UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-QSB

|(Mark One)                                                    |                                                                                          
|------------------------------------------------------------- | -----------------------------------------------------------------------------------------
|ý                                                             | Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934. 
|For the quarterly period ending September 30, 2004           
|or                                                           
|o                                                             | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
|For the transition period
from                             to

Commission file number 000-25839

IMPLANT SCIENCES CORPORATION(Exact name of registrant as specified in its charter)

|Massachusetts(State or other jurisdiction of incorporation or organization)                      |  | 04-2837126(IRS Employer Identification No.)
|------------------------------------------------------------------------------------------------ |  | -------------------------------------------
|107 Audubon Road, #5, Wakefield, MA(Address of principal executive offices)                      |  | 01880(Zip Code)                            
|781-246-0700(Issuers telephone number)                                                          
|Not Applicable(Former name, former address and former fiscal year, if changed since last report)

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 ý    No o

Indicate the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date:

|Class                        |  | Outstanding at October 29, 2004
|---------------------------- |  | -------------------------------
|Common Stock, $.10 par value |  | 8,939,288                      

Transitional
small business disclosure format (check one):
Yes o    No ý

This document consists of 24 pages.

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IMPLANT SCIENCES CORPORATION  INDEX

|                              |  |                                                                                                       |  | Page No.
|----------------------------- |  | ----------------------------------------------------------------------------------------------------- |  | --------
|PART I. FINANCIAL INFORMATION
|Item 1.                       |  | Financial Statements:                                                                                 |  |         
|                              |  | Condensed Balance Sheets as of September 30, 2004 (unaudited) and June 30, 2004                       |  | 3       
|                              |  | Condensed Statements of Operations for the Three Months Ended September 30, 2004 and 2003 (unaudited) |  | 4       
|                              |  | Condensed Statements of Cash Flows for the Three Months Ended September 30, 2004 and 2003 (unaudited) |  | 5       
|                              |  | Notes to Condensed Financial Statements (unaudited)                                                   |  | 7       
|Item 2.                       |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                 |  | 15      
|Item 3.                       |  | Controls and Procedures                                                                               |  | 22      
|PART II. OTHER INFORMATION   
|Item 1.                       |  | Legal Proceedings                                                                                     |  | 23      
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                             |  | 23      
|Item 3.                       |  | Defaults Upon Senior Securities                                                                       |  | 23      
|Item 4.                       |  | Submission of Matters to a Vote of Security-Holders                                                   |  | 23      
|Item 5.                       |  | Other Information                                                                                     |  | 23      
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                      |  | 23      
|                              |  | Signatures                                                                                            |  | 24      

2

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IMPLANT SCIENCES CORPORATION        CONDENSED BALANCE SHEETS

|                                                         |                                                                                                                                                                     | September 30,
2004 |                                            | June 30,
2004 |  
|-------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------ | ------------------------------------------ | ------------- | -
|
|ASSETS                                                   |                                                                                                                                                                     |                    |                                            |               |  
|Current assets:                                          |                                                                                                                                                                     |                    |                                            |               |  
|                                                         | Cash and cash equivalents                                                                                                                                           |                    | $                                          | 5,944,000     |  
|                                                         | Accounts receivable, less allowance of $141,000 and $89,000, respectively                                                                                           |                    |                                            | 1,841,000     |  
|                                                         | Accounts receivable, unbilled                                                                                                                                       |                    |                                            | 1,191,000     |  
|                                                         | Inventories                                                                                                                                                         |                    |                                            | 489,000       |  
|                                                         | Investmentsavailable for sale securities                                                                                                                           |                    |                                            | 295,000       |  
|                                                         | Prepaid expenses and other current assets                                                                                                                           |                    |                                            | 110,000       |  
|                                                         |                                                                                                                                                                     |                    |                                            |               |  
|                                                         |                                                                                                                                                                     |                    | Total current assets                       |               |  
|Property and equipment, net                              |                                                                                                                                                                     |                    | 4,222,000                                  |               |  
|Amortizable intangible assets, net                       |                                                                                                                                                                     |                    | 521,000                                    |               |  
|Investment in unconsolidated subsidiary                  |                                                                                                                                                                     |                    | 88,000                                     |               |  
|Other non-current assets                                 |                                                                                                                                                                     |                    | 173,000                                    |               |  
|                                                         |                                                                                                                                                                     |                    |                                            |               |  
|                                                         |                                                                                                                                                                     |                    | Total assets                               |               | $
|                                                         |                                                                                                                                                                     |                    |                                            |               |  
|LIABILITIES AND STOCKHOLDERS' EQUITY                     |                                                                                                                                                                     |                    |                                            |               |  
|Current liabilities:                                     |                                                                                                                                                                     |                    |                                            |               |  
|                                                         | Payable to Med-Tec                                                                                                                                                  |                    |                                            | 404,000       |  
|                                                         | Current maturities of long-term debt and obligations under capital lease                                                                                            |                    |                                            | 3,000         |  
|                                                         | Accounts payable                                                                                                                                                    |                    |                                            | 956,000       |  
|                                                         | Accrued expenses                                                                                                                                                    |                    |                                            | 717,000       |  
|                                                         | Deferred revenue                                                                                                                                                    |                    |                                            |              |  
|                                                         |                                                                                                                                                                     |                    |                                            |               |  
|                                                         |                                                                                                                                                                     |                    | Total current liabilities                  |               |  
|Long-term liabilities:                                   |                                                                                                                                                                     |                    |                                            |               |  
|                                                         | Payable to Med-Tec, net of current maturities                                                                                                                       |                    |                                            | 107,000       |  
|                                                         | Long-term debt and obligations under capital lease, net of current maturities                                                                                       |                    |                                            | 5,000         |  
|                                                         |                                                                                                                                                                     |                    |                                            |               |  
|                                                         |                                                                                                                                                                     |                    | Total liabilities                          |               |  
|                                                         |                                                                                                                                                                     |                    |                                            |               |  
|Convertible preferred stock: 5,000,000 shares authorized |                                                                                                                                                                     |                    |                                            |               |  
|                                                         | 5% Series C Cumulative Redeemable Convertible Preferred Stock; $10 stated value; 250,000 shares designated; 82,115 and 131,875 issued and outstanding, respectively |                    |                                            | 413,000       |  
|Stockholders' equity:                                    |                                                                                                                                                                     |                    |                                            |               |  
|                                                         | Common stock, $0.10 par value; 20,000,000 shares authorized; 8,575,851 and 8,370,338 shares issued and outstanding, respectively                                    |                    |                                            | 858,000       |  
|                                                         | Treasury Stock, 9,103 and 3,103 common shares, repectively, at cost                                                                                                 |                    |                                            | (88,000       | )
|                                                         | Additional paid-in capital                                                                                                                                          |                    |                                            | 32,847,000    |  
|                                                         | Accumulated deficit                                                                                                                                                 |                    |                                            | (21,002,000   | )
|                                                         | Deferred compensation                                                                                                                                               |                    |                                            | (529,000      | )
|                                                         | Accumulated other comprehensive income                                                                                                                              |                    |                                            | 183,000       |  
|                                                         |                                                                                                                                                                     |                    |                                            |               |  
|                                                         | Total stockholders' equity                                                                                                                                          |                    |                                            | 12,269,000    |  
|                                                         |                                                                                                                                                                     |                    |                                            |               |  
|                                                         |                                                                                                                                                                     |                    | Total liabilities and stockholders' equity |               | $
|                                                         |                                                                                                                                                                     |                    |                                            |               |  

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

3

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IMPLANT SCIENCES CORPORATION        CONDENSED STATEMENTS OF OPERATIONS        (Unaudited)

|                                                                        |                                                                                                                                                                              | Three Months Ended
September 30, |                         
|----------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------- | ------------------------
|
|Revenues:                                                               |                                                                                                                                                                              |                                  |                         
|                                                                        | Medical                                                                                                                                                                      |                                  | $                       
|                                                                        | Semiconductor                                                                                                                                                                |                                  |                         
|                                                                        | Explosives detection                                                                                                                                                         |                                  |                         
|                                                                        |                                                                                                                                                                              |                                  |                         
|                                                                        |                                                                                                                                                                              |                                  | Total revenues          
|                                                                        |                                                                                                                                                                              |                                  |                         
|Costs of revenues:                                                      |                                                                                                                                                                              |                                  |                         
|                                                                        | Cost of medical revenues                                                                                                                                                     |                                  |                         
|                                                                        | Cost of semiconductor revenues                                                                                                                                               |                                  |                         
|                                                                        | Cost of explosives detection revenues                                                                                                                                        |                                  |                         
|                                                                        |                                                                                                                                                                              |                                  |                         
|                                                                        |                                                                                                                                                                              |                                  | Total costs of revenues 
|                                                                        |                                                                                                                                                                              |                                  |                         
|Gross margin                                                            |                                                                                                                                                                              |                                  | 468,000                 
|                                                                        |                                                                                                                                                                              |                                  |                         
|Operating expenses:                                                     |                                                                                                                                                                              |                                  |                         
|                                                                        | Research and development (includes $38,000 and $40,000 of non-cash stock-based compensation for the three months ended September 30, 2004 and 2003, respectively)            |                                  |                         
|                                                                        | Selling, general and administrative (includes $25,000 and $64,000 of non-cash stock-based compensation for the three months ended September 30, 2004 and 2003, respectively) |                                  |                         
|                                                                        |                                                                                                                                                                              |                                  |                         
|                                                                        |                                                                                                                                                                              |                                  | Total operating expenses
|                                                                        |                                                                                                                                                                              |                                  |                         
|Loss from operations                                                    |                                                                                                                                                                              |                                  | (1,172,000              
|                                                                        |                                                                                                                                                                              |                                  |                         
|Other income (expense):                                                 |                                                                                                                                                                              |                                  |                         
|                                                                        | Interest income                                                                                                                                                              |                                  |                         
|                                                                        | Interest expense                                                                                                                                                             |                                  |                         
|                                                                        | Loss on sale of equipment                                                                                                                                                    |                                  |                         
|                                                                        | Equity losses in unconsolidated subsidiaries                                                                                                                                 |                                  |                         
|                                                                        |                                                                                                                                                                              |                                  |                         
|                                                                        |                                                                                                                                                                              |                                  | Total other expense, net
|                                                                        |                                                                                                                                                                              |                                  |                         
|Net loss                                                                |                                                                                                                                                                              |                                  | (1,191,000              
|Preferred distribution, dividends and accretion                         |                                                                                                                                                                              |                                  | (284,000                
|                                                                        |                                                                                                                                                                              |                                  |                         
|Net loss applicable to common shareholders                              |                                                                                                                                                                              | $                                | (1,475,000              
|                                                                        |                                                                                                                                                                              |                                  |                         
|Net loss per share applicable to common shareholders, basic and diluted |                                                                                                                                                                              | $                                | (0.17                   
|                                                                        |                                                                                                                                                                              |                                  |                         
|Weighted average common shares outstanding, basic and diluted           |                                                                                                                                                                              |                                  | 8,466,559               
|                                                                        |                                                                                                                                                                              |                                  |                         

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

4

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IMPLANT SCIENCES CORPORATION        CONDENSED STATEMENTS OF CASH FLOWS        (Unaudited)

|                                                     |                                                                                                                        | Three Months Ended
September 30,             |                                          
|---------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | -----------------------------------------
|
|Cash flows from operating activities:                |                                                                                                                        |                                              |                                          
|                                                     | Net loss                                                                                                               |                                              | $                                        
|                                                     | Adjustments to reconcile net loss to net cash used in operating activities:                                            |                                              |                                          
|                                                     |                                                                                                                        | Depreciation and amortization                |                                          
|                                                     |                                                                                                                        | Stock-based compensation expense             |                                          
|                                                     |                                                                                                                        | Equity in loss in unconsolidated subsidiary  |                                          
|                                                     |                                                                                                                        | Loss on sale of equipment                    |                                          
|                                                     |                                                                                                                        | Changes in operating assets and liabilities: |                                          
|                                                     |                                                                                                                        |                                              | Accounts receivable                      
|                                                     |                                                                                                                        |                                              | Inventories                              
|                                                     |                                                                                                                        |                                              | Prepaid expenses and other current assets
|                                                     |                                                                                                                        |                                              | Accounts payable                         
|                                                     |                                                                                                                        |                                              | Accrued expenses                         
|                                                     |                                                                                                                        |                                              |                                          
|                                                     |                                                                                                                        |                                              |                                          
|                                                     |                                                                                                                        |                                              |                                          
|Cash flows from investing activities:                |                                                                                                                        |                                              |                                          
|                                                     | Purchases of property and equipment                                                                                    |                                              |                                          
|                                                     | Increase in other non-current assets                                                                                   |                                              |                                          
|                                                     |                                                                                                                        |                                              |                                          
|                                                     |                                                                                                                        |                                              |                                          
|                                                     |                                                                                                                        |                                              |                                          
|Cash flows from financing activities:                |                                                                                                                        |                                              |                                          
|                                                     | Proceeds from issuance of common stock in connection with the exercise of options and the Employee Stock Purchase Plan |                                              |                                          
|                                                     | Proceeds from issuance of Series B preferred stock, net of issuance costs                                              |                                              |                                          
|                                                     | Proceeds from warrant exercises                                                                                        |                                              |                                          
|                                                     | Payments of additional issuance costs relating to private placement                                                    |                                              |                                          
|                                                     | Repayments of long-term debt and capital lease obligations                                                             |                                              |                                          
|                                                     | Acquisition of treasury stock                                                                                          |                                              |                                          
|                                                     |                                                                                                                        |                                              |                                          
|                                                     |                                                                                                                        |                                              |                                          
|                                                     |                                                                                                                        |                                              |                                          
|Net (decrease) increase in cash and cash equivalents |                                                                                                                        |                                              | (962,000                                 
|Cash and cash equivalents, beginning                 |                                                                                                                        |                                              | 6,906,000                                
|                                                     |                                                                                                                        |                                              |                                          
|Cash and cash equivalents, ending                    |                                                                                                                        | $                                            | 5,944,000                                
|                                                     |                                                                                                                        |                                              |                                          
|Supplemental Disclosure of Cash Flow Information:    |                                                                                                                        |                                              |                                          
|                                                     | Interest paid in cash                                                                                                  |                                              | $                                        
|                                                     |                                                                                                                        |                                              |                                          
|Noncash Investing and Financing Activity:            |                                                                                                                        |                                              |                                          
|                                                     | Conversion of Series C Cumulative Preferred stock and accrued dividends into common stock                              |                                              | $                                        
|                                                     |                                                                                                                        |                                              |                                          
|                                                     | Accretion of 5% Series C Cumulative Convertible Preferred stock, dividends, beneficial conversion feature and warrants |                                              | $                                        
|                                                     |                                                                                                                        |                                              |                                          

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

5

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IMPLANT SCIENCES CORPORATION        CONDENSED STATEMENTS OF CASH FLOWS        (Unaudited)

|                                          |                                                                                                                       | Three Months Ended
September 30,
|----------------------------------------- | --------------------------------------------------------------------------------------------------------------------- | --------------------------------
|
|Noncash Investing and Financing Activity: |                                                                                                                       |                                 
|                                          | Issuance of Series B warrants                                                                                         |                                 
|                                          |                                                                                                                       |                                 
|                                          | Noncash beneficial conversion featureSeries B                                                                        |                                 
|                                          |                                                                                                                       |                                 
|                                          | Conversion of Series A Cumulative Convertible Preferred Stock and accrued dividends into common stock                 |                                 
|                                          |                                                                                                                       |                                 
|                                          | Value of amortizable intangible asset acquired in exchange for long term note payable                                 |                                 
|                                          |                                                                                                                       |                                 
|                                          | Accretion of 7% Series A Cumulative Convertible Preferred Stock dividends, beneficial conversion feature and warrants |                                 
|                                          |                                                                                                                       |                                 
|                                          | Accretion of 5% Series B Cumulative Convertible Preferred Stock dividends, beneficial conversion feature and warrants |                                 
|                                          |                                                                                                                       |                                 

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

6

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IMPLANT SCIENCES CORPORATION        NOTES TO CONDENSED FINANCIAL STATEMENTS        September 30, 2004        (Unaudited)

1. Description of Business

Implant Sciences Corporation (the "Company") develops products for the medical device and explosives detection industry using ion implantation and thin film
coatings of radioactive and non-radioactive materials. The Company has received Food and Drug Administration 510(k) clearance to market its I-Plant
Iodine-125 radioactive seed for the treatment of prostate cancer. The Company also has under development interventional cardiology devices and temporary coronary brachytherapy systems for
the prevention of restenosis (reclosure of the artery after balloon angioplasty). The Company also modifies the surface characteristics of orthopedic joint implants to reduce polyethylene wear and
thereby increasing the life of the implant and provides ion implantation of electronic dopants for the semiconductor industry. Additionally, the Company continues to develop explosives detection
systems to be used in the detection of trace residues of explosives. On October 15, 2004, the Company completed the acquisition of Core Systems, Inc., a provider of semiconductor implantation
services, for cash and stock having an aggregate value of $5,250,000 (see Note 14 for further discussion).

2. Interim Financial Statements

The financial information for the three months ending September 30, 2004 and 2003 is unaudited but includes all adjustments (consisting only of normal
recurring adjustments), which management considers necessary for a fair presentation of the financial position at such date and of the operating results and cash flows for these periods. The result of
operations and cash flows for the three months ended September 30, 2004 are not necessarily indicative of results that may be expected for the entire year. The information contained in this
Form 10-QSB should be read in conjunction with our audited financial statements, included in our Form 10-KSB/A No. 1 as of and for the year ending
June 30, 2004 filed with the Securities and Exchange Commission on November 10, 2004. Certain amounts in the prior period financial statements have been reclassified to conform to the
current period's presentation.

3. Stock-based Compensation

The Company accounts for its employee stock-based compensation arrangements under the provisions of Accounting Principal Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," rather than the alternative fair value accounting method provided for under Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation." Under APB 25, when the exercise price of options granted to employees and non-employee directors under the Company's stock option plans equals the market
price of the underlying stock on the date of the grant, no compensation expense is recorded.

The
Company has elected to use the disclosure-only provisions of SFAS No. 123 and SFAS No. 148, "Accounting for Stock-Based CompensationTransition
and Disclosure." Had compensation expense for stock option grants to employees been determined based on the fair value method at the

7

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grant
dates for awards under the stock option plans consistent with the method prescribed by SFAS No. 123, the Company's net loss would have increased to the pro forma amounts indicated as
follows:

Three Months Ended
September 30,2004

2003Net loss applicable to common shareholders, as reported

$
(1,475,000
)
$
(1,198,000
)Add: Stock-based employee compensation expense included in reported net loss applicable to common shareholders, net of tax


59,000


133,000Deduct: Total stock-based employee compensation expense determined under the fair value based method of all awards, net of tax


(213,000
)

(82,000
)Pro forma net loss applicable to common shareholders

$
(1,629,000
)
$
(1,147,000
)Net loss per share applicable to common shareholders, basic and diluted:As reported

$
(0.17
)
$
(0.18
)Pro forma

$
(0.19
)
$
(0.17
)


In
December 2003, the Company issued stock options below fair market value. This amount is being amortized over the life of the options which averages 10 years. During the
quarter ended September 30, 2004, the Company recorded $59,000 in compensation expense related to this transaction.

During
the three months ended September 30, 2004, the Company recorded additional deferred compensation of $143,000 relating to 23,000 warrants issued consultants in exchange for
services to be performed. This amount is being amortized over the vesting period of the warrants, which is three years. During the quarter ended September 30, 2001 the Company recorded $4,000
in compensation expense related to this transaction. The Company estimated the fair value of the common stock warrants using the Black Scholes option pricing control. The Company estimated the fair
value of the warrants using the following input assumptions:

Volatility

65%Dividend yield

0%Risk-free interest rate

3.47%Expected lives

5 years


4. Earnings Per Share

Basic earnings per share is computed based only on the weighted average number of common shares outstanding during the period. Diluted earnings per share is
computed by using the weighted average number of common shares outstanding during the period, plus the dilutive effects of shares issuable through the exercise of stock options (common stock
equivalents) unless their inclusion would

8

---



be
antidilutive. All common stock equivalents were anti-dilutive and excluded from the calculation of weighted average number of common shares outstanding during the period.

5. Comprehensive Income (Loss)

The Company has accumulated other comprehensive income (loss) resulting from the unrealized gain/loss on an investment in marketable equity securities of
CardioTech International Inc. (Note 8) and the recognition of the unrealized gain/loss of the Company's share of CardioTech and Implant Sciences stock owned by CorNova (Note 10)
which is recorded in the stockholders' equity section of the balance sheet. Comprehensive income (loss) is summarized below:

Three Months Ended
September 30,2004

2003Net loss

$
(1,191,000
)
$
(754,000
)Other comprehensive income (loss)


(130,000
)

27,000Comprehensive loss

$
(1,321,000
)
$
(727,000
)


6. Accounts Receivable

Contract revenue under cost sharing research and development agreements is recognized as eligible expenses are incurred. Invoicing of research and development
contracts occurs in accordance with the terms of the contract. Revenue recognized but unbilled is recorded as unbilled accounts receivable. At September 30, 2004, unbilled accounts receivable
represented approximately 39% of total accounts receivable. Generally, there are no prerequisites necessary to bill.

7. Private Placement

On November 25, 2003, the Company issued 250,000 shares of Series C 5% Cumulative Convertible Preferred Stock ("Series C") having a stated value of
$10 per share, pursuant to a Securities Purchase Agreement executed on November 25, 2003 with the Laurus Master Fund, Ltd ("Laurus"). The Company received $2,500,000 in gross proceeds,
less a management and placement agent fee of approximately $125,000, and related transaction costs of approximately $86,000. The terms of the Series C provide for repayment with shares of the
Company's common stock or in cash, pursuant to an amortization schedule. Repayment of the Series C commenced on March 31, 2004. The Company has the sole option to determine whether to
satisfy payment of the monthly amount in full on each repayment date either in cash or in shares of common stock, or a combination of both, unless the closing price of the Company's common stock for
any of the eleven trading day preceding a repayment date was less than $7.35, wherein the Company will be required to pay such monthly amount in cash. If the payment of the monthly amount is made in
common stock, the fixed conversion price is $6.75. The Company also issued to Laurus a warrant to purchase 50,000 shares of common stock at $8.44 per share and 50,000 shares of common stock at $10.13
per share. The Securities Purchase Agreement also provides for a security interest in substantially all of the Company's assets and provides Laurus a right

9

---



of
first refusal on future financing arrangements during the Term of the agreement. In the event Laurus declines to exercise its right of first refusal, it hereby agrees to enter into such
documentation as shall be reasonable requested by the Company in order to subordinate its rights under the Series C to the subsequent financier. The Company utilized the proceeds of this
financing to purchase an ion implanter and for general working capital purposes.

In
accordance with the provisions of Emerging Issues Task Force (EITF) Issue 00-27, "Application of EITF Issue No. 98-5 'Accounting for Convertible
Securities with Beneficial Conversion Features of Contingently Adjustable Conversion Ratios', to Certain Convertible Securities," which became effective in November 2000, the allocated value of
the Series C contained a beneficial conversion feature calculated based on the difference between the effective conversion price of the proceeds allocated to the Series C and the fair
market value of the common stock at the date of issuance. The discount arising from the beneficial conversion feature aggregated $700,000. The discount is being amortized and recorded as a preferred
dividend during the period from the issuance of the preferred stock to the mandatory redemption date of June 1, 2005, or the actual conversion date, whichever is earlier using the effective
interest method.

The
Company valued the Series C at issuance to be $1,284,000 based on the relative fair market values of the financial instruments issued in connection with this placement, net of
offering costs and the beneficial conversion feature. The amounts recorded in the financial statements represent the amounts attributed to the sale of the preferred stock, net cash proceeds of
$2,289,000 ($211,000 of issuance costs incurred), the amount allocated to warrants of $305,000, and the amount of the discount related to the value of beneficial conversion feature of $700,000. The
Company is accreting these discounts on the carrying value of the preferred stock to its redemption value of $2,500,000 at June 1, 2005, 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. During the three month's September 30, 2004,
approximately $241,000 was amortized. As of September 30, 2004, the outstanding principal of the Series C was $821,000.

During
the three months ended September 30, 2004, Laurus redeemed 49,760 shares of Series C into 73,719 shares of the Company's common stock at conversion price of $6.75 per share
and redeemed approximately $79,000 of accrued dividends into 11,647 shares of the Company's common stock. During the three months ended September 30, 2004, the Company accrued approximately
$15,000 of dividends. The conversion of accrued dividends into common stock resulted in additional dividends of approximately $28,000 during the three months ended September 30, 2004, in excess
of 5% stated value.

8. Related Party Transactions

SFAS No. 57, "Related Party Disclosures," specifies the nature of information that should be disclosed in financial statements regarding related party
transactions. CardioTech International, Inc. ("CardioTech") a public company whose common stock trades under the symbol CTE on the American Stock Exchange, is a related party with the Company
by virtue of its significant business relationships.

10

---



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

In
March 2000, the Company entered into a joint research agreement with CardioTech to develop a proprietary porous polymer biocompatible coating technology as a platform for the
Company's proprietary radioactive brachytherapy technology. In consideration for this agreement, the Company agreed to pay $150,000 in cash and purchase 100,000 shares of CardioTech stock at a price
of $1.00 per share. As of September 30, 2004, the fair market value of the 100,000 shares of CardioTech stock is $295,000, which is recorded as investment in available for sale securities in
the accompanying balance sheet.

In
March 2004 the Company entered into an Exchange & Venture Agreement with CardioTech and CorNova, Inc. (Note 10). The Company's CEO and the Chairman of the
Audit Committee are also on the Board of Directors of CorNova.

9. MED-TEC

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 will 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 agreement requires the Company to pay the distributor an average of approximately $39,000 per
month over the 28 months, beginning September 1, 2003. As of September 30, 2004, the outstanding principal balance is approximately $511,000. For the three months ended
September 30, 2004, the Company recorded approximately $15,000 of interest expense relating to this transaction.

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. During the three months ended September 30, 2004 and 2003, approximately $104,000 and $70,000 of amortization expense was recognized,
respectively.

10. Investment in Unconsolidated Subsidiaries

In March 2004, the Company entered into an Exchange & Venture Agreement with CardioTech and CorNova. CorNova is a start-up company
focused on the development and marketing of innovative interventional cardiology products. The Company issued 10,344 shares of common stock bearing an aggregate fair market value of $113,000 as of the
date of issuance. In exchange, the Company received 1,500,000 shares of the CorNova's common stock, which represents a 30% ownership position, and a position on the Board of Directors.

11

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Upon
CorNova securing additional financing, in the minimum amount of $1,000,000 and up to a maximum amount of $3,000,000 (the "Series A Financing"), CardioTech and the Company
will each issue additional shares of their common stock (the "Investment Shares"), where the number of Investment Shares to be issued will be equal to twenty-five percent (25%) of the
gross proceeds of the Series A Financing. As of September 30, 2004, 10,344 shares have been issued, 3,103 of which have been categorized as treasury stock. During the three months ended
September 30, 2004, the Company recognized approximately $11,000 of other expense representing the Company's portion of CorNova's net loss. The Company also recorded approximately $5,000 as an
unrealized loss, which is in
accumulated other comprehensive income for the three months ended September 30, 2004. This unrealized loss relates to the Company's portion of the decline in value of the Contributory Shares issued to
CorNova. The Company is accounting for this investment under the equity method under APB Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock."

11. Bay Area MRI

In March 2004, the Company entered into a consulting agreement with Christopher Lang and Bay Area MRI to assist the Company in the sale of radioactive
prostate seeds. As compensation for consulting services, the Company may be required to pay commissions of up to $600,000 ($300,000 in cash and $300,000 in shares of common stock). During the period
ended September 30, 2004, the Company issued 3,205 shares of restricted common stock, having an aggregate fair market value of approximately $37,500 and advanced $50,000 of cash commissions. As
of September 30, 2004, the commissions earned to date were approximately $6,000. As of September 30, 2004, the Company has determined that it is unlikely that it will receive future
benefits from the unearned stock and cash commissions. Accordingly, the Company has expensed the unearned commission balance of approximately $81,500 during the three month period ended
September 30, 2004. The agreement provides that future commissions will be paid quarterly, up to a maximum of $300,000 in cash and $300,000 of common stock based on services provided.

12. Treasury Stock

In June 2004, the Board authorized the Company to repurchase of up to 300,000 shares of the Company's common stock, from time to time in the open market,
privately negotiated transactions, block transactions or at times and prices deemed appropriate by management. During the three months ended September 30, 2004, the Company repurchased 6,000
shares of common stock at prices ranging from $8.91 to $9.02 per share at a total cost of approximately $54,000, which is recorded as treasury stock in the accompanying balance sheet.

13. Financial Information by Segment

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

12

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chief
operating decision making group is composed of the chief executive officer and members of senior management. The Company's reportable segments are: Medical, Semiconductor and Explosives.

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 and expenses related to these segments for the three months ended September 30, 2004 and 2003, respectively, are:

|             |  | Three Months Ended September 30, 2004 |         
|------------ |  | ------------------------------------- | --------
|
|Revenue      |  | $                                     | 960,000 
|COGS         |  |                                       | (797,000
|             |  |                                       |         
|Gross Margin |  | $                                     | 163,000 
|             |  |                                       |         

|             |  | Three Months Ended September 30, 2003 |          
|------------ |  | ------------------------------------- | ---------
|
|Revenue      |  | $                                     | 1,157,000
|COGS         |  |                                       | (825,000 
|             |  |                                       |          
|Gross Margin |  | $                                     | 332,000  
|             |  |                                       |          

14. Subsequent Event

On October 13, 2004, the Company entered into a definitive agreement to acquire all of the capital stock of Core Systems Incorporated ("Core"), a
California corporation. The transaction is being structured as a reorganization of Core with and into a newly formed, wholly-owned subsidiary of the Company. As part of the Transaction, the Company
issued to the former stockholders of Core consideration consisting of shares of the Company's common stock, par value $0.10 per share equal in value to $3,250,000 ("Stock Consideration"), and
$2,000,000 in cash ("Cash Consideration").

On
October 15, 2004 ("Closing Date"), the Company completed the acquisition of Core. In connection with the Transaction, the Company issued 311,437 shares of its common stock as
the Stock Consideration and $2,000,000 in cash, to the former Core stockholders.

The
holders of the shares of common stock comprising the Stock Consideration have agreed not to sell any of their shares of common stock for a period of six months from the Closing Date.
Pursuant to the terms of the merger agreement, the shares of common stock comprising the Stock Consideration will be adjusted in the event the Company's stock price at the end of the
lock-up period is either greater than twenty-five percent higher or lower than $10.4355 per share. In addition, the merger agreement includes an earnout provision equal to
Core's earnings before taxes, depreciation and amortization for the twelve month period beginning on October 13, 2004, the execution date of the merger agreement, and ending on
October 12, 2005, which will be paid in the form of additional shares of the Company's common stock. The number of shares to be issued in connection with the earnout, if

13

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any,
will be calculated by dividing the dollar amount of the earnout by the twenty day average closing price of the Company's common stock prior to the end of the earnout Period. The earnout shares
will also be subject to a six month lock-up, beginning on October 13, 2005, and will be adjusted in the event the Company's stock price is either greater than
twenty-five percent higher or lower than the earnout share price at the end of the earnout lock-up period. The Company has agreed to use its "best-efforts" to
file a registration statement with the Securities and Exchange Commission, registering the resale of all of the shares of common stock included in the Stock Consideration within six months from
the Closing Date.

Additionally,
pursuant to the terms of the merger agreement, ten percent of each of the Stock Consideration and the Cash Consideration has been heldback by the Company, pursuant to a
holdback agreement, for a period of twelve months from the Closing Date for the purpose of settling any undisclosed liabilities that may be discovered by the Company during the Holdback Period, for
indemnification of any breach of the representations and warranties made by Core and its primary stockholder, and for other potential expenses related to the transaction.

14

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following management discussion and analysis should be read in conjunction with the financial statements and notes thereto as filed in our
Form 10-KSB/A No. 1 for the year ended June 30, 2004. In addition to historical information, this Form 10-QSB contains forward-looking statements.
The forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. Readers are
cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof. We undertake no obligation to revise or publicly release the
results of any revision to these forward-looking statements. Readers should carefully review documents that we file from time to time with the Securities and Exchange Commission, including our
Quarterly Reports and Annual Reports filed by us in fiscal 2003 and 2004.

OVERVIEW

Over the past twenty years, Implant Sciences Corporation has developed core technologies using ion implantation and thin film coatings for medical device
applications and has proprietary processes and equipment for the manufacture of medical devices for radiation therapy. This technology has been applied to the manufacture of our I-Plant radioactive
prostate seeds using a dry fabrication process which we believe is more cost-effective and less hazardous than conventional processes which use radioactive wet chemistry. We believe that the
opportunities for radioactive prostate seeds will continue to grow as an attractive alternative to other methods of treatment. We have expanded our radiation therapy products to include a radiation
delivery system, currently under development, to provide breast cancer treatment using accelerated partial breast irradiation therapy. We believe this system will become the treatment of choice for
women following lumpectomy. The Company is also developing a new device for the treatment of ocular melanoma using brachytherapy, which we believe will provide a better distribution of radiation
within the tumor while providing less discomfort for the patient. The Company also has numerous other radiation therapy devices in various stages of development including devices for biliary duct
cancer, brain cancer and intravascular radiation therapy.

We
are also applying our ion implantation technologies to modify surfaces to reduce polyethylene wear generation in orthopedic joint implants, manufactured by the Stryker-Orthopaedics
Division of Stryker Corporation. We also supply ion implantation services to numerous semiconductor manufacturers, research laboratories and universities.

Since
May 1999, we have been performing research to develop a trace explosives detector, which could be used to detect hidden bombs in airports and other public places. This
technology is yet another application of our ion source technology. At present we continue developing both portable and bench-top systems for the use in airports and Department of Defense facilities.
Prototype units have been transported to the Department of Defense and Department of Transportation facilities for demonstration and evaluation. The Company has begun manufacturing of its trace
detection devices and continues to make a significant financial commitment to this project. We currently have one issued United States patent and seven United States patents pending covering these
technologies and processes.

Implant
Sciences Corporation, operates out of a 51,000 square foot leased facility in Wakefield, Massachusetts and since October 15, 2004, in Sunnyvale, CA. The Company has
approximately 80 employees and runs three shifts.

15

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Results of Operations

Comparison for the three months ended September 30, 2004 and 2003

Revenue.Total revenues for the three months ended September 30, 2004, were $2,274,000 as compared to $1,636,000 for
the comparable prior year period, an increase of $638,000 or 39%. The increase is primarily attributable to the revenue recognized from our explosives detection contracts. In the quarter ended
September 30, 2004 revenue from explosives detection technology increased by $796,000 or 432% over the same prior year period. This increase was a combination of government contract revenue and
the completion of our initial manufacturing orders. In addition, our semiconductor revenue increased by $39,000 or 13% in the period ended September 30, 2004 as compared with the comparable
prior year period. This increase in semiconductor revenue is a result of the additional processing being completed on our new MC3 implanters.

These
increases were partially offset by a decline in our medical revenues of $197,000 or 17% in the period ended September 30, 2004 as compared with the comparable prior year
period. Sales to our medical coating customers increased by $121,000 or 32%. This increase was offset by a decline in the sales of our radioactive prostate seeds. Revenue from the sale of our
Iodine-125 radioactive prostate seed was $359,000 as compared with $631,000, a decrease of $272,000 or 43%. The decrease is primarily attributed to a decrease in seed volume; however it
was partially offset by an increase in the average seed price, a result of the value added items offered to our customers.

In
the first quarter of fiscal 2004, we entered into a new agreement with MED-TEC, our former exclusive distributor of I-Plant prostate seeds to replace the
original Distributor Agreement, which had expired. Management believes this direct marketing and sales program will enable the Company to expand distribution channels targeting the radiation oncology
market. MED-TEC agreed to work cooperatively with the Company to transition its customers and marketing materials directly to Implant Sciences and MED-TEC also agreed not to
compete with the Company for a period of three years. Implant Sciences is paying MED-TEC an average of approximately $39,000 per month over a period of 29 months, beginning
September 1, 2003. As of September 30, 2004, the outstanding principal balance is approximately $511,000.

In
addition, revenue generated from medical related government contracts declined by $46,000 or 32% in the period ended September 30, 2004 as compared with 2003, as certain
contracts were completed. Our revenues recognized from Small Business Innovative Research (SBIR) programs, fluctuate due to: (a) our desire to obtain external funding for our research and
development efforts; (b) the availability of government funding; and (c) the time required to obtain approval of a grant application. We have been successful in obtaining SBIR grants in
fiscal 2004 and 2003 and we expect to continue to seek continuation or replacement of our existing SBIR grants during fiscal 2005 and beyond.

Cost of Sales.Cost of sales for the three months ended September 30, 2004 was $1,806,000 as compared to $1,160,000
for the comparable prior year period, an increase of $646,000 or 56%. Cost of medical related revenue for the period ended September 30, 2004, was $797,000 as compared with $825,000 for the
prior year period, a decrease of $28,000 or 3%. This decrease was offset by semiconductor revenue costs of $371,000 as compared with $257,000 in the comparable prior year period. This increase of
$114,000 or 44% is a result of additional labor and material expenses needed to support the increased semiconductor revenue combined with the additional non-cash depreciation expense
relating to the installation of the new MC3 ion implanters. Costs of explosives detection revenue increased by $560,000 or 718% in the period ended September 30, 2004 as compared the comparable
prior year period. This increase in costs relates to the additional labor and materials needed to support the increase in explosives detection revenue.

16

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Research and DevelopmentResearch and development expense for the three months ended September 30, 2004 was $586,000
as compared to $482,000 for the comparable prior year period, an increase of
$104,000 or 22%. This increase is primarily the result of continued development work in the areas of explosives and toxic substance detection, temporary brachytherapy and radioactive prostate seed
product compliments.

Selling, General and Administrative.Selling, general and administrative expenses for the three months ended
September 30, 2004 were $1,054,000 as compared to $706,000 for the comparable prior year period, an increase of $348,000 or 49%. Selling, general and administrative expenses included $25,000
and $64,000 of noncash stock-based compensation recorded in connection with the issuance of stock to employees and warrants to an outside agents, and depreciation and amortization expenses of $112,000
and $100,000, in the three months ended September 30, 2004 and 2003, respectively. Net of the noncash stock-based compensation, and depreciation and amortization, general and administrative
expenses increased by $375,000 or 70%. This increase reflects a $131,000 increase in bad debt and the addition of $81,000 of commissions related to certain sales agreements with Bay Area MRI,
combined, with increases in our administrative staff. However, management continues to exercise strict cost containment measures to ensure control over our administrative spending.

Other Income and Expenses, Net.For the three month period ended September 30, 2004, we recorded other expense, net of
$19,000 as compared to other expense, net of $42,000 in the comparable prior year period. The decrease in other expenses is a result of increase in interest income combined with the decrease in
interest expense relating to the financing of the new ion implanters with Axcelis Corporation in the period ended September 30, 2004.

Net Loss.Net loss for the three months ended September 30, 2004, was $1,191,000 as compared to $754,000 for the
comparable prior year period, an increase in net loss of $437,000 or 58%.

Additionally,
during the period ended September 30, 2004, accretion of dividends, the beneficial conversion feature and amortization of warrants in the amount of $284,000 relating
to the Series C, was recognized as a preferred distribution, as compared with $444,000 for the Series A and B for the prior year period. The effect of these transactions had no overall
effect on stockholders' equity or cash, but increased net loss per share applicable to common shareholders by $0.03 and $0.07 per share, respectively. The basic and diluted net loss per share
applicable to common shares for the period ended September 30, 2004 was ($0.17) per share as compared to ($0.18) per share for the comparable prior year period, a decrease in net loss
applicable to common shares per share of $0.01 or 6%.

Liquidity and Capital Resources

As of September 30, 2004 we had approximately $5,944,000 in cash in the form of cash and cash equivalents. During the three months ended
September 30, 2004, operating activities used cash of approximately $1,248,000. Net cash used by operating activities primarily reflects the net loss of $1,191,000, an $8,000 increase in
inventory, a $30,000 decrease in prepaid expenses and other current assets, a $378,000 increase in accounts payable, an $18,000 increase in accrued expenses, a $6,000 loss on the sale of equipment and
a $889,000 increase in accounts receivable; offset by depreciation and amortization of $334,000, stock-based compensation expense of $63,000 and equity loss in an unconsolidated subsidiary of $11,000.
During the three months ended September 30, 2004, investing activities used cash of approximately $225,000, primarily attributable to the purchase of property and equipment and investments made
in new acquisitions. During the three months ended September 30, 2004, financing activities provided approximately $511,000 in cash. Net cash provided by financing activities primarily includes
net proceeds from the exercise of stock options and warrants offset by payments on our capital lease, non-compete agreement and equipment financing and the acquisition of treasury stock.

17

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On
November 25, 2003, the Company issued 250,000 shares of Series C 5% Cumulative Convertible Preferred Stock ("Series C") having a stated value of $10 per share, pursuant
to a Securities Purchase Agreement executed on November 25, 2003 with the Laurus Master Fund, Ltd ("Laurus"). The Company received $2,500,000 in gross proceeds, less a management and
placement agent fee of approximately $125,000, and related transaction costs of approximately $86,000. The terms of the Series C provide for repayment with shares of the Company's common stock
or in cash, pursuant to an amortization schedule. Repayment of the Series C commences on March 31, 2004. The Company has the sole option to determine whether to satisfy payment of the
monthly amount in full on each repayment date either in cash or in shares of common stock, or a combination of both, unless the closing price of the Company's common stock for any of the eleven
trading day preceding a repayment date was less than $7.35, wherein the Company will be required to pay such monthly amount in cash. If the payment of the monthly amount is made in common stock, the
fixed conversion price is $6.75. The Company also issued to Laurus a warrant to purchase 50,000 shares of common stock at $8.44 per share and 50,000 shares of common stock at $10.13 per share. The
Securities Purchase Agreement also provides for a security interest in substantially all of the Company's assets and provides Laurus a right of first refusal on future financing arrangements during
the Term of the agreement. In the event Laurus declines to exercise its right of first refusal, it hereby agrees to enter into such documentation as shall be reasonable requested by the Company in
order to subordinate its rights under the Series C to the subsequent financier. The Company will utilize the proceeds of this financing to purchase an ion implanter and for general working
capital purposes.

In
accordance with the provisions of Emerging Issues Task Force (EITF) Issue 00-27, "Application of EITF Issue No. 98-5 'Accounting for Convertible
Securities with Beneficial Conversion Features of Contingently Adjustable Conversion Ratios', to Certain Convertible Securities," which became effective in November 2000, the allocated value of
the Series C contained a
beneficial conversion feature calculated based on the difference between the effective conversion price of the proceeds allocated to the Series C and the fair market value of the common stock
at the date of issuance. The discount arising from the beneficial conversion feature aggregated $700,000. The discount is being amortized and recorded as a preferred dividend during the period from
the issuance of the preferred stock to the mandatory redemption date of June 1, 2005, or the actual conversion date, whichever is earlier using the effective interest method.

The
Company valued the Series C at issuance to be $1,284,000 based on the relative fair market values of the financial instruments issued in connection with this placement, net of
offering costs and the beneficial conversion feature. The amounts recorded in the financial statements represent the amounts attributed to the sale of the preferred stock, net cash proceeds of
$2,289,000 ($211,000 of issuance costs incurred), the amount allocated to warrants of $305,000, and the amount of the discount related to the value of beneficial conversion feature of $700,000. The
Company is accreting these discounts on the carrying value of the preferred stock to its redemption value of $2,500,000 at June 1, 2005, 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. During the period ended September 30, 2004, approximately $241,000 was amortized. As of
September 30, 2004, the outstanding principal of the Series C was $821,000.

During
the three months ended September 30, 2004, Laurus redeemed 49,760 shares of Series C into 73,719 shares of the Company's common stock at conversion price of $6.75 per share
and redeemed approximately $79,000 of accrued dividends into 11,647 shares of the Company's common stock.

We
are developing several explosive detection systems that could be used in airports, public and government buildings, and sporting event facilities. The systems use our proprietary
Laser IMS technology, which includes the use of laser beams in combination with ion mobility spectrometry, to electronically detect minute quantities of explosive vapor molecules in the air. This
project has been

18

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ongoing
since approximately May 1999. In November 2001, we developed a portable prototype and in December 2001 we demonstrated it to the U.S. Department of Transportation.
Following this demonstration, we decided to pursue the technology. At present, we are developing both portable and bench-top systems for use in airports and Department of Defense
facilities. Prototype units have been transported to the Department of Defense and Department of Transportation facilities for demonstration and evaluation.

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. Originally, we funded a research and development program for the electronic detection system to produce enough data to write grant proposals for the Department of Defense to detect
unexploded bombs and mines. Since March 2000, we have received seven contracts totaling $1,789,000 for detection of toxic chemicals or explosives from agencies such as the Departments of the
Army, Air Force, Marine Corps and Navy; as well as the National Institutes of Health and the Department of Homeland
Security. In addition, on August 12, 2002, we signed a Cooperative Research and Development Agreement with an agency of the Department of Homeland Security which will permit us and the
government to exchange critical test data and for us to deliver a certain number of units to the Department of Homeland Security for independent evaluation and field testing.

In
June 2000, we developed our first generation device, which demonstrated sensitivity to the explosive TNT. In June 2001, we developed a second generation prototype with
increased sensitivity and selectivity. This device can detect and specify an increasing number of compounds within various explosive materials. The explosives that have been tested to date are TNT,
RDX, PETN, EGDN, and DNT. RDX is the primary component of C3 and C4 explosives, such as Datasheet and Semtex, as well as certain types of black powder explosives. We believe these explosives represent
the majority of the explosives presently used in terrorist activities. After the attack on the World Trade Center occurred on September 11, 2001, management made the decision to continue the
internal funding of the project rather than await funding through government grants. Our electronic detection system has been subjected to controlled testing by third parties and successfully detected
C4. As a result of the successful demonstration, we believed it was appropriate to further pursue the commercial development of our electronic detection system device.

Consistent
with our policy to protect our proprietary technologies, we have been awarded one patent and submitted seven (7) patent applications to the United States Patent and
Trademark Office. These patent applications will cover specific design configurations that are responsible for our improved vapor detection sensitivity.

We
are developing 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 replace bomb-sniffing dogs to clear buildings, aircrafts, or ships where hidden bombs are
believed to exist. We received $600,000 from the U.S. Navy in November 2002 for further development of the portable device. This device was delivered to the U.S. Navy for testing in
May 2003. Tests were successfully completed and in December 2003, the U. S. Navy awarded the Company an additional $1,300,000 to turn this prototype into a manufacturable unit and
deliver three units for testing. We plan to first market these systems to U.S. government agencies for use in airports, government buildings and facilities.

Although
our operations and spending continue to focus on the sales of our semiconductor, contract manufacturing, medical coatings and prostate seed products, we are currently expending
significant resources in the development of our explosives detection devices. We continue to fund as much research and development as possible through government grants in accordance with the
provisions of the respective grant awards. We will require additional funding in order to advance the commercial development of the explosives detection system. We will attempt to obtain such
financing

19

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by:
(i) government grants, (ii) the exercise of the redeemable common stock purchase warrants, (iii) private financing, or (iv) strategic partnerships. However, there can
be no assurance that we will be successful in our attempts to raise such additional financing.

We
will require substantial funds for further research and development, regulatory approvals and continued expansion of commercial-scale manufacturing capabilities, and the marketing of
our 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 purchase of additional
facilities and capital equipment.

As
of September 30, 2004, we were conducting our operations with approximately $5,944,000 in cash and cash equivalents, $2,000,000 of which was used to acquire Core. We estimate
such amounts combined with our cash flow from operations will be sufficient to fund our working capital in the next twelve months. 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
Company's future minimum payments under contractual obligations related to capital leases, operating leases and term notes as of September 30, 2004 are as follows:

Capital
Leases

Operating
Lease

MED-TEC(1)

TotalYear ending June 30:2005

$
3,000

$
434,000

$
404,000

$
841,0002006


5,000


609,000


107,000


721,0002007





610,000





610,0002008





611,000





611,0002009





306,000





306,000Total

$
8,000

$
2,570,000

$
511,000

$
3,089,000


---

On
June 30, 2004, we entered into an employment agreement with Dr. Anthony J. Armini, the Company's President and CEO, with an initial term of three years and an automatic
renewal for a successive period of three years, unless we or Dr. Armini give the other party not less than three months written notice of non-renewal. Under this employment
agreement, Dr. Armini serves as our president and chief executive officer at a base salary of up to $210,000. In addition, Dr. Armini may participate in our employee fringe benefit plans
or programs generally available to employees of comparable status and position. We are 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 we terminate Dr. Armini's employment without cause, we 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. Armini is subject to a
non-competition provision.

On
June 30, 2004, we entered into an employment agreement 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 we 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 our vice president and chief executive scientist at a base salary of up to $150,000. In addition, Dr. Bunker may participate in our employee
fringe benefit plans or programs generally available to employees of

20

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comparable
status and position. We are 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
we terminate Dr. Bunker's employment without cause, we 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 13, 2004, the Company entered into a definitive agreement to acquire all of the capital stock of Core Systems Incorporated ("Core"), a California corporation. The
transaction is being structured as a reorganization of Core with and into a newly formed, wholly-owned subsidiary of the Company. As part of the Transaction, the Company will issue to the former
stockholders of Core consideration consisting of shares of the Company's common stock, par value $0.10 per share equal in value to $3,250,000 ("Stock Consideration"), and $2,000,000 in cash ("Cash
Consideration").

On
October 15, 2004 ("Closing Date"), the Company completed the acquisition of Core. In connection with the Transaction, the Company issued 311,437 shares of its common stock as
the Stock Consideration and $2,000,000 in cash, to the former Core stockholders.

The
holders of the shares of common stock comprising the Stock Consideration have agreed not to sell any of their shares of common stock for a period of six (6) months from the
Closing Date. Pursuant to the terms of the merger agreement, the shares of common stock comprising the Stock Consideration will be adjusted in the event the Company's stock price at the end of the
lock-up period is either greater than twenty-five percent (25%) higher or lower than $10.4355 per share. In addition, the merger agreement includes an earnout provision equal
to Core's earnings before taxes, depreciation and amortization for the twelve (12) month period beginning on October 13, 2004, the execution date of the merger agreement, and ending on
October 12, 2005, which will be paid in the form of additional shares of the Company's common stock. The number of shares to be issued in connection with the earnout, if any, will be calculated
by dividing the dollar amount of the earnout by the twenty (20) day average closing price of the Company's common stock prior to the end of the earnout Period. The earnout shares will also be
subject to a six (6) month lock-up, beginning on October 13, 2005, and will be adjusted in the event the Company's stock price is either greater than twenty-five
percent (25%) higher or lower than the earnout share price at the end of the earnout lock-up period. The Company has agreed to use its "best-efforts" to file a
registration statement with the Securities and Exchange Commission, registering the resale of all of the shares of common stock included in the Stock Consideration within six (6) months from
the Closing Date.

Additionally,
pursuant to the terms of the merger agreement, ten percent (10%) of each of the Stock Consideration and the Cash Consideration has been heldback by the Company, pursuant to
a holdback agreement, for a period of twelve (12) months from the Closing Date for the purpose of settling any undisclosed liabilities that may be discovered by the Company during the Holdback
Period, for indemnification of any breach of the representations and warranties made by Core and its primary stockholder, and for other potential expenses related to the transaction.

In
June 2004, the Board authorized the Company to repurchase up to 300,000 shares of the Company's common stock, from time to time in the open market, privately negotiated
transactions, block transactions or at times and prices deemed appropriate by management. During the three months ended September 30, 2004, the Company repurchased 6,000 shares of common stock
at prices ranging from $8.91 to $9.02 per share at a total cost of approximately $54,000, which is recorded as treasury stock in the accompanying balance sheet.

Critical Accounting Policies

Our significant accounting policies are described in Note 2 to the financial statements included in Item 7 of our Form 10-KSB/A
No. 1 as of June 30, 2004. Our discussion and analysis of our financial

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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. There has been no change to our critical accounting policies during the quarter ending September 30,
2004.

Item 3. Controls and Procedures

Based on an evaluation of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934), the chief executive officer and chief financial officer have concluded that our disclosure controls and procedures as of the end of the three month period ended
September 30, 2004, are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms and are operating in an effective manner.

Based
upon the Controls Evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this quarterly review, except as described in the following paragraphs,
our Disclosure Controls are effective to ensure that material information relating to our company is made known to management, including the CEO and CFO, particularly during the period when our
periodic reports are being prepared, and that our Internal Controls are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with generally
accepted accounting principles.

However,
during our June 30, 2004 audit, our independent auditors reported to our Audit Committee certain matters involving internal controls that our independent auditors
considered to be a reportable condition, but not a material weakness, under standards established by the American Institute of Certified Public Accountants. The reportable condition relates to the
June 30, 2004 financial close process, including financial statement account analysis. This reportable condition resulted from inadequate staffing and supervision over the review and financial
statement close function. The reportable condition lead, in the audit process, to the identification and resolution of accounting matters and substantiation and evaluation of certain account balances
and financial information. In connection with our review of our quarterly financial statements our independent auditor informed us that this reportable condition still existed.

The
reportable condition had 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 support our financial close processes. As part of this commitment, we have begun the
process to identify and hire additional personnel to assist with the financial close process. We have hired an outside consultant to identify and screen potential candidates for this position and have
begun the interview process.

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PART II: OTHER INFORMATION

Item 1. Legal Proceedings

Not Applicable

Item 2. Changes in Securities and Use of Proceeds

During the three months ended September 30, 2004, Laurus redeemed 49,760 shares of Series C into 73,719 shares of the Company's common stock at conversion
price of $6.75 per share and redeemed approximately $79,000 of accrued dividends into 11,647 shares of the Company's common stock. During the three months ended September 30, 2004, the Company
accrued approximately $15,000 of dividends. The conversion of accrued dividends into common stock resulted in additional dividends of approximately $28,000 during the three months ended
September 30, 2004, in excess of 5% stated value.

Item 3. Defaults Upon Senior Securities

Not Applicable

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

Not Applicable

Item 5. Other Information

Not Applicable

Item 6. Exhibits and Reports on Form 8-K





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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 16, 2004 |  | /s/ANTHONY J. ARMINIAnthony J. Armini
President and CEO
|Date: November 16, 2004 |  | /s/DIANE J. RYANDiane J. Ryan
Chief Financial Officer  

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