Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. o

 

TABLE OF CONTENTS	II
PART I
ITEM 1. DESCRIPTION OF BUSINESS
RISK FACTORS
ITEM 2. DESCRIPTION OF PROPERTY
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5.   MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Overview
Results of Operations
Liquidity and Capital Resources
Critical Accounting Standards
Recent Accounting Pronouncements
ITEM 7.  FINANCIAL STATEMENTS
ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 8A(T).  CONTROLS AND PROCEDURES
ITEM 8B.  OTHER INFORMATION
PART III
ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
ITEM 10. EXECUTIVE COMPENSATION
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
ITEM 13. EXHIBITS
ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES
CONSOLIDATED FINANCIAL STATEMENTS	F-1

 

The acquisition of Starsys Research Corporation on January 31, 2006 fundamentally changed our profile.  In 2006, SpaceDev and Starsys Research Corporation merged and had combined revenues of approximately $32 million and operating losses of less than $1.0 million. In 2007, our combined revenues were approximately $35 million and operating profit was approximately $116,000.  We have identified numerous potential synergies between the historic SpaceDev business and the Starsys Research Corporation business and now operate as one company.  During 2006 and 2007, we were required to maintain a certain separation due to the structure of the Starsys Research Corporation earn out.  We integrated certain business management functions in 2006 and 2007 but expect to realize additional efficiencies and cost savings, and more fully integrate our operations as a single company in 2008. 

Our primary products, mission solutions and services include small spacecraft.  These are sophisticated small, micro- and nano- satellites for remote sensing, military, scientific and commercial missions, and space-related technical support services.

We are developing our hybrid rocket-based motor technology, orbital maneuvering and orbital transfer vehicle technology as well as safe sub-orbital and orbital hybrid rocket-based propulsion systems to support small satellites and other related commercial and government business opportunities, including but not limited to small high performance space vehicles and subsystems. Our hybrid rocket motors use synthetic rubber as the solid propellant (i.e., the fuel), and nitrous oxide under compression for the liquid (i.e., the oxidizer) to make the rubber burn.  Traditional rocket motors use two liquids, or a solid propellant that combines the fuel and oxidizer, but both types of rocket motors are explosive, and all solid motors produce copious quantities of toxic exhaust.  Our hybrid rocket motors are safe, non-toxic, are re-startable and do not detonate like solid or liquid rocket motors.

We also manufacture a wide range of products for small and large spacecraft that include high output paraffin actuators, hinges, battery bypass switches, bi-axis gimbals, flat plate gimbals, solar array pointing mechanisms, restraint devices, thermal switches, thermal louvers, and cover systems.  These products are mainly sold as custom systems that are developed for specific small and large spacecraft applications but are also offered as "off-the-shelf" catalog products with spaceflight history.  Our products are typically sold directly to small and large spacecraft manufacturers.  We are also in the process of designing and developing deployable space structures and other structural subsystems for small and large spacecraft.

Our customer base covers a wide range of groups from domestic and international commercial spacecraft companies to civil spacecraft (i.e., NASA) that are primarily scientific in nature, as well as defense spacecraft that support military capability.  We also offer products to certain non-space customers, including aerospace, maritime, educational institutions, and industrial customers that represent less than 2% of our business.

Our engineering and manufacturing capabilities position us to provide our customers and potential customers with an end-to-end mission solution.  A mission might require one or more spacecraft buses, mechanical and electromechanical subsystems, deployable booms, and other spacecraft products and subsystems.  Our strategy is to identify opportunities and either act as a prime contractor by partnering with other (sometimes larger) companies, or act as a subcontractor to larger prime contractors where and when the business opportunity dictates.  The product life cycle for our products within the space industry can range from less than three years to more than fifteen years.

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Our historic SpaceDev business approach has been to provide smaller spacecraft – generally 250 kg (550 pounds) mass and less – and cleaner, safer hybrid propulsion systems to commercial, government, university, and limited international customers. We are developing smaller spacecraft and miniaturized subsystems using proven, lower cost, high-quality off-the-shelf components. Our space products are modular and reproducible, which allows us to create affordable space solutions for our customers. By utilizing our innovative technology and experience, and space-qualifying commercial industry-standard hardware, software and interfaces, we provide increased reliability with reduced costs and risks.

We have been awarded, have concluded, or are concluding contracts from such esteemed government, university, and commercial customers as the Air Force Research Laboratory, the Defense Advanced Research Projects Agency, NASA's Jet Propulsion Laboratory, Lockheed Martin, Northrop Grumman, Swales Aerospace, Space Systems/Loral, the Missile Defense Agency, and many more.  The end users of our products generally are government and commercial enterprises.  Several different groups could fall into one customer category, in a given year, and alone could constitute 10% or more of our consolidated revenues.  In 2007, the Missile Defense Agency, Lockheed Martin and Swales each provided over 10% of our consolidated revenues.

Our business consists of a mix of cost-plus fixed-fee contracts and fixed price contracts together with some product sales. To succeed in our business, we must properly evaluate opportunities, bid on and price contracts, and then execute efficiently so as to achieve profitability.  In the past, we have been challenged in this area due to losses on fixed price development contracts. Our ability to properly bid fixed price development contracts is a key priority for our company.

Recent SpaceDev Contracts and Technology Development

In June 2002, Starsys Research Corporation was awarded a contract from Northrop Grumman Space Technology for the design, development, assembly, and test of two configurations of flat plate gimbal drive assemblies.  These gimbals are used to position six dish antennas and two nulling antenna systems for each of two large spacecraft.  Subsequent to this award, Northrop Grumman Space Technology modified this contract to include a third shipset bringing the total contract value to approximately $7.1 million.  In addition to eight flight unit deliveries per large spacecraft, the program includes development and qualification hardware.  This contract was awarded as a firm fixed price contract with the final delivery scheduled for March 2007 and was part of our acquisition of Starsys Research Corporation on January 31, 2006.  We recorded revenues from this contract for 2007 and from February 1, 2006 through December 31, 2006 of approximately $1.4 million and $2.9 million, respectively. We experienced significant cost overruns on this contract.  Prior to our merger, the contract was modified to add an additional $1.7 million.  After the merger, we negotiated contract modifications in both the timing of payments and in the amount of additional contract consideration of up to $1.0 million based on the achievement of specific milestones. Of the additional possible $1.0 million, we achieved milestones entitling us to the majority of the incentive payments, which will partially mitigate the impact of significant cost, scope and requirement changes and overruns.  Since we were successful in achieving our performance targets, we defrayed some of our cost overruns; however, there were some ongoing costs that we will incur in early 2008 until the program is completed. As of December 31, 2007, the total contract value of this program is approximately $9.8 million.

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In March 2004, we were awarded a five-year, cost-plus fixed-fee indefinite delivery/indefinite quantity contract for up to approximately $43 million to conduct a microsatellite distributed sensing experiment (intended to design and build up to six responsive, affordable, high performance microsatellites to support national missile defense), an option for a laser communications experiment, and other microsatellite studies and experiments as required in support of the Advanced Systems Deputate of the Missile Defense Agency.  The overall contract initially called for us to analyze, design, develop, fabricate, integrate, test, operate and support a networked cluster of three formation-flying boost phase and midcourse tracking microsatellites, with an option to design, develop, fabricate, integrate, test, operate and support a second cluster of three formation-flying microsatellites to be networked on-orbit with high speed laser communications technology.  This overall contract proceeded under a phased approach.  The first phase, executed under Task Order I for approximately $1.1 million, was awarded in April 2004, completed in September 2004, and resulted in a general mission and microsatellite design.  The second phase, executed under Task Order II for approximately $8.3 million, was awarded in October 2004 and was originally expected to be completed by January 2006 but was extended at the request of the Missile Defense Agency with an increased funding of $1.5 million, and subsequently completed in March 2006.  Task Order II resulted in a detailed mission and microsatellite design, which underwent a successful Critical Design Review in March 2006.  Task Order III, the first of several task orders expected during the third phase, was awarded in April 2006 for a total of approximately $1.5 million, which was later amended to approximately $2.5 million and was successfully completed in June 2006. Task Order IV was awarded by the Missile Defense Agency in July 2006, with initial funding of approximately $4.0 million through November 2006.  Task Order IV was subsequently amended to approximately $4.5 million and extended through June 15, 2007.  On April 12, 2007, we finalized a contract modification to Task Order IV with the Missile Defense Agency.  The main content of the change was to: 1) extend the period of performance from June 15, 2007 to September 30, 2007 and subsequently to March 31, 2008, at no additional cost to the government; 2) increase the funding ceiling from approximately $4.5 million to approximately $9.0 million; 3) provide approximately $1.6 million in funding toward the increased ceiling; and 4) change the statement of work to reflect the delivery of one microsatellite.  On May 11, 2007 the remaining $2.9 million in funding was provided to fully fund the $9.0 million task order.  We were informed that there was no Government Fiscal Year 2008 funds available from the Missile Defense Agency to support our microsatellite distributed sensing experiment beyond the funds described above.  We have been working with the Missile Defense Agency and other government agencies for additional funding support.  Government contract funds from the Missile Defense Agency from Government Fiscal Year 2007 were not exhausted by December 31, 2007 and were used to cover anticipated phase completion costs through January 2008.  In January 2008, we arranged for another government agency, the Department of Defense Operationally Responsive Space Office, to fund our continued development through at least May 2008 with a possible extension that may lead to a launch of this experimental satellite. (See Risk Factors: “Some of our government contracts, including our large Missile Defense Agency contract, are staged and we cannot guarantee that all stages of the contracts will be awarded to us or fully funded” and “A substantial portion of our net sales are generated from government contracts, which makes us susceptible to the uncertainties inherent in the government budgeting process.  In addition, many of our contracts can be terminated by the customer.) We recognized revenues of approximately $5.2 million under this contract in 2007, and $22.0 million under this contract from inception through December 31, 2007.

In January 2005, we were awarded a firm fixed price contract from Raytheon in Goleta, California for the design, development, manufacture, assembly and test of the Aerosol Polarimetry Sensor, Scan Mirror Motor/Encoder Assembly.  The Aerosol Polarimetry Sensor instrument is slated to fly on the NASA Glory mission.  The Aerosol Polarimetry Sensor instrument is also a prime candidate for a secondary payload on National Polar-orbiting Operational Environmental Satellite System (NPOESS).  The Scan Mirror Motor/Encoder Assembly consists of low ripple, precision brushless DC motor and optical encoder assembly.  The program consists of a development unit, engineering unit, qualification/life test unit, and flight units. This contract was awarded as a cost-plus fixed-fee contract at a value of $2.5 million.  In July 2006, the contract was modified to add approximately $2.5 million with incremental funding and extend to March 2009.  We recorded revenues from this contract for 2007 and from February 1, 2006 through December 31, 2006 of approximately $1.4 million and $2.0 million, respectively.

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In October 2005, we were awarded a contract from General Dynamics C4 Systems to design and deliver an antenna pointing gimbal and control electronics for the GeoEye-1 program.  The contract awarded was originally valued at $2.0 million, and modified to $2.4 million in 2007. The GeoEye-1 program is a next-generation, high-resolution commercial remote-sensing satellite originally scheduled for launch in 2007. The antenna control system is uniquely designed to operate by greatly reducing motion to the GeoEye-1 spacecraft while pictures are being taken and data is simultaneously transmitted to earth ground stations through incorporation of a low disturbance designed micro-stepping actuator and actuator drive electronics (Quiet Array Drive).  We recorded revenues from this contract for 2007 and from February 1, 2006 through December 31, 2006 of approximately $700,000 and $1.26 million, respectively.  This program was completed in July 2007.

In February 2006, the Air Force Research Laboratory awarded us two deployable boom technology contracts for advance research and development of a self-deployed articulated boom for approximately $950,000 and a jack screw deployed boom for approximately $1.5 million. We recorded revenues from these contracts for 2007 and 2006 of approximately $1.5 million and $833,000, respectively.

In June 2006, Lockheed Martin Commercial Space Systems awarded us a firm fixed price contract for the design and fabrication of the antenna pointing gimbals onboard the US Navy’s Mobile User Objective System.  The initial award is for two flight shipsets and includes two standard A2100 5-meter antenna gimbal assemblies, four Ka-Band antenna gimbal assemblies and two 14-meter gimbal assemblies.  Options are included for additional gimbals supporting three additional large spacecraft.  The contract will include the development and qualification of the Ka-Band and 14-meter gimbal designs in addition to delivery of standard gimbals and solar array deployment hinges that we have previously provided for the A-2100 bus.  The contract value for the initial award was $1.8 million; however, if all options are exercised, the total contract value could exceed $6.0 million.  The current value of this contract is approximately $4.3 million.  We recorded revenues from this contract for 2007 and 2006 of approximately $1.2 million and $625,000, respectively.

In July 2006, we were awarded a contract from the Air Force Research Laboratories in support of a Broad Agency Announcement. This contract allows tasks to be identified, approved, and funded to develop innovative technologies in the field of deployable structures for spaceflight applications. The current contract value is $1.3 million.  Future funding will be available in the amount of $1.1 million from General Dynamics C4 Systems to design and deliver upon task approval. Deployable structures are designed to enable the placement of large payloads within the constrained volume of the launch vehicle and then to deploy, or erect, a larger system once the satellite or vehicle is no longer constrained by the enclosed volume of the launch vehicle fairing. The development efforts to date have focused on deployable antennae for commercial applications, large systems for a variety of radio frequency missions, and deployable optical systems. Several of these efforts have resulted in securing customer funding from potential missions to further design and/or analyses in evaluating the potential application of the SDI deployable structure technologies. We recorded revenues for 2007, and from July 1, 2006 through December 31, 2006 of approximately $381,000 and $6,000 respectively.

In August 2006, we were awarded a government firm fixed price contract to provide the solar array drive, antenna pointing actuators, and gimbal control electronic assemblies for the Lunar Reconnaissance Orbiter program from NASA Goddard Space Flight Center and Swales Aerospace. The total contract value is in excess of $6.6 million.  The Lunar Reconnaissance Orbiter mission is scheduled to launch in the fall of 2008 as part of NASA's Lunar Precursor and Robotic Program. The spacecraft requires two drive actuators to align the solar panels with the sun, and a two axis pointing mechanism to align the downlink antenna for communication with earth.  We are to provide these actuators for the large spacecraft along with the electronics to control them. A total of seven actuators and five control electronics assemblies will be delivered under the contract.  We recorded revenues from this contract for 2007 and 2006 of approximately $4.0 million and $1.8 million, respectively.

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In August and November 2006 we were awarded two contracts to provide hardware for the H-II Transfer Vehicle for Ishikawa Aerospace and JAXA, the Japanese Space Agency. The H-II Transfer Vehicle will provide servicing missions to deliver supplies to the International Space Station. These contracts were obtained as follow-on to a prior development contract started in 2002. The total value of these two contracts is $1.2 million. JAXA is continuing to market supply missions which may result in further contract growth to this award.  We recorded revenues from this contract for 2007 and from August 1, 2006 through December 31, 2006 of approximately $896,000 and $200,000 respectively.

In January 2007, in partnership with the University of Colorado Laboratory for Space Physics, we were awarded a $750,000 contract from the Missile Defense Agency to design and develop a non-sticking cover seal system for the Exo-atmospheric Kill Vehicle program, which is the kill vehicle component of the Ground Based Interceptor (the weapon element of the Ground-based Midcourse Defense System program).  The contract was awarded under the Small Business Technology Transfer Program that provides research funding for partnerships between industry and non-profit research institutions. We recognized approximately $382,000 in revenue under this contract from inception through December 31, 2007.

In February 2007, we were awarded a $1.4 million cost reimbursable design and development subcontract with NASA’s Jet Propulsion Laboratory in support of the Mars Science Laboratory mission.  In 2007, this contract was modified to a value of approximately $1.9 million, and in 2008, we received an additional contract modification bringing the total contract value today to approximately $2.5 million.  We will develop and deliver electromechanical Descent Brake dampers.  The contract period of performance is approximately 18 months.  NASA’s Mars Science Laboratory mission will deliver a 1,800-pound rover to the surface of Mars in 2010.  Rather than the airbag landing system used by the Mars Exploration Rover mission, a “Skycrane” landing system will use a rocket-decelerated Descent Stage that will hover and gently lower the rover on a 25-foot long bridle cord.  A critical component of the “Skycrane” landing system is the Descent Brake that will lower the rover in less than seven seconds with a controlled speed profile that will provide a gentle touch-down on the Martian surface.  We recognized approximately $1.9 million in revenue under this contract from inception through December 31, 2007 and expect to complete this program during the second quarter of 2008.

In February 2007, we were awarded a contract valued at $1.5 million from Space Systems/Loral to deliver cell shorting devices for their communication satellite battery systems. We are now working on the assembly and test of the first 100-unit delivery. This is a follow-on contract for these devices that were originally developed under a previous contract and flight units have been in production since 2001. The Space Systems/Loral communications satellite platform is currently the leading seller among U.S. satellite platforms for commercial communications. The cell shorting devices provide autonomous shorting or override of cells in the event that a cell fails. This preserves the battery system operation and performance at the best possible levels in the event of a cell failure. We recorded revenues from this contract through December 31, 2007 of approximately $636,000.

In March 2007, we were awarded a $500,000 cost reimbursable contract with the Naval Research Laboratory for the preliminary design of the Combined Optical, Radio, Radar Instrument, designed for a small satellite payload application.  Combined Optical, Radio, Radar Instrument integrates three independent capabilities into a single instrument suite: high resolution optical/IR imagery, high-gain broadband RF up/downlink and sensitive proximity radar.  We recognized approximately $450,000 in revenue under this contract from inception through December 31, 2007. This program was successfully completed in February 2008.

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Also in March 2007, we received a follow-on order from Ball Aerospace and Technology Corporation for solar array rotational drive assemblies and drive control electronics for the Digital Globe WorldView-2 satellite program. The value of the order is approximately $1.3 million increasing the total contract value to $2.5 million.  The Starsys Quiet Array Drive Micro-Stepping motion control technology will be utilized on the Ball Aerospace BCP 2000 platform, which will articulate each of the two solar arrays for alignment with the sun. The WorldView-2 satellite is scheduled to be ready for launch in late 2008 and is expected to expand the capabilities of DigitalGlobe’s world imaging portfolio. We recognized revenue on this program through December 31, 2007 of approximately $1.9 million.

In September 2007, we were awarded a cost reimbursable design and development contract with the Defense Advanced Research Projects Agency to develop a Solar Thermal Propulsion demonstration article as a subsystem of a small satellite that is intended to enable the first Solar Thermal Propulsion flight experiment.  The program consists of a six-month Base Program culminating in a Critical Design Review, followed by a six-month option culminating in a Solar Thermal Propulsion demonstration.  The award of the option is contingent on the Defense Advanced Research Projects Agency’s evaluation of the research results of the Base Program against a set of Go and No-Go criteria.  The contract value for the initial Base Program is $3.8 million. However, if the option is exercised, the total contract value would be $7.3 million.  We recognized approximately $1.2 million in revenue under this contract from inception through December 31, 2007.

Business Strategy

Our strategy is based on the belief that innovative advancements in technology and the application of standard business processes and practices will make commercial access to space much more practical and affordable. We believe these factors will cause growth in certain areas of space commerce and will create new space markets and increased demand for our products and services.

Our business strategy and approach for our operations is to:

·	Introduce commercial business practices into the space arena, use off-the-shelf technology in innovative ways and standardize hardware and software to reduce costs and to increase reliability and profits;

·	Start with small, practical and profitable projects, and leverage credibility and profits into larger and ever more bold initiatives - utilizing partnerships where appropriate;

·	Bid, win, and leverage government programs to fund our Research and Development and product development efforts;

·	Integrate our smaller, low cost commercial spacecraft and hybrid space transportation systems to provide one-stop turnkey payload and/or data delivery services to target customers; and,

·	Apply our low cost space products to new applications and to create new users, new markets and new revenue streams.

Today, a majority of our business involves us serving as a subcontractor to a prime contractor who integrates our contributions into a larger spacecraft. However, an increasing portion of our business involves us serving as a prime contractor with other companies (often much larger companies) serving as a subcontractor to us.  Our business development process is generally a competitive bid in response to a request for proposal that is generated by our potential customers.  These proposals have various bases, including firm fixed price, cost-plus fixed-fee, products and time-and-materials.  We typically prepare between ten and twenty proposals in a given month and we usually have one to three weeks to respond to a request for proposal.   We also execute on long term build to requirement contracts with some of the prime contractors.  However, due to our past experiences where we realized losses on fixed price development contracts, we are now more careful in bidding fixed price development work.  It is our preference, wherever possible, to bid development work using a cost reimbursable-type contract; however, when customers require fixed price contracts, we decide to bid or not to bid the opportunity based on the risk premium that we can apply to the proposal.  The risk premium addresses our perceived exposure to bidding development work on a fixed price basis.

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Products and Services; Market

Our space technology business is focused on providing end-to-end spacecraft mission solutions and spacecraft products and services to customers in the space and aerospace marketplace.  We have several areas of space technology, which when applied to customer needs, we believe provides our industry with a sound, profitable and cost effective alternative to the large aerospace solutions.  We operate in small interdisciplinary teams to provide high value at a much lower cost than the large aerospace companies.  We can design and integrate different space products, services and technologies, as customer needs require, across a spectrum of missions to help meet the needs of our customers.  Many of our products and technologies could be employed on a single project or mission to provide an optimal end-to-end solution.  We have flown 2,500 mechanisms and systems on 250 spacecraft with complete on-orbit mission success to affirm our understanding of design/build of space qualified parts and provide the heritage desired by customers in our industry.

Our spacecraft focus is mainly on small satellites, (e.g., microsatellite and nanosatellite spacecraft buses), although many of our products and technologies service larger spacecraft.  The primary benefit of small satellites is lower cost, less weight and more rapid time to deployment.  Due to our business strategy and core business model, we believe that we can dramatically reduce manufacturing costs and the costs to launch small satellites to earth-orbit and deep space.  In doing so, we can pass cost savings on to our customers.  Small, inexpensive satellites were once the exclusive domain of scientific and amateur groups; however, smaller satellites are now a supplement to, and a viable alternative to, larger, more expensive satellites, as they provide a high powered, cost-effective solution to traditional problems.  We design and build low cost, high-performance space-mission solutions involving small satellites generally 250 kg (550 pounds) to meet our customer requirements.  Our approach is to maintain a core business supporting larger satellites while fostering the growth of an emerging small satellite market.

We provide rapid access to space through innovative mission solutions currently lacking in the marketplace. Our approach is to provide smaller spacecraft – generally 500 kg mass and less – and draw upon our other compatible products and technologies to support commercial, university and government customers. The small spacecraft market is evolving and supported by the evolution of microelectronics, common hardware and software interface standards, and smaller launch vehicles. Reduction of the size and mass of traditional spacecraft electronics has reduced the overall spacecraft size, mass, and volume over the past 10 to 15 years. For example, our miniature flight computer is only 24 cubic inches and provides 300 million instructions per second of processing power versus a competitor's more "traditional" solution that requires about 63 cubic inches and only provides 10 million instructions per second. We also provide a wide variety of hybrid propulsion systems to safely and inexpensively enable small satellites and on-orbit delivery systems to rendezvous and maneuver on-orbit and deliver payloads to sub-orbital altitudes.  Hybrid rocket propulsion is a safe and low-cost technology that has tremendous benefits for current and future space missions. Our hybrid rocket propulsion technology features a simple design, is restartable and throttleable, and is easy to transport, handle and store.

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We have our own mission control and operations center, located in our headquarters building near San Diego, coupled with our mission control and operations package, which is Internet-based and allows for the operation and control of missions from anywhere in the world that has access to the Internet.  Our first small satellite, CHIPSat, which was launched in January 2003 and is still operating today, was one of the first U.S. missions to use end-to-end satellite operations with TCP/IP and FTP.  This concept can provide significant advantages. For example, a formation-flying cluster or constellation of TCP/IP-based small satellites can be designed to communicate directly with each other, as a wide area network in space.  Provided any one satellite/node in this network is in line-of-sight with any ground station at any given time, the entire constellation could always maintain ground station connectivity, thus creating a network on-orbit and on the web, a direct extension of CHIPSat's elegantly simple TCP/IP mission operations architecture.

We can provide end-to-end mission design and analysis, including the design of the mission and its science, commerce or technology demonstration goals, the design of an appropriate space vehicle (satellite or spacecraft), prototype development, construction and testing of the spacecraft, integration of one or more payloads (instruments, experiments or technologies) into the spacecraft, integration of the spacecraft onto the launch vehicle (rocket), the launch and the mission control, and operations during the life of the mission.  Our propulsion products and services are being designed to support our small spacecraft, although we are also involved with helping other companies and agencies utilize this safe and efficient hybrid propulsion technology in other applications.  We team with launch providers in order to identify and market affordable launches for the small satellite market.  We can provide customers with a complete on-orbit data delivery service that can also involve our spacecraft and related products and technologies. These innovative, low-cost, turnkey mission solutions could allow us to provide a one-stop shop for mission services, spacecraft, payload accommodation, total flight system integration and test, and mission operations.  Our customers and potential customers only need define their mission (and in some cases provide the payload), and we perform all the tasks required for the customer to get to orbit and begin collecting data.

As an ancillary initiative, we have begun designing a reuseable, piloted, sub-orbital space ship that could be scaled to transport passengers to and from Low Earth Orbit, including the International Space Station. The name of the vehicle is the SpaceDev Dream Chaser™. We signed a non-binding Space Act Memorandum of Understanding with NASA, which confirms our intention to explore novel, hybrid propulsion based hypersonic test beds for routine human space access. We will explore with NASA collaborative partnerships to investigate the potential of using our proven hybrid propulsion and other technologies, and a low cost, private space program development approach to establish and design new piloted small launch vehicles and flight test platforms to enable near-term, low-cost routine space access for NASA and the United States. The SpaceDev Dream Chaser™ is expected to be crewed and launch vertically, like most launch vehicles, and would glide back for a normal horizontal runway landing.  We are continuing to seek funding partners for this activity.

In addition to supporting our own mission solutions, we provide space components, mechanisms and electromechanical systems for larger spacecraft applications. These include electromagnetic motors, pointing systems, thermal control systems, and robotic systems to a variety of general drive applications.  Motors and actuators are required on spacecraft to move instruments, point antennas and solar arrays, and deploy structural elements.  We have a suite of technologies that can be combined to meet a wide variety of spacecraft requirements.  Many of our systems provide critical spacecraft functions.  Our unique suite of technological core competencies enables us to deliver these as turn-key systems. These mission solutions, products and services are being marketed and sold directly into primarily domestic government, university, military and commercial markets.

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Our business is, in part, reliant on the U.S. Government budgeting process and as a result, has elements of seasonality. In addition, our business follows normal industry trends such as increased demand during bullish economic periods, or slow-downs in demand during periods of recession.

Finally, we are working with potential partners to create new markets that can generate new space-related service and commercial revenue streams. While we believe that certain space market opportunities are still several years away, our focus continues to be on the commercialization of space and finding ways to create value for our shareholders through these endeavors.

Components and Raw Materials

Although our business may experience a shortage of certain parts and components related to our products, we have many alternative suppliers and distributors and are not dependent on any individual supplier or distributor.  Furthermore, we have not experienced difficulty in our ability to obtain our parts or component materials, nor do we expect this to be an issue in the future.

We purchase a significant percentage of product materials, components, structural assemblies and certain key satellite components and instruments from third parties.  We also occasionally obtain parts and equipment that we use in the production of our mission solutions and products or in the provision of our services from the U.S. government or customers.  Generally, we do not experience difficulty in obtaining product materials components and equipment, and believe that alternatives to our existing sources of supply are readily available.  If securing alternative sources of supply is necessary or required, increases in costs and delays may be incurred as a result of such actions.  For a relatively small number of unique materials or product components, we do rely upon sole sourced suppliers to provide such items. While alternative sources may be available, the inability of any such supplier to provide us with these items to qualified specifications could have an adverse effect on our ability to manufacture our products and would impact costing and schedules.

Competition

We compete for contracts related to our mission solutions and for sales of our products and services based on price, performance, technical features, contracting approach, reliability, availability, customization, perceived stability, and, in some situations, geography. The following list identifies some of our competitors, depending on the type of contract or sale that we may be seeking:

Ø

AeroAstro

Ø	Aeroflex (a subsidiary of UMTC)

Ø

Alliance

Ø	Alliant Tech Systems

Ø

ATK

Ø

CDA Astro

Ø	Cesaroni Technology Incorporated

Ø	EADS Astrium

Ø	G&H Technologies

Ø	General Dynamics

Ø	Harris Corporation

Ø	Microsat Systems (a subsidiary of Sierra Nevada)

Ø	Moog, Inc.

Ø	MPC Products Corporation

Ø	Planetary Systems, Inc.

Ø	Prime Contractor Internal Mechanisms

Ø	Surrey Satellite Technology Limited

Ø	Swales Aerospace

Ø	TiNi Aerospace

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We believe that our mission solutions, as well as our product and service offerings, provide a significant value to our customers and prospective customers.  Some of our competitors compete across a broader range of opportunities than others.  Several of our current and potential competitors have greater resources, including technical and engineering resources, marketing resources, and political connections. Also, customers may perceive larger competitors to be more stable.

Our customers are sometimes our competitors.  In the aerospace industry, we have found that we subcontract to companies that we also compete with when it comes to responding to requests for proposals and requests for information.  Many of these competitors are larger companies and have substantially greater resources (and rate structures) than we do, which is often why we can supply them with cost effective solutions, components and/or subsystems.  Part of our strategy is to remain non-confrontational with the larger aerospace companies so that we can both supply and compete with them. Even the larger aerospace companies have this issue with each other as they strive to support their customer, e.g., a government agency. 

Furthermore, it is possible that other domestic or foreign companies or governments, some with greater experience in the space and defense industry and many with greater financial resources than we possess, will seek to provide mission solutions, products or services that compete with us. Any such foreign competitor could benefit from subsidies from or other protective measures by its home country.

We also compete with each of our competitors for a qualified work force.  There are a limited number of individuals with all of the requirements that we seek and there can be no assurance that we can locate and recruit these individuals in a timely and cost-effective manner. Many of our competitors have greater resources than we do and can offer higher salaries or better incentives to attract these individuals or to hire our existing employees away from us.

Regulation

Our business activities are regulated by various agencies and departments of the U.S. government and, in certain circumstances, the governments of other countries.  We are required to ensure that any disclosure of scientific and technical information complies with the Export Administration Regulations (EAR) and the International Traffic in Arms Regulations (ITAR).  Exports of our products, services and technical data require either Technical Assistance Agreements or Licenses from the United States Department of State, depending on the complexity of the technology being exported.  The commercial exports of information with respect to ground-based sensors, detectors, and high-speed computers are controlled by the Department of Commerce.  The government is vigilant with respect to strict compliance. Statutes state that failure to comply with the ITAR and/or the Commerce Department regulations may subject guilty parties to substantial fines of up to $1 million and/or up to 10 years imprisonment per violation.  Our failure to comply with any of the previous regulations could have a serious adverse effect on our ability to do business.  Our ability to market, sell and deliver products into international markets may be adversely impacted due to ITAR and/or Commerce Department requirements. Potential negative impacts include, but are not limited to, the inability to sell to certain customers, extended sales cycles, delays in material procurement, manufacturing, test, product delivery, and collection of accounts receivable. Our conservative position is to consider any material beyond standard marketing material to be regulated by federal statute i.e., EAR, ITAR.

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In addition to local, state, and national government regulations that all businesses must adhere to, the space industry has specific federal regulations.  In the United States, command and telemetry frequency assignments for space missions are primarily regulated by the Federal Communications Commission for our domestic commercial products. Our products marketed towards domestic government customers are regulated by the National Telecommunications Information Agency. Products sold internationally are regulated by the International Telecommunications Union.  All launch vehicles that are launched from a launch site in the United States must pass certain launch range safety regulations that are administered by the United States Air Force.  In addition, all commercial space launches that we might perform require a license from the Department of Transportation.  Satellites that are launched must obtain approvals for command and frequency assignments.

We may also be required to obtain permits, licenses, and other authorizations under federal, state, local, and foreign statutes, laws, or regulations or other governmental restrictions relating to the environment or to emissions, discharges or releases of pollutants, contaminants, petroleum or petroleum products, chemicals or industrial, toxic, or hazardous substances or wastes into the environment including, without limitation, ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, petroleum or petroleum products, chemicals or industrial, toxic or hazardous substances or wastes, or the clean-up or other remediation thereof.  Presently, we do not have a requirement to obtain any special environmental licenses or permits.

We may need to utilize the Deep Space Network on some of our missions.  The Deep Space Network is a United States funded network of large antennas that support interplanetary spacecraft missions and radio and radar astronomy observations for the exploration of the solar system and the universe.  The network also supports selected Earth-orbiting missions.  The network is an asset of NASA, and is managed and operated for NASA by the Jet Propulsion Laboratory (JPL) at California Technology Institute.  The Telecommunications and Mission Operations Directorate at JPL manages the Program.

Also, some of our projects with the Department of Defense may need special clearances to continue work advancing our projects.  Classified programs generally will require that we comply with various Executive Orders, Federal laws, regulations and customer security requirements that may include specialized facilities and restrictions on how we develop, store, protect, and share information.  Laboratories, manufacturing and assembly areas, meeting spaces, office areas, storage areas, computers systems, and networks and telecommunications systems may require modification or replacement in order to comply with classified customer requirements.  Classified programs may require our employees to obtain government clearances and restrict our ability to have key employees work on these programs until these clearances are received from the appropriate United States government agencies.

In order to staff these programs we may need to recruit and retain personnel with the appropriate professional training, experience, and security clearances.  There are a very limited number of individuals with all of the requirements that we may be required to seek in the marketplace.  There is no assurance that we can locate and recruit these individuals in a timely and cost-effective manner.  We may be required to modify existing facilities and to develop new facilities and capabilities that will only be utilized by these classified programs.  We may be required to install computer networks, communications systems, and monitoring systems that are dedicated to these classified programs.  Some or all of these requirements may entail additional expense.  It is uncertain whether we will be able to recover all of the costs of these systems from our classified customers.  Many of these classified programs are regulated by Executive Orders, various Federal laws and regulations, and customer requirements.  Failure to comply with any of the aforementioned Executive Orders, Federal laws and regulations and customer requirements could have serious adverse effects on the business.  Also, our ability to successfully market and sell into the Department of Defense markets may be severely restricted if we are unable to meet threshold classified program requirements.  There is no assurance that we will be able to successfully pass the criteria required in order to win new classified programs or to maintain current classified contracts. There is also no assurance that we will maintain any particular level of classified status once it has been granted.

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Employees

As of December 31, 2007, we employed 173 full-time and 12 part-time persons, most of whom are engineers or technicians. We employ the following types of engineers:  spacecraft systems, propulsion systems, avionics, software, guidance/navigation/control, structural, mechanical, electrical, and electro-mechanical.  We employed 114 full-time and 8 part-time employees in the Louisville/Denver area of Colorado, 44 full-time employees in the San Diego area of Southern California, and 15 full-time employees in the Raleigh/Durham area of North Carolina.  We do not have any collective bargaining agreements with our employees.

Intellectual Property

We have protected and intend to continue to protect our intellectual property through a combination of patents, license agreements, trademarks, service marks, copyrights, trade secrets, and other methods of restricting disclosure and transferring title.  We rely, in part, on patents, trade secrets and know-how to develop and maintain our competitive position and technological advantage, particularly with respect to our launch vehicle, satellite products, structures, and mechanisms.  We hold U.S. and foreign patents relating to release devices, deployable truss structures, hybrid propulsion, and battery cell shorting mechanisms.  The majority of our U.S. patents relating to the noted technologies expire between 2019 and 2022.  We have also filed patent applications relating to our hybrid propulsion technology, satellite technology and structures technology.  There can be no assurance that the patents from such applications will be granted.  We have entered, and intend to continue to enter, into confidentiality agreements with our employees, consultants and vendors; entered into license agreements with third parties; and, generally, sought to control access to and distribution of our intellectual property.

Mission Assurance and Testing

Our mission assurance charter is to ensure procured materials, internal processes, and finished products meet contract and Quality Management System requirements.  Our Colorado and North Carolina facilities maintain AS9100 and ISO-9001 third party certified quality management systems.  Both facilities have implemented rigorous employee training and certification programs to empower operator ownership for process adherence and product quality. We perform frequent internal audits and facilitate third party site audits to confirm processes perform to expectations, products comply with engineering requirements and to identify opportunities to provide higher quality and increased value to our customers.

Our Quality Engineering provides up-front support to ensure contract requirements are clearly identified and appropriately flowed down, processes are capable to provide consistent and measurable results, and sub-tier suppliers meet their quality goals and objectives.  Our Quality Inspection provides specialized inspection support for detailed dimensional inspections, independent confirmations of operator self verification activities, and in-line inspections when mandated by regulatory or contract requirements. We have extensive in-house capabilities for aerospace environmental testing, including thermal and thermal/vacuum chambers, and vibration testing. We also have access to certified suppliers for vibration, shock, and electromagnetic interference testing. We maintain an environmentally controlled dimensional inspection lab to house our state of the art, high precision coordinate measuring machine work centers. All test and measurement activities are performed with equipment calibrated to standards traceable to the National Institute of Standards and Technology.

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Although our mission assurance charter extends to all of our operating facilities, our quality management operations have not been third party certified in our California facilities.  We anticipate third party quality management system certification at all of our facilities in the future.

Research and Development

A large portion of our total new product development and enhancement programs is funded under government and customer contracts.