payable - Joe Theisman - interest accrues at 18% per annum, due
April 30 through September 30, 2005, in equal monthly installments,
unsecured. This note
was converted to common stock on March 31, 2005 .........................                --        110,000
                                                                                 ----------     ----------
                                                                                 $1,562,315     $1,137,768
                                                                                 ==========     ==========
</TABLE>

                                      F-25

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8  - SALE OF AIRSHIP

During the year ended December 31, 2004 the Company purchased an airship for
$2,200,000 and exclusive marketing rights for the manufacture of airships for
$500,000 from TSI prior to TSI being acquired by Cyber. Cyber and TSI amended
the agreement to allow TSI to sell the Airship to Sierra Nevada for $2,700,000,
and in turn, Cyber would be designated the seller of the Airship. In accordance
with EITF 99-19, the Company determined that due to the following factors, the
Company recognized revenue on the transaction on a gross basis:

o Cyber was the primary obligor to the customer

o The Company had latitude in establishing price with the customer

o Cyber had general inventory risk, as they provided funding for production

o The Company bore credit risk in the transaction with the customer

o Cyber had physical inventory loss risk

As a result of the above, Cyber recognized the $2,700,000 of revenue for this
transaction on a gross basis for the year ended December 31, 2004. A total of
$500,000 was recognized as gross profit on the transaction, representing the
difference between Cyber's cost of $2,200,000 and the $2,700,000 purchase price
by Sierra Nevada.

The $500,000 exclusive marketing rights were originally capitalized and
amortized over their original useful life of 7 years. For the years ended
December 31, 2005 and 2004 a total of $62,496 and $65,971, respectively, of
amortization expense was recognized. On September 19, 2005 the Company acquired
TSI and the marketing rights were subsequently eliminated.

NOTE 9 - COMMITMENTS AND CONTINGENCIES

On January 1, 2005, we entered into an employment agreement with our Chief
Executive Officer, William Robinson. The term of this agreement is for a period
of one year, subject to renewal for successive one year periods, unless 14 days
prior written notice is provided by either party. Mr. Robinson will receive an
annual salary of not less than $250,000. In addition, we will issue Mr. Robinson
250,000 shares of our Class A Common Stock on the first anniversary of the
effective date of the agreement and every anniversary thereafter. The agreement
may be terminated for due cause, upon death, upon disability, voluntary
termination by him, or us, without due cause by providing 14 days prior written
notice. Mr. Robinson is subject to a non-compete and non-solicitation provision
during the employment term and during a specified Post-Employment Period (as
defined in the employment agreement).

                                      F-26

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



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

On January 1, 2005, we entered into an employment agreement with our Vice
President, James D. Alman. The term of this agreement is for a period of one
year, subject to renewal for successive one year periods, unless 14 days prior
written notice is provided by either party. Mr. Alman will receive an annual
salary of not less than $120,000. In addition, we will issue Mr. Alman 50,000
shares of our Class A Common Stock on the first anniversary of the effective
date of the agreement and every anniversary thereafter. The Agreement may be
terminated for due cause, upon death, upon disability, voluntary termination by
him, or us without due cause by providing 14 days prior written notice. Mr.
Alman is subject to a non-compete and non-solicitation provision during the
employment term and during a specified Post-Employment Period.

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

On September 19, 2005, TSI entered into an employment agreement with Keith
Vierela as Chief Operating Officer effective October 1, 2005. The term of this
agreement is one year, subject to renewal for successive one year periods,
unless 14 days prior written notice is provided by either party. Mr. Vierela
will receive an annual salary of not less than $150,000. The Agreement may be
terminated for due cause, upon death, upon disability, voluntary termination by
him, or us without due cause by providing 14 days prior written notice. Mr.
Vierela is subject to a non-compete and non-solicitation provision during the
employment term and during a specified Post-Employment Period.

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

                                      F-27

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



On September 19, 2005, TSI entered into an employment agreement with John
Youngbeck as Executive Vice President effective October 1, 2005. The term of
this agreement is one year, subject to renewal for successive one year periods,
unless 14 days prior written notice is provided by either party. Mr. Youngbeck
will receive an annual salary of not less than $135,000. The Agreement may be
terminated for due cause, upon death, upon disability, voluntary termination by
him, or us without due cause by providing 14 days prior written notice. Mr.
Youngbeck is subject to a non-compete and non-solicitation provision during the
employment term and during a specified Post-Employment Period.

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

On September 19, 2005, TSI entered into an employment agreement with Michael
Lawson as President effective October 1, 2005. The term of this agreement is one
year, subject to renewal for successive one year periods, unless 14 days prior
written notice is provided by either party. Mr. Lawson will receive an annual
salary of not less than $150,000. The Agreement may be terminated for due cause,
upon death, upon disability, voluntary termination by him, or us without due
cause by providing 14 days prior written notice. Mr. Lawson is subject to a
non-compete and non-solicitation provision during the employment term and during
a specified Post-Employment Period.

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

On September 19, 2005, TSI entered into an employment agreement with Frank
Lively as Secretary and Chief Financial Officer effective October 1, 2005. The
term of this agreement is one year, subject to renewal for successive one year
periods, unless 14 days prior written notice is provided by either party. Mr.
Lively will receive an annual salary of not less than $65,000. The Agreement may
be terminated for due cause, upon death, upon disability, voluntary termination
by him, or us without due cause by providing 14 days prior written notice. Mr.
Lively is subject to a non-compete and non-solicitation provision during the
employment term and during a specified Post-Employment Period.

On January 1, 2006, the Company entered into an hourly consulting agreement for
with Frank Lively. The new agreement supersedes the agreement discussed above.
Fees due under the consulting agreement are convertible into Class A common
shares of the Company by Mr. Lively at the lesser of $0.30 per share or the
closing price on the date of conversion.



                                      F-28

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



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

The Company has an exclusive agreement with Traptec Corporation to represent
Traptec Corporation as a marketing representative. The parties have agreed to
divide equally the before tax net profits generated from any such sales as
generated under the agreement. However, the parties have agreed that if their
efforts have not generated over $200,000 in net sales profits, to be divided
equally, by the end of the 2005, the total license fee for that year shall be at
least $100,000 to Traptec Corporation. As of December 31, 2005, no sales have
been made in connection with this license. The Company believes that there have
been significant breaches by Traptec under the license agreement and as such
believes that no minimum amounts are due to Traptec.

On April 13, 2005, Proxity, then our majority shareholder, announced its
intention to declare a dividend of shares of our common stock, owned by Proxity,
to its holders of record. For each 500 shares of Proxity common stock held by a
Proxity shareholder on the record date, Proxity will grant a dividend of one
share of common stock of Cyber Defense. Proxity intends to distribute a total of
approximately 560,000 shares of Cyber Defense to its holders. We have agreed to
register such shares under the Securities Act of 1933, as amended. Mr. Robinson
owns approximately 33% of the outstanding shares of capital stock of Proxity.

The Company had commitments with independent contractors for services such as
president of Cyber Aerospace, UAV specialist, vice president, vice president of
business development, controller, security consultant, and other consulting
services. Several of the contracts state that payment was to be made in Proxity
capital stock. Most of the contracts had a six month term that was renewable by
the consent of both parties. At December 31, 2004 all such contracts were
cancelled with no further liability to the Company.

The Company has various noncancelable operating leases for administrative office
and warehouse facilities. The leases provide for minimum future rentals. Future
minimum lease payments under noncancelable operating leases with lease terms
exceeding one year as of December 31, 2005 are $95,785 for the year ending
December 31, 2006. In addition, the Company leases office space from a related
party for $4,000 per month. There is no formal agreement that stipulates the
term of the rent.



                                      F-29

<PAGE>


                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10 - STOCKHOLDERS' DEFICIT

COMMON STOCK - At December 31, 2005, the Company had 56,912,893 shares of Class
A Common Stock, 545,455 shares of Class B Common Stock, and 2 shares of Class C
Common Stock issued and outstanding with 200,000,000 shares of Class A and Class
B Common Stock authorized, par value $.001, and 2,000,000 shares of Class C
Common Stock authorized, par value $.001. In addition, the Company had
100,000,000 shares of Class A Preferred Stock authorized, par value $.001, with
no shares issued and outstanding and $14,644,966 in additional paid in capital.
Class B Common Stock allows for 1,000 votes per share. Class C Common Stock
allows for one vote per share and entitles the holder to receive the net assets
of the Company upon dissolution. At December 31, 2004, the Company had
25,921,562 shares of Class A Common Stock, 150,000 shares of Class B Common
Stock, and 2 shares of Class C Common Stock issued and outstanding and $461,762
in additional paid in capital. The accumulated deficit as at December 31, 2005
and 2004 was $16,476,382 and $897,358 respectively.

During 2005, the Company discontinued banking activity in Canada, which resulted
in the recognition of $7,064 of income for the year ended December 31, 2005
related to prior year currency translation adjustments.

NOTE 11 - INCOME TAXES

The Company has paid no federal or state income taxes since its incorporation.
As of December 31, 2005 and December 31, 2004, the Company had net operating
loss carry forwards for federal income tax reporting purposes of $6,154,864 and
$871,229 respectively, which if unused, will begin to expire in 2025 and 2024,
respectively. Deferred tax assets are reduced by a valuation allowance to the
extent that uncertainty exists as to whether the deferred tax assets will
ultimately be realized.

The net deferred tax (liability) asset consists of the following:

                                             December 31           December 31
                                                 2005                 2004
                                           ---------------       -------------
  Deferred tax assets
  Operating loss carryforwards             $    2,316,196        $    326,206
  Amortization                                    110,450               8,378
  Depreciation                                     10,739                  --
  Goodwill                                      1,636,234                  --
  Valuation allowance                                  --            (334,584)
                                           ---------------       -------------
                                                4,073,619                  --
  Deferred tax liabilities
  21st Century License                         (4,290,944)                 --
                                           ---------------       -------------
  Net Deferred Tax Asset (Liability)       $     (217,325)       $         --
                                           ===============       =============



The following is a reconciliation of the income tax computed using the federal
statutory rate to the provision for income taxes:

                                              December 31         December 31
                                                 2005                2004
                                           ----------------    ----------------

  Tax at federal statutory rate             $   (6,129,060)     $    (143,022)
  Non-deductible expenses                        2,986,630                 --
  Benefit of NOL carryforward                    1,989,480                 --
  Change in valuation allowance                   (334,584)           156,904
  State taxes, net of federal benefit             (654,367)           (13,882)
  Other                                           (305,863)                --
                                            ---------------     ---------------
  Income tax benefit                        $   (2,447,764)     $          --
                                            ===============     ===============


                                      F-30

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12 - STOCK OPTIONS AND RESTRICTED STOCK AWARDS

On September 19, 2005, the Board of Directors approved and adopted the Cyber
Defense Systems, Inc. 2005 Stock Option Plan and also approved the grant of
stock options covering 11,379,900 shares of Class A common stock to 25
individuals. All such options have a ten year term, are subject to a two year
vesting schedule providing for 25 % vesting every six months over the first two
years and have an exercise price of $0.20 per share. Stock option expense of
$101,186 for the period of September 19 through December 31, 2005 pursuant to
Black-Scholes calculations and APB 25 has been recorded for these options.

The weighted average grant date fair value of stock options granted during the
fiscal year ended December 31, 2005, calculated using the Black-Scholes
option-pricing model, was $0.23.

The fair value of the options granted in fiscal year 2005 was estimated at the
date of grant using the Black-Scholes option-pricing model with weighted average
assumptions for volatility of 249.9%, interest of 4.25% and an expected life of
10 years.

At December 31, 2005, there were a total of 11,379,900 options outstanding with
exercise and weighted average exercise prices of $0.20 and weighted average
remaining contractual life of 9.72 years. None of the outstanding options were
exercisable at December 31, 2005.

As of December 31, 2004, there were 88,000 exercisable options outstanding with
a weighted average exercise price of $0.06. This option was exercised in 2005.

In connection with their purchase of 88,000 shares of Class A common stock prior
to the merger of On Alert into Cyber Defense, All Stars Marketing, Inc. was
granted an option to acquire up to an additional 88,000 shares for the same
purchase price of $0.0593 per share through August 8, 2005. Stock option
compensation has been calculated at $63,440 and has been recorded as a charge to
earnings in the fiscal year ended December 31, 2004. Registration rights were
also granted for such shares.

The Board of Directors also approved the issuance of 390,000 shares of Class A
common stock as Employee Restricted Stock Awards to five employees. Such shares
were valued at $0.20 per share and a compensation charge in the aggregate amount
of $78,000 has been recorded. In addition, 200,000 shares of Class A common
stock valued at $0.20 per share were issued to the directors of the Company and
a compensation charge in the aggregate amount of $40,000 has been recorded.

The Company also granted an aggregate of 30,461 shares of Class A common stock
valued at $94,125 recorded in 2005 as compensation to two consultants.

The Company also granted an aggregate of 300,000 shares of Class A common stock
valued at $90,000 recorded in 2005 as compensation to Equipment Depot, Inc.

                                      F-31

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13 - SUBSEQUENT EVENTS (unaudited)

In January, 2006 the Company entered into a Strategic Consulting Agreement for
finance consulting services. The agreement calls for a minimum term of 90 days
and the payment of the equivalent of $120,000 of the Company's Class A common
stock at a 30% discount to the closing price and 150,000 warrants at a price to
be determined upon the close of a financing transaction as defined in the
agreement.

In February, 2006, the Company entered into an Investor Relations Agreement for
a term of one year to provide investor and shareholder relations services to the
Company. The agreement calls for a monthly retainer of $6,000 and the issuance
of warrants to purchase 600,000 shares of the Company's Class A common stock at
a strike price of $0.45 per share with a value of $419,760 on the date of grant.
The warrants vest monthly over one year, with 50,000 warrants vesting at the
signing of the agreement, subject to immediate vesting of all remaining warrants
should the retainer become 30 days past due. The warrants expire 7 years after
the anniversary date. The value of these warrants will be recorded ratably over
the vesting period of the warrants.

In March, 2005 the Company executed a Due Diligence Agreement with GreenHills
Ventures, LLC. ("GreenHills"). Under the agreement, the Company paid GreenHills
$10,750 plus expenses for GreenHills to perform due diligence on behalf of
potential purchasers a due diligence fee. In addition, the Company agreed to
compensate GreenHills for any financing transaction (debt, equity, hybrid
security, merger and acquisition or other similar arrangement financing) with
any qualified purchaser as defined in the agreement. The compensation consists
of the payment of cash of 10% the aggregate value of an equity or non-loan
financing and 7% of the value to be paid in Class A common stock of the Company.
In the event of a non-equity financing, the compensation consists of payment of
cash of 3% of the aggregate value of the transaction and 7% of the value to be
paid in Class A common stock of the Company.

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

In January, 2006 the Company issued a Promissory Note to a vendor in the amount
of $88,637 in exchange for services provided to the Company. The note bears
interest at a rate of 5.0% per annum and is due the earlier of April 19, 2006 or
upon the closing of a funding of at least $1,500,000.

On January 15, 2006 the Company issued a Convertible Promissory Note to James
Gardiner in the amount of $90,000 in exchange for cash of $82,000 and loan fees
of $8,000. The note bears interest at the rate of 12%, is unsecured and
convertible into the Company's Class A common stock at a price of $0.30 per
share. The note is due on December 31, 2007 and provides for acceleration of
payment from amounts in excess of a minimum of $7,000,000 that are raised in any
type of financing on a pro rata basis.


                                      F-32

<PAGE>

                    CYBER DEFENSE SYSTEMS INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


On the date of issuance, the Company's common stock was valued at $0.45 per
share. The note contains an embedded derivative in the form of the beneficial
conversion feature on the date of issuance. As a result, the Company valued the
embedded derivative using the Black Scholes method at $127,050, representing an
estimated market value of $0.4235 per share for the 300,000 shares issuable upon
conversion of the note using the following assumptions:

                      Share Price                $0.45
                      Conversion Price           $0.30
                      Remaining life of note     1.96 years
                      Volatility                 253.8%
                      Risk free interest rate    4.39%

The Company will recognize a discount for the $90,000 face amount of the note in
the first quarter of 2007. The discount will be amortized over the life of the
note of 1.96 years. In addition, the Company will recognize a liability for the
fair value of the derivative and the excess of the fair value of the derivative
over the face value of the note as a derivative valuation loss on issuance in
the amount of $37,050 in the first quarter of 2006.

On April 17, 2006 the Company entered into agreements with Equipment Depot,
Inc., to acquire approximately $4,100,000, as valued, of aerospace R & D and
production equipment to further the fulfillment of the Company's anticipated
contracts and purchase orders. The transaction is expected to close upon the
completion of 2,000,000the financing, institution's due diligence and legal
review. The Company is paying approximately $2.7 million, in a combination of
cash and the exchange of newly issued common stock of the Company, valued at
1.00 a share for the purposes of the transactions, to complete the purchase.


                                      F-33