**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





[X]
            Quarterly
                report pursuant to section 13 or 15(d) of the Securities Exchange
                Act of
                1934. For the quarterly period ending September 30,
                2007.[
                ]
            Transition
                report pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934. For the transition period from _____to_____.Commission
                file number 000-25839





**IMPLANT
      SCIENCES CORPORATION**


(Exact
      name of registrant as specified in its charter)





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




**781-246-0700**


(Registrant’s
      Telephone Number, Including Area Code)





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





**Title
      of Each Class**     **Name
      of Each Exchange on Which Registered**


Common
      Stock, $.10 par value  A merican
      Stock Exchange








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




YES  X  NO
      ___





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




Large
      Accelerated Filer ____  Accelerated
      Filer ____   Non-Accelerated
      Filer X





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




YES
      ___
      NO X




The
      aggregate market value of the voting stock held by non-affiliates of the
      registrant was approximately $17,417,000 as of November 9, 2007 (based on the
      closing price for such stock as of November 9, 2007).





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





Class
            Outstanding
                at November 9, 2007Common
                Stock, $.10 par value
            11,854,638











1





**IMPLANT
      SCIENCES CORPORATION**





**INDEX**





Page
                No.PART
                I. FINANCIAL INFORMATIONItem
                1.
            Financial
                Statements (unaudited):Condensed
                Consolidated Balance Sheets as of September 30, 2007 andJune
                30, 2007
            3Condensed
                Consolidated Statements of Operations for the Three Months Ended
                September
                30, 2007 and 2006
            4Condensed
                Consolidated Statements of Cash Flows for the Three Months Ended
                September
                30, 2007 and 2006
            5Notes
                to Condensed Consolidated Financial Statements
            6Item
                2.
            Management's
                Discussion and Analysis of Financial Conditionand
                Results of Operations
            16Item
                3.
            Quantitative
                and Qualitative Disclosure About Market Risk
            19Item
                4.
            Controls
                and Procedures
            19PART
                II. OTHER INFORMATIONItem
                1.
            Legal
                Proceedings
            21Item
                1A
            Risk
                Factors
            21Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            21Item
                3.
            Defaults
                Upon Senior Securities
            21Item
                4.
            Submission
                of Matters to a Vote of Security-Holders
            21Item
                5.
            Other
                Information
            21Item
                6.
            Exhibits
            22Signatures
            23





2





**IMPLANT
                SCIENCES CORPORATION****CONSOLIDATED
                BALANCE SHEETS****September
                30,**
            
            **June
                30,****ASSETS**
            **2007**
            
            **2007**Current
                assets:Cash
                and cash equivalents
            $
                7,143,000
            
            $
                9,621,000Accounts
                receivable, less allowance of $154,000 and $99,000,
                respectively
            2,385,000
            
            1,891,000Accounts
                receivable, unbilled
            90,000
            
            162,000Inventories
            1,123,000
            
            1,166,000Investments
                - available for sale securities
            165,000
            
            158,000Prepaid
                expenses and other current assets
            752,000
            
            755,000Total
                current assets
            11,658,000
            
            13,753,000Property
                and equipment, net
            2,783,000
            
            2,922,000Amortizable
                intangible assets, net
            68,000
            
            77,000Other
                non-current assets
            679,000
            
            786,000Goodwill
            2,062,000
            
            2,062,000Total
                assets
            $
                17,250,000
            
            $
                19,600,000**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                liabilities:Current
                maturities of long-term debt and obligations under capital
                lease
            $
                706,000
            
            $
                708,000Payable
                to Med-Tec
            103,000
            
            143,000Accrued
                expenses
            1,838,000
            
            2,098,000Accounts
                payable
            1,656,000
            
            1,133,000Current
                portion of long- term lease liability
            305,000
            
            301,000Deferred
                revenue
            260,000
            
            281,000Total
                current liabilities
            4,868,000
            
            4,664,000Long-term
                liabilities:Long-term
                debt and obligations under capital lease, net of current maturities
            203,000
            
            633,000Long-term
                lease liability
            660,000
            
            735,000Derivatives
                related to preferred stock features
            283,000
            
            133,000Total
                liabilities
            6,014,000
            
            6,165,000Commitments
                and contingencies (Note 7)Series
                D Cumulative Redeemable Convertible Preferred Stock; $10 stated
                value;500,000
                shares authorized, 378,900 and 393,939 shares
              outstanding as of September 30,2007
                and June 30, 2007, respectively [liquidation value $3,789,000 and
                $3,939,000 at September 30, 2007
              and
                June 30, 2007, respectively]
            3,057,000
            
            2,989,000Stockholders'
                equityCommon
                stock, $0.10 par value; 50,000,000 shares authorized at September
                30, 2007
                and June 30, 2007, respectively; 11,854,638 and
              11,835,661 sharesissued
                and outstanding atSeptember
                30, 2007 and June 30, 2007, respectively
            1,185,000
            
            1,183,000Additional
                paid-in capital
            57,585,000
            
            57,358,000Accumulated
                deficit
            (50,435,000)
            
            (47,927,000)Deferred
                compensation
            (25,000)
            
            (30,000)Accumulated
                other comprehensive loss
            (58,000)
            
            (65,000)Treasury
                stock, 10,545 common shares, respectively, at cost
            (73,000)
            
            (73,000)Total
                stockholders' equity
            8,179,000
            
            10,446,000Total
                liabilities and stockholders' equity
            $
                17,250,000
            
            $
                19,600,000














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







3




**IMPLANT
                  SCIENCES CORPORATION****CONDENSED
                  CONSOLIDATED STATEMENTS OF OPERATIONS**(unaudited)**Three
                  Months Ended September 30,****2007**
              
              **2006**Revenues:Security
              $
                  1,347,000
              
              $
                  481,000Semiconductor
              1,737,000
              
              1,623,000Medical
              134,000
              
              1,160,000Total
                  revenues
              3,218,000
              
              3,264,000Cost
                  of revenues:Cost
                  of security revenues
              821,000
              
              616,000Cost
                  of semiconductor revenues
              1,775,000
              
              1,599,000Cost
                  of medical product revenues
              312,000
              
              850,000Total
                  cost of revenues
              2,908,000
              
              3,065,000Gross
                  margin
              310,000
              
              199,000Operating
                  expenses:Research
                  and development
              690,000
              
              567,000Selling,
                  general and administrative
              1,739,000
              
              1,487,000Total
                  operating expenses
              2,429,000
              
              2,054,000Loss
                  from operations
              (2,119,000)
              
              (1,855,000)Other
                  income (expense):Interest
                  income
              101,000
              
              4,000Interest
                  expense
              (34,000)
              
              (25,000)Change
                  in fair value of embedded derivatives related to
                preferred
                  stock features
              (150,000)
              
              20,000Equity
                  losses in unconsolidated subsidiaries
              -
              
              (120,000)Total
                  other expense, net
              (83,000)
              
              (121,000)Loss
                  from continuing operations
              (2,202,000)
              
              (1,976,000)Preferred
                  distribution, dividends and accretion
              (307,000)
              
              (236,000)Loss
                  from continuing operations applicable to common
                  shareholders
              (2,509,000)
              
              (2,212,000)Income
                  from discontinued operations
              -
              
              366,000Net
                  loss applicable to common shareholders
              $
                  (2,509,000)
              
              $ 
                   (1,846,000)Net
                  loss
              $
                  (2,202,000)
              
              $
                  (1,610,000)Loss
                  per share from continuing operations, basic and diluted
              $
                   (0.19)
              
              $ 
                   (0.17)Loss
                  per share from continuing operations applicable to common shareholders,
                  basic and diluted
              $
                   (0.21)
              
              $
                   ( 0.19)Income
                  per share from discontinued operations
              $ 
                           -
              
              $    
                  0.03Net
                  loss per share applicable to common shareholders, basic and
                  diluted
              $ 
                  (0.21)
              
              $ 
                  (0.16)Net
                  loss per share
              $
                  (
                  0.19)
              
              $
                  (0.14)Weighted
                  average common shares outstanding usedin
                  computing basic and diluted loss per share
              11,837,768
              
              11,763,574The
                  accompanying notes are an integral part of these condensed consolidated
                  financial statements.














4





**IMPLANT
                SCIENCES CORPORATION****CONDENSED
                CONSOLIDATED STATEMENTS OF CASH FLOWS**
              **(unaudited)****Three
                Months Ended September 30,****Cash
                flows from operating activities:**
            **2007**
            
            **2006**Loss
                from continuing operations
            $(2,202,000)
            
            $(1,976,000)Income
                from discontinued operations
            -
            
            366,000Net
                loss
            (2,202,000)
            
            (1,610,000)Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            325,000
            
            370,000Amortization
                of intangible assets
            9,000
            
            42,000Share-based
                compensation expense
            208,000
            
            147,000Equity
                loss in unconsolidated subsidiaries
            -
            
            120,000Change
                in fair value of embedded derivatives
            150,000
            
            (20,000)Reserve
                for bad debts
            55,000
            
            -Warrant
                accretion on Bridge Bank loan
            3,000
            
            -Changes
                in operating assets and liabilities:Accounts
                receivable
            (477,000)
            
            194,000Inventories
            43,000
            
            (164,000)Prepaid
                expenses and other assets
            28,000
            
            146,000Accounts
                payable
            523,000
            
            (313,000)Accrued
                expenses
            (260,000)
            
            34,000Deferred
                revenue
            (21,000)
            
            (15,000)Lease
                liability
            (71,000)
            
            27,000Net
                cash used in continuing operations
            (1,687,000)
            
            (1,042,000)Net
                cash provided by discontinued operations
            -
            
            424,000Net
                cash used in operating activities
            (1,687,000)
            
            (618,000)**Cash
                flows from investing activities:**Purchase
                of property and equipment
            (104,000)
            
            (36,000)Change
                in other non-current assets
            -
            
            (24,000)Net
                cash used in continuing operations
            (104,000)
            
            (60,000)Net
                cash used in discontinued operations
            -
            
            (50,000)Net
                cash used in investing activities
            (104,000)
            
            (110,000)**Cash
                flows from financing activities:**Proceeds
                from issuance of common stock including the exercise ofoptions
                and the Employee Stock Purchase Plan
            26,000
            
            143,000Employee
                notes receivable
            -
            
            (45,000)Dividends
                on Series D Cumulative Redeemable Convertible Preferred
                Stock
            (88,000)
            
            (101,000)Payments
                on Series D Cumulative Redeemable Convertible Preferred
                Stock
            (150,000)
            
            -Principal
                payments of long-term debt and capital lease obligations
            (475,000)
            
            (6,000)Net
                cash used in continuing operations
            (687,000)
            
            (9,000)Net
                cash used in discontinued operations
            -
            
            (101,000)Net
                cash used in financing activities
            (687,000)
            
            (110,000)Net
                change in cash and cash equivalents
            (2,478,000)
            
            (838,000)Cash
                and cash equivalents at beginning of the period
            9,621,000
            
            2,074,000Cash
                and cash equivalents at end of the period
            $
                7,143,000
            
            $
                1,236,000**Supplemental
                Disclosure of Cash Flow Information:**Interest
                paid in cash
            $     
                31,000
            
            $     
                57,000**Noncash
                Investing and Financing Activity:**Capital
                equipment acquired under capital lease
            $               
                -
            
            $  
                139,000Accretion
                of Series D Cumulative Redeemable Convertible Preferred Stock dividends,
                derivatives and warrants
            $  
                 218,000
            
            $ 
                 135,000The
                accompanying notes are an integral part of these condensed consolidated
                financial statements.








5


**IMPLANT
      SCIENCES CORPORATION**


**NOTES
      TO CONDENSED FINANCIAL STATEMENTS**


**September
      30, 2007**


**(Unaudited)**





**1.**  **Description
      of Business**





Implant
      Sciences Corporation (the “Company”) develops products for the security
      equipment, semiconductor processing and medical device industries. The Company has
      both
      developed and acquired technologies using ion implantation and thin film
      coatings for semiconductor and medical device applications, the modification
      of
      orthopedic joint implant surfaces to reduce polyethylene wear generation and
      the
      coating of cardiovascular devices. This technology has further evolved to
      include new applications in the area of trace explosives detection products.





On
      May 1,
      2007, the Company entered into an Asset Purchase Agreement (the “Agreement”) to
      sell substantially all of the assets (the “Transaction”) of its subsidiary,
      Accurel Systems International Corporation (“Accurel), a California corporation,
      to Evans Analytical Group LLC (“Evans”), a Delaware limited liability company.
      Evans acquired all of the fixed assets and accounts receivable of the Company.
      The total purchase price of the Transaction was approximately $12,705,000.
      In
      addition, the Company issued warrants to purchase 350,000 shares of the
      Company’s common stock to Legend Merchant Group, our investment banker involved
      with the Transaction, at a price of $2.00 per share and agreed to pay them
      a fee
      based upon a percentage of gross aggregate consideration received by the
      Company, and an additional 25,000 warrants were issued to other consultants
      involved with the Agreement, at a price of $2.00 per share.





In
      connection with the Transaction, we entered into an escrow agreement (the
“Escrow Agreement”) with Evans, Accurel, and Zions First National Bank. 
Pursuant to the Escrow Agreement, Evans deposited $1,000,000 (the “Escrow
      Amount”) of the total purchase price for the assets into an escrow
      account.  Any valid claims for indemnification made by Evans pursuant to
      the Agreement shall be drawn from this sum. The Escrow Agreement provides,
      subject to any claims of indemnifications, for a release of $500,000 on
      approximately each of March 31, 2008 and March 31, 2009.





Also
      in
      connection with the Transaction, we entered into a Non-competition and
      Nondisclosure Agreement (the “NCD”) with Evans whereby we agreed not to engage
      in any business that directly competes with the business of Accurel. In
      addition, the NCD prohibits us from disclosing any confidential information
      concerning the business of Accurel. The NCD will remain in effect for five
      years
      from the date of its execution.





In
      June
      2007, the Company sold certain of the assets related to its brachytherapy
      products and divested the prostate seed and medical software business and will
      now only supply services and components to medical device manufacturers of
      this
      product line. Management is currently working on a plan to keep the remaining
      assets in service. However, should management be unsuccessful in formalizing
      this plan, there is a possibility that future periods may report discontinued
      operations relating to these remaining assets.





The
      Company currently markets and sells its existing trace explosives detector
      products while continuing to make significant investments in developing the
      next
      generation of these products. In addition, the Company is in the process of
      consolidating all semiconductor processing at its Core Systems subsidiary
      located in Sunnyvale, CA.





*Risks
      and Uncertainties*




While
      the
      Company strives to bring new products to market, it is subject to a number
      of
      risks similar to other technology-based companies, including risks related
      to:
      (a) its dependence on key individuals and collaborative research partners;
      (b)
      competition from substitute products and larger companies; (c) its ability
      to
      develop and market commercially usable products and obtain regulatory approval
      for its products under development; and (d) its ability to obtain the
      substantial additional financing necessary to adequately fund the development,
      commercialization and marketing of its products. For the three months ended
      September 30, 2007, the Company reported a net loss applicable to common
      shareholders of $2,509,000 and used $1,687,000 in cash from operations. As
      of
      September 30, 2007, the Company had an accumulated deficit of approximately
      $50,435,000 and working capital of $6,790,000. The Company has a term loan
      with
      a bank, which matures in August 2009 and has an unpaid balance of approximately
      $872,000. Management continually evaluates plans to reduce its operating
      expenses and increase its cash flow from operations. Failure of the Company
      to
      achieve its projections may require the Company to seek additional financing.





On
      January 3, 2007, the Company executed an agreement with Silicon Valley based
      Bridge Bank, N.A. which increased the Company’s revolving credit facility from
      $1.5 million to $5.0 million (see Note 10). Based on the current sales, expense
      and cash flow projections, and the proceeds from this facility and the sale
      of
      Accurel, the Company believes that the current level of cash and
      cash-equivalents on hand, and the net proceeds from current government contracts
      will be sufficient to fund operations for the next twelve months. However,
      because there can be no assurances that sales will materialize as forecasted,
      management will continue to closely monitor and attempt to control costs at
      the
      Company and will continue to actively seek the needed capital through government
      grants and awards, strategic alliances, private financing sources, and through
      its lending institutions.





Management
      has prepared operating plans which would indicate the Company has sufficient
      financial resources to sustain operations for at least the next twelve months.
      These plans depend on the successful increase in the semiconductor service
      revenue and a substantial increase in sales of the Company’s handheld trace
      explosives detector product. Should forecasted revenues not be met, management
      has developed plans which provide for cost cutting measures. Management believes
      that these cost cutting measures will be sufficient to allow the Company to
      continue as a going concern should revenue projections not be met. In addition,
      the proceeds from the sale of Accurel will further support the business plan
      of
      the Company.





The
      Company's consolidated financial statements have been presented on the basis
      that it is a going concern, which contemplates the realization of assets and
      the
      satisfaction of liabilities in the normal course of business. The Company has
      suffered recurring losses from continuing operations. The Series D preferred
      stock contains mandatory redemptions on a monthly basis. These mandatory
      redemptions are redeemable in cash or shares of the Company’s common stock, at
      the Company’s option so long as the price of the Company’s stock does not fall
      below 110% of the fixed conversion price. The Company received a waiver of
      the
      monthly amortization payments for the period December 2006 - August 2007, to
      the
      mandatory redemption date. The redemption payments resumed in September 2007.




There
      can
      be no assurances that forecasted results will be achieved or that the Company’s
      stock price will remain at a level to allow the Company to redeem the
      outstanding shares of Series D preferred and accrued dividends with shares
      of
      its common stock. These conditions raise substantial doubt about the Company's
      ability to continue as a going concern.  The financial statements do not
      include any adjustments relating to the recoverability and classification of
      asset amounts or the amounts and classification of liabilities that might be
      necessary should the Company be unable to continue as a going
      concern.





During
      fiscal 2007, the Company experienced a significant reduction in its
      semiconductor business. This decline came from the sale of the assets of Accurel
      in May 2007. The effect of this sale is being reported as discontinued
      operations in the accompanying financial statements. In addition, in June 2007,
      the Company sold certain of its assets related to its brachytherapy business
      and
      divested the prostate seed and medical software business and will now only
      supply services and components to medical device manufacturers of this product
      line. Management is currently working on a plan to keep the remaining assets
      in
      service. However, should management be unsuccessful in formalizing this plan,
      there is a possibility that future periods may report discontinued operations
      relating to these remaining assets.





The
      Company has a history of being active in submitting proposals for government
      sponsored grants and contracts and successful in being awarded grants and
      contracts from government agencies. Management will continue to pursue
      government grants and contracts to support its research and development efforts
      primarily in the areas of explosives detection.




6


**2.**  **Interim
      Financial Statements and Basis of Presentation**




The
      accompanying condensed consolidated financial statements of the Company have
      been prepared in accordance with the accounting principles generally accepted
      in
      the United States of America. In the opinion of management, the accompanying
      condensed consolidated financials statements include all adjustments (consisting
      only of normal recurring adjustments), which the Company considers necessary
      for
      a fair presentation of the financial position at such date and of the operating
      results and cash flows for the periods presented. The result of operations
      and
      cash flows for the three months ended September 30, 2007 may not necessarily
      be
      indicative of results that may be expected for any succeeding quarter or for
      the
      entire fiscal year. The information contained in this Form 10-Q should be read
      in conjunction with the Company’s audited financial statements, included in our
      Form 10-K as of and for the year ended June 30, 2007 filed with the Securities
      and Exchange Commission on October 15, 2007.





The
      accompanying condensed consolidated financial statements include the accounts
      of
      the Company and its wholly owned subsidiary Core Systems Incorporated (“Core”)
      (the “Subsidiary”). All intercompany balances have been eliminated in
      consolidation. Substantially all of the assets of the Company’s wholly-owned
      subsidiary, Accurel, have been sold pursuant to the Agreement and accordingly,
      our financial statements have reflected the statement of operations of Accurel
      as discontinued operations for the three months ended September 30, 2006.
      Additionally, the related information contained in the notes to the financial
      statements includes those of the Company’s continuing operations unless
      specifically identified as disclosures related to discontinued operations.





Our
      significant accounting policies are described in Note 2 to the financial
      statements of Item 8 of our Form 10-K as of June 30, 2007. Our discussion and
      analysis of our financial condition and results of operations are based upon
      the
      financial statements, which have been prepared in accordance with accounting
      principles generally accepted in the United States of America (“U.S. GAAP”). The
      preparation of financial statements in conformity with U.S. GAAP requires
      management to make estimates and judgments, which are evaluated on an on-going
      basis, that affect the amounts reported in the Company’s condensed consolidated
      financial statements and accompanying notes. Management bases its estimates
      on
      historical experience and on various other assumptions that it believes are
      reasonable under the circumstances, the results of which form the basis for
      making judgments about the carrying values of assets and liabilities and the
      amounts of revenues and expenses that are not readily apparent from other
      sources. Actual results could differ from those estimates and judgments. In
      particular, significant estimates and judgments include those related to revenue
      recognition, allowance for doubtful accounts, useful lives of property and
      equipment, inventory reserves, business combinations, valuation for goodwill
      and
      acquired intangible assets, accounting for embedded derivatives and warranty
      reserves.





**3.**  **Inventories**




Inventories
      consist of the following:








**September 30, 2007**
            
            **June
                30, 2007**Raw
                materials
            
            $
                695,000
            
            $
                737,000Work-in-progress
            
            128,000
            
            94,000Finished
                goods
            
            300,000
            
            335,000$
                1,123,000
            
            $
                1,166,000







**4.**  **Property
      and Equipment**





Property
      and
      equipment consists of the following **:**





**September
                30, 2007**
            
            **June
                30, 2007**Total
                property and equipment
            
            $
                10,011,000
            
            $
                9,826,000Less:
                accumulated depreciation
            
            (7,228,000)
            
            (6,904,000)$
                2,783,000
            
            $
                2,922,000





The
      Company
      recorded depreciation expense of approximately $325,000 and $370,000 for the
      three month period ended September 30, 2007 and 2006, respectively. Equipment
      purchased pursuant to capital leases and leasehold improvements are amortized
      based upon the lesser of the term of the lease or the useful life of the asset
      and such expense is included in depreciation expense . The
      depreciable lives of the assets acquired in the Core acquisition, which were
      originally given seven year lives, have been revised to five year lives as
      a
      result of the annual goodwill impairment review conducted in August of
      2007.







7





**5.**  **Accrued
      Expenses**





Accrued
      expenses consist of the following:





**September
                30, 2007**
            
            **June
                30, 2007**Accrued
                compensation and benefits
            
            $
                579,000
            
            $
                555,000Accrued
                taxes
            
            299,000
            
            478,000Other
                accrued liabilities
            
            960,000
            
            1,065,000$
                1,838,000
            
            $
                2,098,000







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




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







**6.**  **Investment
      in Unconsolidated Subsidiaries**





As
      of
      September 30, 2007, the Company has a 16.2% interest in CorNova, Inc. as a
      result of 87,031 shares having been issued to CorNova by the Company. For the
      three month period ended September 30, 2007 and 2006, the Company recognized
      approximately $0 and $120,000 of equity losses in unconsolidated subsidiaries,
      representing the Company’s portion of CorNova’s net loss.





As
      a
      result of the cumulative net losses incurred, the Company’s investment in
      CorNova is zero. No further writedowns will be incurred unless CorNova has
      cumulative net income sufficient to offset the cumulative net
      losses.





**7.**
            **Commitments
                and Contingencies**




(a)
      Capital and Operating Leases




The
      Company has an operating lease for its manufacturing, research and office space
      in Wakefield, MA which expires on December 31, 2008. The Company has an option
      to extend the lease for five additional years. Under the terms of the lease,
      the
      Company is responsible for its proportionate share of real estate taxes and
      operating expenses relating to this facility. The Company also has leases for
      both of its facilities in Sunnyvale, CA. The leases expire in December 2009
      and
      September 2010 and the Company has an option to extend each lease for five
      additional years. Effective with the sale of the assets of Accurel Systems
      on
      May 1, 2007, the Company executed a sublease agreement for one of its California
      facilities and terminated the lease for its satellite facility in Austin, TX.





In
      conjunction with the acquisition of Accurel, the Company recorded a lease
      liability of $829,000. This liability reflected management’s estimate of the
      excess of payments required under the Accurel facility lease, at the date of
      acquisition, versus the fair market value of lease payments that would have
      been
      required, if the lease had been negotiated under current market conditions.
      Subsequently, as a result of the sale of Accurel, the Company has recorded
      an
      additional lease liability of $487,000 representing that portion of the lease
      in
      excess of the sublease arrangement with Evans. The balance of the lease
      liability on September 30, 2007 is $965,000 of which $305,000 is current. Under
      the terms of the leases, the Company is responsible for its proportionate share
      of real estate taxes and operating expenses relating to these
      facilities.




8


Future
      minimum rental payments required under capital leases and operating leases
      with
      non-cancelable terms in excess of one year at September 30, 2007, together
      with
      the present value of net minimum lease payments are as follows:







**Capital
                Lease Payments**
            **Operating
                Lease**
              **Payments
                (1)**
            **Sublease**
              **Income**Year
                ending June 30:2008
            
            $
                20,000
            $
                1,105,000
            $
                185,0002009
            
            27,000
            1,201,000
            253,0002010
            
            15,000
            578,000
            260,0002011
                and remaining
            
            2,000
            84,000
            66,000Total
                future minimum lease payments
            64,000
            $
                2,968,000
            $
                764,000Less:
                amounts representing interest
            (6,000)Present
                value of future minimum lease payments
            58,000Less:
                current portion
            (17,000)Capital
                lease obligation, net of current portion
            $
                41,000




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






(b)  Employment
      Agreements




On
      June
      30, 2004, the Company entered into an employment agreement with Dr. Stephen
      Bunker, the Company’s Vice President and Chief Scientist, with an initial term
      of three years and an automatic renewal for a successive period of three years,
      unless the Company or Dr. Bunker give the other party not less than three months
      written notice of non-renewal. Under this employment agreement, Dr. Bunker
      serves as the Company’s vice president and chief executive scientist at a base
      salary of up to $150,000, subject to increase as authorized by the Compensation
      Committee. In addition, Dr. Bunker may participate in the Company’s employee
      fringe benefit plans or programs generally available to employees of comparable
      status and position. The Company is entitled to terminate his employment for
      any
      material breach of his employment agreement at any time upon at least 30 days’
written notice. In the event the Company terminates Dr. Bunker’s employment
      without cause, the Company will pay him 12 months’ salary. Under his employment
      agreement, he is subject to restrictive covenants, including confidentiality
      provisions. Also, during his employment and for a period of two years after
      the
      term of the employment agreement, Dr. Bunker is subject to a non-competition
      provision.





On
      October 15, 2004, the Company entered into an employment agreement with Walter
      J. Wriggins, the Company’s Vice President and General Manager of Core Systems,
      with an initial term of one year and an automatic renewal for a successive
      period of one year, unless the Company or Mr. Wriggins give the other party
      not
      less than thirty days written notice of non-renewal. Under this employment
      agreement, Mr. Wriggins serves as the Company’s vice president of business
      development/operations and general manager of Core Systems at a initial
      base salary of $140,000, subject to increase as authorized by the Compensation
      Committee. In addition, Mr. Wriggins may participate in the Company’s employee
      fringe benefit plans or programs generally available to employees of comparable
      status and position. The Company is entitled to terminate his employment for
      any
      material breach of his employment agreement at any time upon at least 30 days’
written notice. In the event the Company terminates Mr. Wriggins’ employment
      without cause, the Company will pay him the balance of the salary due for the
      term of the agreement. Under his employment agreement, he is subject to
      restrictive covenants, including confidentiality provisions. Also, during his
      employment and for a period of two years after the term of the employment
      agreement, Mr. Wriggins is subject to a non-competition provision





On
      March
      12, 2007, the Company entered into an employment agreement with Phillip C.
      Thomas, the Company’s President and CEO, whereby should Mr. Thomas’ employment
      be terminated for reasons other than cause during his first year of service,
      he
      will be paid six months base salary in compensation and one year of base
      compensation after one year of service.





On
      September 27, 2007, the Company entered into a Transition Agreement with Dr.
      Anthony J. Armini, the Company’s former President and CEO, with a term of twenty
      four months. Under this Transition Agreement Dr. Armini stepped down as
      President and Chief Executive Officer and assumed the position of Scientific
      Advisor. Dr. Armini will remain the Chairman of the Board of Directors until
      the
      next annual meeting of shareholders. During the Transition Period, the Company
      will compensate Dr. Armini at the annual rate of $250,000. In addition, Dr.
      Armini may participate in the Company’s medical and dental insurance programs.
      The Company may terminate this Transition Agreement only for cause and Dr.
      Armini may terminate the Transition Agreement for any reason, with each party
      giving the other written notice. In conjunction with this, Dr. Armini has been
      issued a stock option for 200,000 shares of common stock at an exercise price
      of
      $2.09 per share, of which 25,000 shares vest immediately, and the remaining
      175,000 shares vest 25,000 per quarter over the term of the Transition
      Agreement. These options were valued using the Black Scholes method and the
      following assumptions: volatility 96%, risk free interest rate of 4.01% and
      expected life of 1.75 years.





9


(c)  Litigation




From
      time
      to time, we are subject to various claims, legal proceedings and investigations
      covering a wide range of matters that arise in the ordinary course of our
      business activities. Each of these matters is subject to various uncertainties.





On
      March
      23, 2005, we entered into a Development, Distribution and Manufacturing
      Agreement (the “Rapiscan Agreement”) with Rapiscan Systems, Inc.
      (“Rapiscan”).  Under the terms of this agreement, we gave Rapiscan the
      exclusive worldwide rights to market our Quantum Sniffer TM portable
      and benchtop trace detection devices under their private label.  We also
      agreed to give Rapiscan the exclusive worldwide rights to distribute certain
      other new security products which we may develop in the future with their
      funding, as well as rights, in some circumstances, to manufacture certain
      components of the private-labeled Quantum Sniffer TM portable
      and benchtop trace detection devices.





On
      March
      23, 2006, Rapiscan filed a complaint against the Company and its contract
      assembler, Columbia Tech, in the United States District Court for the Central
      District of California, regarding the Rapiscan Agreement.  Rapiscan’s
      complaint against the Company is based upon claims of breach of contract and
      breach of warranty and is requesting a decree for specific performance,
      declaratory relief and injunctive relief. Rapiscan’s complaint against Columbia
      Tech is based upon injunctive relief, declaratory relief and tortuous
      interference with contractual relations. On April 12, 2006, Rapiscan dismissed
      all claims against Columbia Tech.





On
      March
      24, 2006, the Company brought suit in the United States District Court in the
      District of Massachusetts against Rapiscan and its parent, OSI Systems, Inc.
      (“OSI”). The Company is requesting rescission of the Rapiscan Agreement, plus
      damages, based on claims of misrepresentation. In the alternative, the Company
      is seeking termination of the Rapiscan Agreement due to material breaches of
      contract and the implied covenant of good faith and fair dealing and for damages
      due to Rapiscan’s breach of contract and the implied covenant of good faith and
      fair dealing.





In
      August
      2006, as a result of motions made by both parties, the two lawsuits have been
      consolidated in the United States District Court for the Central District of
      California with the Company as plaintiff. In late 2006, Rapiscan and OSI filed
      a
      motion to dismiss certain of the Company’s claims. The court dismissed Company’s
      claim of breach of fiduciary duty, but the motion to dismiss was denied in
      all
      other respects. The parties are presently near the end of the discovery process,
      which should be completed in early December 2007. OSI and Rapiscan have filed
      four motions for partial summary judgment with respect to certain discrete
      claims. Two of the motions were denied in their entirety. The third was denied
      in the only material respect and granted in two immaterial respects. The fourth
      motion is scheduled to be heard in late November 2007. The trial is expected
      in
      early 2008.





Should
      the Company be unsuccessful in prosecuting this matter, it may have a material
      adverse effect on its business and results of operations. No
      revenue has been recorded related to the Rapiscan Agreement.





We
      may,
      from time to time, be involved in other actual or potential proceedings that
      we
      consider to be in the normal course of our business. We do not believe that
      any
      of these proceedings will have a material adverse effect on our
      business.





**8.**
            **Redeemable
                Convertible Preferred Stock**





The
      following table reflects the required redemption of the Series D before the
      effect of the accrued dividends:





**Year
                ending June 30:**
            
            **Preferred
                Stock Monthly Redemption Schedule**2008
                remaining 9 months
            
            $
                1,365,0002009
            
            2,424,000$
                3,789,000








On
      December 28, 2006, Laurus consented to permit the Company to defer the December
      2006, January 2007, February 2007, March 2007, April 2007, May 2007, June 2007,
      July 2007, and August 2007 redemptions to the end of the term. The monthly
      redemption of approximately $152,000 plus accrued dividends resumed on September
      1, 2007. Subject to certain conditions, including the market price being above
      $4.57 per common share, it is at the Company’s option to pay this amount in cash
      or in common stock at a fixed conversion price of $4.15 per common share.





The
      Company valued the Series D at issuance at its residual value of $2,700,000
      based on the fair values of the financial instruments issued in connection
      with
      this preferred stock financing, including the warrants, the embedded derivative
      instruments and offering costs. The amounts recorded in the financial statements
      represent the amounts attributed to the sale of the Series D preferred stock,
      the amount allocated to warrants, the value attributed to the embedded
      derivatives and issuance costs. The Company is accreting these discounts on
      the
      carrying value of the preferred stock to its redemption value at September
      1, 2008, or the actual conversion date, whichever is earlier. The accretion
      of
      these amounts is being recorded as a preferred dividend in the period of
      accretion. As of September 30, 2007, $1,569,000 was amortized. As of September
      30, 2007 and June 30, 2007, the fair value of this conversion feature
      approximated $283,000 and $133,000, respectively. The value of
      the embedded derivatives related to the adjustable dividend rate and the
      potential default provisions were determined to be immaterial at September
      30,
      2007.





10


**9.**
            **Share-based
                compensation plans**





*Stock
      Option Plans*




As
      of
      September 30, 2007, a total of 137,003, 55,602, and 278,000 shares are available
      for issuance under the 1998 Stock Option Plan, the 2000 Incentive and
      Non-Qualified Stock Option Plan and the 2004 Stock Option Plan, respectively.





The
      following table presents the cumulative activity of the stock option plans
      for
      the three months ended September 30, 2007:




**Shares**
            
            **Weighted
                Average**
              **Exercise
                Price**Outstanding
                at June 30, 2007
            1,790,738
            
            $
                  4.66Granted
            210,000
            
            $
                  2.09Exercised
            -
            
            -Cancelled
            (20,000)
            
            $
                10.15Outstanding
                at September 30, 2007
            1,980,738
            
            $ 
                 4.36Options
                exercisable at end of period
            1,251,858
            
            $ 
                 5.27Weighted-average
              fair value of options granted during period
            
            
            $ 
               0.91





On
      December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standard (“SFAS”) No. 123 (Revised 2004)
“Share-Based Payments,” (“SFAS 123R”), which is a revision of SFAS No. 123,
“Accounting for Stock-Based Compensation.” SFAS 123R supersedes Accounting
      Principal Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to
      Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the
      approach in SFAS 123R is similar to the approach described in SFAS 123, however,
      SFAS 123R requires all share-based payments to employees, including grants
      of
      employee stock options and stock issued from certain employee stock purchase
      plans, to be recognized in earnings based on their modified-grant date fair
      values. Pro forma disclosure is no longer an alternative. Effective July 1,
      2005, the Company adopted SFAS 123R.




The
      Company recorded $208,000 and $147,000 of stock based compensation, which
      includes $8,000 and $7,000 of compensation expense attributable to its Employee
      Stock Purchase Plan and $26,000 and $11,000 of non-cash stock-based compensation
      related to warrants issued to non-employees, in the three month period ended
      September 30, 2007 and 2006, respectively





The
      total
      non-cash stock-based compensation expense, included in the consolidated
      statement of operations for the three month period ended September 30, 2007
      and
      2006, respectively, is included in the following expense categories:





**Three
                months ended**
              **September
                30,****2007**
            
            **2006**Cost
                of revenues
            $
                32,000
            
            $
                40,000Research
                and development
            23,000
            
            21,000Selling,
                general and administrative
            153,000
            
            86,000Total
            $
                208,000
            
            $
                147,000




As
      of
      September 30, 2007 there was $722,000 of total unrecognized compensation expense
      related to unvested share based compensation arrangements under the various
      share-based compensation plans.





**Period
                Ended June 30:**Remaining
                9 months 2008
            $
                321,0002009
            285,0002010
            115,000Thereafter
            1,000Total
            $
                722,000





11


The
      fair
      value of each option award is estimated on the date of grant using the
      Black-Scholes option pricing model using the assumptions noted in the following
      table. Expected volatility is based on historical volatility of the Company’s
      common stock. The Company uses historical data to estimate future option
      forfeitures within the valuation model. The expected term of options granted
      is
      calculated using the “Simplified Method” as outlined SFAS 123R and reflects the
      period of time that options granted are expected to be outstanding. The
      risk-free rate for periods within the contractual life of the option is based
      on
      the U.S Treasury yield curve in effect at the time of grant. There are no
      special terms relating to the rights to exercise options relating to the
      employee terminations in conjunction with the sale of Accurel.




**Three
                month period ended**
              **September
                30, 2007**
            
            **Three
                month period ended**
              **September
                30, 2006**Stock
                Option Plan
            
            Stock
                Purchase Plan
            
            Stock
                Option Plan
            
            Stock
                Purchase PlanRisk
                free interest rate
            4.01%
                - 4.34%
            
            4.95%
            
            4.85%
                - 5.07%
            
            5.17%Expected
                dividend yield
            0%
            
            0%
            
            0%
            
            0%Expected
                lives (years)
            1.75
                - 3.5 years
            
            6
                months
            
            3.5
                - 6 years
            
            6
                monthsExpected
                volatility
            96%
                - 97%
            
            97%
            
            78%
                - 79%
            
            78%Expected
                forfeiture rate
            10%
            
            0%
            
            10%
            
            0%Contractual
                term
            2
                -
                5 years
            
            6
                months
            
            5
                -
                10 years
            
            6
                months





*Employee
      Stock Purchase Plan*





In
      September 1998, the Company adopted the 1998 Employee Stock Purchase Plan (the
      “Plan”). The Plan provides a method whereby employees of the Company will have
      an opportunity to acquire an ownership interest in the Company through the
      purchase of shares of common stock of the Company through payroll deductions.
      After 12 months of employment, an employee is eligible to participate and can
      defer up to 10% of their wages into this Plan, with a maximum of $25,000 in
      any
      calendar year. The purchase price of the common stock is calculated at the
      lower
      of 85% of the closing price of the stock on the first day of the plan period
      or
      the last day of the plan period. The periods are January 1 to June 30 and July
      1
      to December 31. Fractional shares are not issued. Participants may withdraw
      at
      any time by giving written notice to the Company and will be credited the
      amounts of deferrals in their account. The maximum number of shares eligible
      to
      be issued under the Plan is 141,000. As of September 30, 2007, a total of 10,669
      shares are available for issuance under the Plan.





In
      December 2006, the Company adopted the 2006 Employee Stock Purchase Plan (the
      “2006 Plan”). The 2006 Plan provides a method whereby employees of the Company
      will have an opportunity to acquire an ownership interest in the Company through
      the purchase of shares of common stock of the Company through payroll
      deductions. After 12 months of employment, an employee is eligible to
      participate and can defer up to 10% of their wages into this Plan, with a
      maximum of $25,000 in any calendar year. The purchase price of the common stock
      is calculated at the lower of 85% of the closing price of the stock on the
      first
      day of the plan period or the last day of the plan period. The periods are
      January 1 to June 30 and July 1 to December 31. Fractional shares are not
      issued. Participants may withdraw at any time by giving written notice to the
      Company and will be credited the amounts of deferrals in their account. The
      maximum number of shares eligible to be issued under the 2006 Plan is 500,000.
      As of September 30, 2007, a total of 481,023 shares are available for issuance
      under the 2006 Plan.





Compensation
      expense under the 1998 and 2006 Plans for the three month periods ended
      September 30, 2007 and 2006 is $8,000 and $7,000 respectively.




*Non-qualified
      options and warrants*





Included
      in the consolidated statement of operations for the period ended September
      30,
      2007 is $26,000 of compensation expense attributable to other non-employee
      options and warrants.





**10.**
            **Long-term
                Debt and Credit
                Arrangements**




*MED-TEC
      Payment Obligation*





On
      July
      31, 2003, the Company entered into an agreement with its former exclusive
      distributor of prostate seeds, to release each other from further obligations
      under the original Distributor Agreement.  The new agreement conveys to the
      Company direct marketing and sales capabilities to sell its I-Plant Seed
      brachytherapy seeds for use in the treatment of prostate cancer.  In
      connection with this, the Company’s former exclusive distributor agreed to work
      cooperatively to transition customers and marketing materials directly to the
      Company.  The distributor also agreed not to compete with the Company for a
      period of three years.  The present value of this payment obligation was
      recorded as approximately $1,007,000, using a rate of 10.24%. This amount was
      recorded as an intangible asset and is being amortized over its estimated useful
      life of 29 months.  As
      of
      September 30, 2007, the outstanding and past due principal balance is
      approximately $103,000.  For the three months ended September 30, 2007 and
      2006, the Company recorded approximately $3,000 and $6,000, respectively, of
      interest expense relating to this transaction.





12


*Revolving
      Credit Facility and Term Note with Bridge Bank*





On
      January 3, 2007, the Company executed an Amended and Restated Loan and Security
      Agreement (the “Loan Agreement”) which amended and restated the terms of a
      Business Financing Agreement originally dated as of June 1, 2005 with Silicon
      Valley based Bridge Bank, N.A. (the “Bank”) increasing the revolving credit
      facility from $1.5 million to $5.0 million. This revolving credit facility
      (the
“line of credit”) has a two year term, provides for advances of up to eighty
      percent (80%) of the Company’s eligible accounts receivable and up to the lesser
      of $1,000,000 or forty percent (40%) of eligible inventory, bears interest
      at
      the prime rate, plus one-half percent (1/2%) per annum, and is collateralized
      by
      all assets of the Company.




In
      addition, pursuant to the terms of the Loan Agreement, the Company converted
      $1,600,000 of the outstanding line of credit balance into a 30 month term note
      bearing an interest rate at the prime rate plus one percent (1%) per annum
      payable in thirty (30) equal monthly installments of principal, plus all accrued
      interest beginning on February 10, 2007.





Pursuant
      to the Loan Agreement, the Company issued to Bridge Bank. N.A. a seven-year
      warrant to purchase up to 18,939 shares of the Company’s common stock at a price
      equal to $2.64 per share. The warrants were valued using the Black Scholes
      model
      and the following assumptions: volatility of 78%, an expected life 7 years,
      and
      a risk free interest rate of 4.54%. Pursuant to ABP No 14 “Accounting for
      Convertible Debt and Debt Issued with Stock Purchase Warrants”, the note and
      warrants have been recorded at their relative fair value. The Company will
      accrete the value of the warrants, $28,000, to the term note over the life
      of
      the note. As of September 30, 2007, approximately $9,000 has been
      amortized.





As
      of
      September 30, 2007 and June 30, 2007, this revolving credit facility had a
      zero
      balance. As of September 30, 2007 and June 30, 2007, the term note had a balance
      of $872,000 and $1,299,000, respectively.




**11.**
            **Financial
                Information by Segment and Customer
                Concentration**





Under
      SFAS No. 131, “Disclosures about Segments of an Enterprise and Related
      Information,” operating segments are defined as components of an enterprise
      about which separate financial information is available that is evaluated
      regularly by the chief operating decision maker, or decision making group,
      in
      deciding how to allocate resources and in assessing performance. The Company's
      chief operating decision making group is composed of the chief executive officer
      and members of senior management. The Company's reportable segments are:
      Security Products, Semiconductor and Medical..




Gross
      margin is the measure that management uses when evaluating the Company’s
      segments; therefore, operating expenses are excluded from the financial
      information below.





The
      revenues, expenses and assets related to these segments from
      continuing operations for the three months ended September 30, 2007 and 2006
      are:








**Three
                months ended September 30, 2007**
            **Security**
            
            **Semiconductor**
            
            **Medical**
            
            **Total**Revenue
            $
                1,347,000
            
            $
                1,737,000
            
            $
                134,000
            
            $ 
                 3,218,000Cost
                of revenues
            821,000
            
            1,775,000
            
            312,000
            
            2,908,000Gross
                profit (deficit)
            $
                526,000
            
            $  
                 (38,000)
            
            $
                 (178,000)
            
            $    
                310,000Assets
            $
                5,409,000
            
            $10,029,000
            
            $
                1,812,000
            
            $17,250,000**Three
                months ended September 30, 2006**Revenue
            $   
                481,000
            
            $
                1,623,000
            
            $
                1,160,000
            
            $
                3,264,000Cost
                of revenues
            616,000
            
            1,599,000
            
            850,000
            
            3,065,000Gross
                profit (deficit)
            $
                (135,000)
            
            $
                24,000
            
            $
                310,000
            
            $   
                199,000Assets
            $
                1,704,000
            
            $10,758,000
            
            $
                3,310,000
            
            $15,772,000




International
      sales accounted for $809,000 and $1,458,000 for the three month period ended
      September 30, 2007 and 2006 respectively.




During
      the three months ended September 30, 2007 the Company had one customer that
      comprised 20% of the consolidated revenue and 26% of the consolidated accounts
      receivable.








13


**12.**
            **Goodwill
                and Other Intangible
                Assets**




At
      September 30, 2007 and June 30 2007, the Company had goodwill of $2,062,000.
      SFAS No. 142, “Goodwill and Other Intangible Assets”, requires that goodwill and
      intangible assets with indefinite lives no longer be amortized but instead
      be
      measured for impairment at least annually or whenever events indicate that
      there
      may be an impairment. In order to determine if impairment exists, management
      continually estimates the reporting unit’s fair value based on market conditions
      and operational performance. The Company may employ the work of independent
      appraisers in making its determination. The Company makes its annual assessment
      as of August 31st of each year to determine if its goodwill is impaired.





Intangible
      assets with finite lives are valued according to the future cash flows they
      are
      estimated to produce. These assigned values are amortized over the period of
      time those cash flows are estimated to be produced. Management continually
      evaluates whether events or circumstances have occurred that indicate that
      the
      estimated remaining useful life or the carrying value of these assets has been
      impaired. As of September 30, 2007, management believes no impairment exists.





SFAS
      No.
      144, “ Accounting
      for the Impairment or Disposal of Long-Lived Assets,” requires that long lived
      assets and/or asset groups shall be tested for recoverability whenever events
      or
      changes in circumstances indicate that its carrying amount may not be
      recoverable due to certain events or changes in circumstances. At June 30,
      2007,
      when management measured the semiconductor processing reporting unit, it
      concluded that an impairment existed and recorded an adjustment of $3,829,000.





There
      were no changes in the carrying value of goodwill for the three months ended
      September 30, 2007, however, future events could cause management to conclude
      that impairment indicators exist and that goodwill and intangible assets with
      indefinite lives associated with the Company’s acquired businesses are impaired.
      Any resulting impairment loss could have a material adverse impact on the
      Company’s financial condition and results of operations.





Goodwill
      is as follows:




Semiconductor
                ServicesBalance
              as of September 30, 2007 and June 30, 2007
            $        
                2,062,000






The
      following table summarizes the Company’s intangible assets as of September 30,
      2007:





**Gross
                carrying amount**
            
            **Accumulated
                Amortization**
            
            **Net
                Carrying Amount****June****30,**
              **2007**
            **Additions**
            **September****30,
                2007**
            
            **June
                30,**
              **2007**
            **Additions**
            **September****30,
                2007**
            
            **September****30,
                2007**Customer
                Base
            
            $
                161,000
            $       
                -
            $
                161,000
            
            $113,000
            $
                6,000
            $
                119,000
            
            $
                42,000Technology
            
            97,000
            -
            97,000
            
            68,000
            3,000
            71,000
            
            26,000Total
            
            $
                258,000
            $   
                      -
            $
                258,000
            
            $
                181,000
            $
                9,000
            $
                190,000
            
            $
                68,000





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





2008
                remaining 9 months
            
            $
                25,0002009
            
            34,0002010
            
            9,000$
                68,000





14


**13.**
            **Earnings
                (loss)**




The
      Company had the following potential dilutive securities outstanding on September
      30, 2007; options and warrants to purchase 1,980,738 and 2,593,267 shares,
      respectively, of the Company’s common stock at weighted average exercise prices
      of $4.36 and $5.58 per share, respectively and Series D Preferred Stock
      convertible into an aggregate of 913,107 shares of the Company’s common stock.
      Such potential dilutive securities were not included in the calculation of
      diluted loss per share in the period ended September 30, 2007 because the
      inclusion thereof would be antidilutive.








**14.**
            **Discontinued
                Operations**





On
      May
      1,  2007,
      the
      Company completed the sale of its Accurel Division to Evans (“Asset Sale”). The
      Asset Sale was completed in accordance with the terms and conditions of the
      Purchase Agreement. As consideration for the Asset Sale, the Company received
      cash proceeds of approximately $12,705,000 of which $1,000,000 was placed in
      escrow. At June 30, 2007, the Company determined that the proceeds, less the
      related transaction costs of approximately $1,794,000 in cash fees and expenses,
      taxes of $197,000, and $390,000 in a non-cash charge for three year warrants
      issued, were less than the book value of the net assets transferred of
      $11,570,000 and therefore a loss on the sale of Accurel of $1,246,000 was
      recorded in the year ended June 30, 2007 as a component of the loss from
      discontinued operations





In
      accordance with Statement of Financial Accounting Standards No.144, “Accounting
      for the Impairment or Disposal of Long-Lived Assets”, the September 30, 2007
      financial statements have been prepared and historical statements of operations
      have been reclassified to present the results of Accurel as discontinued
      operations. The Company has clearly (i) eliminated Accurel’s financial results
      from its ongoing operations, (ii) determined that Accurel, as operated as a
      separate subsidiary was a separate component of its aggregated business as,
      historically, management reviewed separately the Accurel financial results
      and
      cash flows apart from its ongoing continuing operations, and (iii) determined
      that it will have no further continuing involvement in the operations of Accurel
      after the sale.





Condensed
      results of operations relating to Accurel for the three months ended September
      30, 2006 are as follows:





**Three
                Months Ended**
              **September
                30, 2006**Revenues:
            $2,316,000Gross
                profit
            $
                866,000Operating
                income
            $
                390,000Income
                from discontinued operations
            $
                366,000





**15.**
              **Income
                  Taxes**
 
 The
        Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No.
        48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on July 1,
        2007.  FIN 48 clarifies the accounting for uncertainty in income taxes
        recognized in an enterprise’s financial statements in accordance with FASB
        Statement No. 109, “Accounting for Income Taxes.”  FIN 48 prescribes a
        two-step process to determine the amount of tax benefit to
        recognize.  First, the tax position must be evaluated to determine the
        likelihood that it will be sustained upon examination by a tax
        authority.  If the tax position is deemed “more-likely-than-not” to be
        sustained, the tax position is then assessed to determine the amount of benefit
        to recognize in the financial statements.  The amount of the benefit
        that may be recognized is the largest amount that has a greater than 50 percent
        likelihood of being realized upon ultimate settlement.  If the tax
        position does not meet the “more-likely-than-not” threshold, then it is not
        recognized in the financial statements.  The Company’s adoption of FIN
        48 as of July 1, 2007 did not have a material impact on the Company’s financial
        position or results of operations.
 
 The
        Company has reviewed the tax positions to taken, or to be taken, in its tax
        returns for all tax years currently open to examination by taxing authority
        in
        accordance with the recognition and measurement standards of FIN
        48.  At September 30, 2007, there is no aggregate tax effect of
        differences between tax return positions and the benefits recognized in our
        financial statements.


15





**ITEM
      2.**  **MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**





**OVERVIEW**





Over
      the
      past twenty three years, Implant Sciences Corporation has both developed and
      acquired technologies using ion implantation and thin film coatings. Initially
      this technology was used in semiconductor processing but soon expanded to
      include various medical device applications including the modification of
      orthopedic joint implant surfaces to reduce polyethylene wear generation and
      the
      manufacture of products for radiation therapy treatments. Our latest application
      of this technology includes the manufacturing of trace explosives detection
      equipment.





We
      currently provide ion implantation services to numerous semiconductor
      manufacturers, research laboratories and universities. In October 2004 and
      March
      2005, we acquired two California semiconductor companies, Core Systems (“Core”)
      and Accurel Systems International (“Accurel”), respectively. In May 2007, we
      sold our Accurel subsidiary for a total purchase price of approximately
      $12,705,000. Other applications of our ion beam technology had been in the
      area
      of temporary brachytherapy products. In June 2007, we sold certain assets
      associated with this product and divested the prostate seed and medical software
      business and will now only supply services and components of this product line.
      Management is currently working on a plan to keep the remaining assets in
      service. However, should management be unsuccessful in formalizing this plan,
      there is a possibility that future periods may report discontinued operations
      relating to these remaining assets.





The
      Company manages its business and reports results from operations for three
      business segments: Security Products, which includes development contracts
      and
      product sales related to the Company’s trace explosives detection products;
      Semiconductor, which includes ion implantation, disk refurbishment and source
      conditioning equipment, and Medical, which includes orthopedic and radiopaque
      coatings, and other related activities.





Substantially
      all of the assets of the Company’s wholly-owned subsidiary, Accurel, have been
      sold. Management’s discussion and analysis of financial condition and results of
      operations are based on the Company’s continuing operations.





**RESULTS
      OF OPERATIONS**





The
      following is a discussion and analysis of the financial condition and results
      of
      operation of the Company for the three month period ended September 30, 2007
      and
      2006. It should be read in conjunction with the financial statements and notes
      thereto appearing elsewhere herein.





*Three
      Month Period Ended September 30, 2007 vs. September 30, 2006*





Revenues
      for the three months ended September 30, 2007 were $3,218,000 as compared to
      $3,264,000 in the three months ended September 30, 2006, a decrease of $46,000
      or 1%. Our revenues by business segment are as follows:





**Three
                months ended****September
                30, 2007**
            
            **September
                30, 2006**Security
                products
            $
                1,347,000
            
            $   
                481,000Semiconductor
            1,737,000
            
            1,623,000Medical
            134,000
            
            1,160,000Total
            $
                3,218,000
            
            $
                3,264,000








The
      Security Products business segment revenue increased by $866,000 or 180%. This
      increase is due to an increase in the number of units shipped during the three
      months ended September 30, 2007 as compared to the three months ended September
      30, 2006. Our Semiconductor business segment revenues increased by $114,000
      or
      7%. This increase is due to a general increase in the demand for disk
      refurbishment equipment and services. Revenues in the Medical business segment
      for the three months ended September 30, 2007 were $134,000 as compared to
      $1,160,000 in the three months ended September 30, 2006, a decrease of
      $1,026,000 or 88%. This decrease in revenues is primarily due to a certain
      orthopedic customer discontinuing its need for our coating combined with the
      sale of certain assets related to the prostate seeds and medical software in
      June, 2007. We expect this decline in medical revenue as compared to fiscal
      2007
      will continue throughout fiscal 2008.





*Cost
      of Revenues* .
      Cost of
      revenues for the three months ended September 30, 2007 was $2,908,000 as
      compared to $3,065,000 in the prior three months period ended September 30,
      2006, a decrease of $157,000 or 5%. The cost of revenues by business segment
      is
      as follows:








**Three
                months ended****September
                30, 2007**
            
            **September
                30, 2006**Security
                products
            $
                821,000
            
            $
                616,000Semiconductor
            1,775,000
            
            1,599,000Medical
            312,000
            
            850,000Total
            $
                2,908,000
            
            $
                3,065,000








Cost
      of
      revenues for our Security Products segment was $821,000 for the three months
      ended September 30, 2007 as compared to $616,000 for the prior year period
      representing an increase of $205,000 or 33%. The increase in the Security
      products business segment costs of revenues is primarily related to the increase
      in the Security products business segment revenues. Semiconductor business
      segment cost of revenues was $1,775,000 for the three months ended September
      30,
      2007 as compared to $1,599,000 for the prior year three month period, an
      increase of $176,000 or 11%. The increase in Semiconductor cost of revenue
      reflects the increased revenues at our Semiconductor business segment. Cost
      of
      revenues for our Medical business segment was $312,000 for the three months
      ended September 30, 2007 as compared to $850,000 for the three months ended
      September 30, 2006, a decrease of $538,000, or 63%. This decrease in cost of
      revenues is primarily the result of the decrease in Medical revenues due to
      the
      Company divesting its prostate seed and medical software business in June,
      2007.





16


*Gross
      Margins (deficit)*





**Three
                months ended September 30, 2007****Security**
            
            **Semiconductor**
            
            **Medical**
            
            **Total**Revenues
            $1,347,000
            
            $
                1,737,000
            
            $  
                134,000
            
            $
                3,218,000Cost
                of revenues
            821,000
            
            1,775,000
            
            312,000
            
            2,908,000Gross
                margin (deficit)
            $ 
                526,000
            
            $  
                (38,000)
            
            $
                (178,000)
            
            $  
                310,000Margin
                %
            39%
            
            (2%)
            
            (133%)
            
            10%








**Three
                months ended September 30, 2006****Security**
            
            **Semiconductor**
            
            **Medical**
            
            **Total**Revenues
            $
                481,000
            
            $
                1,623,000
            
            $1,160,000
            
            $
                3,264,000Cost
                of revenues
            616,000
            
            1,599,000
            
            850,000
            
            3,065,000Gross
                margin (deficit)
            $
                (135,000)
            
            $      
                24,000
            
            $  
                310,000
            
            $  
                 199,000Margin
                %
            (28%)
            
            1%
            
            27%
            
            6%





Overall
      gross margins were 10% of revenues in the three months ended September June
      30,
      2007 as compared to 6% in the prior year period. The increase in overall gross
      margins is primarily the result of an increase in gross margins in our Security
      products business segment. Security products had a gross margin of $526,000
      or
      39% as compared with a gross margin loss of $135,000 or 28% in the corresponding
      prior year period. The improvement in security products gross margin is due
      to a
      significant increase in unit sales of our handheld explosives detectors in
      the
      three month period ended September 30, 2007 as compared with the corresponding
      prior year period. The Semiconductor business segment showed a gross margin
      deficit of $38,000 or 2% in the three months ended September 30, 2007, as
      compared to a gross margin of $24,000 or 1%. The decrease in the Semiconductor
      gross margin was primarily a result of increased expenses incurred relating
      to
      the relocation of certain pieces of capital equipment from our Wakefield
      facility to our Sunnyvale facility. This move required additional outside
      consultants and services to bring the equipment back on line. The Medical
      products business segment showed a gross deficit of $178,000 in the three months
      ended September 30, 2007 as compared to a gross margin of $310,000 in the prior
      year three month period. This decrease in gross margin in the Medical products
      business segment is due to the decrease in revenues to a level below the
      associated fixed and variable costs due to the Company divesting its prostate
      seed and medical software business in June, 2007.





*Research
      and Development* .
      Research and development expense for the three months ended September 30, 2007
      was $690,000 as compared to $567,000 for the comparable prior year period,
      an
      increase of $123,000 22%. The Company continued to expend funds to further
      the
      development of new products in the areas of explosives and toxic substance
      detection. In addition, the increase in research and development expenses
      relates to the volume and timing of customer funded programs, primarily through
      government grants and contracts. The Company charges its research and
      development personnel to cost of revenues for work performed on these contracts
      and grants. Research and development expenses prior to starting the government
      contracts are charged to operating expenses.





*Selling,
      General and Administrative* .
      Selling, general and administrative expense for the three months ended September
      30, 2007 was $1,739,000 as compared to $1,487,000 for the comparable prior
      year
      period, an increase of $252,000, or 17%. The majority of this increase relates
      to increases in legal and accounting fees combined with increased travel and
      share-based compensation expenses.





*Other
      Income and Expense, Net* .
      For the
      three months ended September 30, 2007, we recorded other expense, net, of
      $83,000 as compared to $121,000, in the comparable prior year period, a decrease
      of $38,000 or 31%. Other income and expense includes a loss of $0 and $121,000
      for the period ended September 30, 2007 and 2006, respectively, representing
      the
      Company’s share of losses attributable to its investment in CorNova, an
      unconsolidated subsidiary accounted for under the equity method of accounting.
      Interest expense in the current year period was $34,000 compared to $25,000
      in
      the prior year period. This increase in interest expense was offset by an
      increase in interest income of $97,000 as compared with the comparable prior
      year period. This increase is a result of investing the cash proceeds from
      the
      sale of Accurel.




*Loss
      from Continuing Operations.* Loss
      for
      the three months ended September 30, 2007 was $2,202,000 as compared with
      $1,976,000 for the comparable prior year period, an increase in net loss of
      $226,000, or 11%. The increase in net loss is primarily the result of a $375,000
      increase in operating expenses offset by a $97,000 increase in interest income.





Preferred
      distribution, dividends and accretion on Series D Redeemable Convertible
      Preferred Stock were $307,000 in the three months ended September 30, 2007
      as
      compared to $236,000 in the prior year period.





*Income
      From Discontinued Operations.* Income
      for the three months ended September 30, 2007 was $0 as compared with income
      of
      $366,000 in the corresponding prior year period. The Company sold the assets
      of
      its Accurel subsidiary on May 1, 2007.





17


**LIQUIDITY
      AND CAPITAL RESOURCES**





As
      of
      September 30, 2007, the Company had approximately $7,143,000 in the form of
      cash
      and cash equivalents. During the three months ended September 30, 2007,
      operating activities used cash of approximately $1,687,000. Net cash used by
      operating activities primarily reflects the $2,202,000 net loss, increased
      by a $477,000 increase in accounts receivable due to shipments of handheld
      explosive detection units in September along with an increase in accrued
      expenses of $260,000, which were partially offset by a $523,000 increase in
      accounts payable, depreciation and amortization expenses of $325,000 and share
      based compensation expenses of $208,000. The Company has approximately $620,000
      of raw materials and finished goods inventories related to its handheld
      explosives detection product. This inventory was acquired in anticipation of
      future shipments of this product to customers. Orders for the explosives
      detection product to date have typically been from foreign governments or
      agencies of foreign governments. The sales cycle to these entities can take
      a
      number of months to close the order, set up letters of credit from the customer
      covering the payment, and obtain the necessary export licenses and other
      required documentation. Investing activities used $104,000 of cash primarily
      for
      investment in, or deposits on property and equipment. Financing activities
      used
      cash of $687,000 and consist primarily of $475,000 in cash payments on bank
      loans and capital leases along with $238,000 in cash dividends and payments
      to
      the holders of the Series D preferred stock.





The
      Company currently has a $5.0 million revolving credit facility (the “line of
      credit”) with with Silicon Valley based Bridge Bank, N.A. (the “Bank”). This
      line of credit, which expires in December 2008, provides for advances of up
      to
      eighty percent (80%) of the Company’s eligible accounts receivable and up to the
      lesser of $1,000,000 or forty percent (40%) of eligible inventory, bears
      interest at the prime rate, plus one-half percent (1/2%) per annum, and is
      collateralized by all assets of the Company. In addition, the Company has a
      30-month term loan with the Bank, bearing an interest rate at the prime rate
      plus one percent (1%) per annum payable in thirty (30) equal monthly
      installments of principal, plus all accrued interest beginning on February
      10,
      2007.




Since
      May
      1999, we have been developing several explosive detection systems that could
      be
      used in airports, public and government buildings, and sporting event
      facilities. The
      systems use our proprietary technology, which includes the use of a photon-based
      non-radioactive ion source in combination with ion mobility spectrometry, to
      electronically detect minute quantities of explosive vapor molecules in the
      air.





This
      project is currently being undertaken by both our internal scientists and
      outside contractors. The development of new applications is typically funded
      through government grants or internal funding. Since March 2000, we have
      received seventeen contracts totaling over $12 million for detection of toxic
      chemicals or explosives from agencies such as the Departments of the Army,
      Air
      Force, Marine Corps, Navy and the Department of Homeland Security.





We
      are
      now manufacturing several versions of our explosives detection systems,
      including: (i) a table-top unit, which can be used to screen passengers and
      carry-on baggage in airports and (ii) a portable system, which can be used
      to
      clear buildings, aircrafts, or ships where hidden bombs are believed to exist.
      We are also developing, in conjunction with a contract from the Transportation
      Security Administration, a walk-through passenger portal. We are currently
      selling our portable and bench-top version of these products both domestically
      and internationally. We plan to market these systems to U.S. government agencies
      for use in airports, government buildings and facilities.





We
      are
      currently expending significant resources to develop the next generation of
      our
      current product and to develop new products. Although we continue to fund as
      much research and development as possible through government grants and
      contracts in accordance with the provisions of the respective grant awards
      we
      will require additional funding in order to continue the advancement of the
      commercial development and manufacturing of the explosives detection system.
      We
      will attempt to obtain such financing by: (i) government grants, (ii) private
      financing, or (iii) strategic partnerships. However, there can be no assurance
      that we will be successful in our attempts to raise such additional
      financing.





Consistent
      with our policy to protect our proprietary technologies, we have been awarded
      six patents and have submitted an additional five patent applications to the
      United States Patent and Trademark Office. These patents and applications will
      cover specific design configurations that are responsible for our improved
      vapor
      detection sensitivity.





We
      will
      require substantial funds for further research and development, regulatory
      approvals and the marketing of our explosives detection products. Our capital
      requirements depend on numerous factors, including but not limited to, the
      progress of our research and development programs; the cost of filing,
      prosecuting, defending and enforcing any intellectual property rights; competing
      technological and market developments; changes in our development of
      commercialization activities and arrangements; and the hiring of additional
      personnel and capital equipment.





Based
      on
      the current sales, expense and cash flow projections, including cash flows
      generated from the sale of our Accurel subsidiary in May 2007, the Company
      believes that the current level of cash and cash-equivalents on hand, the net
      proceeds from its revolving line of credit, cash from operations and the funds
      remaining on a contract received from the U.S. Army in August 2006, will be
      sufficient to fund operations for the next twelve months. However, because
      there
      can be no assurances that sales will materialize as forecasted, management
      will
      continue to closely monitor and attempt to control costs at the Company and
      will
      continue to actively seek the needed capital through government grants and
      awards, strategic alliances, private financing sources, the sale of assets
      and
      through its lending institutions. Future expenditures for research and product
      development, especially relating to outside testing, are discretionary and,
      accordingly, can be adjusted, as can certain selling, general and administrative
      expenses, based on the availability of cash. The financial statements do not
      include any adjustments relating to the recoverability and classification of
      asset amounts or the amounts and classification of liabilities that might be
      necessary should the Company be unable to continue as a going
      concern.





18


The
      Company’s future minimum payments under contractual obligations related to
      capital leases, operating leases and term notes as of September 30, 2007 are
      as
      follows:





**Debt
                and Capital**
              **Lease(1)**
            
            **Operating
                Lease(1)(2)**
            
            **MED-TEC**
            
            **Total**2008
            
            $
                2,071,000
            
            $
                1,105,000
            
            $
                167,000
            
            $
                3,343,0002009
            
            2,618,000
            
            1,201,000
            
            -
            
            3,819,0002010
            
            15,000
            
            578,000
            
            -
            
            593,0002011
            
            2,000
            
            84,000
            
            -
            
            86,000Total
            
            $
                4,706,000
            
            $
                2,968,000
            
            $
                167,000
            
            $
                7,841,000




(1)
      Payments include
      interest


(2)
      Adjusted for
      sublease





*Critical
      Accounting Policies*




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





****


**ITEM
      3.**  **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**





The
      Company’s financial instruments include cash and cash equivalents. Cash and cash
      equivalents include cash on hand, demand deposits and short-term investments
      with maturities of three months or less when acquired. Cash equivalents
      represent a deposit in a money market account. The Company does not utilize
      derivative financial instruments, derivative commodity instruments or other
      market risk sensitive instruments, positions or transactions in any material
      fashion. The principal objective of the Company’s asset management activities is
      to maximize net investment income, while maintaining acceptable levels of
      interest rate risk and facilitating its funding needs. At September 30, 2007,
      the carrying values of the Company’s financial instruments approximated fair
      values based upon current market prices and rates.





**ITEM
      4. CONTROLS AND PROCEDURES**





EVALUATION
      OF OUR DISCLOSURE CONTROLS AND INTERNAL CONTROLS




As
      of the
      end of the period covered by this quarterly report, we evaluated the
      effectiveness of the design and operation of our disclosure controls and
      procedures ("Disclosure Controls") and our internal controls and procedures
      for
      financial reporting ("Internal Controls"). This evaluation (the "Controls
      Evaluation") was done under the supervision and with the participation of our
      management, including our Chief Executive Officer ("CEO") and Chief Financial
      Officer ("CFO"). Rules adopted by the SEC require that in this section of the
      Quarterly Report, we present the conclusions of our CEO and the CFO about the
      effectiveness of our Disclosure Controls and Internal Controls based on and
      as
      of the date of the Controls Evaluation.





CEO
      AND
      CFO CERTIFICATIONS




Appearing
      as exhibits to this Quarterly Report are "Certifications" of the CEO and the
      CFO. The Certifications are required pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (the "Section 302 Certifications"). This section
      of
      the Quarterly Report contains information concerning the Controls Evaluation
      referred to in the Section 302 Certifications and this information should be
      read in conjunction with the Section 302 Certifications for a more complete
      understanding of the topics presented.





DISCLOSURE
      CONTROLS AND INTERNAL CONTROLS




Disclosure
      Controls are procedures that are designed with the objective of ensuring that
      information required to be disclosed in our reports filed under the Securities
      Exchange Act of 1934 ("Exchange Act"), such as this Quarterly Report, is
      recorded, processed, summarized and reported within the time periods specified
      in the SEC's rules and forms. Disclosure Controls are also designed with the
      objective of ensuring that such information is accumulated and communicated
      to
      our management, including the CEO and CFO, as appropriate, to allow timely
      decisions regarding required disclosure. Internal Controls are procedures which
      are designed with the objective of providing reasonable assurance that (1)
      our
      transactions are properly authorized, recorded and reported; and (2) our assets
      are safeguarded against unauthorized or improper use, to permit the preparation
      of our financial statements in conformity with generally accepted accounting
      principles.





19


LIMITATIONS
      ON THE EFFECTIVENESS OF CONTROLS




Our
      management, including the CEO and CFO, has concluded that our disclosure
      controls and procedures are designed to provide reasonable assurance of
      achieving their objectives and have concluded that the controls and procedures
      are effective at that reasonable assurance level.





SCOPE
      OF
      THE CONTROLS EVALUATION




The
      CEO/CFO evaluation of our Disclosure Controls and Internal Controls included
      a
      review of the controls' objectives and design, the controls’ implementation by
      us and the effect of the controls on the information generated for use in this
      Quarterly Report. In the course of the Controls Evaluation, management sought
      to
      identify data errors, controls problems or acts of fraud and to confirm that
      appropriate corrective action, including process improvements, were being
      undertaken. This type of evaluation will be done on a quarterly basis so that
      the conclusions concerning controls effectiveness can be reported in our
      Quarterly Reports on Form 10-Q and Annual Report on Form 10-K. The overall
      goals
      of these various review and evaluation activities are to monitor our Disclosure
      Controls and Internal Controls and to make modifications as necessary; our
      intent in this regard is that the Disclosure Controls and the Internal Controls
      will be maintained as dynamic systems that change (including with improvements
      and corrections) as conditions warrant.




Among
      other matters, management sought in its evaluation to determine whether there
      were any "significant deficiencies" or "material weaknesses" in our Internal
      Controls, or whether we had identified any acts of fraud involving personnel
      who
      have a significant role in our Internal Controls. In the professional auditing
      literature, "significant deficiencies" are referred to as “reportable
      conditions;” these are control issues that could have a significant adverse
      effect on the ability to record, process, summarize and report financial data
      in
      the financial statements. A "material weakness" is defined in the auditing
      literature as a particularly serious reportable condition where the internal
      control does not reduce to a relatively low level the risk that misstatements
      caused by error or fraud may occur in amounts that would be material in relation
      to the financial statements and not be detected within a timely period by
      employees in the normal course of performing their assigned
      functions.





Changes
      in Internal Control over Financial Reporting





There
      were no changes to the Company’s internal control over financial reporting
      during the quarter ended September 30, 2007, that has materially affected,
      or
      are reasonably likely to materially affect the Company’s internal control over
      financial reporting.





CONCLUSIONS




Based
      upon the Controls Evaluation, our CEO and CFO have concluded that, as of the
      end
      of the period covered by this quarterly report, our Disclosure Controls are
      effective to provide reasonable assurance that our financial statements are
      fairly presented in conformity with generally accepted accounting principles.




In
      June
      2007, our independent auditors reported to our Audit Committee certain matters
      involving internal controls that our independent auditors considered to be
      a
      significant deficiency. A significant deficiency is a control deficiency or
      combination of control deficiencies, that adversely affects the company’s
      ability to initiate, authorize, record, process, or report external financial
      data reliably in accordance with generally accepted accounting principles such
      that there is more than a remote likelihood that a misstatement of the company’s
      annual or interim financial statements that is more than inconsequential will
      not be prevented or detected.





The
      reportable condition related primarily to the analysis conducted in regards
      to
      the annual goodwill impairment testing.  Management is confident that our
      financial statements for the year ended June 30, 2007 fairly present, in all
      material respects, our financial condition and results of operations.





The
      reportable condition has been discussed in detail among management, our Audit
      Committee and our independent auditors, and we are committed to addressing
      and
      resolving these matters fully and promptly, by putting in place the personnel,
      processes, technology and other resources appropriate to improve the
      communication between our subsidiary and the parent company as well as to
      provide better forecasting models. As part of this commitment, in the second
      quarter of our fiscal year ending June 30, 2008, we will begin by educating
      the
      staff and revising the internal forecasting and reporting procedures to ensure
      that changes are provided in a timely manner to management. Management will
      continue to evaluate these procedures to improve the process.





20


**PART
      II**  **OTHER
      INFORMATION**





**Item
      1.**   **Legal
      Proceedings**





On
      March
      23, 2005, we entered into a Development, Distribution and Manufacturing
      Agreement (the “Rapiscan Agreement”) with Rapiscan Systems, Inc.
      (“Rapiscan”).  Under the terms of this agreement, we gave Rapiscan the
      exclusive worldwide rights to market our Quantum Sniffer TM portable
      and benchtop trace detection devices under their private label.  We also
      agreed to give Rapiscan the exclusive worldwide rights to distribute certain
      other new security products which we may develop in the future with their
      funding, as well as rights, in some circumstances, to manufacture certain
      components of the private-labeled Quantum Sniffer TM portable
      and benchtop trace detection devices.





On
      March
      23, 2006, Rapiscan filed a complaint against the Company and its contract
      assembler, Columbia Tech, in the United States District Court for the Central
      District of California, regarding the Rapiscan Agreement.  Rapiscan’s
      complaint against the Company is based upon claims of breach of contract and
      breach of warranty and is requesting a decree for specific performance,
      declaratory relief and injunctive relief. Rapiscan’s complaint against Columbia
      Tech is based upon injunctive relief, declaratory relief and tortuous
      interference with contractual relations. On April 12, 2006, Rapiscan dismissed
      all claims against Columbia Tech.





On
      March
      24, 2006, the Company brought suit in the United States District Court in the
      District of Massachusetts against Rapiscan and its parent, OSI Systems, Inc.
      (“OSI”). The Company is requesting rescission of the Rapiscan Agreement, plus
      damages, based on claims of misrepresentation. In the alternative, the Company
      is seeking termination of the Rapiscan Agreement due to material breaches of
      contract and the implied covenant of good faith and fair dealing and for damages
      due to Rapiscan’s breach of contract and the implied covenant of good faith and
      fair dealing.





In
      August
      2006, as a result of motions made by both parties, the two lawsuits have been
      consolidated in the United States District Court for the Central District of
      California with the Company as plaintiff. In late 2006, Rapiscan and OSI filed
      a
      motion to dismiss certain of the Company’s claims. The court dismissed Company’s
      claim of breach of fiduciary duty, but the motion to dismiss was denied in
      all
      other respects. The parties are presently near the end of the discovery process,
      which should be completed in early December 2007. OSI and Rapiscan have filed
      four motions for partial summary judgment with respect to certain discrete
      claims. Two of the motions were denied in their entirety. The third was denied
      in the only material respect and granted in two immaterial respects. The fourth
      motion is scheduled to be heard in late November 2007. Trial is expected in
      early 2008.





Should
      the Company be unsuccessful in prosecuting this matter, it may have a material
      adverse effect on its business and results of operations. No
      revenue has been recorded related to the Rapiscan Agreement.





We
      may,
      from time to time, be involved in other actual or potential proceedings that
      we
      consider to be in the normal course of our business. We do not believe that
      any
      of these proceedings will have a material adverse effect on our
      business.





**Item
      1a**   **Risk
      Factors**





An
      investment in our securities involves a high degree of risk. There have been
      no
      material changes to the risk factors previously disclosed in the Company's
      Annual Report on Form 10-K for the fiscal year ended June 30, 2007. You should
      consider carefully all of the material risks described in the Form 10-K,
      before making a decision to invest in our securities. If any of the events
      described therein occur, our business, financial conditions and results of
      operations may be materially adversely affected. In that event, the trading
      price of our securities could decline, and you could lose all or part of your
      investment.







**Item
      2.**   **Unregistered
      Sales of Equity Securities and Use of Proceeds**





Not
      applicable.





**Item
      3.**   **Defaults
      Upon Senior Securities**





Not
      applicable.




**Item
      4.**   **Submission
      of Matters to a Vote of Security Holders**





Not
      applicable.





**Item
      5.**   **Other**




None





21


**Item
      6.**   **List
      of Exhibits and Reports**








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




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

















22


SIGNATURES





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





Implant
      Sciences
      Corporation





Date:
      November 14, 2007 /s/Phillip
      C. Thomas


Phillip
      C. Thomas


President
      and
      CEO










November
      14, 2007 /s/
      Diane J. Ryan


Diane
      J.
      Ryan


Chief
      Financial
      Officer