## ** **

## **UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

## **Washington, D.C.  20549**

 

**FORM 10-QSB/A**

**(AmendmentNo. 1)**

 

| ý | **Quarterly  report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934**. **For the quarterly period ending March  31, 2004.**                                                                                         |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                       |
| **or** |
|   |                                                                                                                                                                                                                                       |
| o      | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934. For the  transition period from           to          ** |

 

**Commission file number 000-25839**

 

**IMPLANTSCIENCES 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**              |

 

**781-246-0700**

(Issuers telephonenumber)

 

**Not Applicable**

(Former name,former address and former fiscal year, if changed since last report.)

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.

YES  ý        NO  o

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date:

 

| Class                             | Outstanding at  April 30, 2004 |
|-----------------------------------|--------------------------------|
| **Common Stock,  $.10 par value** | **7,592,312**                  |

 

Transitional smallbusiness disclosure format (check one):

YES  o        NO  ý

 

----

 

**IMPLANT SCIENCES CORPORATION**

 

**INDEX**

 
|                           |                                                                                                         |   |
|--------------------------------|--------------------------------------------------------------------------------------------------------------|--------|
| PART I.  FINANCIAL INFORMATION |
|                           |                                                                                                         |   |
| Item 1.                        | Financial  Statements:                                                                                       |   |
|                           |                                                                                                         |   |
|                           | Condensed Balance Sheets as  of March 31, 2004 and June 30, 2003 (audited)                                   |   |
|                           |                                                                                                         |   |
|                           | Condensed Statements  of Operations for the Three and Nine Months Ended March 31, 2004 and 2003  (unaudited) |   |
|                           |                                                                                                         |   |
|                           | Condensed Statements  of Cash Flows for the Nine Months Ended March 31, 2004 and 2003 (unaudited)            |   |
|                           |                                                                                                         |   |
|                           | Notes to  Condensed Financial Statements (unaudited)                                                         |   |
|                           |                                                                                                         |   |
| Item  2.                       | Management’s  Discussion and Analysis of Financial Conditionand Results of Operations                   |   |
|                           |                                                                                                         |   |
| Item 3.                        | Controls and  Procedures                                                                                     |   |
|                           |                                                                                                         |   |
| PART II. OTHER INFORMATION     |
|                           |                                                                                                         |   |
|                           |                                                                                                         |   |
| Item 1.                        | Legal Proceedings                                                                                            |   |
|                           |                                                                                                         |   |
| Item  2.                       | Changes  in Securities and Use of Proceeds                                                                   |   |
|                           |                                                                                                         |   |
| Item 3.                        | Defaults Upon  Senior Securities                                                                             |   |
|                           |                                                                                                         |   |
| Item  4.                       | Submission  of Matters to a Vote of Security-Holders                                                         |   |
|                           |                                                                                                         |   |
| Item 5.                        | Other Information                                                                                            |   |
|                           |                                                                                                         |   |
| Item  6.                       | Exhibits  and Reports on Form 8-K                                                                            |   |
|                           |                                                                                                         |   |
|                           | Signatures                                                                                                   |   |

 

EXPLANATORY NOTE

 

This Amendment No. 1 isbeing filed to correct an error in the calculations of the fair value of certain warrantsissued to non-employees and warrants issued in connection with the Series B andSeries C preferred stock issuances, reflected in the Company’s financialstatements reported on Form 10-QSB for the period ended March 31, 2004.  The calculations had erroneously assumed atax benefit, which decreased the non-cash stock-based expense and preferreddividends.  The Company has recalculatedthese non-cash items removing the previously included tax benefit.  For this reason, we are filing this reportin order to amend Item 1.  “FinancialStatements,” Item 2. “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and Item 3. “Controls and Procedures”solely to the extent necessary to reflect the adjustments described herein.

 

In order to preserve the nature of the disclosures setforth in the Original Report, except as expressly noted above, this reportspeaks as of the date of the filing of the Original Report, dated May 17, 2004,and we have not updated the disclosures in this report to speak of as a laterdate.  All information contained in thisamended report is subject to updating and supplementing as provided in ourreports with the SEC subsequent to the date of the Original Report.

 

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**IMPLANTSCIENCES CORPORATION**

**CONDENSEDBALANCE SHEETS**

**(Unaudited)**

** **
| ** **                                                                                                                                                  | ** ** | **March 31**   | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------|------------|--------------|------------|
| ** **                                                                                                                                                  | ** ** | **2004**       | ** ** | **2003**     | ** ** |
| **ASSETS**                                                                                                                                                  | ** ** | **(Restated)** | ** ** | ** **   | ** ** |
| Current assets:                                                                                                                                             |       |           |       |         |       |
| Cash and cash equivalents                                                                                                                                   |       | $              | 2,828,000  |         | $          | 959,000 |   |
| Accounts receivable, net                                                                                                                                    |       | 1,489,000      |       | 778,000      |       |
| Inventories                                                                                                                                                 |       | 454,000        |       | 473,000      |       |
| Investments - available for sale securities                                                                                                                 |       | 515,000        |       | 177,000      |       |
| Prepaid expenses and other current assets                                                                                                                   |       | 179,000        |       | 33,000       |       |
| Total current assets                                                                                                                                        |       | 5,465,000      |       | 2,420,000    |       |
|                                                                                                                                                        |       |           |       |         |       |
| Property and equipment, net                                                                                                                                 |       | 4,306,000      |       | 4,741,000    |       |
| Amoritzable intangible assets, net (Note 10)                                                                                                                |       | 729,000        |       | —       |       |
| Other non-current assets, net                                                                                                                               |       | 262,000        |       | 136,000      |       |
|                                                                                                                                                        |       |           |       |         |       |
| Total assets                                                                                                                                                |       | $              | 10,762,000 |         | $          | 7,297,000 |   |
|                                                                                                                                                        |       |           |       |         |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                               |       |           |       |         |       |
| Current liabilities:                                                                                                                                        |       |           |       |         |       |
| Current maturities of long-term debt                                                                                                                        |       | $              | 767,000    |         | $          | 1,269,000 |   |
| Current maturities of obligations under capital leases                                                                                                      |       | 4,000          |       | 5,000        |       |
| Accounts payable                                                                                                                                            |       | 602,000        |       | 749,000      |       |
| Accrued expenses                                                                                                                                            |       | 757,000        |       | 669,000      |       |
| Total current liabilities                                                                                                                                   |       | 2,130,000      |       | 2,692,000    |       |
|                                                                                                                                                        |       |           |       |         |       |
| Long-term liabilities:                                                                                                                                      |       |           |       |         |       |
| Obligations under capital lease, net of current maturities                                                                                                  |       | 7,000          |       | 11,000       |       |
| Long-term debt, net of current maturities                                                                                                                   |       | 315,000        |       | —       |       |
| Total liabilities                                                                                                                                           |       | 2,452,000      |       | 2,703,000    |       |
|                                                                                                                                                        |       |           |       |         |       |
| Convertible preferred stock: 5,000,000 shares authorized;                                                                                                   |       |           |       |         |       |
| 7% Series A Cumulative Convertible Preferred Stock, $10 stated value;  250,000 shares designated;150,000 shares issued and outstanding at June 30,  2003    |       | —         |       | 966,000      |       |
| 5% Series B Cumulative Convertible Preferred Stock, $10 stated value;  200,000 shares designated; no shares issued and outstanding                          |       | —         |       | —       |       |
| 5% Series C Cumulative Convertible Preferred Stock, $10 stated value;  250,000 shares designated; 250,000 shares issued and outstanding at March 31,  2004. |       | 1,591,000      |       | —       |       |
| Stockholders’ equity:                                                                                                                                  |       |           |       |         |       |
| Common stock, $.10 par value; 20,000,000 shares authorized; 7,595,415  and 6,650,156 issued as of March 31, 2004 and June 30, 2003, respectively            |       | 760,000        |       | 665,000      |       |
| Treasury stock, 3,103 common shares as of March 31, 2003, at cost  (Note 11)                                                                                |       | (34,000        | )          | —       |       |
| Additional paid-in capital                                                                                                                                  |       | 24,079,000     |       | 16,064,000   |       |
| Accumulated deficit                                                                                                                                         |       | (17,890,000    | )          | (12,988,000  | )          |
| Deferred compensation                                                                                                                                       |       | (615,000       | )          | (7,000       | )          |
| Accumulated other comprehensive income                                                                                                                      |       | 419,000        |       | 117,000      |       |
| Notes receivable from employees                                                                                                                             |       | —         |       | (223,000     | )          |
|                                                                                                                                                        |       |           |       |         |       |
| Total stockholders’ equity                                                                                                                             |       | 6,719,000      |       | 3,628,000    |       |
|                                                                                                                                                        |       |           |       |         |       |
| Total liabilities and stockholders’ equity                                                                                                             |       | $              | 10,762,000 |         | $          | 7,297,000 |   |
|                                                                                                                                                        |       |           |       |         |       |

 

Theaccompanying notes are an integral part of these condensed financialstatements.

 

2

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**IMPLANT SCIENCES CORPORATION**

**CONDENSEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                                                                                                                                                                                                                                             |   | **Three  Months Ended** |       | **Nine  Months Ended** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                                                                                                                                                                                                                                                             |   | **March 31**            |       | **March 31**           |   |
|                                                                                                                                                                                                                                                                             |   | **2004**                |       | **2003**               |   | **2004** |   | **2003** |   |
|                                                                                                                                                                                                                                                                             |   | **(Restated)**          |       |                   |   | **(Restated)** |   |   |   |
| Revenues:                                                                                                                                                                                                                                                                        |   |                    |       |                   |   |   |   |   |   |
| Product and contract research:                                                                                                                                                                                                                                                   |   |                    |       |                   |   |   |   |   |   |
| Medical                                                                                                                                                                                                                                                                          |   | $                       | 868,000    |                   | $      | 629,000 |   | $ | 2,145,000 |   | $ | 1,993,000 |   |
| Contract manufacturing                                                                                                                                                                                                                                                           |   | 769,000                 |       | 672,000                |   | 2,003,000 |   | 2,037,000 |   |
| Government contracts and other                                                                                                                                                                                                                                                   |   | 998,000                 |       | 392,000                |   | 2,012,000 |   | 964,000 |   |
| Total revenues                                                                                                                                                                                                                                                                   |   | 2,635,000               |       | 1,693,000              |   | 6,160,000 |   | 4,994,000 |   |
| Costs and expenses:                                                                                                                                                                                                                                                              |   |                    |       |                   |   |   |   |   |   |
| Cost of product and contract research, includes $90,000 of non-cash  stock-based compensation for the nine months ended March 31, 2004.                                                                                                                                          |   | 1,167,000               |       | 999,000                |   | 3,846,000 |   | 2,996,000 |   |
| Cost of government contracts and other                                                                                                                                                                                                                                           |   | 701,000                 |       | 459,000                |   | 701,000 |   | 988,000 |   |
| Total costs and expenses                                                                                                                                                                                                                                                         |   | 1,868,000               |       | 1,458,000              |   | 4,547,000 |   | 3,984,000 |   |
| Gross margin                                                                                                                                                                                                                                                                     |   | 767,000                 |       | 235,000                |   | 1,613,000 |   | 1,010,000 |   |
| Operating expenses:                                                                                                                                                                                                                                                              |   |                    |       |                   |   |   |   |   |   |
| Research and development, (includes $103,000 and $1,000 non-cash  charge for stock-based compensation for the three months ended March 31, 2004  and 2003, respectively, and $275,000 and $17,000 for the nine months ended  March 31, 2004 and 2003, respectively.)             |   | 418,000                 |       | 389,000                |   | 1,299,000 |   | 1,257,000 |   |
| Selling, general and administrative, (includes $275,000 and $97,000  non-cash charge for stock-based compensation for the three months ended March  31, 2004 and 2003, respectively and $533,000 and $136,000 for the nine months  ended March 31, 2004 and 2003, respectively.) |   | 1,156,000               |       | 608,000                |   | 2,905,000 |   | 1,762,000 |   |
| Total operating expenses                                                                                                                                                                                                                                                         |   | 1,574,000               |       | 997,000                |   | 4,204,000 |   | 3,019,000 |   |
|                                                                                                                                                                                                                                                                             |   |                    |       |                   |   |   |   |   |   |
| Loss from operations                                                                                                                                                                                                                                                             |   | (807,000                | )          | (762,000               | )      | (2,591,000 | ) | (2,009,000 | ) |
|                                                                                                                                                                                                                                                                             |   |                    |       |                   |   |   |   |   |   |
| Other income (expense):                                                                                                                                                                                                                                                          |   |                    |       |                   |   |   |   |   |   |
| Interest income                                                                                                                                                                                                                                                                  |   | 6,000                   |       | 6,000                  |   | 14,000 |   | 21,000 |   |
| Interest expense                                                                                                                                                                                                                                                                 |   | (33,000                 | )          | (1,000                 | )      | (111,000 | ) | (12,000 | ) |
| Equity losses in unconsolidated subsidiaries                                                                                                                                                                                                                                     |   | (5,000                  | )          | (2,000                 | )      | (12,000 | ) | (2,000 | ) |
| Total other income (expense)                                                                                                                                                                                                                                                     |   | (32,000                 | )          | 3,000                  |   | (109,000 | ) | 7,000 |   |
|                                                                                                                                                                                                                                                                             |   |                    |       |                   |   |   |   |   |   |
| Net loss                                                                                                                                                                                                                                                                         |   | (839,000                | )          | (759,000               | )      | (2,700,000 | ) | (2,002,000 | ) |
| Preferred distribution, dividends and accretion (Note 8)                                                                                                                                                                                                                         |   | (1,227,000              | )          | (266,000               | )      | (2,201,000 | ) | (467,000 | ) |
| Net loss applicable to common shareholders                                                                                                                                                                                                                                       |   | $                       | (2,066,000 | )                      | $      | (1,025,000 | ) | $ | (4,901,000 | ) | $ | (2,469,000 | ) |
|                                                                                                                                                                                                                                                                             |   |                    |       |                   |   |   |   |   |   |
| Net loss per share:                                                                                                                                                                                                                                                              |   |                    |       |                   |   |   |   |   |   |
| Per share - basic and diluted:                                                                                                                                                                                                                                                   |   |                    |       |                   |   |   |   |   |   |
| Net loss                                                                                                                                                                                                                                                                         |   | $                       | (0.11      | )                      | $      | (0.12 | ) | $ | (0.38 | ) | $ | (0.32 | ) |
| Preferred distribution                                                                                                                                                                                                                                                           |   | (0.16                   | )          | (0.04                  | )      | (0.31 | ) | (0.08 | ) |
| Net loss per share applicable to common shareholders                                                                                                                                                                                                                             |   | $                       | (0.27      | )                      | $      | (0.16 | ) | $ | (0.69 | ) | $ | (0.40 | ) |
|                                                                                                                                                                                                                                                                             |   |                    |       |                   |   |   |   |   |   |
| Weighted average common shares outstanding basic and diluted                                                                                                                                                                                                                     |   | 7,447,253               |       | 6,284,556              |   | 7,090,465 |   | 6,243,350 |   |

 

The accompanying notes are an integral part of these condensedfinancial statements.

 

3

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**IMPLANTSCIENCES CORPORATION**

**CONDENSEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                                                              | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                              | ** ** | **March 31,**         | ** ** |
| ** **                                                                                                              | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                                                                                                              | ** ** | **(Restated)**        | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities**                                                                               | ** ** | ** **            | ** ** | ** ** | ** ** |
| Net loss                                                                                                                |       | $                     | (2,700,000 | ) | $ | (2,002,000 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities:                                            |       |                  |       |   |   |
| Depreciation and amortization                                                                                           |       | 914,000               |       | 598,000 |   |
| Stock-based compensation expense                                                                                        |       | 898,000               |       | 153,000 |   |
| Equity losses in unconsolidated subsidiaries                                                                            |       | 12,000                |       | — |   |
| Changes in assets and liabilities:                                                                                      |       |                  |       |   |   |
| Accounts receivable                                                                                                     |       | (711,000              | )          | 151,000 |   |
| Inventories                                                                                                             |       | 19,000                |       | (224,000 | ) |
| Prepaid expenses and other current assets                                                                               |       | (109,000              | )          | (12,000 | ) |
| Accounts payable                                                                                                        |       | (147,000              | )          | 119,000 |   |
| Accrued expenses                                                                                                        |       | 38,000                |       | (278,000 | ) |
| Net cash used in operating activities                                                                                   |       | (1,786,000            | )          | (1,495,000 | ) |
| **Cash flows from investing activities**                                                                                |       |                  |       |   |   |
| Purchases of property and equipment                                                                                     |       | (194,000              | )          | (255,000 | ) |
| Investment in available for sale securities                                                                             |       | (40,000               | )          | — |   |
| Other non-current assets                                                                                                |       | (56,000               | )          | (51,000 | ) |
| Net cash used in investing activities                                                                                   |       | (290,000              | )          | (306,000 | ) |
| **Cash flows from financing activities**                                                                                |       |                  |       |   |   |
| Proceeds from common stock                                                                                              |       | 358,000               |       | 105,000 |   |
| Proceeds from issuance of Series A preferred stock, net of issuance  costs                                              |       | 593,000               |       | 2,099,000 |   |
| Proceeds from issuance of Series B preferred stock, net of issuance  costs                                              |       | 1,818,000             |       | — |   |
| Proceeds from issuance of Series C preferred stock, net of issuance  costs                                              |       | 2,289,000             |       | — |   |
| Repayments of long-term debt                                                                                            |       | (308,000              | )          | (243,000 | ) |
| Repayments of capital lease obligations                                                                                 |       | (4,000                | )          | — |   |
| Repayment received from note receivable                                                                                 |       | 85,000                |       | — |   |
| Repayments of equipment financing                                                                                       |       | (886,000              | )          | — |   |
| Net cash provided by financing activities                                                                               |       | 3,945,000             |       | 1,961,000 |   |
| Net increase in cash and cash equivalents                                                                               |       | 1,869,000             |       | 160,000 |   |
| Cash and cash equivalents, beginning                                                                                    |       | 959,000               |       | 1,014,000 |   |
| Cash and cash equivalents, ending                                                                                       |       | $                     | 2,828,000  |   | $ | 1,174,000 |   |
| **Noncash Investing and Financing Activity:**                                                                           |       |                  |       |   |   |
| Issuance of Series A warrants                                                                                           |       | $                     | —     |   | $ | 128,000 |   |
| Noncash beneficial conversion feature - Series A                                                                        |       | $                     | —     |   | $ | 537,000 |   |
| Issuance of Series B warrants                                                                                           |       | $                     | 184,000    |   | $ | — |   |
| Noncash beneficial conversion feature - Series B                                                                        |       | $                     | 826,000    |   | $ | — |   |
| Issuance of Series C warrants                                                                                           |       | $                     | 305,000    |   | $ | — |   |
| Noncash beneficial conversion feature - Series C                                                                        |       | $                     | 700,000    |   | $ | — |   |
| Conversion of Series A Cumulative Convertible Preferred stock and  accrued dividends into common stock                  |       | $                     | 1,500,000  |   | $ | 168,000 |   |
| Conversion of Series B Cumulative Convertible Preferred stock and  accrued dividends into common stock                  |       | $                     | 2,000,000  |   | $ | — |   |
| Value of amortizable intangible asset acquired in exchange for long  term note payable                                  |       | $                     | 1,007,000  |   | $ | — |   |
| Accretion of 7% Series A Cumulative Convertible Preferresd Stock dividends,  beneficial conversion feature and warrants |       | $                     | 556,000    |   | $ | 467,000 |   |
| Accretion of 5% Series B Cumulative Convertible Preferred Stock dividends,  beneficial conversion feature and warrants  |       | $                     | 1,254,000  |   | $ | — |   |
| Accretion of 5% Series C Cumulative Convertible Preferred Stock dividends,  beneficial conversion feature and warrants  |       | $                     | 336,000    |   | $ | — |   |
| Value of non-cash investment in CorNova                                                                                 |       | $                     | 113,000    |   | $ | — |   |

 

Theaccompanying notes are an integral part of these condensed financialstatements.

 

4

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**IMPLANT SCIENCES CORPORATION**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**March 31, 2004**

**(Unaudited)**

 

 

**1.     Descriptionof Business**

Implant Sciences Corporation (the “Company”) develops products for themedical device and explosives detection industry using ion implantation andthin film coatings of radioactive and non-radioactive materials.  The Company has received Food and DrugAdministration 510(k) clearance to market its I-PlantäIodine-125 radioactive seed for the treatment of prostate cancer.  The Company also has under developmentinterventional cardiology devices and temporary coronary brachytherapy systemsfor the prevention of restenosis (reclosure of the artery after balloonangioplasty).  In addition, the Companymodifies the surface characteristics of orthopedic joint implants to reducepolyethylene wear and thereby increasing the life of the implant and providesion implantation of electronic dopants for the semiconductor industry.  Additionally, the Company is developing anexplosives detection device to be used in the detection of trace residues ofexplosives.

**2.     Interim Financial Statements andRestatements**

The financialinformation for the three and nine months ending March 31, 2004 and 2003 isunaudited but includes all adjustments (consisting only of normal recurringadjustments), which we consider necessary for a fair presentation of thefinancial position at such date and of the operating results and cash flows forthese periods.  The result of operations andcash flows for the three and nine months ended March 31, 2004 are notnecessarily indicative of results that may be expected for the year ended June30, 2004.  The information contained inthis Form 10-QSB/A No. 1 should be read in conjunction with our auditedfinancial statements, included in our Form 10-KSB/A No. 1 as of and for theyear ending June 30, 2003 filed with the Securities and Exchange Commission onOctober 1, 2003.  Certain amounts in theprior period financial statements have been reclassified to conform to thecurrent period’s presentation.

The Company restated its previously issued financial statements as ofand for the three and nine months ended March 31, 2004.  ThisAmendment No. 1 is being filed to correct an error in the calculationsof the fair value of certain warrants issued to non-employees and warrantsissued in connection with the Series B and Series C preferred stock issuances,reflected in the Company’s financial statements reported on Form 10-QSB for theperiod ended March 31, 2004.  Thecalculations had erroneously assumed a tax benefit, which decreased stock-basedcompensation expense and preferred dividends. The Company has recalculated these non-cash items removing thepreviously included tax benefit.  Forthis reason, we are filing this report in order to amend Item 1.  “Financial Statements,” Item 2. “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andItem 3. “Controls and Procedures” solely to the extent necessary to reflect theadjustments described herein.

 

In order topreserve the nature of the disclosures set forth in the Original Report, exceptas expressly noted above, this report speaks as of the date of the filing ofthe Original Report, dated May 17, 2004, and we have not updated thedisclosures in this report to speak of as a later date.  All information contained in this amendedreport is subject to updating and supplementing as provided in our reports withthe SEC subsequent to the date of the Original Report

The followinglists the accounts in the statements of operations and balance sheets that wereaffected by the restatements discussed above, with comparisons of the restatedamounts to previously reported amounts, and the effect of such restatements:

 

5

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| ** **                                            | ** ** | **Three Months Ended  March 31, 2004** | ** ** | **Nine Months Ended  March 31, 2004** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                            | ** ** | **As restated**                        | ** ** | **As reported**                       | ** ** | **As restated** | ** ** | **As reported** | ** ** |
| Research and development                              |       | $                                      | 418,000    |                                  | $          | 398,000 |   | $ | 1,299,000 |   | $ | 1,279,000 |   |
| Selling, general and administrative                   |       | 1,156,000                              |       | 1,078,000                             |       | 2,905,000 |   | 2,827,000 |   |
| Total operating expenses                              |       | 1,574,000                              |       | 1,476,000                             |       | 4,204,000 |   | 4,106,000 |   |
| Loss from operations                                  |       | (807,000                               | )          | (709,000                              | )          | (2,591,000 | ) | (2,493,000 | ) |
| Net loss                                              |       | (839,000                               | )          | (741,000                              | )          | (2,700,000 | ) | (2,602,000 | ) |
| Preferred distribution, dividends, and  accretion     |       | (1,227,000                             | )          | (1,062,000                            | )          | (2,201,000 | ) | (2,036,000 | ) |
| Net loss applicable to common shareholders            |       | (2,066,000                             | )          | (1,803,000                            | )          | (4,901,000 | ) | (4,638,000 | ) |
| Net loss per share - basic and diluted:               |       |                                   |       |                                  |       |   |   |   |   |
| Net loss                                              |       | $                                      | (0.11      | )                                     | $          | (0.10 | ) | $ | (0.38 | ) | $ | (0.37 | ) |
| Preferred dividend                                    |       | (0.16                                  | )          | (0.14                                 | )          | (0.31 | ) | (0.29 | ) |
| Net loss per share applicable to common  shareholders |       | $                                      | (0.27      | )                                     | $          | (0.24 | ) | $ | (0.69 | ) | $ | (0.66 | ) |

 
| ** **                                          | ** ** | **March 31, 2004** | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|
| ** **                                          | ** ** | **As  restated**   | ** ** | **As reported** | ** ** |
| 5% Series C Cumulative Convertible  Preferred Stock |       | $                  | 1,591,000  |   | 1,733,000 |   |
| Additional paid-in-capital                          |       | 24,079,000         |       | 23,674,000 |   |
| Accumulated deficit                                 |       | (17,890,000        | )          | (17,627,000 | ) |
| Total stockholders’ equity                     |       | 6,719,000          |       | 6,577,000 |   |
|                                                     |            |                    |            |  |  |  |

 

**3.****              Stock-basedCompensation**

The Companyaccounts for its employee stock based compensation arrangements under theprovisions of Accounting Principal Board (APB) Opinion No. 25, “Accounting forStock Issued to Employees,” rather than the alternative fair value accountingmethod provided for under SFAS No. 123, “Accounting for Stock-BasedCompensation.”  Under APB 25, when theexercise price of options granted to employees and non-employee directors underthese plans equals the market price of the underlying stock on the date of thegrant, no compensation expense is recorded.

The Company haselected to use the disclosure-only provisions of SFAS No. 123 and SFAS No. 148,“Accounting for Stock-Based Compensation-Transition and Disclosure.”  Had compensation expense for stock optiongrants to employees been determined based on the fair value method at the grantdates for awards under the stock option plans consistent with the methodprescribed by SFAS No. 123, the Company’s net loss would have increased to thepro forma amounts indicated as follows:

 

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| ** **                                                                                                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                       | ** ** | **March 31,**          | ** ** | **March 31,**         | ** ** |
| ** **                                                                                                                       | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                       | ** ** | **(Restated)**         | ** ** | ** **            | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
|                                                                                                                             |       |                   |       |                  |       |   |   |   |   |
| Net loss applicable to common shareholders,  as reported                                                                         |       | $                      | (2,066,000 | )                     | $          | (1,025,000 | ) | $ | (4,901,000 | ) | $ | (2,469,000 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss applicable to common shareholders, net  of tax     |       | 70,000                 |       | —                |       | 551,000 |   | 15,000 |   |
| Deduct: Total stock-based employee  compensation expense determined under the fair value based method of all  awards, net of tax |       | (193,000               | )          | (250,000              | )          | (576,000 | ) | (480,000 | ) |
|                                                                                                                             |       |                   |       |                  |       |   |   |   |   |
| Pro forma net loss applicable to common  shareholders                                                                            |       | $                      | (2,189,000 | )                     | $          | (1,275,000 | ) | $ | (4,926,000 | ) | $ | (2,934,000 | ) |
|                                                                                                                             |       |                   |       |                  |       |   |   |   |   |
| Net loss applicable to common shareholders  per basic and dilutive shares:                                                       |       |                   |       |                  |       |   |   |   |   |
| As reported                                                                                                                      |       | $                      | (0.27      | )                     | $          | (0.16 | ) | $ | (0.69 | ) | $ | (0.40 | ) |
| Pro forma                                                                                                                        |       | $                      | (0.29      | )                     | $          | (0.20 | ) | $ | (0.69 | ) | $ | (0.47 | ) |
|                                                                                                                             |       |                   |       |                  |       |   |   |   |   |
| Weighted average common shares otstanding  basic and diluted                                                                     |       | 7,447,253              |       | 6,284,556             |       | 7,090,465 |   | 6,243,350 |   |

 

 

In August 2003, the Companyissued 45,550 shares of restricted common stock to employees in lieu of cashraises.  These shares of restricted stockwere subject to forfeiture if the employee’s employment with the Company ceasedprior to January 2, 2004.  Additionally,the shares may not be sold, transferred or assigned until August 2004.  The Company recorded deferred compensation of$265,000 related to this transaction. This amount is being amortized over the four month vesting period.  During the three and nine months ended March31, 2004, the Company recorded $0 and $261,000 in compensation expenserespectively, related to these restricted shares.

        The Company recorded additional deferred compensation of $739,000relating to stock options issued below fair market value.  This amount is being amortized over the lifeof the options which averages 10 years. During the quarter ended March 31, 2004, the Company recorded $70,000 incompensation expense related to this transaction.

        During the three months ended March 31, 2004, the Company issued 2,000shares of restricted common stock to a consultant in exchange forservices.  The Company recognizedapproximately $20,000 in expense associated with the stock granted to thisconsultant.

        The Company granted 260,000 warrants to purchase common stock to threeconsultants in exchange for services during the three months ended March 31,2004.  The Company recorded approximately$288,000 in expense associated with this issuance.  The Company estimated the fair value of thecommon stock options and warrants using the Black-Scholes option-pricingmodel.  The Company estimated the fairvalue of the options and warrants using the following input assumptions:

 

| Volatility              |   | 66.00           | %      |
|-------------------------|--------|-----------------|--------|
| Dividend                |   | 0               | %      |
| Risk-free interest rate |   | 0.94 - 3.27     | %      |
| Expected lives          |   | 4 mos - 5 years |   |

 

 

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**4.****              Earnings Per Share**

Basic earningsper share is computed based only on the weighted average number of commonshares outstanding during the period. Diluted earnings per share is computed by using the weighted averagenumber of common shares outstanding during the period, plus the dilutiveeffects of shares issuable through the exercise of stock options (common stockequivalents) unless their inclusion would be antidilutive.

 

**5.****              ComprehensiveIncome   (Loss)**

 The Company has accumulated other comprehensiveincome (loss) resulting from the unrealized gain on an investment in marketableequity securities of CardioTech International Inc. (Note 9) and the recognitionof the unrealized gain/loss of the Company’s share of CardioTech and ImplantSciences stock owned by CorNova (Note 11) which is recorded in thestockholders’ equity section of the balance sheet.  Comprehensive income (loss) is summarizedbelow:

 
| ** **                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **March 31,**          | ** ** | **March 31,**         | ** ** |
| ** **                        | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                        | ** ** | **(Restated)**         | ** ** | ** **            | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
|                              |       |                   |       |                  |       |   |   |   |   |
| Net Loss                          |       | $(839,000              | )          | $(759,000             | )          | $(2,700,000 | ) | $(2,002,000 | ) |
| Other Comprehensive Income (Loss) |       | 195,000                |       | (19,000               | )          | 302,000 |   | (43,000 | ) |
|                              |       |                   |       |                  |       |   |   |   |   |
| Comprehensive Loss                |       | $(644,000              | )          | $(778,000             | )          | $(2,398,000 | ) | $(2,045,000 | ) |
|                              |       |                   |       |                  |       |   |   |   |   |

 

 

**6.****              Accounts Receivable**

Contractrevenue under cost sharing research and development agreements is recognized aseligible expenses are incurred. Invoicing of research and development contracts occurs in accordancewith the terms of the contract.  Revenuerecognized but unbilled is recorded as unbilled accounts receivable.  At March 31, 2004 and June 30, 2003, unbilledaccounts receivable represented approximately 38% and 10% of total accountsreceivable, respectively.  Generally,there are no prerequisites necessary to bill.

 

**7.****              Credit Arrangements**

        In June, 2003, the Company purchased a MC3, mass-analyzed ion implanterand wafer handling end-station (the “System”) from Axcelis Technologies, Inc.(“Axcelis”) for a price of $1,300,000. The Company had financed the System with Axcelis via monthlyinstallments of approximately $43,000 beginning July 2003 and continuingthrough December 31, 2003.  Interest isbeing calculated at prime plus 6.25%.  InDecember 2003, the Company made a lump sum payment of approximately$571,000.  The remaining balance of$571,000 has been financed by Axcelis and is due via monthly installments ofapproximately $98,000 beginning January 2004 and continuing through June 30,2004.  Title for the equipment shallremain with Axcelis until the system is paid in full.  Should the Company fail to pay the balance infull, Axcelis has the right to recover the system from the Company.  The value of the equipment is included inproperty and equipment.  As of March 31,2004, the unpaid balance on this equipment is approximately $384,000, all ofwhich is classified as current.

 

**8.****              Private Placement**

On October 7, 2002, the Company issued 250,000 shares of Series A 7%Cumulative Convertible Preferred Stock (“Series A”) having a stated value of$10 per share, pursuant to a Securities Purchase Agreement executed on October7, 2002 with the Laurus Master Fund, Ltd. The Company received $2,500,000 in gross proceeds, less a management andplacement agent fee of approximately $300,000, and related transaction costs ofapproximately $101,000.  The terms of theSeries A provide for repayment of outstanding principal and accrued dividendsin either cash or with shares of the Company’s common stock, at the Company’soption, over a 14 month period beginning February 1, 2003.  If the Company elects to convert into sharesof the Company’s common stock, the common stock will be valued at $5.19 pershare.  However, if the closing price ofthe Company’s common stock for any of the 11 trading days prior to a monthlyrepayment date is less than $5.70, 

 

 

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the commonstock will be valued at the greater of 83% of the average of the three lowestclosing prices during the 30 trading days immediately preceding the repaymentdate or $2.02 and Laurus Master Fund, Ltd. will be permitted to convert suchpart of the monthly payment, up to the amount the Company elected to repay,into shares of common stock.  Any part ofthe monthly amount not converted into common stock shall be paid in cash on thefollowing monthly repayment date.  The Companyalso granted the investor a security interest in substantially all of theCompany’s assets.  In connection with theissuance of the Series A, the investor received a warrant to purchase 55,000shares of the Company’s common stock. The common stock purchase warrant may be exercised at any time and isvalid for five years from the date of issuance at an exercise price of $6.23per share.

 

In accordance with the provisions of Emerging Issues Task Force (EITF)Issue 00-27, “Application of EITF Issue No. 98-5 ‘Accounting for ConvertibleSecurities with Beneficial Conversion Features of Contingently AdjustableConversion Ratios’, to Certain Convertible Securities”, which became effectivein November 2000, the allocated value of the Series A contained a beneficialconversion feature calculated based on the difference between the effectiveconversion price of the proceeds allocated to the Series A and the fair marketvalue of the common stock at the date of issuance.  The discount arising from the beneficial conversionfeature aggregated $537,000.  Thediscount is being amortized and recorded as a preferred dividend during theperiod from the issuance of the preferred stock to the mandatory redemptiondate of April 7, 2004 or the actual conversion date, whichever is earlier.

 

The Companyvalued the Series A at issuance at $1,434,000 based on the relative fair marketvalues of the financial instruments issued in connection with this placement,net of offering costs and the beneficial conversion feature.  The amounts recorded in the financialstatements represent the amounts attributed to the sale of the preferred stock,net cash proceeds of $2,099,000 ($401,000 of issuance costs incurred), amountallocated to warrants of $128,000, and the amount of the discount related tothe value of beneficial conversion feature of $537,000.  The Company was accreting these discounts onthe carrying value of the preferred stock to its redemption value of $2,500,000at April 7, 2004, or the actual conversion date, whichever is earlier.  The accretion of these amounts is beingrecorded as a preferred dividend in the period of redemption.  As of March 31, 2004, all amounts were fullyamortized and the principal balance of the Series A has been paid in full.  All Series A shares had been converted into672,458 shares of common stock

        On August 28, 2003,the Company issued 200,000 shares of Series B 5% Cumulative ConvertiblePreferred Stock (“Series B”) having a stated value of $10 per share, pursuantto a Securities Purchase Agreement executed on August 28, 2003 with the LaurusMaster Fund, Ltd.  The Company received$2,000,000 in gross proceeds, less a management and placement agent fee ofapproximately $108,000, and related transaction costs of approximately$70,000.  The terms of the Series Bprovide for repayment with shares of the Company’s common stock or in cash,pursuant to an amortization schedule. Repayment of the Series B commenced on December 1, 2003.  The Company has the sole option to determinewhether to satisfy payment of the monthly amount in full on each repayment dateeither in cash or in shares of common stock, or a combination of both.  However, if the closing price for any of the11 trading days preceding a repayment date is less than $6.00, the Companywould be required to pay such monthly amount in cash at 105% of the monthlyobligation.  If the payment of themonthly amount is made in common stock, the fixed conversion price is$5.50.  The Company also issued to Laurusa warrant to purchase 25,000 shares of common stock at $6.88 per share and45,000 shares of common stock at $8.25 per share.  The Securities Purchase Agreement alsoprovides for a security interest in substantially all of the Company’s assetsand provides Laurus a right of first refusal on future financing arrangementsduring the Term of the agreement.  In theevent Laurus declines to exercise its right of first refusal, it hereby agreesto enter into such documentation as shall be reasonable requested by the Companyin order to subordinate its rights under the Series B to the subsequentfinancier.  The Company utilized theproceeds of this financing to commercialize its explosives detection system andfor general working capital purposes.

 

In accordancewith the provisions of Emerging Issues Task Force (EITF) Issue 00-27,“Application of EITF Issue No. 98-5 ‘Accounting for Convertible Securities withBeneficial Conversion Features of Contingently Adjustable Conversion Ratios’,to Certain Convertible Securities”, which became effective in November 2000,the allocated value of the Series B contained a beneficial conversion featurecalculated based on the difference between the effective conversion price ofthe proceeds allocated to the Series B and the fair market value of the commonstock at the date of issuance.  Thediscount arising from the beneficial conversion feature aggregated$826,000.  The discount is beingamortized and recorded as a preferred dividend during the period from theissuance of the preferred stock to the mandatory redemption date of March 1,2005, or the actual conversion 

 

9

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date, whichever is earlier.

The Company valued the Series B at issuance to be $812,000 based on therelative fair market values of the financial instruments issued in connectionwith this placement, net of offering costs and the beneficial conversionfeature.  The amounts recorded in thefinancial statements represent the amounts attributed to the sale of thepreferred stock, net cash proceeds of $1,822,000 ($178,000 of issuance costsincurred), amount allocated to warrants of $184,000, and the amount of thediscount related to the value of beneficial conversion feature of$826,000.  The Company is accreting thesediscounts on the carrying value of the preferred stock to its redemption valueof $2,000,000 at March 1, 2005, or the actual conversion date, whichever isearlier.  The accretion of these amountsis being recorded as a preferred dividend in the period of redemption.  During the period ended March 31, 2004,approximately $897,000 was amortized.  Asof March 31, 2004, all amounts were fully amortized.

During the three months ended March 31, 2004, Laurus converted 145,000shares of Series B into 263,636 shares of the Company’s common stock, at aconversion price of $5.50 per share.  Asof March 31, 2004, the principal balance of the Series B was paid in full.  For the three months ended March 31, 2004,the Company accrued approximately $9,000 of dividends.  The conversion of accrued interest intocommon stock resulted in additional dividends of $53,000 during the three andnine months ended March 31, 2004, in excess of the 5% stated value.  As of March 31, 2004, all Series B shares hadbeen converted into 363,636 shares of common stock.

On November 25, 2003, the Company issued250,000 shares of Series C 5% Cumulative Convertible Preferred Stock (“SeriesC”) having a stated value of $10 per share, pursuant to a Securities PurchaseAgreement executed on November 25, 2003 with the Laurus Master Fund, Ltd.  The Company received $2,500,000 in grossproceeds, less a management and placement agent fee of approximately $125,000,and related transaction costs of approximately $86,000.  The terms of the Series C provide forrepayment with shares of the Company’s common stock or in cash, pursuant to anamortization schedule.  Repayment of theSeries C commences on March 31, 2004. The Company has the sole option to determine whether to satisfy paymentof the monthly amount in full on each repayment date either in cash or in sharesof common stock, or a combination of both. If the payment of the monthly amount is made in common stock, the fixedconversion price is $6.75.  The Companyalso issued to Laurus a warrant to purchase 50,000 shares of common stock at$8.44 per share and 50,000 shares of common stock at $10.13 per share.  The Securities Purchase Agreement alsoprovides for a security interest in substantially all of the Company’s assetsand provides Laurus a right of first refusal on future financing arrangementsduring the Term of the agreement.  In theevent Laurus declines to exercise its right of first refusal, it hereby agreesto enter into such documentation as shall be reasonable requested by theCompany in order to subordinate its rights under the Series C to the subsequentfinancier.  The Company will utilize theproceeds of this financing to purchase an ion implanter and for general workingcapital purposes.

In accordancewith the provisions of Emerging Issues Task Force (EITF) Issue 00-27,“Application of EITF Issue No. 98-5 ‘Accounting for Convertible Securities withBeneficial Conversion Features of Contingently Adjustable Conversion Ratios’,to Certain Convertible Securities”, which became effective in November 2000,the allocated value of the Series C contained a beneficial conversion featurecalculated based on the difference between the effective conversion price ofthe proceeds allocated to the Series C and the fair market value of the commonstock at the date of issuance.  Thediscount arising from the beneficial conversion feature aggregated$700,000.  The discount is beingamortized and recorded as a preferred dividend during the period from theissuance of the preferred stock to the mandatory redemption date of June 1,2005, or the actual conversion date, whichever is earlier using the effectiveinterest method.

The Company valued the Series C at issuance to be $1,284,000 based onthe relative fair market values of the financial instruments issued inconnection with this placement, net of offering costs and the beneficialconversion feature.  The amounts recordedin the financial statements represent the amounts attributed to the sale of thepreferred stock, net cash proceeds of $2,289,000 ($211,000 of issuance costsincurred), the amount allocated to warrants of $305,000,and the amount of thediscount related to the value of beneficial conversion feature of$700,000.  The Company is accreting thesediscounts on the carrying value of the preferred stock to its redemption valueof $2,500,000 at June 1, 2005, or the actual conversion date, whichever isearlier.  The accretion of these amountsis being recorded as a preferred dividend in the period of redemption.  During the three months ended March 31, 2004,approximately $237,000 was amortized.  Asof March 31, 2004, the outstanding principal of the Series C was$2,500,000.  For the three months endedMarch 31, 2004, the Company accrued approximately $31,000 of dividends.

 

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**9.****              Related PartyTransactions**

SFAS No. 57,“Related Party Disclosures,” specifies the nature of information that should bedisclosed in financial statements regarding related party transactions.  CardioTech, a public company, is a relatedparty with the Company by virtue of its significant business relationships.

Certaindirectors of the Company hold positions as directors of CardioTech.  The CEO and Chairman of the Board ofDirectors of the Company is also a director of CardioTech.  The CEO and Chairman of the Board ofDirectors of CardioTech is also a director of the Company.

In March 2000, the Company entered into a joint research agreement withCardioTech to develop a proprietary porous polymer biocompatible coatingtechnology as \a platform for the Company’s proprietary radioactive brachytherapytechnology.  In consideration for thisagreement, the Company agreed to pay $150,000 in cash and purchase 100,000shares of CardioTech stock at a price of $1.00 per share.  As of March 31, 2004, the fair market valueof the CardioTech shares held as investment is $515,000.  CardioTech is a publicly traded company whosecommon stock trades under the symbol CTE on the American Stock Exchange.

In January 2004, a director of the Company entered into a SalesRepresentative Agreement with the Company to sell radioactive prostateseeds.  In April 2004, this directorresigned from the board to pursue this opportunity and eliminate any possibleconflict.

In March 2004 the Company entered into an Exchange & VentureAgreement with CardioTech International, Inc. (“CardioTech”) and CorNova, Inc.(“CorNova”).  CorNova is a start-upcompany which is focused on the development and marketing of innovativeinterventional cardiology products. CardioTech granted CorNova an exclusive license for the technology andboth CardioTech and the Company have issued equity securities to CorNova.  As of March 31, 2004, the Company has issued10,344 shares to CorNova in exchange for a 30% interest in CorNova. (Note 11).  Our CEO and the Chairman of our AuditCommittee are also on the Board of Directors of CorNova.

 

**10.****       MED-TEC**

On July 31,2003, the Company entered into an agreement with its former exclusivedistributor of prostate seeds, to release each other from further obligationsunder the 2000 Agreement.  The newagreement conveys to the Company direct marketing and sales capabilities tosell its I-Plant Seed brachytherapy seeds for use in the treatment of prostatecancer.  In connection with this, theCompany’s former exclusive distributor will work cooperatively to transitioncustomers and marketing materials directly to the Company.  The distributor also agreed not to competewith the Company for a period of three years. The Company will pay the distributor an average of approximately $39,000per month over the 28 months, beginning September 1, 2003.  As of March 31, 2004, the outstandingprincipal balance is approximately $698,000. For the three months ended March 31, 2004, the Company recorded approximately$19,000 of interest expense relating to this transaction.

The presentvalue of this asset was recorded as approximately $1,007,000, using a rate of10.24%, and is being amortized over its estimated useful life of 29months.  As of March 31, 2004,approximately $278,000 of accumulated amortization expense was recognized.

**11.****      **  **CorNova**

In March 2004,the Company entered into an Exchange & Venture Agreement with CardioTechand CorNova.  CorNova is a start-upcompany focused on the development and marketing of innovative interventionalcardiology products.  The Company issued10,344 shares of common stock bearing an aggregate fair market value of$113,000 as of the date of issuance.  Inexchange, the Company received 1,500,000 shares of the CorNova’s common stock,which represents a 30% ownership position, and a position on the Board ofDirectors.  Other board members include,Dr. Michael Szycher, of CardioTech and Dr. Eric Ryan of CorNova. Upon CorNovasecuring Series A financing, the Company will issue up to a maximum of $750,000of common stock.  As of March 31, 2004,10,344 shares have been issued, 3,103 of which have been categorized astreasury stock.  During the quarter endedMarch 31, 2004, the Company recognized approximately $1,000 in other income(expense) representing our portion of CorNova’s net loss.  The Company is accounting for this investmentunder the equity method under APB Opinion No. 18, “The Equity Method ofAccounting for Investments in Common Stock.”

**12.****      **    **Bay Area MRI**

In March 2004, the Company entered into a consulting agreement withChristopher Lang and Bay Area 

 

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MRI to assistthe Company in the sale of radioactive prostate seeds.  As compensation for consulting services, theCompany may be required to pay commissions of up to $600,000 ($300,000 in cashand $300,000 in shares of common stock.). During the period, the Company issued 3,205 shares of restricted commonstock, bearing an aggregate fair market value of approximately $37,500 andadvanced $50,000 of cash commissions. As of March 31, 2004, these amounts areclassified as prepaid commissions, which will be amortized as expense whenearned.  Future commissions will be paidquarterly, up to a maximum of $300,000 in cash and $300,000 of common stockbased on services provided.

 

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**Item 2.****           Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

Thefollowing management discussion and analysis should be read in conjunction withthe financial statements and notes thereto as filed in our Form 10-KSB/A No. 1for the year ended June 30, 2003.  Inaddition to historical information, this Form 10-QSB/A No. 1 containsforward-looking statements.  Theforward-looking statements are subject to certain risks and uncertainties thatcould cause actual results to differ materially from those reflected in suchforward-looking statements.  Readers arecautioned not to place undue reliance on these forward-looking statements,which reflect management’s opinions only as of the date hereof.  We undertake no obligation to revise orpublicly release the results of any revision to these forward-lookingstatements.  Readers should carefullyreview documents that we file from time to time with the Securities andExchange Commission, including our Quarterly Reports and Annual Reports filedby us in fiscal 2003 and 2004.

ImplantSciences Corporation, incorporated in 1984, operates out of a 43,000 squarefoot leased facility in Wakefield, Massachusetts.  The Company has approximately 76 employeesand runs three shifts.  The Company  generates revenues from the sale of ionimplantation services which include, semiconductor wafer processing, and  medical and industrial coatings, combinedwith radioactive prostate seed manufacturing and the performance of governmentresearch and development contracts.  TheCompany continues to make a significant financial commitment to the developmentof its trace explosives detection device, currently being evaluated by variousgovernment agencies.

**Results of Operations**

*Comparison for the three months ended March 31, 2004and  2003*

*Revenues. *Total revenuesfor the three months ended March 31, 2004, were $2,635,000 as compared to$1,693,000 for the comparable prior year period, an increase of $942,000 or56%.  The increase is primarilyattributable to the revenue recognized from new government contracts to developapplications and products using our Laser Ion Mobility Spectrometry (“IMS”)technology.  Our Laser IMS technology isthe platform technology used in our explosives detection devices.  Government contract revenues increased to$898,000 for the quarter ended March 31, 2004, as compared with $392,000 forthe comparable prior year period, an increase of $506,000 or 129%.  Our grant revenues, principally Small BusinessInnovative Research (SBIR) programs, fluctuate due to: (a) our desire to obtainexternal funding for our research and development efforts; (b) the availabilityof government funding; and (c) the time required to obtain approval of a grantapplication.  We have been successful inobtaining SBIR grants in fiscal 2004 and 2003. We expect to continue to seek continuation or replacement of ourexisting SBIR grants during fiscal 2004 and beyond

                Inthe three months ended March 31, 2004, we recognized $100,000 relating to theissuance of an exclusive option to license our technology to InVision Technologies, Inc.  This agreement is to jointly evaluate thecapabilities of the Company’s non-contact trace explosives detection technologyfor future incorporation in an automated explosives detection system forairport checkpoint screening of passengers and/or carry-on bags.  The agreement gives InVision an exclusiveoption during the limited evaluation period, to enter into a definitiveagreement for exclusive distribution rights to the Company’s technology foraviation security.  The exclusivityagreement was extended through March 31, 2004. The Company is currently evaluating its relationship with InVision.

 

Revenuefrom contract manufacturing increased to $769,000 for the three months endedMarch 31, 2004 as compared to $672,000 for the comparable prior year period, anincrease of $97,000 or 14%.  Thisincrease was attributed to a $76,000 or 32% increase in semiconductors revenuein the period ended March 31, 2004, as compared with the comparable prior yearperiod, combined with a $37,000 or 8% increase in medical and industrialcoating revenues.  The increase insemiconductor revenue is primarily attributable to the revenue generated fromthe Company’s new MC3 mass analyzed ion implanters.  We believe that revenues from theseimplanters will continue to increase as our customer’s production needs growand we identify new customers requiring the larger wafer implants that thisequipment can accommodate.  We believefluctuations in sales in our semiconductor business from quarter-to-quarter arenormal occurrences; however, we believe that growth will continue to beachieved.

Revenueof the I-PlantTM prostate seed for the three months ended March 31,2004 was approximately $853,000 as compared to $623,000 for the comparableprior year period, an increase of $230,000 or 37%.  The increase is a result of increased seedvolume combined with a 32% increase in average seed price.  This increase in average seed price is thedirect result of the value added items offered to our customers.  Additionally, we continue to build our directsales force as the Company transitions from a distributorship.  Two additional regional sales representativeswere hired in the quarter ended March 31, 2004. These new hires may facilitate an increase in the volume of seeds soldin future periods.

 

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Inthe fourth quarter of fiscal 2003, management hired a new director of nationalsales in order to open new channels of distribution for sales of our prostateseeds and to assist our current distributors in growing the volume of seedssold.  In the first quarter of fiscal2004, we entered into a new agreement with MED-TEC, our former exclusivedistributor of I-Plant prostate seeds to replace the original DistributorAgreement, which had expired.  This newagreement outlines an orderly transition of the direct sales responsibilitiesfor the I-Plant prostate seed to the Company. Management believes this direct marketing and sales program will put thesales process in the complete control of the Company and will enable theCompany to expand distribution channels targeting the radiation oncologymarket.  As a result, MED-TEC will workcooperatively with the Company to transition its customers and marketingmaterials directly to Implant Sciences and MED-TEC also agreed not to competewith the Company for a period of three years. Implant Sciences is paying MED-TEC an average of approximately $39,000 permonth over a period of 29 months, beginning September 1, 2003.  As of March 31, 2004, the outstandingprincipal balance is approximately $698,000.

Combinedsales to our two major customers, the U.S. Government and Howmedica/OsteonicsDivision of Stryker Corporation, accounted for 50% and 47% of revenue for thethree months ended March 31, 2004 and 2003, respectively. Government contractand grant revenue as a percentage of total revenues increased as a result ofour receiving several new grants and contracts, primarily related to our Laser IMStechnology

*Cost of Sales*.  Costof sales for the three months ended March 31, 2004 was $1,868,000 as comparedto $1,458,000 for the comparable prior year period, an increase of $410,000 or28%.  Cost of government contracts forthe three month period ended March 31, 2004 was $701,000 as compared to$459,000 for the comparable prior year period, an increase of $242,000 or53%.  Contract manufacturing costs forthe three months ended March 31, 2004, were $1,167,000 as compared with$999,000 for the comparable prior year period, an increase of $168,000 or17%.  This increase is attributed to thecosts associated with an increase in staff size combined with an increase indepreciation expenses relating to the installation of the new MC3 ionimplanters.  As a percentage of productrevenues, the cost of contract manufacturing decreased to 71% for the threemonths ended March 31, 2004 as compared to 77% for the comparable prior yearperiod.  During the fiscal quarters endedMarch 31, 2004 and 2003, we utilized Small Business Innovative Research grantsas a source of funding for our research and development efforts.  Our obligation with respect to these grantsis to perform the research on a best-efforts basis.

*Research and Development*.  Research and development expenses for thethree months ended March 31, 2004 were $418,000 as compared to $389,000 for thecomparable prior year period, an increase of $29,000 or 7%. This increase is aresult of the increase government contracts subsidizing our research anddevelopment work in the areas of explosives and toxic substance detection.  Research and development expenses included$103,000 and $1,000 of noncash stock-based compensation recorded in connectionwith the issuance of stock and stock options to employees and warrants tooutside agents and $21,000 and $28,000 in depreciation and amortizationexpenses for the three month period ended March 31, 2004 and 2003 respectively.

*Selling, General and Administrative*.  Selling, general and administrative expensesfor the three months ended March 31, 2004 were $1,156,000 as compared to$608,000 for the comparable prior year period, an increase of $548,000 or90%.  Selling, general and administrativeexpenses included $275,000 and $97,000 of noncash stock-based compensationrecorded in connection with the issuance of stock options to employees andwarrants to an outside agent in the three months ended March 31, 2004 and2003.  In the three month period endedMarch 31, 2004, depreciation and amortization expenses relating to the MED-TECnon-compete agreement were $107,000, and depreciation expenses totaled $40,000in the respective prior year period.  Netof the noncash stock-based compensation, and depreciation and amortization,selling, general and administrative expenses increased by $303,000 or 64%.  This increase reflects our addition of salespersonnel needed to support our continued growth and increased travel and tradeshow costs relating to the marketing our products.  However, management continues to exercisestrict cost containment measures to ensure control over our administrativespending.

*Other Income and Expenses, Net.*  For the three month period ended March 31,2004, we recorded other expense, net of $32,000 as compared to other income,net of $3,000 in the comparable prior year period.  The increase in other expenses is a result ofincreased interest expense relating to the financing of the new ion implanterswith Axcelis Corporation and the Med-Tec non-compete payments in the periodended March 31, 2004.

*NetLoss.*  Net loss for thethree months ended March 31, 2004 was $839,000 as compared to $759,000 for thecomparable prior year period, an increase in net loss of $80,000  or 10%. Net loss for three months ended March 31, 2004 includes an approximatecharge of $378,000 related to stock based compensation as compared to $98,000in the comparable prior year period and $350,000 and $188,000 of depreciationand amortization expenses in the period ended March 31, 2004 and 2003,respectively.  Accordingly, the net lossfor the period ended March 31, 2004 before giving effect to the charge forstock-based compensation and depreciation and amortization expense is

 

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$108,000 as compared to$473,000 for the comparable prior year period, a decrease in net loss of$365,000 or 77%.

 

Additionally,during the period ended March 31, 2004, accretion of dividends, the beneficialconversion feature and amortization of warrants in the amount of $959,000 and$268,000 relating to the Series B and C, respectively, was recognized as apreferred distribution, as compared with $266,000 for the prior yearperiod.  The effect of these transactionshad no overall effect on stockholders’ equity or cash, but increased net lossper share applicable to common shareholders by $0.16 per share.  The basic and diluted net loss per shareapplicable to common shares for the period ended March 31, 2004 was ($0.27) pershare as compared to ($0.16) per share for the comparable prior year period, anincrease in net loss applicable to common shares per share of $0.11 or 69%.

*Comparison for the nine months ended March  31, 2004 and2003*

*                Revenues. *Total revenues for the ninemonths ended March 31, 2004 were $6,160,000 as compared to $4,994,000 for thecomparable prior year period, an increase of $1,166,000 or 23%.  The increase is primarily attributable torevenue recognized from new government contracts to develop new applicationsand products using our Laser IMS technology. Our Laser IMS technology is the platform technology used in ourexplosives detection devices.  Governmentcontracts revenues increased to $1,874,000 for the nine months ended March 31,2004, as compared with $964,000 for the comparable prior year period, anincrease of $910,000 or 94%.

                In the nine months ended March31, 2004, we recognized $138,000 relating to the issuance of an exclusiveoption to license our technology to InVisionTechnologies, Inc.  This agreement is tojointly evaluate the capabilities of the Company’s non-contact trace explosivesdetection technology for future incorporation in an automated explosivesdetection system for airport checkpoint screening of passengers and/or carry-onbags.  The agreement gives InVision anexclusive option during the limited evaluation period, to enter into adefinitive agreement for exclusive distribution rights to the Company’stechnology for aviation security.  Theexclusivity agreement was extended through March 31, 2004.  The Company is currently evaluating itsrelationship with InVision.

Salesof the I-PlantTM prostate seeds for the nine month period endedMarch 31, 2004 were $2,145,000 as compared to $1,993,000 for the comparableprior year period, an increase of $152,000 or 8%.  Seed volume decreased by 10% in the periodended March 31, 2004 as compared with the comparable prior year period.  This decrease was offset by a 20% increase inaverage seed price.  This increase inaverage seed price is the direct result of the value added items offered to ourcustomers.

                These increases in revenues wereoffset by a decrease in revenues from contract manufacturing.  Revenues for the nine months ended March 31,2004 were $2,003,000 as compared to $2,037,000 in the comparable prior yearperiod, a decrease of $34,000 or 2%. This decrease was attributed to a $171,000 or 12% decrease in medicaland industrial coatings, offset by a $131,000 increase in semiconductorsrevenue in the period ended March 31, 2004, as compared with the comparableprior year period, an increase of 20%. The increase in semiconductor revenue isprimarily attributable to the revenue generated from the Company’s new MC3 massanalyzed ion implanters.  We believe thatrevenue from these implanters will continue to increase as our customer’s productionneeds grow and we identify new customers requiring the larger wafer implantsthat this equipment can accommodate.  Webelieve fluctuations in sales in our semiconductor business from period toperiod are normal occurrences, however, we believe that growth will continue tobe achieved

                 Combined sales to our two major customers, theU.S. Government and Howmedica/Osteonics Division of Stryker Corporation,accounted for 49% and 52% of revenue for the nine months ended March 31, 2004and 2003, respectively. Government contract and grant revenue as a percentageof total revenues increased as a result of our receiving several new grants andcontracts, primarily related to our Laser IMS technology

*Cost ofSales*.  Cost of salesfor the nine months ended March 31, 2004 were $4,547,000 as compared to$3,984,000 for the comparable prior year period, an increase of $563,000 or14%.  The increases are, in general,attributable to the costs associated with an increase in staff and materialsneeded to support the increase in sales, combined with $90,000 and $0 ofstock-based compensation and depreciation expense of $657,000 and $426,000 inthe nine months ended March 31, 2004 and 2003, respectively.  Management is continually evaluating andimplementing strategies to improve the cost of materials to produce prostateseeds, developing new products related to the delivery of seeds in prostateprocedures, and assessing additional channels of distribution that couldincrease seed sales volume.  Duringfiscal 2004 and 2003, we utilized SBIR grants as a significant source offunding for our research and development efforts.  We will continue to use SBIR grants as asource of funding for our research and development efforts in fiscal 2004.  Our obligation with respect to these grantsis to perform the research on a best-efforts basis.  Periodically, we may continue our researchand development efforts related to these projects at its own

 

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expense.  This cost is considered company-fundedresearch and development.

 

*Research and Development*.  Research and development expense for the ninemonths ended March 31, 2004 was $1,299,000 as compared to $1,257,000 for thecomparable prior year period, an increase of $42,000 or 3%.  The award of new government contractssubsidized certain of our research and development expenses for the periodended March 31, 2004.  Research anddevelopment expenses included $275,000 and $17,000 of noncash stock-basedcompensation recorded in connection with the issuance of stock and stock optionsto employees and warrants to outside consultants and $61,000 and $83,000 indepreciation and amortization expenses for the nine month period ended March31, 2004 and 2003 respectively.  TheCompany continues to work in the areas of explosives and toxic substancedetection, temporary brachytherapy and radioactive prostate seed productcompliments.  We anticipate increases infuture expenditures resulting from these and new product development plans.  We will continue to use SBIR grants as asource of funding for our research and development efforts in fiscal 2004.

*Selling, General and Administrative*.  Selling, general and administrative expensesfor the nine months ended March 31, 2004 were $2,905,000 as compared to$1,762,000 for the comparable prior year period, an increase of $1,143,000 or65%.  The increase is primarilyattributable to a $533,000 and $136,000 charge for noncash stock-basedcompensation and $332,000 and $89,000 of depreciation and amortization expensein the nine month period ended March 31, 2004 and 2003 respectively.  Net of the noncash stock based compensationand amortization expenses, selling, general and administrative expensesincreased by $500,000 or 32%.  Thisincrease reflects our addition of certain administrative personnel necessary tosupport our continued growth.  However,management continues to exercise strict cost containment measures to ensurecontrol over our administrative spending.

*Other Income and Expense, Net.*  For the nine month period ended March 31,2004, we recorded other expense, net, of $109,000, as compared to other incomeof $7,000 for the comparable prior year period, an increase in other expensesnet of $116,000.  The increase in otherexpense, net, is attributable to the interest expense relating to the financingof the mass analyzed ion implanters with Axcelis Corporation and Med-Tecnon-compete agreement.

*Net Loss.*  Net loss for the nine month period endedMarch 31, 2004 was $2,700,000 as compared to $2,002,000 for the comparableprior year period, an increase of $698,000 or 35%.  This increase in net loss is primarily aresult of the costs associated with noncash stock-based compensation anddepreciation and amortization expenses. Accordingly, before giving effect to the charge for stock-basedcompensation of $899,000 and $153,000 and depreciation and amortization expenseof $914,000 and $598,000 for the nine month period ended March 31, 2004 and2003, respectively,  the net loss for thenine month period ended March 31, 2004 and 2003 is $885,000 as compared to$1,253,000, a decrease in net loss of $368,000 of 29%.

Additionally, during thenine months ended March 31, 2004, accretion of dividends, the beneficialconversion feature and amortization of warrants in the amounts of $565,000,$1,287,000 and $349,000 for the Series A, B, and C, respectively, wererecognized as a preferred distribution in the nine month period ended March 31,2004, as compared with $467,000 in the comparable prior year period relating tothe Series A only.  The effect of thesetransactions had no overall effect on stockholders’ equity or cash, butincreased net loss per share applicable to common shareholders by $0.29 and$.08 per share for the nine month period ended March 31, 2004 and 2003respectively.  The basic and diluted netloss per share applicable to common shares for the period ended March 31, 2004was ($0.69) per share as compared to ($0.40) per share for the comparable prioryear period, an increase in net loss applicable to common shares per share of$0.29 or 73%.

** **

**Liquidity and Capital Resources**

 

As of March 31, 2004, wehad approximately $2,828,000 in cash in the form of cash and cash equivalents.During the nine months ended March 31, 2004, operating activities used cash ofapproximately $1,786,000.  Net cash usedby operating activities primarily reflects the net loss of $2,700,000, a$711,000 increase in accounts receivable, a $109,000 increase in prepaidexpenses and other current assets, a $147,000 decrease in accounts payable, anda $38,000 decrease in accrued expenses. These were offset by depreciation and amortization of $914,000,stock-based compensation expense of $898,000 and a $19,000 decrease ininventories.  The additional governmentcontracts increased both the accounts payable and accounts receivable balancesin the nine month period ended March 31, 2004 as well as the prepaid commissionpaid to Christopher Lang at Bay Area MRI (Note 12).  These items increased the Company’s net cashused in operating activities as compared with the same prior year period.

Duringthe nine months ended March 31, 2004, investing activities used cash ofapproximately $290,000,

 

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primarilyattributable to the purchases of property and equipment, seed demonstrationequipment, the purchase of 40,000 shares of CardioTech stock (Note 9).  These shares are unregistered and subject tothe Securities Act of 1933.

Duringthe nine months ended March 31, 2004, financing activities providedapproximately $3,945,000 in cash.  Netcash provided by financing activities primarily includes net proceeds from theSeries B and Series C preferred stock and the exercise of stock options offsetby payments on our capital leases, non-compete agreement and equipmentfinancing.

On August 28, 2003, we issued 200,000 shares ofSeries B 5% Cumulative Convertible Preferred Stock (“Series B”) having a statedvalue of $10 per share, pursuant to a Securities Purchase Agreement executed onAugust 28, 2003 with the Laurus Master Fund, Ltd.  We received $2,000,000 in gross proceeds,less a management and placement agent fee of approximately $108,000, andrelated transaction costs of approximately $70,000.  The terms of the Series B provide forrepayment with shares of our common stock or in cash, pursuant to an amortizationschedule.  Repayment of the Series Bcommenced on December 1, 2003.  We havethe sole option to determine whether to satisfy payment of the monthly amountin full on each repayment date either in cash or in shares of common stock, ora combination of both.  However, if theclosing price for any of the 11 trading days preceding a repayment date is lessthan $6.00, we would be required to pay such monthly amount in cash at 105% ofthe monthly obligation.  If the paymentof the monthly amount is made in common stock, the fixed conversion price is$5.50.  We also issued to Laurus awarrant to purchase 25,000 shares of common stock at $6.88 per share and 45,000shares of common stock at $8.25 per share. The Securities Purchase Agreement also provides for a security interestin substantially all of our assets and provides Laurus a right of first refusalon future financing arrangements during the Term of the agreement.  In the event Laurus declines to exercise itsright of first refusal, it hereby agrees to enter into such documentation asshall be reasonable requested by us in order to subordinate its rights underthe Series B to the subsequent financier. We will utilize the proceeds of this financing to commercialize itsexplosives detection system and for general working capital purposes.

                In accordance with theprovisions of Emerging Issues Task Force (EITF) Issue 00-27, “Application ofEITF Issue No. 98-5 ‘Accounting for Convertible Securities with BeneficialConversion Features of Contingently Adjustable Conversion Ratios’, to CertainConvertible Securities”, which became effective in November 2000, the allocatedvalue of the Series B contained a beneficial conversion feature calculatedbased on the difference between the effective conversion price of the proceedsallocated to the Series B and the fair market value of the common stock at thedate of issuance.  The discount arisingfrom the beneficial conversion feature aggregated $826,000.  The discount is being amortized and recordedas a preferred dividend during the period from the issuance of the preferredstock to the mandatory redemption date of March 1, 2005 or the actualconversion date, whichever is earlier.

We valued the Series B at issuance to be $812,000 based on the relativefair market values of the financial instruments issued in connection with thisplacement, net of offering costs and the beneficial conversion feature.  The amounts recorded in the financialstatements represent the amounts attributed to the sale of the preferred stock,net cash proceeds of $1,822,000 ($178,000 of issuance costs incurred), amountallocated to warrants of $184,000, and the amount of the discount related tothe value of beneficial conversion feature of $826,000.  We are accreting these discounts on the carryingvalue of the preferred stock to its redemption value of $2,000,000 at March 1,2005 or the actual conversion date, whichever is earlier.  The accretion of these amounts is beingrecorded as a preferred dividend in the period of accretion.  During the period ended March 31, 2004,approximately $897,000 was amortized.  Asof March 31, 2004, all amounts were fully amortized.

During the three months ended March 31, 2004, Laurus converted 145,000shares of Series B into 263,636 shares of our common stock, at a conversionprice of $5.50 per share.  As of March31, 2004, the principal balance of the Series B was paid in full.  For the three months ended March 31, 2004, weaccrued approximately $9,000 in dividends. The conversion of accrued interest into common stock resulted inadditional dividends of $53,000 during the three and nine months ended March31, 2004, in excess of the 5% stated value. As of March 31, 2004, all Series B shares had been converted into363,636 shares of common stock.

        On November 25, 2003, we issued 250,000shares of Series C 5% Cumulative Convertible Preferred Stock (“Series C”)having a stated value of $10 per share, pursuant to a Securities PurchaseAgreement executed on November 25, 2003 with the Laurus Master Fund, Ltd.  We received $2,500,000 in gross proceeds,less a management and placement agent fee of approximately $125,000, andrelated transaction costs of approximately $86,000.  The terms of the Series C provide forrepayment with shares of our common stock or in cash, pursuant to anamortization schedule.  Repayment of theSeries C commences on March 31, 2004.  Wehave the sole option to determine whether to satisfy payment of the monthlyamount in full on each repayment date either in cash or in shares of commonstock, or a combination of both.  If thepayment of the monthly amount is made in common stock,

 

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the fixed conversion price is $6.75.  We also issued to Laurus a warrant topurchase 50,000 shares of common stock at $8.44 per share and 50,000 shares ofcommon stock at $10.13 per share.  TheSecurities Purchase Agreement also provides for a security interest insubstantially all of our assets and provides Laurus a right of first refusal onfuture financing arrangements during the Term of the agreement.  In the event Laurus declines to exercise itsright of first refusal, it hereby agrees to enter into such documentation asshall be reasonable requested by us in order to subordinate its rights underthe Series C to the subsequent financier. We will utilize the proceeds of this financing to purchase an ionimplanter and for general working capital purposes.

 

Inaccordance with the provisions of Emerging Issues Task Force (EITF) Issue00-27, “Application of EITF Issue No. 98-5 ‘Accounting for ConvertibleSecurities with Beneficial Conversion Features of Contingently AdjustableConversion Ratios’, to Certain Convertible Securities”, which became effectivein November 2000, the allocated value of the Series C contained a beneficialconversion feature calculated based on the difference between the effectiveconversion price of the proceeds allocated to the Series C and the fair marketvalue of the common stock at the date of issuance.  The discount arising from the beneficial conversionfeature aggregated $700,000.  Thediscount is being amortized and recorded as a preferred dividend during theperiod from the issuance of the preferred stock to the mandatory redemptiondate of June 1, 2005, or the actual conversion date, whichever is earlier,using the effective interest method.

We valued the Series C at issuance to be $1,284,000 based on therelative fair market values of the financial instruments issued in connectionwith this placement, net of offering costs and the beneficial conversionfeature.  The amounts recorded in thefinancial statements represent the amounts attributed to the sale of thepreferred stock, net cash proceeds of $2,289,000 ($211,000 of issuance costsincurred), the amount allocated to warrants of $305,000, and the amount of thediscount related to the value of beneficial conversion feature of$700,000.  We are accreting thesediscounts on the carrying value of the preferred stock to its redemption valueof $2,500,000 at June 1, 2005, or the actual conversion date, whichever isearlier.  The accretion of these amountsis being recorded as a preferred dividend in the period of accretion.

During the period ended March 31, 2004, approximately $237,000 wasamortized.  As of March 31, 2004, theoutstanding principal of the Series C was $2,500,000.  For the three months ended March 31, 2004, weaccrued approximately $31,000 of dividends.

Weare developing several explosive detection systems that could be used inairports, public and government buildings, and sporting event facilities.  The systems use our proprietary Laser IMStechnology, which includes the use of laser beams in combination with ionmobility spectrometry, to electronically detect minute quantities of explosivevapor molecules in the air.  This projecthas been ongoing since approximately May 1999.

Thisresearch is currently being undertaken by both our internal scientists andcertain outside contractors.  Thedevelopment of new applications is typically funded through government grantsor internal funding.  Originally, wefunded a research and development program for the electronic detection systemto produce enough data to write grant proposals for the Department of Defenseto detect unexploded bombs and mines. Since March 2000, we have received eleven contracts totalingapproximately $5,700,000 for detection of toxic chemicals or explosives fromagencies such as the Departments of the Army, Air Force, Marine Corps and Navy;as well as the National Institutes of Health.

InJune 2000, we developed our first generation device, which demonstratedsensitivity to the explosive TNT.  InJune 2001, we developed a second generation prototype with increasedsensitivity and selectivity.  This devicecan detect and specify an increasing number of compounds within variousexplosive materials.  The explosives thathave been tested to date are TNT, RDX, PETN, EGDN, and DNT.  RDX is the primary component of C3 and C4explosives, such as Datasheet and Semtex, as well as certain types of blackpowder explosives.  We believe theseexplosives represent the majority of the explosives presently used in terroristactivities.  After the attack on theWorld Trade Center occurred on September 11, 2001, management made the decisionto continue the internal funding of the project rather than await fundingthrough government grants.  Ourelectronic detection system has been subjected to controlled testing by thirdparties and successfully detected C4.  Asa result of the successful demonstration, we believed it was appropriate to furtherpursue the commercial development of our electronic detection system device

InNovember 2001, we developed a portable prototype and in December 2001, wedemonstrated it to the U.S. Department of Transportation.  Following this demonstration, we decided topursue the technology.  At present, weare developing both portable and bench-top systems for use in airports andDepartment of Defense facilities. Prototype units have been transported to the Department of Defense andDepartment of Homeland Security (DHS) for demonstration and evaluation.  On August 12, 2002, we signed a CooperativeResearch and Development

 

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Agreement(CRDA) with an agency of the Department of Transportation (now Homeland Security)which will permit us and the government to exchange critical test data and forus to deliver a certain number of units to the Transportation SecurityAdministration  (TSA) for independentevaluation and field testing.  The TSAtested the breadboard system at their technical center in Atlantic City and asa result of these tests funded the CRDA with $1,000,000 to develop a bench-topexplosives detection system.  As of March31, 2004, $1,000,000 has been released to the Company

Weare developing several versions of our explosives detection systems, including:(i) a table-top unit, which can be used to screen passengers and carry-onbaggage in airports; and (ii) a portable system, which can be used to replacebomb-sniffing dogs to clear buildings, aircrafts, or ships where hidden bombsare believed to exist.  We received$600,000 from the U.S. Navy in November 2002 for further development of theportable device.  This device was deliveredto the U.S. Navy for testing in May 2003. The U.S. Navy tested the unit in simulated outdoor conditions and theirengineers were satisfied with the results of the tests.  There can be no guarantee however, that thefinal production model will pass the government tests or that the governmentwill purchase any equipment from the Company. In December 2003, we received a $1,700,000 contract to deliver threeproduction ready handheld units.  InApril 2004, this contract was increased by $215,000 to include additionaltasks.  We plan to first market thesesystems to U.S. government agencies for use in airports, government buildingsand facilities.

Consistentwith our policy to protect our proprietary technologies, we have submittedtwenty one patent applications to the United States Patent and TrademarkOffice.  Twelve of these patentapplications will cover specific design configurations that are responsible forour improved vapor detection sensitivity relating to our explosives detectionsystems.

Althoughour operations and spending continue to focus on the sales of our semiconductor,medical coatings and prostate seed products, we are currently expendingsignificant resources in the development of our explosives detectiondevices.  We continue to fund as muchresearch and development as possible through government grants in accordancewith the provisions of the respective grant awards.  We will require additional funding in orderto advance the commercial development of the explosives detection system.  We will attempt to obtain such financing by:(i) government grants, (ii) the exercise of the redeemable common stockpurchase warrants, (iii) private financing, or (iv) strategicpartnerships.  However, there can be noassurance that we will be successful in our attempts to raise such additionalfinancing.

Wewill require substantial funds for further research and development, futurepre-clinical and clinical trials, regulatory approvals, continued expansion ofcommercial-scale manufacturing capabilities, and the marketing of ourproducts.  Our capital requirementsdepend on numerous factors, including but not limited to, the progress of ourresearch and development programs; the progress of pre-clinical and clinicaltesting; the time and costs involved in obtaining regulatory approvals; thecost of filing, prosecuting, defending and enforcing any intellectual propertyrights; competing technological and market developments; changes in ourdevelopment of commercialization activities and arrangements; and the purchaseof additional facilities and capital equipment.

Asof March 31, 2004, we were conducting our operations with approximately$2,828,000 in cash and cash equivalents. We estimate such amounts combined with our cash flow from operationswill be sufficient to fund our working capital in the next twelve months.  Future expenditures for research and productdevelopment, especially relating to outside testing and clinical trials, arediscretionary and, accordingly, can be adjusted, as can certain selling,general and administrative expenses, based on the availability of cash.

TheCompany’s future minimum payments under contractual obligations related tocapital leases, operating leases and term notes as of March 31, 2004, are asfollows:

 

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| ** **           | ** ** | **Capital Lease** | ** ** | **Operating Leases** | ** ** | **Axcelis Technologies, Inc.** | ** ** | **MED-TEC** | ** ** | **Total** | ** ** |
|----------------------|------------|-------------------|------------|----------------------|------------|--------------------------------|------------|-------------|------------|-----------|------------|
| Year ending June 30: |       |              |       |                 |       |                           |       |        |       |      |       |
| 2004                 |       | $                 | 4,000      |                 | $          | 114,000                        |       | $           | 384,000    |      | $          | 92,000 |   | $ | 594,000 |   |
| 2005                 |       | 5,000             |       | 531,000              |       |                           |       | 394,000     |       | 930,000   |       |
| 2006                 |       | 2,000             |       | 568,000              |       |                           |       | 212,000     |       | 782,000   |       |
| 2007                 |       | —            |       | 569,000              |       |                           |       |        |       | 569,000   |       |
| 2008                 |       | —            |       | 570,000              |       |                           |       |        |       | 570,000   |       |
| Thereafter           |       | —            |       | 285,000              |       |                           |       |        |       | 285,000   |       |
| Total                |       | $                 | 11,000     |                 | $          | 2,637,000                      |       | $           | 384,000    |      | $          | 698,000 |   | $ | 3,730,000 |   |
|                      |            |                   |            |                      |            |                                |            |             |            |           |            |  |  |  |  |  |  |  |

 

*Critical Accounting Policies*

Oursignificant accounting policies are described in Note 1 to the financialstatements included in Item 7 of our Form 10-KSB/A No. 1 as of June 30,2003.  Our discussion and analysis of ourfinancial condition and results of operations are based upon the financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets, liabilities,revenues and expenses, and related disclosure of contingent assets andliabilities.  On an on-going basis, weevaluate our estimates, including those related to bad debts, product returns,inventories, investments, intangible assets and warranty obligations.  We base our estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources.  Inthe past, actual results have not been materially different from ourestimates.  However, results may differfrom these estimates under different assumptions or conditions.  There has been no change to our criticalaccounting policies during the quarter ending March 31, 2004.

 

**Item3.    Controls and Procedures**

Basedon  an evaluation of our disclosurecontrols and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under theSecurities Exchange Act of 1934), the chief executive officer and chieffinancial officer have concluded that our disclosure controls and procedures asof the end of the three and nine months ended March 31, 2004, are designed toensure that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms and areoperating in an effective manner.

Subsequent to March 31, 2004, and in connectionwith our year-end audit, it was discovered that there was an error in thecalculation of the fair value of certain warrants issued to non-employees andwarrants issued in connection with the Series B and Series C preferred stockissuances, which were used to determine charges to our statement of operationsduring the three and nine months ended March 31, 2004.  Our chief executive officer and chieffinancial officer concluded that the weakness that lead to these errors did notconstitute a material weakness in internal control.  These amounts were corrected as of August 31,2004 and the financial statements for the third quarter of fiscal 2004 wererestated accordingly.  Managementconcluded that our disclosure controls and procedures were effective becausethe errors were inadvertent and isolated. In addition, our reporting and disclosure procedures were modified tocorrect this situation and those people who made the inadvertent errors wereappropriately educated and additional review procedures were implemented.

 

 

PARTII:  OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

                Not Applicable

 

Item 2.  Changes in Securities and Use of Proceeds

 

        On August 28, 2003, the Companyissued 200,000 shares of Series B 5% Cumulative Convertible Preferred Stock(“Series B”) having a stated value of $10 per share, pursuant to a SecuritiesPurchase Agreement executed on August 28, 2003 with the Laurus Master Fund,Ltd.  The Company received $2,000,000 ingross proceeds, less a management and placement agent fee of approximately$108,000, and related transaction costs of

 

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approximately $70,000.  The terms of the Series B provide forrepayment with shares of the Company’s common stock or in cash, pursuant to anamortization schedule.  Repayment of theSeries B commenced on December 1, 2003. The Company has the sole option to determine whether to satisfy paymentof the monthly amount in full on each repayment date either in cash or inshares of common stock, or a combination of both.  However, if the closing price for any of the11 trading days preceding a repayment date is less than $6.00, the Companywould be required to pay such monthly amount in cash at 105% of the monthlyobligation.  If the payment of themonthly amount is made in common stock, the fixed conversion price is$5.50.  The Company also issued to Laurusa warrant to purchase 25,000 shares of common stock at $6.88 per share and45,000 shares of common stock at $8.25 per share.  The Securities Purchase Agreement alsoprovides for a security interest in substantially all of the Company’s assetsand provides Laurus a right of first refusal on future financing arrangementsduring the Term.  In the event Laurusdeclines to exercise its right of first refusal, it hereby agrees to enter intosuch documentation as shall be reasonable requested by the Company in order tosubordinate its rights under the Series B to the subsequent financier.  The Company will utilize the proceeds of thisfinancing to commercialize its explosives detection system and for generalworking capital purposes.

 

Duringthe three months ended March 31, 2004, Laurus converted 145,000 shares ofSeries B into 263,636 shares of the Company’s common stock, at a conversionprice of $5.50 per share.  As of March31, 2004, the principal balance of the Series B was paid in full.  For the three months ended March 31, 2004,the Company accrued approximately $9,000 of dividends.  The conversion of accrued interest into commonstock resulted in additional dividends of $53,000 during the three and ninemonths ended March 31, 2004, in excess of the 5% stated value.  As of March 31, 2004, all Series B shares hadbeen converted into 363,636 shares of common stock.

On November 25, 2003, the Company issued 250,000shares of Series C 5% Cumulative Convertible Preferred Stock (“Series C”)having a stated value of $10 per share, pursuant to a Securities PurchaseAgreement executed on November 25, 2003 with the Laurus Master Fund, Ltd.  The Company received $2,500,000 in grossproceeds, less a management and placement agent fee of approximately $125,000,and related transaction costs of approximately $86,000.  The terms of the Series C provide forrepayment with shares of the Company’s common stock or in cash, pursuant to anamortization schedule.  Repayment of theSeries C commences on March 31, 2004. The Company has the sole option to determine whether to satisfy paymentof the monthly amount in full on each repayment date either in cash or inshares of common stock, or a combination of both.  If the payment of the monthly amount is madein common stock, the fixed conversion price is $6.75.  The Company also issued to Laurus a warrantto purchase 50,000 shares of common stock at $8.44 per share and 50,000 sharesof common stock at $10.13 per share.  TheSecurities Purchase Agreement also provides for a security interest insubstantially all of the Company’s assets and provides Laurus a right of firstrefusal on future financing arrangements during the Term of the agreement.  In the event Laurus declines to exercise itsright of first refusal, it hereby agrees to enter into such documentation asshall be reasonable requested by the Company in order to subordinate its rightsunder the Series C to the subsequent financier. The Company will utilize the proceeds of this financing to purchase anion implanter and for general working capital purposes.

 

Duringthe period ended March 31, 2004, approximately $237,000 was amortized.  As of March 31, 2004, the outstandingprincipal of the Series C was $2,500,000. For the three months ended March 31, 2004, the Company accruedapproximately $31,000 of dividends.

Item 3.  Defaults Upon Senior Securities

 

                Not Applicable

 

Item 4.  Submission of Matters of a Vote toSecurity-Holders

 

                Not Applicable

 

Item 5.  Other Information

 

                Not Applicable

 

Item 6.  List ofExhibits and Reports on Form 8-K

 

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(a)          The following exhibits, required by Item 601 ofRegulation S-B, are filed as part of this Quarterly Report on Form 10-QSB.  Exhibit numbers, where applicable, in theleft hand column correspond to those of Item 601 of Regulation S-B.

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                               |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.78          |       | Exchange  and Venture agreement between Implant Sciences Corporation, CardioTech  International, and CorNova, Inc. dated March 5, 2004.                       |
| 31.1            |       | Certification of the Chief  Executive Officer Under Rule 13a-14(a) of the Securities Exchange Act  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2            |       | Certification of the Chief  Financial Officer Under Rule 13a-14(a) of the Securities Exchange Act  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)           Current Report on Form 8K dated March 5,2004 regarding the Exchange and Venture agreement entered into with CorNova, Inc.CardioTech International, Inc. and Implant Sciences Corporation.

(c)            Current Report on Form 8K dated August31, 2004, regarding the restatement of the 10-QSB for the period ended March31, 2004.

 

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SIGNATURES

 

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

 
|                     | Implant  Sciences Corporation |
|--------------------------|-------------------------------|
|                     |                          |
| Date:  September 1, 2004 | /s/  Anthony J. Armini        |
|                     | Anthony  J. Armini            |
|                     | President  and CEO            |
|                     |                          |
|                     |                          |
| Date:  September 1, 2004 | /s/  Diane J. Ryan            |
|                     | Diane  J. Ryan                |
|                     | Chief  Financial Officer      |

 

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