UNITED STATES


SECURITIES AND EXCHANGE
COMMISSION


Washington, D.C.
20549





FORM 10-Q





[X]
            Quarterly
      report pursuant to section 13 or 15(d) of the Securities Exchange Act of
      1934. For the quarterly period ending December 31,
2007.[
      ]
            Transition
      report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934. For the transition period from _____to_____.Commission
      file number 000-25839





IMPLANT SCIENCES
CORPORATION


(Exact
name of registrant as specified in its charter)





Massachusetts
            
            04-2837126(State
      or other jurisdiction
              of
      incorporation or organization)
            
            (IRS
      Employer
              Identification
      number)107
      Audubon Road, #5 Wakefield, MA
            
            01880(Address
      of Principal Executive Offices)
            
            (Zip
      Code)


781-246-0700


(Registrant’s
Telephone Number, Including Area Code)





Securities
registered pursuant to Section 12(b) of the Act:





Title of Each
Class                                                                        Name of Each Exchange on
Which Registered


Common Stock, $.10 par
value                                                                        American Stock
Exchange








Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.


YESX     NO ___





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer.


Large Accelerated Filer
____                                                        Accelerated Filer
____                                                      Non-Accelerated FilerX





Indicate by checkmark whether the
Registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act)


YES ___
NO X




The
aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $14,172,000 as of February 13,
2008  (based on the closing price for such stock as of February 13,
2008).





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock:





Class
            Outstanding
      at February 13, 2008Common
      Stock, $.10 par value
            12,114,553





1


IMPLANT SCIENCES
CORPORATION





INDEX





Page
      No.PART
      I.  FINANCIAL INFORMATIONItem
      1.
            Financial
      Statements (unaudited):Condensed
      Consolidated Balance Sheets as of December 31, 2007 and
              June
      30, 2007
            3Condensed
      Consolidated Statements of Operations for the Three and Six Months Ended
      December 31, 2007 and 2006
            4Condensed
      Consolidated Statements of Cash Flows for the Six Months Ended December
      31, 2007 and 2006
            5Notes
      to Condensed Consolidated Financial Statements
            6Item
      2.
            Management's
      Discussion and Analysis of Financial Conditionand
      Results of Operations
            15Item
      3.
            Quantitative
      and Qualitative Disclosure About Market Risk
            19Item
      4.
            Controls
      and Procedures
            19PART
      II.  OTHER INFORMATIONItem
      1.
            Legal
      Proceedings
            21Item
      1A
            Risk
      Factors
            21Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            21Item
      3.
            Defaults
      Upon Senior Securities
            21Item
      4.
            Submission
      of Matters to a Vote of Security-Holders
            22Item
      5.
            Other
      Information
            22Item
      6.
            Exhibits
            22Signatures
            23


2




IMPLANT SCIENCES
      CORPORATIONCONSOLIDATED BALANCE
      SHEETSDecember
      31,                         June
      30,ASSETS
            
            2007
            
            
            2007Current
      assets:Cash
      and cash equivalents
            
            $
            4,804,000
            
            
            $
            9,621,000Accounts
      receivable, less allowance of $159,000 and $99,000,
      respectively
            
            
            1,188,000
            
            
            
            1,891,000Accounts
      receivable, unbilled
            
            
            14,000
            
            
            
            162,000Inventories
            
            
            1,199,000
            
            
            
            1,166,000Investments
      - available for sale securities
            
            
            93,000
            
            
            
            158,000Prepaid
      expenses and other current assets
            
            
            740,000
            
            
            
            755,000Total
      current assets
            
            
            8,038,000
            
            
            
            13,753,000Property
      and equipment, net
            
            
            1,702,000
            
            
            
            2,922,000Amortizable
      intangible assets, net
            
            
            23,000
            
            
            
            77,000Other
      non-current assets
            
            
            684,000
            
            
            
            786,000Goodwill
            
            
            765,000
            
            
            
            2,062,000Total
      assets
            
            $
            11,212,000
            
            
            $
            19,600,000LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      liabilities:Current
      maturities of long-term debt and obligations under capital
      lease
            
            $
            716,000
            
            
            $
            708,000Line
      of credit
            
            
            228,000
            
            
            
            -Payable
      to Med-Tec
            
            
            83,000
            
            
            
            143,000Accrued
      expenses
            
            
            1,757,000
            
            
            
            2,298,000Accounts
      payable
            
            
            1,419,000
            
            
            
            1,133,000Current
      portion of long- term lease liability
            
            
            308,000
            
            
            
            301,000Deferred
      revenue
            
            
            34,000
            
            
            
            81,000Total
      current liabilities
            
            
            4,545,000
            
            
            
            4,664,000Long-term
      liabilities:Long-term
      debt and obligations under capital lease, net of current
      maturities
            
            
            30,000
            
            
            
            633,000Long-term
      lease liability
            
            
            608,000
            
            
            
            735,000Derivatives
      related to preferred stock features
            
            
            -
            
            
            
            133,000Total
      liabilities
            
            
            5,183,000
            
            
            
            6,165,000Commitments
      and contingencies (Note 7)Series
      D Cumulative Redeemable Convertible Preferred Stock; $10 stated
      value;500,000
      shares authorized,333,333
      and 393,939shares
      outstanding
              as
      of December 31, 2007,and
      June 30, 2007, respectively (liquidation value $3,333,000 and $3,939,000
      at December 31, 2007 and June 30, 2007, respectively)
            
            
            2,813,000
            
            
            
            2,989,000Stockholders'
      equityCommon
      stock, $0.10 par value; 50,000,000 shares authorized at December 31, 2007
      and June 30, 2007, respectively;
              11,854,638
      and 11,835,661 shares issued and  outstanding atDecember
      31, 2007 and June 30, 2007, respectively
            
            
            1,185,000
            
            
            
            1,183,000Additional
      paid-in capital
            
            
            57,781,000
            
            
            
            57,358,000Accumulated
      deficit
            
            
            (55,540,000
            )
            
            
            (47,927,000
            )Deferred
      compensation
            
            
            (7,000
            )
            
            
            (30,000
            )Accumulated
      other comprehensive loss
            
            
            (130,000
            )
            
            
            (65,000
            )Treasury
      stock, 10,545 common shares, respectively, at cost
            
            
            (73,000
            )
            
            
            (73,000
            )Total
      stockholders' equity
            
            
            3,216,000
            
            
            
            10,446,000Total
      liabilities and stockholders' equity
            
            $
            11,212,000
            
            
            $
            19,600,000




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









3


IMPLANT SCIENCES
      CORPORATIONCONDENSED CONSLIDATED
      STATEMENTS OF OPERATIONS(unaudited)Three
      months ended December 31,
            
            
            Six
      months ended December 31,Revenues:
            
            2007
            
            
            2006
            
            
            2007
            
            
            2006Security
            
            $
            369,000
            
            
            $
            1,905,000
            
            
            $
            1,716,000
            
            
            $
            2,386,000Semiconductor
            
            
            1,353,000
            
            
            
            1,915,000
            
            
            
            3,090,000
            
            
            
            3,538,000Medical
            
            
            162,000
            
            
            
            1,038,000
            
            
            
            296,000
            
            
            
            2,198,000Total
      revenues
            
            
            1,884,000
            
            
            
            4,858,000
            
            
            
            5,102,000
            
            
            
            8,122,000Cost
      of revenues:Cost
      of security revenues
            
            
            408,000
            
            
            
            1,160,000
            
            
            
            1,229,000
            
            
            
            1,776,000Cost
      of semiconductor revenues
            
            
            1,518,000
            
            
            
            1,667,000
            
            
            
            3,293,000
            
            
            
            3,266,000Cost
      of medical product revenues
            
            
            367,000
            
            
            
            934,000
            
            
            
            679,000
            
            
            
            1,784,000Total
      cost of revenues
            
            
            2,293,000
            
            
            
            3,761,000
            
            
            
            5,201,000
            
            
            
            6,826,000Gross
      margin (deficit)
            
            
            (409,000
            )
            
            
            1,097,000
            
            
            
            (99,000
            )
            
            
            1,296,000Operating
      expenses:Research
      and development
            
            
            699,000
            
            
            
            433,000
            
            
            
            1,389,000
            
            
            
            1,000,000Selling,
      general and administrative
            
            
            1,812,000
            
            
            
            1,770,000
            
            
            
            3,551,000
            
            
            
            3,257,000Impairment of
      long lived assets and goodwill
            
            
            2,215,000
            
            
            
            37,000
            
            
            
            2,215,000
            
            
            
            37,000Total
      operating expenses
            
            
            4,726,000
            
            
            
            2,240,000
            
            
            
            7,155,000
            
            
            
            4,294,000Loss
      from operations
            
            
            (5,135,000
            )
            
            
            (1,143,000
            )
            
            
            (7,254,000
            )
            
            
            (2,998,000
            )Other
      income (expense):Interest
      income
            
            
            64,000
            
            
            
            8,000
            
            
            
            165,000
            
            
            
            12,000Interest
      expense
            
            
            (27,000
            )
            
            
            (32,000
            )
            
            
            (61,000
            )
            
            
            (57,000
            )Change
      in fair value of embedded derivatives related to preferred stock
      features
            
            
            283,000
            
            
            
            685,000
            
            
            
            133,000
            
            
            
            705,000Equity
      losses in unconsolidated subsidiaries
            
            
            -
            
            
            
            (38,000
            )
            
            
            -
            
            
            
            (158,000
            )Total
      other expense, net
            
            
            320,000
            
            
            
            623,000
            
            
            
            237,000
            
            
            
            502,000Loss
      from continuing operations
            
            
            (4,815,000
            )
            
            
            (520,000
            )
            
            
            (7,017,000
            )
            
            
            (2,496,000
            )Preferred
      distribution, dividends and accretion
            
            
            (289,000
            )
            
            
            (145,000
            )
            
            
            (596,000
            )
            
            
            (381,000
            )Loss
      from continuing operations applicable to common
    shareholders
            
            
            (5,104,000
            )
            
            
            (665,000
            )
            
            
            (7,613,000
            )
            
            
            (2,877,000
            )Income
      from discontinued operations
            
            
            -
            
            
            
            123,000
            
            
            
            -
            
            
            
            489,000Net
      loss applicable to common shareholders
            
            
            (5,104,000
            )
            
            
            (542,000
            )
            
            
            (7,613,000
            )
            
            
            (2,388,000
            )Net
      loss
            
            $
            (4,815,000
            )
            
            $
            (397,000
            )
            
            $
            (7,017,000
            )
            
            $
            (2,007,000
            )Loss
      per share from continuing operations, basic and diluted
            
            $
            (0.41
            )
            
            $
            (0.04
            )
            
            $
            (0.59
            )
            
            $
            (0.21
            )Loss
      per share from continuing operations applicable to common shareholders,
      basic and diluted
            
            $
            (0.43
            )
            
            $
            (0.06
            )
            
            $
            (0.64
            )
            
            $
            (0.24
            )Income
      per share from discontinued operations
            
            $
            -
            
            
            $
            0.01
            
            
            $
            -
            
            
            $
            0.04Net
      loss per share applicable to common shareholders, basic and
      diluted
            
            $
            (0.43
            )
            
            $
            (0.05
            )
            
            $
            (0.64
            )
            
            $
            (0.20
            )Net
      loss per share
            
            $
            (0.41
            )
            
            $
            (0.03
            )
            
            $
            (0.59
            )
            
            $
            (0.17
            )Weighted
      average common shares outstanding used in computing basic and diluted loss
      per share
            
            
            11,844,093
            
            
            
            11,775,557
            
            
            
            11,840,931
            
            
            
            11,768,986The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





4


IMPLANT SCIENCES
      CORPORATIONCONDENSED CONSLIDATED
      STATEMENTS OF CASH FLOWS(unaudited)Six Months Ended December
      31,Cash flows from operating
      activities:
            
            2007
            
            
            2006Loss from continuing
      operations
            
            $
            (7,017,000
            )
            
            $
            (2,496,000
            )Income from discontinued
      operations
            
            
            -
            
            
            
            489,000Net loss
            
            
            (7,017,000
            )
            
            
            (2,007,000
            )Adjustments to reconcile net loss
      to net cash used in operating activities:Depreciation and
      amortization
            
            
            637,000
            
            
            
            694,000Amortization of intangible
      assets
            
            
            17,000
            
            
            
            83,000Share-based compensation
      expense
            
            
            422,000
            
            
            
            428,000Equity loss in unconsolidated
      subsidiaries
            
            
            -
            
            
            
            175,000Change in fair value of
      embedded derivatives
            
            
            (133,000
            )
            
            
            (705,000
            )Loss on equipment sale or
      write down
            
            
            -
            
            
            
            37,000Impairment of long lived assets and goodwill
            
            
            2,224,000
            
            
            
            -Reserve for bad
      debts
            
            
            60,000
            
            
            
            (21,000
            )Deferred
      compensation
            
            
            -
            
            
            
            (37,000
            )Warrant accretion on Bridge
      Bank loan
            
            
            6,000
            
            
            
            -Changes in operating assets and
      liabilities:Accounts
      receivable
            
            
            791,000
            
            
            
            (791,000
            )Inventories
            
            
            (33,000
            )
            
            
            117,000Prepaid expenses and other
      assets
            
            
            35,000
            
            
            
            317,000Accounts
    payable
            
            
            286,000
            
            
            
            193,000Accrued
    expenses
            
            
            (541,000
            )
            
            
            (257,000
            )Deferred
    revenue
            
            
            (47,000
            )
            
            
            6,000Lease
liability
            
            
            (120,000
            )
            
            
            60,000Net cash used in continuing
      operations
            
            
            (3,413,000
            )
            
            
            (1,708,000
            )Net cash provided by discontinued
      operations
            
            
            -
            
            
            
            1,029,000Net cash used in operating
      activities
            
            
            (3,413,000
            )
            
            
            (679,000
            )Cash flows from investing
      activities:Purchase of property and
      equipment
            
            
            (225,000
            )
            
            
            (36,000
            )Change in other non-current
      assets
            
            
            -
            
            
            
            (227,000
            )Net cash used in continuing
      operations
            
            
            (225,000
            )
            
            
            (263,000
            )Net cash used in discontinued
      operations
            
            
            -
            
            
            
            (131,000
            )Net cash used in investing
      activities
            
            
            (225,000
            )
            
            
            (394,000
            )Cash flows from financing
      activities:Proceeds from issuance of common
      stock including the exercise of options and the Employee Stock Purchase
      Plan
            
            
            26,000
            
            
            
            154,000Dividends on Series D Cumulative
      Redeemable Convertible Preferred Stock
            
            
            (166,000
            )
            
            
            (349,000
            )Payments on Series D Cumulative
      Redeemable Convertible Preferred Stock
            
            
            (606,000
            )
            
            
            -Net proceeds  (payments) on
      line of credit
            
            
            228,000
            
            
            
            (34,000
            )Principal payments of long-term
      debt and capital lease obligations
            
            
            (661,000
            )
            
            
            (13,000
            )Net cash used in continuing
      operations
            
            
            (1,179,000
            )
            
            
            (242,000
            )Net cash used in discontinued
      operations
            
            
            -
            
            
            
            (221,000
            )Net cash used in financing
      activities
            
            
            (1,179,000
            )
            
            
            (463,000
            )Net change in cash and cash
      equivalents
            
            
            (4,817,000
            )
            
            
            (1,536,000
            )Cash and cash equivalents at
      beginning of the period
            
            
            9,621,000
            
            
            
            2,074,000Cash and cash equivalents at end
      of the period
            
            $
            4,804,000
            
            
            $
            538,000Supplemental Disclosure of Cash
      Flow Information:Interest paid in
    cash
            
            $
            61,000
            
            
            $
            62,000Noncash Investing and Financing
      Activity:Accretion of Series D Cumulative
      Redeemable Convertible Preferred Stock Dividends, derivatives and
      warrants
            
            $
            430,000
            
            
            $
            381,000Execution of credit agreement
      pending receipt of cash proceeds
            
            $
            -
            
            
            $
            1,050,000Relative fair value of warrants
      issued in conjunction with executed credit agreement
            
            $
            -
            
            
            $
            450,000The
      accompanying notes are an integral part of these condensed consolidated
      financial statements


5
 IMPLANT SCIENCES
CORPORATION
 NOTES TO CONDENSED FINANCIAL
STATEMENTS
 December 31, 2007
 (Unaudited)
 
 1.           Description
of Business
 Implant Sciences Corporation (the “Company”) provides products and services for
the security, safety and drug (“SS&D”) market as well as semiconductor and
medical device industries. The Company has both developed and acquired
technologies using ion implantation and thin film coatings for semiconductor and
medical device applications, including the coating of cardiovascular devices and
other products.  This technology has further evolved to include
applications in the area of trace explosives detection products.
 
 On May 1, 2007, the Company entered
into an Asset Purchase Agreement (the “Agreement”) to sell substantially all of
the assets (the “Transaction”) of its subsidiary, Accurel Systems International
Corporation (“Accurel), a California corporation, to Evans Analytical Group LLC
(“Evans”), a Delaware limited liability company.  Evans acquired all
of the fixed assets and accounts receivable of the Company.  The total
purchase price of the Transaction was approximately $12,705,000. In addition,
the Company issued warrants to purchase 350,000 shares of the Company’s common
stock to Legend Merchant Group, the investment banker involved with the
Transaction, at a price of $2.00 per share and agreed to pay them a fee based
upon a percentage of the gross aggregate consideration received by the Company.
An additional 25,000 warrants were issued to other consultants involved with the
Agreement, at a price of $2.00 per share.
 
 In
connection with the Transaction, we entered into an escrow agreement (the
“Escrow Agreement”) with Evans, Accurel, and Zions First National Bank. 
Pursuant to the Escrow Agreement, Evans deposited $1,000,000 (the “Escrow
Amount”) of the total purchase price for the assets into an escrow
account.  Any valid claims for indemnification made by Evans pursuant to
the Agreement shall be drawn from this sum.  The Escrow Agreement
provides, subject to any claims of indemnifications, for a release of $500,000
on approximately each of March 31, 2008 and March 31, 2009.
 
 Also in
connection with the Transaction, we entered into a Non-competition and
Nondisclosure Agreement (the “NCD”) with Evans whereby we agreed not to engage
in any business that directly competes with the business of
Accurel.  In addition, the NCD prohibits us from disclosing any
confidential information concerning the business of Accurel.  The NCD
will remain in effect for five years from the date of its
execution.
 
 In June 2007, the Company sold certain
of the assets related to its brachytherapy products and divested the prostate
seed and medical software businesses.  Management is currently working
on a plan to keep the remaining coating assets in service by offering services
and components to certain medical device manufacturers.  However,
should management be unsuccessful in formalizing this plan, there is a
possibility that future periods may report discontinued operations relating to
these remaining assets.
  The Company currently markets and sells its existing trace explosives detector
products while continuing to make significant investments in developing the next
generation of these products.
 In February 2008, the Company
entered into a binding term sheet to acquire substantially all of the assets and
certain enumerated liabilities of San Diego, CA based Ion Metrics,
Inc.  Ion Metrics is in the business of producing low cost mass sensor
systems for the detection and analysis of chemical compounds such as explosives,
chemical warfare agents, narcotics, and toxic industrial chemicals for the
homeland defense, forensic, environmental, and safety/security
markets.  The integration of the Ion Metrics technologies into the
Company’s  Quantum Sniffer product line provide us with opportunities
to introduce smaller, lower cost, and higher performance security
solutions.
 
 The
Company has largely completed the process of consolidating all semiconductor
processing at its Core Systems subsidiary located in Sunnyvale,
CA.  In February 2008, the Board of Directors of the Company
instructed management to actively pursue identifying a buyer for this
subsidiary.
 Risks
and Uncertainties
  While the Company strives to bring new
products to market, it is subject to a number of risks similar to other
technology-based companies, including risks related to: (a) its dependence on
key individuals and collaborative research partners; (b) competition from
substitute products and larger companies; (c) its ability to develop and market
commercially usable products and obtain regulatory approval for its products
under development; and (d) its ability to obtain the substantial additional
financing necessary to adequately fund the development, commercialization and
marketing of its products. For the six months ended December 31, 2007, the
Company reported a net loss applicable to common shareholders of $7,613,000 and
used $3,413,000 in cash from operations. As of December 31, 2007, the Company
had an accumulated deficit of approximately $55,540,000 and working capital of
$3,493,000. The Company has a term loan with a bank, which matures in August
2009 and has an unpaid balance of approximately $712,000.  Management
continually evaluates plans to reduce its operating expenses and increase its
cash flow from operations. Failure of the Company to achieve its projections may
require the Company to seek additional financing or discontinue
operations.
 
 On January 3, 2007, the Company
executed an agreement with San Jose, CA based Bridge Bank, N.A. which increased
the Company’s revolving credit facility from $1.5 million to $5.0 million (see
Note 10).  Based on the current sales, expense and cash flow
projections, the proceeds from this facility and the sale of certain assets,
management believes there are plans in place to sustain operations for at least
the next twelve months.  However, there can be no assurance that
management will be successful in executing these plans.  These plans
depend on a substantial increase in sales of the Company’s handheld trace
explosives detector product.  Management will continue to closely
monitor and attempt to control costs at the Company and will continue to
actively seek the needed capital through sales of its products, government
grants and awards, strategic alliances, private financing sources, and through
its lending institutions.
 
 The
Company's consolidated financial statements have been presented on the basis
that it is a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
suffered recurring losses from continuing operations. The Series D preferred
stock contains mandatory redemptions on a monthly basis. These mandatory
redemptions are redeemable in cash or shares of the Company’s common stock, at
the Company’s option, so long as the price of the Company’s stock does not fall
below 110% of the fixed conversion price.  The Company received a
waiver of the monthly amortization payments for the period December 2006 –
August 2007, to the mandatory redemption date. The redemption payments resumed
in September 2007.
 
 There can
be no assurances that forecasted results will be achieved or that the Company’s
stock price will remain at a level to allow the Company to redeem the
outstanding shares of Series D preferred and accrued dividends with shares of
its common stock.  These conditions raise substantial doubt about the
Company's ability to continue as a going concern.  The financial statements
do not include any adjustments relating to the recoverability and classification
of asset amounts or the amounts and classification of liabilities that might be
necessary should the Company be unable to continue as a going
concern.
 
 During fiscal 2007, the Company
experienced a significant reduction in its semiconductor
business.  This decline resulted from the sale of the assets of
Accurel in May 2007.  The effect of this sale is being reported as
discontinued operations in the accompanying financial statements.  In
addition, in June 2007, the Company sold certain of its assets related to its
brachytherapy business and divested the prostate seed and medical software
businesses.  Management is currently working on a plan to keep the
remaining coating assets in service by offering services and components to
certain medical device manufacturers.  However, should management be
unsuccessful in formalizing this plan, there is a possibility that future
periods may report discontinued operations relating to these remaining
assets.
 The Company experienced a significant reduction in security product sales in the
quarter ended December 31, 2007, as compared with the comparable prior year
period.  Security product sales have a long sale cycle, and are often
subject to export control.  In an effort to identify new opportunities
and stimulate sales, the Company has expanded its sales staff and implemented a
new sales tool to assist in this effort.  However, there can be no
assurance that these efforts will translate to improved revenue.
 The Company has a history of being
active in submitting proposals for government sponsored grants and contracts and
successful in being awarded grants and contracts from government agencies.
Management will continue to pursue these grants and contracts to support its
research and development efforts primarily in the areas of trace explosives
detection.
  6
  2.           Interim
Financial Statements and Basis of Presentation
 The
accompanying condensed consolidated financial statements of the Company have
been prepared in accordance with the accounting principles generally accepted in
the United States of America (“U.S. GAAP”).  In the opinion of
management, the accompanying condensed consolidated financials statements
include all adjustments (consisting only of normal recurring adjustments), which
the Company considers necessary for a fair presentation of the financial
position at such date and of the operating results and cash flows for the
periods presented.  The result of operations and cash flows for the
six months ended December 31, 2007 may not necessarily be indicative of results
that may be expected for any succeeding quarter or for the entire fiscal
year.  The information contained in this Form 10-Q should be read in
conjunction with the Company’s audited financial statements, included in our
Form 10-K as of and for the year ended June 30, 2007 filed with the Securities
and Exchange Commission on October 15, 2007.
 
 The accompanying condensed consolidated
financial statements include the accounts of the Company and its wholly owned
subsidiary Core Systems Incorporated (“Core”) (the “Subsidiary”).  All
intercompany balances have been eliminated in
consolidation.  Substantially all of the assets of the Company’s
wholly-owned subsidiary, Accurel, have been sold pursuant to the Agreement and
accordingly, our financial statements have reflected the statement of operations
of Accurel as discontinued operations for the three and six months ended
December 31, 2007 and 2006.  Additionally, the related information
contained in the notes to the financial statements includes those of the
Company’s continuing operations unless specifically identified as disclosures
related to discontinued operations.
 
 Our significant accounting policies are
described in Note 2 to the financial statements of Item 8 of our Form 10-K as of
June 30, 2007.  Our discussion and analysis of our financial condition
and results of operations are based upon the financial statements, which have
been prepared in accordance with U.S. GAAP.  The preparation of
financial statements in conformity with U.S. GAAP  requires management
to make estimates and judgments, which are evaluated on an on-going basis, that
affect the amounts reported in the Company’s condensed consolidated financial
statements and accompanying notes.  Management bases its estimates on
historical experience and on various other assumptions that it believes are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities and the
amounts of revenues and expenses that are not readily apparent from other
sources.  Actual results could differ from those estimates and
judgments.  In particular, significant estimates and judgments include
those related to revenue recognition, allowance for doubtful accounts, useful
lives of property and equipment, inventory reserves, business combinations,
valuation for goodwill and acquired intangible assets, accounting for embedded
derivatives and warranty reserves.
  Certain
reclassifications were made to the fiscal year 2007 financial statements to
confform to the fiscal year 2008 presentation.
  3.           Inventories
  Inventories consist of the
following:


December
    31,
            
            
            June 30,2007
            
            
            2007Raw
      materials
            
            $
            661,000
            
            
            $
            737,000Work-in-progress
            
            
            125,000
            
            
            
            94,000Finished
      goods
            
            
            413,000
            
            
            
            335,000$
            1,199,000
            
            
            $
            1,166,000





4.           Property and
Equipment




Property and equipment consists of the
following:





December
    31,
            
            
            June 30,2007
            
            
            2007Total
      property and equipment
            
            $
            9,243,000
            
            
            $
            9,826,000Less:  accumulated
      depreciation
            
            
            (7,541,000
            )
            
            
            (6,904,000
            )$
            1,702,000
            
            
            $
            2,922,000


The Company
recorded depreciation expense of approximately $312,000 and $324,000 for the
three month periods ended December 31, 2007 and 2006, respectively, and $637,000
and $694,000 for the six month periods ended December 31, 2007 and 2006,
respectively. Equipment purchased pursuant to capital leases and leasehold
improvements are amortized based upon the lesser of the term of the lease or the
useful life of the asset and such expense is included in depreciation
expense.  The
depreciable lives of the assets acquired in the Core acquisition, which were
originally given seven year lives, were revised to five year lives at June 30,
2007, as a result of the annual goodwill impairment review conducted in August
of 2007.  In February 2008, the Board of Directors committed to a plan
to actively pursue a buyer for its Semiconductor Reporting Unit.  As a
result, in the quarter ending March 31, 2008, the Company expects to present its
Semiconductor Reporting Unit as "Assets Held for Sale" and these assets will
cease to be depreciated.
  5.           Accrued
Expenses
 
 Accrued
expenses consist of the following:


December
    31,
            
            
            June 30,2007
            
            
            2007Accrued
      compensation and benefits
            
            $
            423,000
            
            
            $
            555,000Accrued
      taxes
            
            
            285,000
            
            
            
            478,000Accrued
      legal and accounting
            
            
            119,000
            
            
            
            192,000Accured
      interest
            
            
            101,000
            
            
            
            105,000Rapiscan
      settlement accrual
            
            
            200,000
            
            
            
            200,000Other
      accrued liabilities
            
            
            629,000
            
            
            
            768,000$
            1,757,000
            
            
            $
            2,298,000


The
Company accrues warranty costs in the period the related revenue is recognized
and adjusts the reserve balance as needed to address potential future
liabilities.  The following table details the changes in the Company’s
warranty reserve, which is included in other accrued liabilities in the schedule
above.





Balance
      at June 30, 2007
            
            $
            57,000Accrued
      warranty expense
            
            
            32,000Charges
      against the reserve
            
            
            (19,000
            )Balance
      at September 30, 2007
            
            $
            70,000Accrued
      warranty expense
            
            
            5,000Charges
      against the reserve
            
            
            (24,000
            )Balance
      at December 31, 2007
            
            $
            51,000








6.           Investment
in Unconsolidated Subsidiaries
  As of
December 31, 2007 the Company has a 15.1% interest in CorNova, Inc. as a result
of 87,031 shares having been issued to CorNova by the Company.  The
Company recognized approximately $0 and $38,000 for the three month periods
ended December 31, 2007 and 2006, respectively, of equity losses in
unconsolidated subsidiaries, representing the Company’s portion of CorNova’s net
loss, and $0 and $175,000 for the six month periods ended December 31, 2007 and
2006, respectively.  A s a
result of the cumulative net losses incurred, the Company’s investment in
CorNova is $0.
  The
Company had been accounting for its investment in this unconsolidated subsidiary
under the equity method due in part to the significant control the Company had
as a result of Dr. A. J. Armini, the former President and CEO of Implant
Sciences, being on CorNova’s Board of Directors.  As a result of Dr.
Armini resigning from his board position at CorNova, the equity method is no
longer appropriate and the cost method will be used.
 7.
                Commitments and
      Contingencies
  (a) Capital and Operating
Leases
  The Company has an operating lease for its manufacturing, research and office
space in Wakefield, MA which expires on December 31, 2008. The Company has an
option to extend the lease for five additional years. Under the terms of the
lease, the Company is responsible for its proportionate share of real estate
taxes and operating expenses relating to this facility. The Company also has
leases for both of its facilities in Sunnyvale, CA. The leases expire in
December 2009 and September 2010 and the Company has an option to extend each
lease for five additional years.  Effective with the sale of the
assets of Accurel Systems on May 1, 2007, the Company executed a sublease
agreement for one of its California facilities and terminated the lease for its
satellite facility in Austin, TX.
 
 In conjunction with the acquisition of
Accurel, in March 2005, the Company recorded a lease liability of $829,000. This
liability reflected management’s estimate of the excess of payments required
under the Accurel facility lease, at the date of acquisition, versus the fair
market value of lease payments that would have been required, if the lease had
been negotiated under current market conditions.  Subsequently, as a
result of the sale of Accurel, the Company has recorded an additional lease
liability of $487,000 representing that portion of the lease in excess of the
sublease arrangement with Evans.  The balance of the lease liability
on December 31, 2007 is $916,000 of which $308,000 is current.  Under
the terms of the leases, the Company is responsible for its proportionate share
of real estate taxes and operating expenses relating to these
facilities.
  In conjunction with the Company’s plans
to do some research and development and minor manufacturing work in New Mexico,
in April 2007, the Company executed an operating lease which expires on May 1,
2010.  The lease allows for early termination as well as providing the
Company an option to extend the lease for five additional years. Under the terms
of the lease, the Company is responsible for its proportionate share of real
estate taxes and operating expenses relating to this facility.  The
fit out of the facility was completed in November 2007.
 
 Future minimum rental payments required
under capital leases and operating leases with non-cancelable terms in excess of
one year at December 31, 2007, together with the present value of net minimum
lease payments are as follows:


Capital Lease
      Payments
            
            
            Operating Lease Payments
      (1)
            
            
            Sublease
              IncomeYear
      ending Dec 31:2008,
      remaining 6 months
            
            $
            13,000
            
            
            $
            738,000
            
            
            $
            124,0002009
            
            
            27,000
            
            
            
            1,201,000
            
            
            
            253,0002010
            
            
            15,000
            
            
            
            578,000
            
            
            
            260,0002011
      and remaining
            
            
            2,000
            
            
            
            84,000
            
            
            
            66,000Total
      future minimum lease payments
            
            
            57,000
            
            
            $
            2,601,000
            
            
            $
            703,000Less:
      amounts representing interest
            
            
            (7,000
            )Present
      value of future minimum lease payments
            
            
            50,000Less:
      current portion
            
            
            (20,000
            )Capital
      lease obligation, net of current portion
            
            $
            30,000





(1)
adjusted for the effect of the sublease on the Lucerne Road
facility





(b) Employment
Agreements
  On
September 27, 2007, the Company entered into a Transition Agreement with Dr.
Anthony J. Armini, the Company’s former President and Chief Executive Officer
(“CEO”), with a term of twenty four months.  Under this Transition
Agreement Dr. Armini stepped down as President and CEO and assumed the position
of Scientific Advisor.  Dr. Armini remained the Chairman of the Board
of Directors until the December 2007 annual meeting of shareholders, at which
time he left the Board..  During the Transition Period, the Company
will compensate Dr. Armini at the annual rate of $250,000.  In
addition, Dr. Armini may participate in the Company’s medical and dental
insurance programs.  The Company may terminate this Transition
Agreement only for cause and Dr. Armini may terminate the Transition Agreement
for any reason, with each party giving the other written notice.  In
conjunction with this, Dr. Armini has been issued a stock option for 200,000
shares of common stock at an exercise price of $2.09 per share, of which 25,000
shares vest immediately, and the remaining 175,000 shares vest 25,000 per
quarter over the term of the Transition Agreement.  These options were
valued using the Black Scholes method and the following
assumptions:  volatility 96%, risk free interest rate of 4.01% and
expected life of 1.75 years.
 
 On December 12, 2007, the Company
entered into an employment agreement with Mr. Phillip Thomas, the Company’s
President and Chief Executive Officer, having an initial term of three years, an
annual base salary of $275,000, an annual incentive bonus program and a car
allowance.  In conjunction with this, Mr. Thomas has been issued an
option for 280,000 shares of common stock at an exercise price of $1.15 per
share, of which 93,333 vest immediately, and the remaining 186,667 vest over 24
months.  These options were valued using the Black Scholes method and
the following assumptions:  volatility 82%, risk free interest rate of
3.67% and expected life of 6 years.  In addition, Mr. Thomas may
participate in the Company’s employee fringe benefit plans or programs generally
available to employees of comparable status and position. The Company may
terminate his employment for any material breach of his employment agreement at
any time upon at least 30 days’ written notice. In the event the Company
terminates Mr. Thomas’ employment without cause, the Company will pay him 12
months salary on a regular payroll basis.  Under his employment
agreement, he is subject to restrictive covenants, including confidentiality
provisions and a one year non-compete and non-solicitation
provision.
 
 (c)           Litigation
  From time to time, we
are subject to various claims, legal proceedings and investigations covering a
wide range of matters that arise in the ordinary course of our business
activities. Each of these matters is subject to various
uncertainties.
 On March 23, 2005,
we entered into a Development, Distribution and Manufacturing Agreement (the
“Rapiscan Agreement”) with Rapiscan Systems, Inc. (“Rapiscan”).  Under the
terms of this agreement, we gave Rapiscan the exclusive worldwide rights to
market our Quantum Sniffer portable and benchtop trace detection devices
under their private label.  We also agreed to give Rapiscan the exclusive
worldwide rights to distribute certain other new security products which we may
develop in the future with their funding, as well as rights, in some
circumstances, to manufacture certain components of the private-labeled Quantum
Sniffer portable and benchtop trace detection devices.
 
 On March 23, 2006, Rapiscan filed a
complaint against the Company and its contract assembler, Columbia Tech, in the
United States District Court for the Central District of California, regarding
the Rapiscan Agreement.  Rapiscan’s complaint against the Company
was based upon claims of breach of contract and breach of warranty and
was requesting a decree for specific performance, declaratory relief and
injunctive relief. Rapiscan’s complaint against Columbia Tech was based upon
injunctive relief, declaratory relief and tortuous interference with contractual
relations. On April 12, 2006, Rapiscan dismissed all claims against Columbia
Tech.
 
 On March 24, 2006, the Company brought
suit in the United States District Court in the District of Massachusetts
against Rapiscan and its parent, OSI Systems, Inc. (“OSI”). The Company
requested rescission of the Rapiscan Agreement, plus damages, based on claims of
misrepresentation.  In the alternative, the Company was seeking
termination of the Rapiscan Agreement due to material breaches of contract and
the implied covenant of good faith and fair dealing and for damages due to
Rapiscan’s breach of contract and the implied covenant of good faith and fair
dealing.
 
 In August
2006, as a result of motions made by both parties, the two lawsuits (the
“Pending Litigation”) have been consolidated in the United States District Court
for the Central District of California with the Company as
plaintiff.  In late 2006, Rapiscan and OSI filed a motion to dismiss
certain of the Company’s claims.  The court dismissed Company’s claim
of breach of fiduciary duty, but the motion to dismiss was denied in all other
respects.  OSI and Rapiscan had filed four motions for partial summary
judgment with respect to certain discrete claims.  Two of the motions
were denied in their entirety.  The third was denied in the only
material respect and granted in two immaterial respects.
 
 On
January 4, 2008, the Company executed a Settlement Agreement (the “Settlement
Agreement”) with OSI and Rapiscan to resolve the Pending Litigation and to enter
into additional agreements.  In addition to the immediate dismissal of
the Pending Litigation, other terms of the Settlement Agreement include, (i) the
rescission of the Rapiscan Agreement, (ii) the payment by the Company of
$200,000, such payment to be made in the form of shares of the Company’s common
stock,  (iii) the granting of non-exclusive distribution rights to
Rapiscan, (iv) the payment by the Company of up to $1,000,000 in Technology
Transfer Fees, payable over time at a rate of 2% of the gross sales price
received by the Company when and if a passenger portal is sold, and (v) the
opportunity for OSI to supply certain components to the Company.
 
 We may, from time to time, be involved
in other actual or potential proceedings that we consider to be in the normal
course of our business. We do not believe that any of these proceedings will
have a material adverse effect on our business.
  8.
                Redeemable Convertible Preferred
      Stock
 
 The following table reflects the
required redemption of the Series D, to Laurus Master Fund,
LLP.  (“Laurus”), before the effect of the accrued
dividends:
    Year ending June
      30:
                
                Preferred Stock Monthly

                  Redemption
      Schedule2008 remaining
      6 months
                $
                909,0002009
                
                2,424,000$
                3,333,000
 
 On
December 28, 2006, Laurus consented to permit the Company to defer the December
2006, January 2007, February 2007, March 2007, April 2007, May 2007, June 2007,
July 2007, and August 2007 redemptions to the end of the term. The monthly
redemption of approximately $152,000 plus accrued dividends resumed on September
1, 2007 and will continue until the final payment date in September 2008 for
approximately $2.1 million.  Subject to certain
conditions,  including the market price being above $4.57 per common
share, it is at the Company’s option to pay this amount in cash or in common
stock at a fixed conversion price of $4.15 per common share.
 
 The Company valued the Series D at
issuance at its residual value of $2,700,000 based on the fair values of the
financial instruments issued in connection with this preferred stock financing,
including the warrants, the embedded derivative instruments and offering costs.
The amounts recorded in the financial statements represent the amounts
attributed to the sale of the Series D preferred stock, the amount allocated to
warrants, the value attributed to the embedded derivatives and issuance costs.
The Company is accreting these discounts on the carrying value of the preferred
stock to its redemption value at September 1, 2008, or the actual
conversion date, whichever is earlier. The accretion of these amounts is being
recorded as a preferred dividend in the period of accretion. As of December 31,
2007, $1,781,000 was amortized. As of December 31, 2007 and June 30, 2007, the
fair value of this conversion feature approximated $0 and $133,000,
respectively.  The value of the embedded derivatives related
to the adjustable dividend rate and the potential default provisions were
determined to be immaterial at December 31, 2007.


9.
                Share-based compensation
      plans
 
 Stock Option
Plans
  As of
December 31, 2007, a total of 137,003, 63,602, and 833,000 shares are available
for issuance under the 1998 Stock Option Plan, the 2000 Incentive and
Non-Qualified Stock Option Plan and the 2004 Stock Option Plan,
respectively.


Shares
            
            Weighted Average
              Exercise
      PriceOutstanding
      at June 30, 2007
            
            1,790,738
            
            $
            4.66Granted
            
            210,000
            
            $
            2.09Exercised
            
            -
            
            
            -Cancelled
            
            (20,000)
            
            $
            10.15Outstanding
      at September 30, 2007
            
            1,980,738
            
            $
            4.33Granted
            
            635,000
            
            $
            1.23Exercised
            
            -
            
            
            -Cancelled
            
            (208,000)
            
            $
            4.70Outstanding
      at December 31, 2007
            
            2,407,738
            
            $
            3.48Options
      exercisable at end of period
            
            1,276,721
            
            $
            4.87Weighted-average
      fair value of options granted during period
            
            
            
            $
            0.90




The Company recorded $214,000 and $281,000 of stock based compensation, which
includes $8,000 and $7,000 of compensation expense attributable to its Employee
Stock Purchase Plan and a reduction of $14,000 and an expense of $3,000 of
non-cash stock-based compensation related to warrants issued to non-employees,
in the three month period ended December 31, 2007 and 2006,
respectively.  The
Company recorded $422,000 and $428,000 of stock based compensation, which
includes $16,000 and $14,000 of compensation expense attributable to its
Employee Stock Purchase Plan and expenses of $11,000 and $14,000 of non-cash
stock-based compensation related to warrants issued to non-employees, in the six
month period ended December 31, 2007 and 2006, respectively.
  The total
non-cash stock-based compensation expense, included in the consolidated
statement of operations for the three and six month periods ended December 31,
2007 and 2006, respectively, is included in the following expense
categories:


Three months ended December
      31,2007
            
            
            2006Cost
      of revenues
            
            $
            31,000
            
            
            $
            60,000Research
      and development
            
            
            14,000
            
            
            
            22,000Selling,
      general and administrative
            
            
            169,000
            
            
            
            199,000Total
            
            $
            214,000
            
            
            $
            281,000




Six months ended December
      31,2007
              
              
              2006Cost
      of revenues
              
              $
              63,000
              
              
              $
              100,000Research
      and development
              
              
              38,000
              
              
              
              43,000Selling,
      general and administrative
              
              
              321,000
              
              
              
              285,000Total
              
              $
              422,000
              
              
              $
              428,000


As of
December 31, 2007 there was $904,000 of total unrecognized compensation expense
related to unvested share based compensation arrangements under the various
share-based compensation plans.





Period Ended June
      30:Remaining
      6 months 2008
            
            $
            254,0002009
            
            
            414,0002010
            
            
            203,000Thereafter
            
            
            33,000Total
            
            $
            904,000





The fair
value of each option award is estimated on the date of grant using the
Black-Scholes option pricing model using the assumptions noted in the following
table. Expected volatility is based on historical volatility of the Company’s
common stock. The Company uses historical data to estimate future option
forfeitures within the valuation model. The expected term of options granted is
calculated using the “Simplified Method” as outlined SFAS 123R and reflects the
period of time that options granted are expected to be outstanding. The
risk-free rate for periods within the contractual life of the option is based on
the U.S Treasury yield in effect at the time of grant.






Six month period
      ended
              December 31,
      2007
            
            Six month period
      ended
              December 31,
      2006Stock
      Option Plan
            
            Stock
      Purchase Plan
            
            Stock
      Option Plan
            
            Stock
      Purchase PlanRisk
      free interest rate
            3.13%
      - 4.34%
            
            4.95%
            
            4.58%
      – 4.72%
            
            5.17%Expected
      dividend yield
            0%
            
            0%
            
            0%
            
            0%Expected
      lives (years)
            1.75
      – 6 years
            
            6
      months
            
            3.5
      - 6 years
            
            6
      monthsExpected
      volatility
            55%
      - 91%
            
            97%
            
            78%
            
            78%Expected
      forfeiture rate
            10%
            
            0%
            
            10%
            
            0%Contractual
      term
            5 -
      10 years
            
            6
      months
            
            5 -
      10 years
            
            6
      months








Employee Stock Purchase
Plan
  In September 1998, the Company adopted the 1998 Employee Stock Purchase Plan
(the “Plan”). The Plan provides a method whereby employees of the Company will
have an opportunity to acquire an ownership interest in the Company through the
purchase of shares of common stock of the Company through payroll deductions.
After 12 months of employment, an employee is eligible to participate and can
defer up to 10% of their wages into this Plan, with a maximum of $25,000 in any
calendar year. The purchase price of the common stock is calculated at the lower
of 85% of the closing price of the stock on the first day of the plan period or
the last day of the plan period. The periods are January 1 to June 30 and July 1
to December 31. Fractional shares are not issued. Participants may withdraw at
any time by giving written notice to the Company and will be credited the
amounts of deferrals in their account. The maximum number of shares eligible to
be issued under the Plan is 141,000. As of December 31, 2007, a total of 10,669
shares are available for issuance under the Plan.
 In December 2006, the Company adopted
the 2006 Employee Stock Purchase Plan (the “2006 Plan”). The 2006 Plan provides
a method whereby employees of the Company will have an opportunity to acquire an
ownership interest in the Company through the purchase of shares of common stock
of the Company through payroll deductions. After 12 months of employment, an
employee is eligible to participate and can defer up to 10% of their wages into
this Plan, with a maximum of $25,000 in any calendar year. The purchase price of
the common stock is calculated at the lower of 85% of the closing price of the
stock on the first day of the plan period or the last day of the plan period.
The periods are January 1 to June 30 and July 1 to December 31. Fractional
shares are not issued. Participants may withdraw at any time by giving written
notice to the Company and will be credited the amounts of deferrals in their
account. The maximum number of shares eligible to be issued under the 2006 Plan
is 500,000. As of December 31, 2007, a total of 481,023 shares are available for
issuance under the 2006 Plan.
 
 Compensation expense under the 1998 and 2006 Plans for the three and six month
periods ended December 31, 2007 and 2006 is $8,000 and $16,000 and $7,000 and
$14,000, respectively.
 
 Non-qualified options and
warrants
  Included
in the consolidated statement of operations for the three month periods ended
December 31, 2007 and December 31, 2006, is a reduction in stock based
compensation expense of $14,000 and an expense of $3,000, respectively,
attributable to other non-employee options and warrants.  For the six month
periods ended December 31, 2007, and December 31, 2006, the Company recorded an
expense of $11,000 and $14,000, respectively, attributable to other non-employee
options and warrants.
 
 10.
              Long-term Debt and Credit
      Arrangements
  MED-TEC Payment
Obligation On July 31,
2003, the Company entered into an agreement with its former exclusive
distributor of prostate seeds, to release each other from further obligations
under the original Distributor Agreement.  The new agreement conveys to the
Company direct marketing and sales capabilities to sell its I-Plant Seed
brachytherapy seeds for use in the treatment of prostate cancer.  In
connection with this, the Company’s former exclusive distributor agreed to work
cooperatively to transition customers and marketing materials directly to the
Company.  The distributor also agreed not to compete with the Company for a
period of three years.  The present value of this payment obligation was
recorded as approximately $1,007,000, using a rate of 10.24%. This amount was
recorded as an intangible asset and is being amortized over its estimated useful
life of 29 months.  As of December 31, 2007, the outstanding and past
due principal balance is approximately $83,000.  For the three months ended
December 31, 2007 and 2006, the Company recorded approximately $2,000 and
$6,000, respectively, and $5,000 and $12,000 for the six month periods ended
December 31, 2007 and 2006 respectively, of interest expense relating to this
transaction.
  Revolving Credit Facility and Term
Note with Bridge Bank
  On
January 3, 2007, the Company executed an Amended and Restated Loan and Security
Agreement (the “Loan Agreement”) which amended and restated the terms of a
Business Financing Agreement originally dated as of June 1, 2005 with Silicon
Valley based Bridge Bank, N.A. (the “Bank”) increasing the revolving credit
facility from $1.5 million to $5.0 million.  This revolving credit
facility (the “line of credit”) has a two year term, provides for advances of up
to eighty percent (80%) of the Company’s eligible accounts receivable and up to
the lesser of $1,000,000 or forty percent (40%) of eligible inventory, bears
interest at the prime rate, plus one-half percent (1/2%) per annum, and is
collateralized by all assets of the Company.
  In
addition, pursuant to the terms of the Loan Agreement, the Company converted
$1,600,000 of the outstanding line of credit balance into a 30 month term note
bearing an interest rate at the prime rate plus one percent (1%) per annum
payable in thirty (30) equal monthly installments of principal, plus accrued
interest beginning on February 10, 2007.
 
 Pursuant
to the Loan Agreement, the Company issued to Bridge Bank N.A. a seven-year
warrant to purchase up to 18,939 shares of the Company’s common stock at a price
equal to $2.64 per share.  The warrants were valued using the Black
Scholes model and the following assumptions: volatility of 78%, an expected life
7 years, and a risk free interest rate of 4.54%.  Pursuant to ABP No
14 “Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants”, the note and warrants have been recorded at their relative fair
value.  The Company accretes the value of the warrants, $28,000, to
the term note over the life of the note.   As of December 31,
2007, approximately $12,000 has been amortized.
 
 The
Company was in violation of certain covenants associated with this facility at
December 31, 2007.  The Company has requested, but not yet received, a
waiver from the bank for this covenant violation.  As of December 31, 2007
and June 30, 2007, this revolving credit facility had a balance of $228,000 and
$0, respectively.  As of December 31, 2007 and June 30, 2007, the term
note had a balance of $712,000 and $1,299,000, respectively.
 
 
 11.
              Financial Information by
      Segment and Customer
Concentration
  Under SFAS
No. 131, “Disclosures about Segments of an Enterprise and Related Information,”
operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. The Company's chief operating
decision making group is composed of the chief executive officer and members of
senior management. The Company's reportable segments are: Security Products,
Semiconductor and Medical.
 
 Gross margin is the measure that
management uses when evaluating the Company’s segments; therefore, operating
expenses are excluded from the financial information below.
 
 The
revenues, expenses and assets related to these segments from
continuing operations for the three and six months ended December 31, 2007 and
2006 are:





Three months ended December 31,
      2007
            
            Security
            
            
            Semiconductor
            
            
            Medical
            
            
            TotalRevenue
            
            $
            369,000
            
            
            $
            1,353,000
            
            
            $
            162,000
            
            
            $
            1,884,000Cost
      of revenues
            
            
            408,000
            
            
            
            1,518,000
            
            
            
            367,000
            
            
            
            2,293,000Gross  deficit
            
            $
            (39,000
            )
            
            $
            (165,000
            )
            
            $
            (205,000
            )
            
            $
            (409,000
            )Assets
            
            $
            3,655,000
            
            
            $
            6,080,000
            
            
            $
            1,477,000
            
            
            $
            11,212,000Three months ended December 31,
      2006Revenue
            
            $
            1,905,000
            
            
            $
            1,915,000
            
            
            $
            1,038,000
            
            
            $
            4,858,000Cost
      of revenues
            
            
            1,160,000
            
            
            
            1,667,000
            
            
            
            934,000
            
            
            
            3,761,000Gross
      profit
            
            $
            745,000
            
            
            $
            248,000
            
            
            $
            104,000
            
            
            $
            1,097,000Assets
            
            $
            1,704,000
            
            
            $
            24,051,000
            
            
            $
            3,310,000
            
            
            $
            29,065,000





Six months ended December 31,
      2007
            
            Security
            
            
            Semiconductor
            
            
            Medical
            
            
            TotalRevenue
            
            $
            1,716,000
            
            
            $
            3,090,000
            
            
            $
            296,000
            
            
            $
            5,102,000Cost
      of revenues
            
            
            1,229,000
            
            
            
            3,293,000
            
            
            
            679,000
            
            
            
            5,201,000Gross  profit
      (deficit)
            
            $
            487,000
            
            
            $
            (203,000
            )
            
            $
            (383,000
            )
            
            $
            (99,000
            )Assets
            
            $
            3,655,000
            
            
            $
            6,080,000
            
            
            $
            1,477,000
            
            
            $
            11,212,000Six months ended December 31,
      2006Revenue
            
            $
            2,386,000
            
            
            $
            3,538,000
            
            
            $
            2,198,000
            
            
            $
            8,122,000Cost
      of revenues
            
            
            1,776,000
            
            
            
            3,266,000
            
            
            
            1,784,000
            
            
            
            6,826,000Gross
      profit
            
            $
            610,000
            
            
            $
            272,000
            
            
            $
            414,000
            
            
            $
            1,296,000Assets
            
            $
            1,704,000
            
            
            $
            24,051,000
            
            
            $
            3,310,000
            
            
            $
            29,065,000





International
sales accounted for $495,000 and $1,361,000 for the three month period ended
December 31, 2007 and 2006, respectively, and $1,954,000 and $2,150,000 for the
six month period ended December 31, 2007 and 2006,
respectively.




12.
            Goodwill and Other Intangible
      Assets




At
December 31, 2007 and June 30 2007, the Company had goodwill of $765,000 and
$2,062,000, respectively. SFAS No. 142, “Goodwill and Other Intangible Assets,”
requires that goodwill and intangible assets with indefinite lives no longer be
amortized but instead be measured for impairment at least annually or whenever
events indicate that there may be an impairment. In order to determine if
impairment exists, management continually estimates the reporting unit’s fair
value based on market conditions and operational performance.  The
Company may employ the work of independent appraisers in making its
determination. The Company makes its annual assessment as of August 31st of each
year to determine if its goodwill is impaired.
 
 Intangible
assets with finite lives are valued according to the future cash flows they are
estimated to produce. These assigned values are amortized over the period of
time those cash flows are estimated to be produced. Management continually
evaluates whether events or circumstances have occurred that indicate that the
estimated remaining useful life or the carrying value of these assets has been
impaired.
 
 SFAS No.
144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires
that long lived assets and/or asset groups shall be tested for recoverability
whenever events or changes in circumstances indicate that its carrying amount
may not be recoverable due to certain events or changes in
circumstances.  At June 30, 2007, when management measured the
semiconductor processing reporting unit, it concluded that an impairment existed
and recorded an adjustment of $3,829,000.
  At December
31, 2007, the Company determined that the long-lived assets of its Semiconductor
Reporting Unit, including its goodwill and intangibles, were further impaired as
the reporting unit will most likely be sold prior to the end of its useful
life.  As a result, the Company provided for an estimated impairment
charge of $2,224,000 in the quarter ended December 31, 2007, using a market
method approach.  As this impairment charge is an estimate, the
Company will employ an independent appraiser to finalize this calculation which
may require an adjustment in a future period.  Any resulting
additional impairment could have a material adverse impact on the Company’s
financial condition and results of operations.
  Goodwill is as
follows:


Semiconductor
      ServicesBalance
      as of  June 30, 2007
            
            $
            2,062,000Impairment
            
            
            (1,297,0000
            )Balance
      as of December 31, 2007
            
            $
            765,000








The following
table summarizes the Company’s intangible assets as of December 31,
2007:





Gross carrying
      amount
            
            
            Accumulated
      Amortization
            
            
            Net Carrying
      AmountJune 30
              2007
            
            
            Additions
            
            
            December
      31, 2007
            
            
            June 30,
              2007
            
            
            Additions
            
            
            December 31,
      2007
            
            
            December
              31, 2007Customer
      Base
            
            $
            161,000
            
            
            
            (23,000)
            
            
            $
            138,000
            
            
            $
            113,000
            
            
            $
            11,000
            
            
            $
            124,000
            
            
            $
            14,000Technology
            
            
            97,000
            
            
            
            (14,000)
            
            
            
            83,000
            
            
            
            68,000
            
            
            
            6,000
            
            
            
            74,000
            
            
            
            9,000Total
            
            $
            258,000
            
            
            $
            (37,000)
            
            
            $
            221,000
            
            
            $
            181,000
            
            
            $
            17,000
            
            
            $
            198,000
            
            
            $
            23,000





Estimated
amortization expense for intangible assets with finite lives on our balance
sheet as of December 31, 2007, for the fiscal years ending June 30, is as
follows:





2008
      remaining 6 months
            
            $
            7,0002009
            
            
            13,0002010
            
            
            3,000$
            23,000





13.
            Earnings (loss) Per
      Share




The
Company had the following potential dilutive securities outstanding on December
31, 2007; options and warrants to purchase 2,407,738 and 2,538,267 shares,
respectively, of the Company’s common stock at weighted average exercise prices
of $3.48 and $5.57 per share, respectively and Series D Preferred Stock
convertible into an aggregate of 803,213 shares of the Company’s common stock.
Such potential dilutive securities were not included in the calculation of
diluted loss per share in the period ended December 31, 2007 because the
inclusion thereof would be antidilutive.


14.
            Discontinued
      Operations




On May
1,2007,
the Company completed the sale of its Accurel subsidiary to Evans (“Asset
Sale”). The Asset Sale was completed in accordance with the terms and conditions
of the Purchase Agreement. As consideration for the Asset Sale, the Company
received cash proceeds of approximately $12,705,000 of which $1,000,000 was
placed in escrow. At June 30, 2007, the Company determined that the proceeds,
less the related transaction costs of approximately $1,794,000 in cash fees and
expenses, taxes of $197,000, and $390,000 in a non-cash charge for three year
warrants issued, were less than the book value of the net assets transferred of
$11,570,000 and therefore a loss on the sale of Accurel of $1,246,000 was
recorded in the year ended June 30, 2007 as a component of the loss from
discontinued operations
 
 In
accordance with Statement of Financial Accounting Standards No.144, “Accounting
for the Impairment or Disposal of Long-Lived Assets”, the December 31, 2007
financial statements have been prepared and historical statements of operations
have been reclassified to present the results of Accurel as discontinued
operations. The Company has clearly (i) eliminated Accurel’s financial results
from its ongoing operations, (ii) determined that Accurel, as operated as a
separate subsidiary was a separate component of its aggregated business as,
historically, management reviewed separately the Accurel financial results and
cash flows apart from its ongoing continuing operations, and (iii) determined
that it will have no further continuing involvement in the operations of Accurel
after the sale.
 
 Condensed results of operations
relating to Accurel for the three and six months ended December 31, 2006 are as
follows:


Three Months
      Ended
              December 31,
      2006
            
            
            Six Months
      Ended
              December 31,
      2006Revenues:
            
            $
            2,260,000
            
            
            $
            4,576,000Gross
      profit
            
            $
            712,000
            
            
            $
            1,578,000Operating
      income
            
            $
            169,000
            
            
            $
            559,000Income
      from discontinued  operations
            
            $
            123,000
            
            
            $
            489,000





15.           Income
Taxes


The
Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No.
48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on July 1,
2007.  FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, “Accounting for Income Taxes.”  FIN 48 prescribes a
two-step process to determine the amount of tax benefit to
recognize.  First, the tax position must be evaluated to determine the
likelihood that it will be sustained upon examination by a tax
authority.  If the tax position is deemed “more-likely-than-not” to be
sustained, the tax position is then assessed to determine the amount of benefit
to recognize in the financial statements.  The amount of the benefit
that may be recognized is the largest amount that has a greater than 50 percent
likelihood of being realized upon ultimate settlement.  If the tax
position does not meet the “more-likely-than-not” threshold, then it is not
recognized in the financial statements.  The Company’s adoption of FIN
48 as of July 1, 2007 did not have a material impact on the Company’s financial
position or results of operations.
 
 The
Company has reviewed the tax positions to taken, or to be taken, in its tax
returns for all tax years currently open to examination by taxing authority in
accordance with the recognition and measurement standards of FIN
48.  At December 31, 2007, there is no aggregate tax effect of
differences between tax return positions and the benefits recognized in our
financial statements.
 
 
 16.
              Recent Accounting
      Pronouncements
 
 In December 2007, the FASB issued
Statement of Financial Accounting Standards (“FAS”) No. 141 (revised 2007),“Business Combinations” (“FAS 141(R)”)which
replaces FAS No.141, “Business Combinations”. FAS 141(R) retains the underlying
concepts of FAS 141 in that all business combinations are still required to be
accounted for at fair value under the purchase method of accounting, but FAS
141(R) changed the method of applying the purchase method in a number of
significant aspects. FAS 141(R) is effective on a prospective basis for all
business combinations for which the acquisition date is on or after the
beginning of the first fiscal year subsequent to December 15, 2008, with the
exception of the accounting for valuation allowances on deferred taxes and
acquired tax contingencies. FAS 141(R) amends FAS 109 such that adjustments made
to valuation allowances on deferred taxes and acquired tax contingencies
associated with acquisitions that closed prior to the effective date of FAS
141(R) would also apply the provisions of FAS 141(R). The Company is currently
analyzing the impact, if any, of this standard.
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51”(“SFAS 160”), which establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. The Statement also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 is effective for fiscal years beginning after December 15, 2008.  The
Company is currently assessing the potential impact that adoption of SFAS
No. 160 would have on our financial statements.
 17.
                Subsequent
      events
  On
February 12, 2008, the Company entered into a Term Sheet with Ion Metrics,
Inc. (“IMI”), a San Diego, CA based privately held company, to acquire
substantially all of the assets and certain enumerated liabilities of
IMI.  The Term Sheet is intended to constitute a binding agreement in
principle between Implant and IMI.  As part of the transaction, the
Company will issue to the former stockholders of IMI consideration consisting of
2,000,000 shares of the Company’s common stock, par value $0.10 per
share.  Both parties agree to work toward execution of definitive
agreements and complete the transaction on or before March 15,
2008.
  14


ITEM
2.                      MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 
 OVERVIEW
  Over the
past twenty three years, Implant Sciences Corporation has developed technologies
using ion beam technology and thin film coatings. Initially this technology was
used in semiconductor wafer processing, but expanded to include various medical
device applications including the modification of orthopedic joint implant
surfaces to reduce polyethylene wear generation and the manufacture of products
for brachytherapy treatments.  Our latest application of our ion beam
technology includes the manufacturing of trace explosives detection
equipment.
 
 We
currently provide ion implantation services to numerous semiconductor wafer
manufacturers, research laboratories and universities. In October 2004 and March
2005, we acquired two California semiconductor related companies, Core Systems
(“Core”) and Accurel Systems International (“Accurel”),
respectively.  In May 2007, we sold our Accurel subsidiary for a total
purchase price of approximately $12,705,000.  Other applications of
our ion beam technology had been in the area of temporary brachytherapy
products. In June 2007, we sold certain assets associated with this product line
and divested the prostate seed and medical software
businesses.  Management is currently working on a plan to keep the
remaining coating assets in service by offering services and components to
certain medical device manufacturers.  However, should management be
unsuccessful in formalizing this plan, there is a possibility that future
periods may report discontinued operations relating to these remaining
assets.
  On February
15, 2008, the Company’s Board of Directors committed to a plan for management to
actively pursue a buyer for its Semiconductor Reporting Unit.  As this
decision was made subsequent to the balance sheet date, the plan is being
disclosed and the Company currently expects to present its Semiconductor
Reporting Unit as a discontinued operation in the third quarter ending March 31,
2008.
  The Company manages its business and
reports results from operations for three business segments: Security Products,
which includes development contracts and product sales related to the Company’s
trace explosives detection products; Semiconductor, which includes ion
implantation, disk refurbishment and source conditioning equipment, and Medical,
which includes orthopedic and radiopaque coatings, and other related
activities.  Substantially all of the assets of the Company’s
wholly-owned subsidiary, Accurel, have been sold.   Management’s
discussion and analysis of financial condition and results of operations are
based on the Company’s continuing operations.
 
 RESULTS OF
OPERATIONS
 
 The following is a discussion and
analysis of the financial condition and results of operation of the Company for
the three month period ended December 31, 2007 and 2006. It should be read in
conjunction with the financial statements and notes thereto appearing elsewhere
herein.
 
 Three Month Period Ended December
31, 2007 vs. December 31, 2006
 
 Revenues for the three months ended
December 31, 2007 were $1,884,000 as compared to $4,858,000 in the three months
ended December 31, 2006, a decrease of $2,974,000 or 61%. Our revenues by
business segment are as follows:


Three months
      endedDecember 31,
      2007
            
            
            December 31,
      2006Security
      products
            
            $
            369,000
            
            
            $
            1,905,000Semiconductor
            
            
            1,353,000
            
            
            
            1,915,000Medical
            
            
            162,000
            
            
            
            1,038,000Total
            
            $
            1,884,000
            
            
            $
            4,858,000




The
Security Products business segment revenue decreased by $1,536,000 or
81%.  This decrease is due to a decrease in the number of units
shipped during the three months ended December 31, 2007 as compared to the three
months ended December 31, 2006.  During the three month period ending
December 31, 2006, we shipped a large order of handheld units and did not have
an order of the same size during the current three month period.  Our
Semiconductor business segment revenues decreased by $562,000 or
29%.  This decrease is due to the revenue lost from downtime as we
consolidate equipment in California and get it back on-line combined with a
reduction in sales of our Krytek source conditioners.  Revenues in the
Medical segment for the three months ended December 31, 2007 were $162,000 as
compared to $1,038,000 in the three months ended December 31, 2006, a decrease
of $876,000 or 84%.  This decrease in revenues is due to the loss of
revenue relating to the divestiture of brachytherapy product line and medical
software in June 2007 combined with a certain orthopedic customer discontinuing
its need for our coating services.
 Cost of Revenues. Cost of
revenues for the three months ended December 31, 2007 was $2,293,000 as compared
to $3,761,000 in the prior three months period ended December 31, 2006, a
decrease of $1,468,000 or 39%. The cost of revenues by business segment is as
follows:


Three months
      endedDecember 31,
      2007
            
            
            December 31,
      2006Security
      products
            
            $
            408,000
            
            
            $
            1,160,000Semiconductor
            
            
            1,518,000
            
            
            
            1,667,000Medical
            
            
            367,000
            
            
            
            934,000Total
            
            $
            2,293,000
            
            
            $
            3,761,000








Cost of
revenues for our Security Products segment was $408,000 for the three months
ended December 31, 2007 as compared to $1,160,000 for the prior year period
representing a decrease of $752,000 or 65%.  The decrease in the
Security products business segment costs of revenues is related to the decrease
in the unit sales of our Security products, as well as a decline in government
contracts work.  Semiconductor business segment cost of revenues was
$1,518,000 for the three months ended December 31, 2007 as compared to
$1,667,000 for the prior year three month period, a decrease of $149,000 or 9%.
The decrease in Semiconductor cost of revenue reflects the savings from
consolidating semiconductor processing into one facility combined with a
reduction in variable costs related to a decline in Krytek product sales in the
three months ended December 31, 2007 as compared with the corresponding prior
year period.    Cost of revenues for our Medical business
segment was $367,000 for the three months ended December 31, 2007 as compared to
$934,000 for the three months ended December 31, 2006, a decrease of $567,000,
or 61%.  This decrease in cost of revenues is the result of the
divestiture of the brachytherapy product line and the elimination of related
expenses in June 2007.


Gross Margins
(deficit)





Three months ended December 31,
      2007Security
            
            
            Semiconductor
            
            
            Medical
            
            
            TotalRevenues
            
            $
            369,000
            
            
            $
            1,353,000
            
            
            $
            162,000
            
            
            $
            1,884,000Cost
      of revenues
            
            
            408,000
            
            
            
            1,518,000
            
            
            
            367,000
            
            
            
            2,293,000Gross deficit
            
            $
            (39,000
            )
            
            $
            (165,000
            )
            
            $
            (205,000
            )
            
            $
            (409,000
            )Deficit %
            
            
            (11%)
            
            
            
            (12%)
            
            
            
            (127%)
            
            
            
            (22%)








Three months ended December 31,
      2006Security
            
            
            Semiconductor
            
            
            Medical
            
            
            TotalRevenues
            
            $
            1,905,000
            
            
            $
            1,915,000
            
            
            $
            1,038,000
            
            
            $
            4,858,000Cost
      of revenues
            
            
            1,160,000
            
            
            
            1,667,000
            
            
            
            934,000
            
            
            
            3,761,000Gross
      margin
            
            $
            745,000
            
            
            $
            248,000
            
            
            $
            104,000
            
            
            $
            1,097,000Margin
      %
            
            
            39%
            
            
            
            13%
            
            
            
            10%
            
            
            
            23%




Overall gross deficits were 22% of revenues in the three months ended December
31, 2007 as compared to an overall gross margin of 23% in the corresponding
prior year period. The decrease in overall gross margins is primarily the result
of high fixed costs, such as rent and utilities, and decreased revenues in all
of the business segments.  Security products had a gross deficit of
$39,000 or 11% as compared with a gross margin of $745,000 or 39% in the
corresponding prior year period.  The decrease in security products
gross margin is due to a significant decrease in unit sales of our handheld
explosives detectors in the three month period ended December 31, 2007 as
compared with the corresponding prior year period.  The Semiconductor
business segment showed a gross deficit of $165,000 or 12% in the three months
ended December 31, 2007, as compared to a gross margin of $248,000 or
13%.  The decrease in the Semiconductor gross margin was primarily a
result of increased expenses incurred relating to the relocation of certain
pieces of capital equipment from our Wakefield facility to our Sunnyvale
facility as well as a decrease in revenues.  This move required
additional outside consultants and services to bring the equipment back on
line.  The Medical products business segment showed a gross deficit of
$205,000 in the three months ended December 31, 2007 as compared to a gross
margin of $104,000 in the prior year three month period.  This
decrease in gross margin in the Medical products business segment is due to the
decrease in revenues to a level below the associated fixed and variable costs
due to the Company divesting its prostate seed and medical software business in
June, 2007.  In addition, the Medical segment currently bears the
additional costs related to putting the remaining coating assets into
service.
 
 Research and Development.
Research and development expense for the three months ended December 31, 2007
was $699,000 as compared to $433,000 for the comparable prior year period, an
increase of $266,000 or 61%. The Company continued to expend funds to further
the development of new products in the areas of explosives detection, as well as
preparing for certain government laboratory acceptance testing.  In
addition, the increase in research and development expenses relates to the
volume and timing of customer funded programs, primarily through government
grants and contracts. The Company charges its research and development personnel
to cost of revenues for work performed on these contracts and grants. Research
and development expenses prior to starting the government contracts are charged
to operating expenses.
 
 Selling, General and
Administrative. Selling, general and administrative expense for the three
months ended December 31, 2007 was $1,812,000 as compared to $1,770,000 for the
comparable prior year period, an increase of $42,000, or
2%.   The majority of this increase relates to increases in legal
and accounting fees.  The Company anticipates the selling, general and
administrative expenses will increase in future periods as a result of the
additional expenses relating to consulting services for Sarbanes-Oxley
compliance.
 
 Impairment of long lived assets
and goodwill.  For the three months ended December 31, 2007,
the Company recorded a net impairment of $2,215,000 as compared to $37,000 in
the comparable prior year period.  This increase in impairment expense
is a direct result of the Board of Director’s decision to sell the Semiconductor
Reporting Unit.  This event required management’s assessment of the
fair value of the reporting unit which
resulted in an estimated impairment charge of $2,224,000.  This
impairment may require further adjustment in the third quarter ending
March 31, 2008.
  Other Income and Expense,
Net. For the three months ended December 31, 2007, we recorded other
income, net, of $320,000 as compared to $623,000, in the comparable prior year
period, a decrease of $303,000 or 49%. The decrease in other income and
expenses, net, is primarily the result of a decrease of $402,000 of other
expenses related to marking to market the embedded derivatives associated with
the Series D preferred Stock.  Interest income increased to $64,000
for the three month period ending December 31, 2007 as compared to $8,000 in the
prior year period, an increase of $56,000 as a result of investing the cash
proceeds from the sale of Accurel which occurred in May of
2007.  Other income and expense includes a loss of $0 and $38,000 for
the period ended December 31, 2007 and 2006, respectively, representing the
Company’s share of losses attributable to its investment in
CorNova. The
Company had been accounting for its investment in this unconsolidated subsidiary
under the equity method due in part to the significant control the Company had
as a result of Dr. A. J. Armini, the former President and CEO of Implant
Sciences, being on CorNova’s Board of Directors.  As a result of Dr.
Armini resigning from his board position at CorNova, the equity method is no
longer appropriate and the cost method will be used.  Interest expense
in the current year period was $27,000 compared to $32,000 in the prior year
period.
 Loss from Continuing
Operations.Loss from continuing operations for the three
months ended December 31, 2007 was $4,815,000 as compared with $520,000 for the
comparable prior year period, an increase in net loss of $4,295,000, or
826%.  The increase in net loss is primarily the result of a
$1,506,000 decrease in gross margins as a result of $2,974,000 decrease in
revenues, the $2,224,000 impairment of the Semiconductor Reporting Unit,
combined with a $402,000 decrease in other income and expense related to the
change in the fair value of embedded derivatives related to preferred stock
features.
 
 Preferred distribution, dividends and
accretion on Series D Redeemable Convertible Preferred Stock were $289,000 in
the three months ended December 31, 2007 as compared to $145,000 in the prior
year period.
 
 Income from Discontinued
Operations.Income from discontinued operations for the three
months ended December 31, 2007 was $0 as compared with income of $123,000 in the
corresponding prior year period.  The Company sold the assets of its
Accurel subsidiary on May 1, 2007.
 
 Six Month Period Ended December 31,
2007 vs. December 31, 2006
 
 Revenues for the six months ended
December 31, 2007 were $5,102,000 as compared to $8,122,000 in the six months
ended December 31, 2006, a decrease of $3,020,000 or 37%. Our revenues by
business segment are as follows:


Six months
      endedDecember 31,
      2007
            
            
            December 31,
      2006Security
      products
            
            $
            1,716,000
            
            
            $
            2,386,000Semiconductor
            
            
            3,090,000
            
            
            
            3,538,000Medical
            
            
            296,000
            
            
            
            2,198,000Total
            
            $
            5,102,000
            
            
            $
            8,122,000




The
Security Products business segment revenue decreased by $670,000 or
28%.  This decrease is due to a decrease in the number of units
shipped during the six months ended December 31, 2007 as compared to the six
months ended December 31, 2006.  Our Semiconductor business segment
revenues decreased by $448,000 or 13%.  This decrease is due to the
lost sales relating to downtime of our semiconductor equipment as we consolidate
processing in California.  Revenues in the Medical business segment
for the six months ended December 31, 2007 were $296,000 as compared to
$2,198,000 in the six months ended December 31, 2006, a decrease of $1,902,000
or 87%.  This decrease in revenues is due to the divestiture of our
brachytherapy product line in June 2007 and the elimination of the related
expenses.  We expect this decline in medical revenue as compared to
fiscal 2007 will continue throughout fiscal 2008.
 
 Cost of Revenues. Cost of
revenues for the six months ended December 31, 2007 was $5,201,000 as compared
to $6,826,000 in the corresponding prior year period, a decrease of $1,625,000
or 24%. The cost of revenues by business segment is as
follows:


Six months
      endedDecember 31,
      2007
            
            
            December 31,
      2006Security
      products
            
            $
            1,229,000
            
            
            $
            1,776,000Semiconductor
            
            
            3,293,000
            
            
            
            3,266,000Medical
            
            
            679,000
            
            
            
            1,784,000Total
            
            $
            5,201,000
            
            
            $
            6,826,000


Cost of
revenues for our Security Products segment was $1,229,000 for the six months
ended December 31, 2007 as compared to $1,776,000 for the prior year period
representing a decrease of $547,000 or 31%.  The decrease in the
Security products business segment costs of revenues is primarily related to the
decrease in the variable cost of our handheld explosive detection products as a
result of reduced unit sales.  Semiconductor cost of revenues was
$3,293,000 for the six months ended December 31, 2007 as compared to $3,266,000
for the corresponding prior year period, an increase of $27,000 or 1%. The
increase in Semiconductor cost of revenue reflects the additional costs
associated with the consolidation of semiconductor activities in
California.     Cost of revenues for our Medical
business segment was $679,000 for the six months ended December 31, 2007 as
compared to $1,784,000 for the six months ended December 31, 2006, a decrease of
$1,105,000, or 62%.  This decrease in cost of revenues is the result
of the Company divesting its prostate seed and medical software business in
June, 2007, and the elimination of related expenses.


Gross Margins
(deficit)


Six months ended December 31,
      2007Security
            
            
            Semiconductor
            
            
            Medical
            
            
            TotalRevenues
            
            $
            1,716,000
            
            
            $
            3,090,000
            
            
            $
            296,000
            
            
            $
            5,102,000Cost
      of revenues
            
            
            1,229,000
            
            
            
            3,293,000
            
            
            
            679,000
            
            
            
            5,201,000Gross
      margin (deficit)
            
            $
            487,000
            
            
            $
            (203,000
            )
            
            $
            (383,000
            )
            
            $
            (99,000
            )Margin
      (deficit) %
            
            
            28%
            
            
            
            (7%)
            
            
            
            (129%)
            
            
            
            (2%)





Six months ended December 31,
      2006Security
              
              
              Semiconductor
              
              
              Medical
              
              
              TotalRevenues
              
              $
              2,386,000
              
              
              $
              3,538,000
              
              
              $
              2,198,000
              
              
              $
              8,122,000Cost
      of revenues
              
              
              1,776,000
              
              
              
              3,266,000
              
              
              
              1,784,000
              
              
              
              6,826,000Gross
      margin
              
              $
              610,000
              
              
              $
              272,000
              
              
              $
              414,000
              
              
              $
              1,296,000Margin
      %
              
              
              26%
              
              
              
              8%
              
              
              
              19%
              
              
              
              16%




Overall gross deficits were 2% of revenues in the six months ended December 31,
2007 as compared to a gross margin of 16% in the prior year period. The decrease
in overall gross margins is primarily the result of decreases in gross margins
in our Semiconductor and Medical business segments as a result of decreased
revenues in each of those business segments, combined with high fixed costs such
as rent and utilities.  Security products had a gross margin of
$487,000 or 28% as compared with a gross margin of $610,000 or 26% in the
corresponding prior year period.  The slight improvement in security
products gross margin is a result of some cost cutting measurements by the
Company.  The Semiconductor business segment showed a gross deficit of
$203,000 or 7% in the six months ended December 31, 2007, as compared to a gross
margin of $272,000 or 8% in the comparable prior year period.  The
decrease in the Semiconductor gross margin was primarily a result of increased
expenses incurred relating to the relocation of certain pieces of capital
equipment from our Wakefield facility to our Sunnyvale facility as well as a
decrease in revenues.  This move required additional outside
consultants and services to bring the equipment back on line.  The
Medical products business segment showed a gross deficit of $383,000 in the six
months ended December 31, 2007 as compared to a gross margin of $414,000 in the
prior year six month period.  This decrease in gross margin in the
Medical products business segment is due to the decrease in revenues to a level
below the associated fixed and variable costs due to the Company divesting its
prostate seed and medical software business in June, 2007.  In
addition, the Medical segment currently bears the additional costs related to
putting the remaining coating assets into service.
 
 Research and Development.
Research and development expense for the six months ended December 31, 2007 was
$1,389,000 as compared to $1,000,000 for the comparable prior year period, an
increase of $389,000, or 39%. The Company continues to expend funds to further
the development of new products in the areas of explosives
detection.  The increase in research and development expenses relates
to the volume and timing of customer funded programs, primarily through
government grants and contracts. The Company charges its research and
development personnel to cost of revenues for work performed on these contracts
and grants. Research and development expenses prior to starting the government
contracts are charged to operating expenses.
 
 Selling, General and Administrative. Selling,
general and administrative expense for the six months ended December 31, 2007
was $3,551,000 as compared to $3,257,000 for the comparable prior year period,
an increase of $294,000, or 9%.   The majority of this increase
relates to increases in legal and accounting fees. The Company anticipates
the selling, general and administrative expenses will increase in future periods
as a result of the additional expenses relating to consulting services for
Sarbanes-Oxley compliance.
 
 Impairment of long lived assets
and goodwill.  For
the six months ended December 31, 2007, the Company recorded a net impairment of
$2,215,000 as compared to $37,000 in the comparable prior year
period.  This increase in impairment expense is a direct result of the
Board of Director’s decision to sell the Semiconductor Reporting
Unit.  This event required management’s assessment of the fair value
of the reporting unit which
resulted in an estimated impairment charge of $2,224,000.  This
impairment may require further adjusted in the third quarter ending March
31, 2008.
  Other Income and Expense,
Net. For
the six months ended December 31, 2007, we recorded other income, net, of
$237,000 as compared to $502,000, in the comparable prior year period, a
decrease of $265,000 or 53%. The decrease in other income and expenses, net, is
primarily the result of a decrease of $572,000 of other income related to
marking to market the embedded derivatives associated with the Series D
preferred Stock.  Interest income increased to $165,000 for the six
month period ending December 31, 2007 as compared to $12,000 in the prior year
period, an increase of $153,000 as a result of investing the cash proceeds from
the sale of Accurel which occurred in May of 2007.  Other income and
expense includes a loss of $0 and $158,000 for the period ended December 31,
2007 and 2006, respectively, representing the Company’s share of losses
attributable to its investment in CorNova.  The
Company had been accounting for its investment in this unconsolidated subsidiary
under the equity method due in part to the significant control the Company had
as a result of Dr. A. J. Armini, the former President and CEO of Implant
Sciences, being on CorNova’s Board of Directors.  As a result of Dr.
Armini resigning from his board position at CorNova, the equity method is no
longer appropriate and the cost method will be used.  Interest expense
in the current year period was $61,000 compared to $57,000 in the prior year
period.
 
 Loss from Continuing
Operations.Loss
from continuing operations for the six months ended December 31, 2007 was
$7,017,000 as compared with $2,496,000 for the comparable prior year period, an
increase in net loss of $4,521,000, or 181%.  The increase in net loss
is primarily the result of a $1,395,000 decrease in gross margins as a result of
a $3,020,000 decrease in revenues, the $2,224,000 impairment of the
Semiconductor Reporting Unit and a significant increase in legal and audit
fees.
 
 Preferred
distribution, dividends and accretion on Series D Redeemable Convertible
Preferred Stock were $596,000 in the six months ended December 31, 2007 as
compared to $381,000 in the prior year period.
 
 Income from Discontinued
Operations.Income
from discontinued operations for the six months ended December 31, 2007 was $0
as compared with income of $489,000 in the corresponding prior year
period.  The Company sold the assets of its Accurel subsidiary on May
1, 2007.
 
 LIQUIDITY AND CAPITAL
RESOURCES
  As of December 31, 2007, the Company had approximately $4,804,000 in the form of
cash and cash equivalents. During the six months ended December 31, 2007,
operating activities used cash of approximately $3,413,000. Net cash used by
operating activities primarily reflects the $7,017,000 net loss, increased
by a $541,000 decrease in accrued expenses, partially offset by a the
$2,224,000 impairment in our Semiconductor Reporting Unit, $791,000 decrease in
accounts receivable, $637,000 of depreciation expense and $422,000 of share
based compensation expense.  The Company has approximately $665,000 of
raw materials and finished goods inventories related to its handheld explosives
detection product.  This inventory was acquired in anticipation of
future shipments of this product to customers.  Orders for the
explosives detection product to date have typically been from foreign
governments or agencies of foreign governments.  The sales cycle to
these entities can take a number of months to close the order, set up letters of
credit from the customer covering the payment, and obtain the necessary export
licenses and other required documentation.  Investing activities used
$225,000 of cash primarily for investment in, or deposits on property and
equipment.  Financing activities used cash of $1,179,000 and consist
primarily of $683,000 in cash payments on bank loans and capital leases along
with $772,000 in cash dividends and payments to the holders of the Series D
preferred stock, offset by proceeds of $250,000 received on a line of credit
with Bridge Bank.
 The
Company currently has a $5.0 million revolving credit facility (the “line of
credit”) with Silicon Valley based Bridge Bank, N.A. (the
“Bank”).  This line of credit, which expires in December 2008,
provides for advances of up to eighty percent (80%) of the Company’s eligible
accounts receivable and up to the lesser of $1,000,000 or forty percent (40%) of
eligible inventory, bears interest at the prime rate, plus one-half percent
(1/2%) per annum, and is collateralized by all assets of the
Company.  In addition, the Company has a 30-month term loan with the
Bank, bearing an interest rate at the prime rate plus one percent (1%) per annum
payable in thirty (30) equal monthly installments of principal, plus all accrued
interest beginning on February 10, 2007.
  Since May
1999, we have been developing several explosive detection systems that could be
used in airports, public and government buildings, and sporting event
facilities. The systems use our proprietary technology, which includes the use
of a photon-based non-radioactive ion source in combination with ion mobility
spectrometry, to electronically detect minute quantities of explosive vapor
molecules in the air.
 
 This project is currently being
undertaken by both our internal scientists and outside contractors. The
development of new applications is typically funded through government grants or
internal funding. Since March 2000, we have received seventeen contracts
totaling over $12 million for detection of toxic chemicals or explosives from
agencies such as the Departments of the Army, Air Force, Marine Corps, Navy and
the Department of Homeland Security.
 
 Consistent with our policy to protect
our proprietary technologies, we have been awarded six patents and have
submitted an additional six patent applications to the United States Patent and
Trademark Office. These patents and applications will cover specific design
configurations that are responsible for our improved vapor detection
sensitivity.
 
 We are
now manufacturing several versions of our explosives detection systems,
including: (i) a bench-top unit, which can be used to screen passengers and
carry-on baggage in airports and (ii) a portable system, which can be used to
clear buildings, aircrafts, or ships where hidden bombs are believed to
exist.  We are currently selling our portable and bench-top version of
these products both domestically and internationally. We plan to market these
systems to government agencies for use in airports, government buildings and
facilities.
 
 We are currently expending significant
resources to develop the next generation of our current product and to develop
new products. Although we continue to fund as much research and development as
possible through government grants and contracts in accordance with the
provisions of the respective grant awards we will require additional funding in
order to continue the advancement of the commercial development and
manufacturing of the explosives detection system. We will attempt to obtain such
financing by: (i) government grants, (ii) private financing, or (iii) strategic
partnerships. However, there can be no assurance that we will be successful in
our attempts to raise such additional financing.
 
 We will require substantial funds for
further research and development, regulatory approvals and the marketing of our
explosives detection products. Our capital requirements depend on numerous
factors, including but not limited to, the progress of our research and
development programs; the cost of filing, prosecuting, defending and enforcing
any intellectual property rights; competing technological and market
developments; changes in our development of commercialization activities and
arrangements; and the hiring of additional personnel and capital
equipment.
 
 Based on the
current sales, expense and cash flow projections, advances on its line of credit
and the proceeds from the sale of certain assets, management believes it has
plans in place to fund operations for the next twelve months.  Because
there can be no assurances that sales will materialize as forecasted, and/or
that management will be successful in executing these plans, management will
continue to closely monitor and attempt to control costs at the Company and will
continue to actively seek the needed capital through government grants and
awards, strategic alliances, private financing sources, and through its lending
institutions. Future expenditures for research and product development are
discretionary and, can be adjusted, as can certain selling, general and
administrative expenses, based on the availability of cash.  The
financial statements do not include any adjustments relating to the
recoverability and classification of asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern
 
 The Company’s future minimum payments
under contractual obligations related to capital leases, operating leases and
term notes as of December 31, 2007 are as follows:


Debt and
              Capital
      Lease(1)
            
            
            Operating
              Lease(1)(2)
            
            
            MED-TEC
            
            
            Total2008
            
            $
            1,233,000
            
            
            $
            738,000
            
            
            $
            83,000
            
            
            $
            2,054,0002009
            
            
            2,840,000
            
            
            
            1,201,000
            
            
            
            -
            
            
            
            4,041,0002010
            
            
            15,000
            
            
            
            578,000
            
            
            
            -
            
            
            
            593,0002011
            
            
            2,000
            
            
            
            84,000
            
            
            
            -
            
            
            
            86,000Total
            
            $
            4,090,000
            
            
            $
            2,601,000
            
            
            $
            83,000
            
            
            $
            6,774,000




(1)
Payments include interest


(2)  Adjusted
for sublease





Critical Accounting
Policies




Our
significant accounting policies are described in Note 2 to the financial
statements included in Item 8 of our Form 10-K as of June 30,
2007.  Our discussion and analysis of our financial condition and
results of operations are based upon the financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States.  The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities.  On an on-going basis, we evaluate our estimates,
including those related to bad debts, product returns, inventories, investments,
intangible assets and warranty obligations.  We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources.  In the past, actual results
have not been materially different from our estimates.  However,
results may differ from these estimates under different assumptions or
conditions.  In accordance with SFAS No. 142, (“Goodwill and Other
Intangible Assets”), goodwill and other intangible assets with indefinite lives
are no longer amortized, but rather such assets are subject to annual impairment
reviews or more frequently, if events or circumstances indicate that they may be
impaired.




Recent
Accounting Pronouncements




In December
2007, the FASB issued Statement of Financial Accounting Standards (“FAS”) No.
141 (revised 2007), “Business
Combinations” (“FAS 141(R)”) which replaces FAS No.141, “Business Combinations”. FAS
141(R) retains the underlying concepts of FAS 141 in that all business
combinations are still required to be accounted for at fair value under the
purchase method of accounting, but FAS 141(R) changed the method of applying the
purchase method in a number of significant aspects. FAS 141(R) is effective on a
prospective basis for all business combinations for which the acquisition date
is on or after the beginning of the first fiscal year subsequent to December 15,
2008, with the exception of the accounting for valuation allowances on deferred
taxes and acquired tax contingencies. FAS 141(R) amends FAS 109 such that
adjustments made to valuation allowances on deferred taxes and acquired tax
contingencies associated with acquisitions that closed prior to the effective
date of FAS 141(R) would also apply the provisions of FAS 141(R). The Company is
currently analyzing the impact, if any, of this standard.


In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51”(“SFAS 160”), which establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. The Statement also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 is effective for fiscal years beginning after December 15, 2008.  The
Company is currently assessing the potential impact that adoption of SFAS
No. 160 would have on our financial statements.
   ITEM
3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
  The Company’s
financial instruments include cash and cash equivalents. Cash and cash
equivalents include cash on hand, demand deposits and short-term investments
with maturities of three months or less when acquired. Cash equivalents
represent a deposit in a money market account.  The Company does not
utilize derivative financial instruments, derivative commodity instruments or
other market risk sensitive instruments, positions or transactions in any
material fashion. The principal objective of the Company’s asset management
activities is to maximize net investment income, while maintaining acceptable
levels of interest rate risk and facilitating its funding needs. At December 31,
2007, the carrying values of the Company’s financial instruments approximated
fair values based upon current market prices and
rates.
 
 ITEM 4.   CONTROLS AND
PROCEDURES
 
 EVALUATION
OF OUR DISCLOSURE CONTROLS AND INTERNAL CONTROLS
  As of the end
of the period covered by this quarterly report, we evaluated the effectiveness
of the design and operation of our disclosure controls and procedures
("Disclosure Controls") and our internal controls and procedures for financial
reporting ("Internal Controls"). This evaluation (the "Controls Evaluation") was
done under the supervision and with the participation of our management,
including our Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO"). Rules adopted by the SEC require that in this section of the Quarterly
Report, we present the conclusions of our CEO and the CFO about the
effectiveness of our Disclosure Controls and Internal Controls based on and as
of the date of the Controls Evaluation.
 
 
 CEO AND
CFO CERTIFICATIONS
  Appearing as exhibits to this Quarterly
Report are "Certifications" of the CEO and the CFO. The Certifications are
required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (the "Section
302 Certifications"). This section of the Quarterly Report contains information
concerning the Controls Evaluation referred to in the Section 302 Certifications
and this information should be read in conjunction with the Section 302
Certifications for a more complete understanding of the topics
presented.
 
 DISCLOSURE
CONTROLS AND INTERNAL CONTROLS
  Disclosure Controls are procedures that
are designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934
("Exchange Act"), such as this Quarterly Report, is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. Disclosure Controls are also designed with the objective of ensuring that
such information is accumulated and communicated to our management, including
the CEO and CFO, as appropriate, to allow timely decisions regarding required
disclosure. Internal Controls are procedures which are designed with the
objective of providing reasonable assurance that (1) our transactions are
properly authorized, recorded and reported; and (2) our assets are safeguarded
against unauthorized or improper use, to permit the preparation of our financial
statements in conformity with generally accepted accounting
principles.
 
 LIMITATIONS
ON THE EFFECTIVENESS OF CONTROLS
  Our management, including the CEO and
CFO, has concluded that our disclosure controls and procedures are designed to
provide reasonable assurance of achieving their objectives and have concluded
that the controls and procedures are effective at that reasonable assurance
level.
 
 SCOPE OF
THE CONTROLS EVALUATION
  The CEO/CFO evaluation of our
Disclosure Controls and Internal Controls included a review of the controls'
objectives and design, the controls’ implementation by us and the effect of the
controls on the information generated for use in this Quarterly Report. In the
course of the Controls Evaluation, management sought to identify data errors,
controls problems or acts of fraud and to confirm that appropriate corrective
action, including process improvements, were being undertaken. This type of
evaluation will be done on a quarterly basis so that the conclusions concerning
controls effectiveness can be reported in our Quarterly Reports on Form 10-Q and
Annual Report on Form 10-K. The overall goals of these various review and
evaluation activities are to monitor our Disclosure Controls and Internal
Controls and to make modifications as necessary; our intent in this regard is
that the Disclosure Controls and the Internal Controls will be maintained as
dynamic systems that change (including with improvements and corrections) as
conditions warrant.
  Among other matters, management sought
in its evaluation to determine whether there were any "significant deficiencies"
are
referred to as a deficiency or a combination of deficiencies, in internal
control over financial reporting, that is less severe than a material weakness,
yet important enough to merit attention by those responsible for oversight of
the Company’s financial reporting.  In the final standard, a “material
weakness” is defined as “a deficiency, or a combination of deficiencies in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Company’s annual or interim
financial statements will not be prevented or detected on a timely
basis.”
  Changes
in Internal Control over Financial Reporting
 
 There were no changes to the Company’s
internal control over financial reporting during the quarter ended December 31,
2007, that has materially affected, or are reasonably likely to materially
affect the Company’s internal control over financial reporting.
 
 CONCLUSIONS
  Based upon the Controls Evaluation, our
CEO and CFO have concluded that, as of the end of the period covered by this
quarterly report, our Disclosure Controls are effective to provide reasonable
assurance that our financial statements are fairly presented in conformity with
generally accepted accounting principles.
   In June 2007, our independent
auditors reported to our Audit Committee certain matters involving internal
controls that our independent auditors considered to be a significant
deficiency.  A significant deficiency is a deficiency or combination
of deficiencies in internal control over financial reporting, that is less
severe than a material weakness yet important enough to merit attention by those
responsible for oversight of the company’s financial reporting.
  The reportable condition related
primarily to the analysis conducted in regards to the annual goodwill impairment
testing.   Management is confident that our financial statements
for the year ended June 30, 2007 fairly present, in all material respects, our
financial condition and results of operations.
 
 The reportable condition has been
discussed in detail among management, our Audit Committee and our independent
auditors, and we are committed to addressing and resolving these matters fully
and promptly, by putting in place the personnel, processes, technology and other
resources appropriate to improve the communication between our subsidiary and
the parent company as well as to provide better forecasting
models.  As part of this commitment, in the second quarter of our
fiscal year ending June 30, 2008, we will begin by educating the staff and
revising the internal forecasting and reporting procedures to ensure that
changes are provided in a timely manner to
management.    Management will continue to evaluate these
procedures to improve the process.
  
 PART
II                      OTHER
INFORMATION
 
 Item
1.                                Legal
Proceedings
  On March 23,
2005, we entered into a Development, Distribution and Manufacturing Agreement
(the “Rapiscan Agreement”) with Rapiscan Systems, Inc. (“Rapiscan”).  Under
the terms of this agreement, we gave Rapiscan the exclusive worldwide rights to
market our Quantum Sniffer portable and benchtop trace detection devices
under their private label.  We also agreed to give Rapiscan the exclusive
worldwide rights to distribute certain other new security products which we may
develop in the future with their funding, as well as rights, in some
circumstances, to manufacture certain components of the private-labeled Quantum
Sniffer portable and benchtop trace detection devices.
 On March 23, 2006, Rapiscan filed a
complaint against the Company and its contract assembler, Columbia Tech, in the
United States District Court for the Central District of California, regarding
the Rapiscan Agreement.  Rapiscan’s complaint against the Company
was based upon claims of breach of contract and breach of warranty and
was requesting a decree for specific performance, declaratory relief and
injunctive relief. Rapiscan’s complaint against Columbia Tech was based
upon injunctive relief, declaratory relief and tortuous interference with
contractual relations. On April 12, 2006, Rapiscan dismissed all claims against
Columbia Tech.
 
 On March 24, 2006, the Company brought
suit in the United States District Court in the District of Massachusetts
against Rapiscan and its parent, OSI Systems, Inc. (“OSI”). The Company
requested rescission of the Rapiscan Agreement, plus damages, based on claims of
misrepresentation.  In the alternative, the Company was seeking
termination of the Rapiscan Agreement due to material breaches of contract and
the implied covenant of good faith and fair dealing and for damages due to
Rapiscan’s breach of contract and the implied covenant of good faith and fair
dealing.
 
 In August
2006, as a result of motions made by both parties, the two lawsuits have been
consolidated in the United States District Court for the Central District of
California with the Company as plaintiff.  In late 2006, Rapiscan and
OSI filed a motion to dismiss certain of the Company’s claims.  The
court dismissed Company’s claim of breach of fiduciary duty, but the motion to
dismiss was denied in all other respects.  The parties are presently
near the end of the discovery process, which should be completed in early
December 2007.  OSI and Rapiscan had filed four motions for partial
summary judgment with respect to certain discrete claims.  Two of the
motions were denied in their entirety.  The third was denied in the
only material respect and granted in two immaterial respects.
 
 On
January 4, 2008, the Company executed a Settlement Agreement (the “Settlement
Agreement”) with OSI and Rapiscan to resolve the Pending Litigation and to enter
into additional agreements.  In addition to the immediate dismissal of
the Pending Litigation, other terms of the Settlement Agreement include, (i) the
rescission of the Rapiscan Agreement, (ii) the payment by the Company of
$200,000, such payment to be made in the form of shares of the Company’s common
stock,  (iii) the granting of non-exclusive distribution rights to
Rapiscan and OSI, (iv) the payment by the Company of up to $1,000,000 in
Technology Transfer Fees, payable over time at a rate of 2% of the gross sales
price received by the Company when a passenger portal is sold, and (v) the
opportunity for OSI to supply certain components to the Company.
 
 We may, from time to time, be involved
in other actual or potential proceedings that we consider to be in the normal
course of our business. We do not believe that any of these proceedings will
have a material adverse effect on our business.
 Item
1a.                                Risk
Factors
 
 An
investment in our securities involves a high degree of risk. There have been no
material changes to the risk factors previously disclosed in the Company's
Annual Report on Form 10-K for the fiscal year ended June 30, 2007. You should
consider carefully all of the material risks described in the Form 10-K,
before making a decision to invest in our securities. If any of the events
described therein occur, our business, financial conditions and results of
operations may be materially adversely affected. In that event, the trading
price of our securities could decline, and you could lose all or part of your
investment.
  Item
2.                                Unregistered
Sales of Equity Securities and Use of Proceeds
  Not applicable.
 
 Item
3.                                Defaults
Upon Senior Securities
 
 Not applicable.
 
 
 Item
4.                                Submission
of Matters to a Vote of Security Holders
 
 We held our annual shareholder’s
meeting on December 12, 2007.  Phillip Thomas, Joseph Levangie,
Michael Szycher, David Eisenhaure, and Michael Turmelle were elected as
directors of the Company to hold office until the 2008 annual meeting of
shareholders.  The results for this vote were as
follows:


Name
            For
            WithheldPhillip
      Thomas
            9,799,988
            448,802Joseph
      Levangie
            9,161,455
            1,087,355Michael
      Szycher
            9,132,187
            1,116,603David
      Eisenhaure
            8,842,244
            1,406,546Michael
      Turmelle
            9,457,757
            791,033








Proposal
No. 2 was to approve an amendment to the Company’s 2004 incentive and
nonqualified stock option plan to increase the number of shares available for
issuance by 1,000,000 to 2,000,000 shares.  The results for this
proposal were as follows:





For
            Against
            Abstain3,668,581
            1,076,674
            349,431





Item
5.                                Other
Information





None





Item
6.                                Exhibits








(a)           The
following exhibits, required by Item 601 of Regulation S-K, are filed as part of
this Quarterly Report on Form 10-Q.  Exhibit numbers, where
applicable, in the left hand


column correspond
to those of Item 601 of Regulation S-K.




Exhibit
      No.
            Description31.1
            
            Certification
      of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
            
            Certification
      of the Chief Financial Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
            
            Certification
      of the Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.32.2
            
            Certification
      of the Chief  Financial Officer Pursuant to 18 U.S.C. 1350, as
      adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.





(b)  Reports
on Form 8-K





Current
Report on Form 8-K dated October 2, 2007 regarding the retirement of Dr. Anthony
J. Armini, President and Chief Executive Officer.





Current
Report on Form 8-K dated November 23, 2007 regarding the receipt of a warning
letter from the American Stock Exchange December 29, 2006 regarding
non-compliance with certain continuing listing requirements.





Current
Report on Form 8-K dated December 13, 2007 regarding the election of a new Board
of Directors.





Current
Report on Form 8-K dated December 18, 2007 regarding an amendment to the
Company’s Bylaws to provide for the issuance of uncertificated shares of the
Company and the trading of the Company’s securities in book-entry
form.





Current
Report on Form 8-K/A dated December 21, 2007 regarding the notification by the
American Stock Exchange of the Company’s compliance with its continuing listing
requirements.





Current
Report on Form 8-K dated January 9, 2008 regarding the settlement of certain
legal proceedings between the Company and OSI Systems, Inc. and Rapiscan
Systems, Inc.






22






SIGNATURES





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





Implant Sciences
Corporation




Date:
February 19, 2008        /s/ Phillip C.
Thomas


Phillip C. Thomas


President and CEO





Date:
February 19, 2008        /s/ Diane J.
Ryan


Diane J. Ryan


Chief Financial Officer