UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





[X]  Quarterly
report pursuant to section 13 or 15(d) of the Securities Exchange Act of
1934. For the
quarterly period ending March 31, 2008.





[
]  Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the
transition period from _____to_____.





Commission
file number 000-25839





IMPLANT SCIENCES
CORPORATION


(Exact
name of registrant as specified in its charter)





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


781-246-0700


(Registrant’s
Telephone Number, Including Area Code)





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





Title of
Each
Class                                                                        Name of
Each Exchange on Which Registered


Common Stock, $.10 par
value                                                                 
                 American Stock
Exchange








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


YESX     NO ___





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large Accelerated Filer
____     Accelerated Filer
____ Non-Accelerated
Filer ____        Smaller Reporting
Company  X


(do
not check if a smaller reporting company)






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


YES ___
NO X




The
aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $12,725,000 as of May 13 2008 (based on the closing
price for such stock as of May 13, 2008).





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




Class                                     
Outstanding at May 13,
2008


Common Stock, $.10
par
value                                                              12,114,553





IMPLANT
SCIENCES CORPORATION





INDEX





Page
      No.PART
      I.  FINANCIAL INFORMATIONItem
      1.
            Financial
      Statements (unaudited):Condensed
      Consolidated Balance Sheets as of March 31, 2008 andJune
      30, 2007
            3Condensed
      Consolidated Statements of Operations for the Three andNine
      Months Ended March 31, 2008 and 2007
            4Condensed
      Consolidated Statements of Cash Flows for the Nine MonthsEnded
      March 31, 2008 and 2007
            5Notes
      to Condensed Consolidated Financial Statements
            6Item
      2.
            Management's
      Discussion and Analysis of Financial Conditionand
      Results of Operations
            15Item
      3.
            Quantitative
      and Qualitative Disclosure About Market Risk
            19Item
      4.
            Controls
      and Procedures
            19PART
      II.  OTHER INFORMATIONItem
      1.
            Legal
      Proceedings
            21Item
      1A
            Risk
      Factors
            21Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            21Item
      3.
            Defaults
      Upon Senior Securities
            21Item
      4.
            Submission
      of Matters to a Vote of Security-Holders
            22Item
      5.
            Other
      Information
            22Item
      6.
            Exhibits
            22Signatures
            23







IMPLANT
      SCIENCES CORPORATIONCONDENSED
      CONSOLIDATED BALANCE SHEETS(Unaudited)ASSETS
              
              March
      31, 2008
              
              
              June
      30, 2007Current
      assets:Cash
      and cash equivalents
              
              $
              2,421,000
              
              
              $
              9,621,000Restricted
      cash
              
              
              75,000
              
              
              
              25,000Accounts
      receivable, less allowance of $48,000 and $20,000,
      respectively
              
              
              269,000
              
              
              
              346,000Accounts
      receivable, unbilled
              
              
              64,000
              
              
              
              162,000Inventories
              
              
              566,000
              
              
              
              683,000Investments
      - available for sale securities
              
              
              54,000
              
              
              
              133,000Prepaid
      expenses and other current assets
              
              
              255,000
              
              
              
              712,000Current
      assets held for sale
              
              
              1,720,000
              
              
              
              2,071,000Total
      current assets
              
              
              5,424,000
              
              
              
              13,753,000Property
      and equipment, net
              
              
              477,000
              
              
              
              530,000Other
      non-current assets
              
              
              1,181,000
              
              
              
              711,000Non-current
      assets held for sale
              
              
              2,583,000
              
              
              
              4,606,000Total
      assets
              
              $
              9,665,000
              
              
              $
              19,600,000LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Current
      maturities of long-term debt and obligations under capital
      lease
              
              $
              556,000
              
              
              $
              705,000Line
      of credit
              
              
              227,000
              
              
              
              -Payable
      to Med-Tec
              
              
              63,000
              
              
              
              143,000Accrued
      expenses
              
              
              1,248,000
              
              
              
              1,763,000Accounts
      payable
              
              
              974,000
              
              
              
              570,000Current
      portion of long- term lease liability
              
              
              313,000
              
              
              
              301,000Deferred
      revenue
              
              
              330,000
              
              
              
              71,000Current
      liabilities held for sale
              
              
              942,000
              
              
              
              1,111,000Total
      current liabilities
              
              
              4,653,000
              
              
              
              4,664,000Long-term
      liabilities:Long-term
      debt and obligations under capital lease, net of current
      maturities
              
              
              24,000
              
              
              
              629,000Long-term
      lease liability
              
              
              498,000
              
              
              
              735,000Derivatives
      related to preferred stock features
              
              
              97,000
              
              
              
              133,000Long
      term liabilities held for sale
              
              
              2,000
              
              
              
              4,000Total
      liabilities
              
              
              5,274,000
              
              
              
              6,165,000Commitments
      and contingencies (Note 7)Series
      D Cumulative Redeemable Convertible Preferred Stock; $10 stated
      value;500,000
      shares authorized, 288,000 and 393,939 shares outstanding as of March 31,
      2008and
      June 30, 2007, respectively (liquidation value $2,879,000 and $3,939,000
      at March 31, 2008 and June 30, 2007, respectively)
              
              
              2,551,000
              
              
              
              2,989,000Stockholders'
      equityCommon
      stock, $0.10 par value; 50,000,000 shares authorized at March 31, 2008 andJune
      30, 2007, respectively; 12,114,553 and 11,835,661 shares issued
      and  outstanding atMarch
      31, 2008 and June 30, 2007, respectively
              
              
              1,211,000
              
              
              
              1,183,000Additional
      paid-in capital
              
              
              58,170,000
              
              
              
              57,358,000Accumulated
      deficit
              
              
              (57,317,000)
              
              
              
              (47,927,000)Deferred
      compensation
              
              
              (7,000)
              
              
              
              (30,000)Accumulated
      other comprehensive loss
              
              
              (144,000)
              
              
              
              (65,000)Treasury
      stock, 10,545 common shares, respectively, at cost
              
              
              (73,000)
              
              
              
              (73,000)Total
      stockholders' equity
              
              
              1,840,000
              
              
              
              10,446,000Total
      liabilities and stockholders' equity
              
              $
              9,665,000
              
              
              $
              19,600,000The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.






IMPLANT
      SCIENCES CORPORATIONCONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)Three
      months ended March
    31,
            
            
            Nine months ended March
    31,2008
            
            
            2007
            
            
            2008
            
            
            2007Security
      revenues
            
            $
            787,000
            
            
            $
            1,121,000
            
            
            $
            2,505,000
            
            
            $
            3,507,000Cost
      of security revenues
            
            
            581,000
            
            
            
            780,000
            
            
            
            1,809,000
            
            
            
            2,560,000Gross
      margin
            
            
            206,000
            
            
            
            341,000
            
            
            
            696,000
            
            
            
            947,000Operating
      expenses:Research
      and development
            
            
            822,000
            
            
            
            326,000
            
            
            
            2,135,000
            
            
            
            1,212,000Selling,
      general and administrative
            
            
            1,328,000
            
            
            
            977,000
            
            
            
            4,185,000
            
            
            
            2,722,000Total
      operating expenses
            
            
            2,150,000
            
            
            
            1,303,000
            
            
            
            6,320,000
            
            
            
            3,934,000Loss
      from operations
            
            
            (1,944,000
            )
            
            
            (962,000
            )
            
            
            (5,624,000
            )
            
            
            (2,987,000
            )Other
      income (expense):Interest
      income
            
            
            29,000
            
            
            
            11,000
            
            
            
            193,000
            
            
            
            22,000Interest
      expense
            
            
            (22,000
            )
            
            
            (226,000
            )
            
            
            (82,000
            )
            
            
            (282,000
            )Change
      in fair value of embedded derivatives related to preferred stock
      features
            
            
            (97,000
            )
            
            
            95,000
            
            
            
            36,000
            
            
            
            800,000Gain
      on disposal of fixed assets
            
            
            -
            
            
            
            -
            
            
            
            9,000
            
            
            
            -Equity
      losses in unconsolidated subsidiaries
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (158,000
            )Total
      other income (expense), net
            
            
            (90,000
            )
            
            
            (120,000
            )
            
            
            156,000
            
            
            
            382,000Loss
      from continuing operations
            
            
            (2,034,000
            )
            
            
            (1,082,000
            )
            
            
            (5,468,000
            )
            
            
            (2,605,000
            )Preferred
      distribution, dividends and accretion
            
            
            (249,000
            )
            
            
            (277,000
            )
            
            
            (845,000
            )
            
            
            (658,000
            )Loss
      from continuing operations applicable to common
    shareholders
            
            
            (2,283,000
            )
            
            
            (1,359,000
            )
            
            
            (6,313,000
            )
            
            
            (3,263,000
            )Income(loss)
      from discontinued operations
            
            
            506,000
            
            
            
            (810,000
            )
            
            
            (3,078,000
            )
            
            
            (1,295,000
            )Net
      loss applicable to common shareholders
            
            
            (1,777,000
            )
            
            
            (2,169,000
            )
            
            
            (9,391,000
            )
            
            
            (4,558,000
            )Net
      loss
            
            $
            (1,528,000
            )
            
            $
            (1,892,000
            )
            
            $
            (8,546,000
            )
            
            $
            (3,900,000
            )Loss
      per share from continuing operations, basic and diluted
            
            $
            (0.17
            )
            
            $
            (0.09
            )
            
            $
            (0.46
            )
            
            $
            (0.22
            )Loss
      per share from continuing operations applicable to common shareholders,
      basic and diluted
            
            $
            (0.19
            )
            
            $
            (
      0.12
            )
            
            $
            (0.53
            )
            
            $
            (
      0.28
            )Income
      (loss) per share from discontinued operations
            
            $
            0.04
            
            
            $
            (
      0.07
            )
            
            $
            (0.26
            )
            
            $
            (0.11
            )Net
      loss per share applicable to common shareholders, basic and
      diluted
            
            $
            (0.15
            )
            
            $
            (0.18
            )
            
            $
            (0.79
            )
            
            $
            (0.39
            )Net
      loss per share
            
            $
            (
      0.13
            )
            
            $
            (0.16
            )
            
            $
            (
      0.72
            )
            
            $
            (0.33
            )Weighted
      average common shares outstanding used in computing basic and diluted loss
      per share
            
            
            11,956,189
            
            
            
            11,815,310
            
            
            
            11,879,350
            
            
            
            11,784,427The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.







IMPLANT
      SCIENCES CORPORATIONCONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)Nine
      Months Ended March 31,Cash
      flows from operating activities:
              
              2008
              
              
              2007Net
      Loss
              
              $
              (8,546,000
              )
              
              $
              (3,900,000
              )Loss
      from discontinued operations
              
              
              (3,078,000
              )
              
              
              (1,295,000
              )Loss
      from continuing operations
              
              
              (5,468,000
              )
              
              
              (2,605,000
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation and amortization
              
              
              127,000
              
              
              
              187,000Share-based compensation expense
              
              
              515,000
              
              
              
              575,000Equity loss in unconsolidated subsidiaries
              
              
              -
              
              
              
              184,000Change in fair value of embedded derivatives
              
              
              (36,000
              )
              
              
              (800,000
              )Bad debt expense
              
              
              28,000
              
              
              
              (50,000
              )Deferred compensation
              
              
              -
              
              
              
              (23,000
              )Warrant accretion on Bridge Bank loan
              
              
              9,000
              
              
              
              -Changes
      in operating assets and liabilities:Accounts receivable
              
              
              147,000
              
              
              
              108,000Inventories
              
              
              117,000
              
              
              
              170,000Prepaid expenses and other assets
              
              
              (13,000
              )
              
              
              (77,000
              )Accounts payable
              
              
              404,000
              
              
              
              (274,000
              )Accrued expenses
              
              
              (315,000
              )
              
              
              (30,000
              )Deferred revenue
              
              
              259,000
              
              
              
              30,000Net
      cash used in continuing operations
              
              
              (4,226,000
              )
              
              
              (2,605,000
              )Net
      cash used by discontinued operations
              
              
              (506,000
              )
              
              
              1,200,000Net
      cash used in operating activities
              
              
              (4,732,000
              )
              
              
              (1,405,000
              )Cash
      flows from investing activities:Purchase of property and equipment, net
              
              
              (74,000
              )
              
              
              (68,000
              )Investment in certificate of deposit
              
              
              (50,000
              )
              
              
              -Net
      cash used in continuing operations
              
              
              (124,000
              )
              
              
              (68,000
              )Net
      cash used in discontinued operations
              
              
              (271,000
              )
              
              
              (78,000
              )Net
      cash used in investing activities
              
              
              (395,000
              )
              
              
              (146,000
              )Cash
      flows from financing activities:Proceeds from issuance of common stock including the exercise of options
      and the Employee Stock Purchase Plan
              
              
              52,000
              
              
              
              183,000Proceeds  from secured term note, net of fees and transaction
      costs
              
              
              -
              
              
              
              3,278,000Dividends on Series D Cumulative Redeemable Convertible Preferred
      Stock
              
              
              (222,000
              )
              
              
              (440,000
              )Payments on Series D Cumulative Redeemable Convertible Preferred
      Stock
              
              
              (1,060,000
              )
              
              
              -Principal payments of long-term debt and capital lease
      obligations
              
              
              (1,068,000
              )
              
              
              (981,000
              )Proceeds on line of credit, net
              
              
              227,000
              
              
              
              (962,000
              )Net
      cash used in continuing operations
              
              
              (2,071,000
              )
              
              
              1,078,000Net
      cash used in discontinued operations
              
              
              (2,000
              )
              
              
              -Net
      cash (used in) provided by financing activities
              
              
              (2,073,000
              )
              
              
              1,078,000Net
      change in cash and cash equivalents
              
              
              (7,200,000
              )
              
              
              (473,000
              )Cash
      and cash equivalents at beginning of the period
              
              
              9,621,000
              
              
              
              2,204,000Cash
      and cash equivalents at end of the period
              
              $
              2,421,000
              
              
              $
              1,731,000Supplemental Disclosure of Cash Flow
      Information:Interest paid in cash
              
              $
              97,000
              
              
              $
              241,000Noncash
      Investing and Financing Activity:Settlement fee paid in shares of common stock
              
              $
              200,000
              
              
              
              -Accretion of Series D Cumulative Redeemable Convertible Preferred Stock
      dividends, derivatives and warrants
              
              $
              622,000
              
              
              $
              371,000The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.
  
 IMPLANT
SCIENCES CORPORATION


NOTES
TO CONDENSED FINANCIAL STATEMENTS
 March
31, 2008
 (Unaudited)
 
 1.           Description
of Business
 
 Implant Sciences Corporation (the
“Company”) provides systems and sensors for the homeland security market and
related industries.  The Company has both developed and acquired
technologies using ion mobility spectrometry to develop a product line for use
in trace explosives detection.
 
 On May 1, 2007, the Company entered
into an Asset Purchase Agreement (the “Agreement”) to sell substantially all of
the assets (the “Transaction”) of its subsidiary, Accurel Systems International
Corporation (“Accurel), a California corporation, to Evans Analytical Group LLC
(“Evans”), a Delaware limited liability company.  Evans acquired all
of the fixed assets and accounts receivable of Accurel.  The total
purchase price of the Transaction was approximately $12,705,000. In addition,
the Company issued warrants to purchase 350,000 shares of the Company’s common
stock to Legend Merchant Group, the investment banker involved with the
Transaction, at a price of $2.00 per share and agreed to pay them a fee based
upon a percentage of the gross aggregate consideration received by the Company.
An additional 25,000 warrants were issued to other consultants involved with the
Agreement, at a price of $2.00 per share.
 
 In
connection with the Transaction, we entered into an escrow agreement (the
“Escrow Agreement”) with Evans, Accurel, and Zions First National Bank. 
Pursuant to the Escrow Agreement, Evans deposited $1,000,000 (the “Escrow
Amount”) of the total purchase price for the assets into an escrow
account.  Any valid claims for indemnification made by Evans pursuant to
the Agreement shall be drawn from this sum.  The Escrow Agreement
provided, subject to any claims of indemnifications, for a release of $500,000
on approximately each of March 31, 2008 and March 31,
2009.
 
 Also in
connection with the Transaction, we entered into a Non-competition and
Nondisclosure Agreement (the “NCD”) with Evans whereby we agreed not to engage
in any business that directly competes with the business of
Accurel.  In addition, the NCD prohibits us from disclosing any
confidential information concerning the business of Accurel.  The NCD
will remain in effect for five years from the date of its
execution.
 
 On
February 22, 2008, Evans filed suit against the Company requesting rescission of
the Transaction and damages based on claims of misrepresentation.  On
March 28, 2008, Evans filed a formal Claims Notice with the escrow agent
prohibiting release of any portion of the escrow to the Company as a result of
the suit filed on February 22, 2008.  The Company has retained legal
counsel in defense of these claims.
 
 In June 2007, the Company sold certain
of the assets related to its brachytherapy products and divested the prostate
seed and medical software businesses.  In March 2008, the Company
informed its medical coatings customers of its intention to discontinue coating
operations by the end of the 2008 calendar year.  Management is
currently working on several plans to sell the remaining medical coating assets
and has signed non-binding term sheets with two different
companies.  Because these series of transactions are more likely than
not to occur within the next 12 months, the Medical Reporting Unit is reported
as discontinued operations in the accompanying financial
statements.
 
 In February 2008, the Company announced
its plan to sell Core Systems, Inc. (“Core” or “Core Systems”), its wholly-owned
semiconductor subsidiary and engaged Noblemen Holdings, LLC to facilitate this
plan.  Because this sale is more likely than not to occur within the
next 12 months, the Semiconductor Reporting Unit is reported as discontinued
operations in the accompanying financial statements.
 
 The
Company currently markets and sells its existing trace explosives detector
products while continuing to make significant investments in developing the next
generation of these products.  In April 2008, the Company closed a
transaction to acquire substantially all of the assets and certain liabilities
of San Diego, CA based Ion Metrics, Inc.  Ion Metrics was in the
business of producing low cost mass sensor systems for the detection and
analysis of chemical compounds such as explosives, chemical warfare agents,
narcotics, and toxic industrial chemicals for the homeland defense, forensic,
environmental, and safety/security markets.  The integration of the
Ion Metrics technologies into the Company’s Quantum Sniffer product line is
expected to provide us with opportunities to introduce smaller, lower cost, and
higher performance security solutions.
 
 Risks
and Uncertainties
  While the Company strives to bring new
products to market, it is subject to a number of risks similar to other
technology-based companies, including risks related to: (a) its dependence on
key individuals and collaborative research partners; (b) competition from
substitute products and larger companies; (c) its ability to develop and market
commercially usable products and obtain regulatory approval for its products
under development; and (d) its ability to obtain the substantial additional
financing necessary to adequately fund the development, commercialization and
marketing of its products. For the nine months ended March 31, 2008, the Company
reported a net loss from continuing operations of $5,468,000  and used
$4,732,000 in cash from operations. As of March 31, 2008, the Company had an
accumulated deficit of approximately $57,317,000 and working capital of
$771,000. The Company has a term loan with a bank, which matures in August 2009,
having an unpaid balance of approximately $552,000.  Management
continually evaluates plans to reduce its operating expenses and increase its
cash flow from operations. Failure of the Company to achieve its projections may
require the Company to seek additional financing or discontinue
operations.
 
 On January 3, 2007, the Company
executed an agreement with San Jose, CA-based Bridge Bank, N.A. which increased
the Company’s revolving credit facility from $1.5 million to $5.0 million (see
Note 10).  Based on current sales, expense and cash flow projections,
the cash available from the Company’s line of credit, the sale of Core Systems
and certain other assets, management believes there are plans in place to
sustain operations for the next several months.  These plans depend on
a substantial increase in sales of the Company’s handheld trace explosives
detector product, the sale of Core and other assets.  To further
sustain the Company, improve its cash position, and enable it to grow while
reducing debt, management plans to seek additional capital through private
financing sources during the next twelve months.  However, there can
be no assurance that management will be successful in executing these
plans.  Management will continue to closely monitor and attempt to
control costs at the Company and actively seek needed capital through sales of
its products, equity infusions, government grants and awards, strategic
alliances, and through its lending institutions
 
 The
Company's consolidated financial statements have been presented on the basis
that it is a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
suffered recurring losses from operations. The Company’s Series D Preferred
Stock contains mandatory redemptions on a monthly basis. These mandatory
redemptions are redeemable in cash or shares of the Company’s common stock, at
the Company’s option, so long as the price of the Company’s stock does not fall
below 110% of the fixed conversion price.  The Company received a
waiver of the monthly amortization payments for the period December 2006 –
August 2007, to the mandatory redemption date. The redemption payments resumed
in September 2007.
 
 There can
be no assurances that forecasted results will be achieved or that the Company’s
stock price will remain at a level to allow the Company to redeem the
outstanding shares of Series D Preferred Stock and accrued dividends with shares
of its common stock.  These conditions raise substantial doubt about
the Company's ability to continue as a going concern.  The financial
statements do not include any adjustments relating to the recoverability and
classification of asset amounts or the amounts and classification of liabilities
that might be necessary should the Company be unable to continue as a going
concern.
 
 As a result of the decision of the
Board of Directors to sell the remaining semiconductor assets associated with
Core Systems, in conjunction with the sale of the assets of Accurel in May 2007,
the Semiconductor Reporting Unit is being reported as discontinued operations in
the accompanying financial statements.  In June 2007, the Company sold
certain of the assets related to its brachytherapy products and divested the
prostate seed and medical software businesses.  In March 2008, the
Company informed its medical coatings customers of its intention to discontinue
coating operations by the end of the 2008 calendar year.  Management
is currently working on several plans to sell the remaining medical coating
assets.  Because these series of transactions are more likely than not
to occur within the next 12 months, the Medical Reporting Unit is reported as
discontinued operations in the accompanying financial statements.
 
 The Company has experienced a reduction
in security revenue in the three month period ended March 31, 2008 as compared
with the comparable prior year period, relating to a decline in government
research and development contract work which was offset by an increase in unit
sales of its trace explosives products.  Security product sales tend
to have a long sale cycle, and are often subject to export
controls.  In an effort to identify new opportunities and stimulate
sales, the Company has expanded its sales staff and implemented a new sales tool
to assist in this effort.  However, there can be no assurance that
these efforts will increase revenue.  In addition, the Company
expanded its research and development staff to support internal research and
development programs including new product development.
 
 The Company has a history of being
active in submitting proposals for government sponsored grants and contracts and
successful in being awarded grants and contracts from government agencies.
Management will continue to pursue these grants and contracts to support its
research and development efforts primarily in the areas of trace explosives
detection.
 
 2.           Interim
Financial Statements and Basis of Presentation
  The accompanying condensed consolidated
financial statements of the Company have been prepared in accordance with the
accounting principles generally accepted in the United States of America (“U.S.
GAAP”).  In the opinion of management, the accompanying condensed
consolidated financial statements include all adjustments (consisting only of
normal recurring adjustments), which the Company considers necessary for a fair
presentation of the financial position at such date and of the operating results
and cash flows for the periods presented.  The results of operations
and cash flows for the nine months ended March 31, 2008 may not necessarily be
indicative of results that may be expected for any succeeding quarter or for the
entire fiscal year.  The information contained in this Form 10-Q
should be read in conjunction with the Company’s audited financial statements,
included in our Form 10-K as of and for the year ended June 30, 2007 filed with
the Securities and Exchange Commission on October 15, 2007.
 
 The accompanying condensed consolidated
financial statements reflect the statement of operations of our Semiconductor
and Medical Reporting Units as discontinued operations for the three and nine
months ended March 31, 2008 and 2007.  The related information
contained in the notes to the financial statements includes those of the
Company’s continuing operations unless specifically identified as disclosures
related to discontinued operations.
 
 Our significant accounting policies are
described in Note 2 to the financial statements included in our Form 10-K for
the year ended June 30, 2007.  Our discussion and analysis of our
financial condition and results of operations are based upon the financial
statements, which have been prepared in accordance with U.S.
GAAP.  The preparation of financial statements in conformity with U.S.
GAAP  requires management to make estimates and judgments, which are
evaluated on an on-going basis, that affect the amounts reported in the
Company’s condensed consolidated financial statements and accompanying
notes.  Management bases its estimates on historical experience and on
various other assumptions that it believes are reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities and the amounts of revenues and
expenses that are not readily apparent from other sources.  Actual
results could differ from those estimates and judgments.  In
particular, significant estimates and judgments include those related to revenue
recognition, allowance for doubtful accounts, useful lives of property and
equipment, inventory reserves, business combinations, valuation for goodwill and
acquired intangible assets, accounting for embedded derivatives and warranty
reserves.
 
 Certain reclassifications were made to
the fiscal year 2007 financial statements to conform to the fiscal year 2008
presentation.
 
 3.           Inventories
  Inventories consist of the
following:
  March
      31,
              
              
              June
      30,2008
              
              
              2007Raw
      materials
              
              $
              297,000
              
              
              $
              407,000Work-in-progress
              
              
              24,000
              
              
              
              32,000Finished
      goods
              
              
              245,000
              
              
              
              244,000$
              566,000
              
              
              $
              683,000
 
  4.           Property and
Equipment
 
 Property and equipment consists of the
following:
 
 March
      31,
              
              
              June
      30,2008
              
              
              2007Total
      property and equipment
              
              $
              1,906,000
              
              
              $
              1,832,000Less:  accumulated
      depreciation
              
              
              (1,429,000
              )
              
              
              (1,302,000
              )$
              477,000
              
              
              $
              530,000
 
 The Company recorded depreciation
expense of approximately $44,000 and $39,000 the three month periods ended March
31, 2008 and 2007, respectively, and $127,000 and $187,000  for the
nine month periods ended March 31, 2008 and 2007, respectively. Equipment
purchased pursuant to capital leases and leasehold improvements are amortized
based upon the lesser of the term of the lease or the useful life of the asset
and such expense is included in depreciation expense.  The depreciable
lives of the assets acquired in the Core acquisition, which were originally
given seven-year lives, were revised to five year lives at June 30, 2007, as a
result of the annual goodwill impairment review conducted in August of
2007.  In February 2008, the Company committed to a plan to actively
pursue a buyer for the Semiconductor Reporting Unit and in March 2008, informed
its medical coatings customers of its intention to cease medical coating
operations by end of calendar year 2008.  As a result, the Company is
presenting the assets of its Semiconductor and Medical Reporting Units as Assets
Held for Sale and these assets have ceased to be depreciated.
 
 
 5.           Accrued Expenses
 
 Accrued
expenses consist of the following:
 
 March
      31,
              
              
              June
      30,2008
              
              
              2007Accrued
      compensation and benefits
              
              $
              381,000
              
              
              $
              252,000Accrued
      taxes
              
              
              289,000
              
              
              
              478,000Accrued
      legal and accounting
              
              
              184,000
              
              
              
              192,000Accrued
      interest
              
              
              92,000
              
              
              
              105,000Rapiscan
      settlement accrual
              
              
              -
              
              
              
              200,000Other
      accrued liabilities
              
              
              302,000
              
              
              
              536,000$
              1,248,000
              
              
              $
              1,763,000
 
 
 The
Company accrues warranty costs in the period the related revenue is recognized
and adjusts the reserve balance as needed to address potential future
liabilities.  The following table details the changes in the Company’s
warranty reserve, which is included in other accrued liabilities in the schedule
above.
  Balance
      at June 30, 2007
              
              $
              57,000Accrued
      warranty expense
              
              
              39,000Charges
      against the reserve
              
              
              (36,000
              )Balance
      at March 31, 2008
              
              $
              60,000
 
 
 6.           Investment
in Unconsolidated Subsidiaries
 
 As of
March 31, 2008 the Company has a 15.1% interest in CorNova, Inc.  The
Company recognized $0 for the three and nine month periods ended March 31, 2008
and $0 and $158,000 for the three and nine month periods ended March 31, 2007
respectively, of equity losses in unconsolidated subsidiaries, representing the
Company’s portion of CorNova’s net loss.  As a result of the
cumulative net losses incurred, the Company’s investment in CorNova is
$0.
 
 The
Company has historically accounted for its investment in this unconsolidated
subsidiary under the equity method due in part to the significant influence the
Company had over CorNova which resulted from Dr. A. J. Armini, the former
President and Chief Executive Officer of the Company , being on CorNova’s Board
of Directors.  As a result of Dr. Armini resignation from CorNova’s
board, in September 2007, the equity method is no longer appropriate and the
cost method will be used.
 
 7.
              Commitments
      and Contingencies
  (a)           
Capital and Operating Leases
  The Company has an operating lease for
its manufacturing, research and office space in Wakefield, MA which expires on
December 31, 2008. Under the terms of the lease, the Company is responsible for
its proportionate share of real estate taxes and operating expenses relating to
this facility. The Company also has leases for two facilities in Sunnyvale, CA.
The leases expire in December 2009 and September 2010 and the Company has an
option to extend each lease for five additional years.  Effective with
the sale of the assets of Accurel Systems on May 1, 2007, the Company executed a
sublease agreement for one of its California facilities and terminated the lease
for its satellite facility in Austin, TX.  In addition, in March 2008,
the Company entered into a six month lease for office space in Beijing, China,
to support the sales activities in the region.  The total lease
expense for the six months is approximately $6,000.
 
 In conjunction with the acquisition of
Accurel, in March 2005, the Company recorded a lease liability of $829,000. This
liability reflected management’s estimate of the excess of payments required
under the Accurel facility lease, at the date of acquisition, versus the fair
market value of lease payments that would have been required, if the lease had
been negotiated under current market conditions.  Subsequently, as a
result of the sale of Accurel, the Company has recorded an additional lease
liability of $487,000 representing that portion of the lease in excess of the
sublease arrangement with Evans.  The balance of the lease liability
on March 31, 2008 is $811,000 of which $313,000 is current.
  In April 2007, in conjunction with the
Company’s original plans to conduct research, development and minor
manufacturing work in New Mexico, the Company executed an operating lease which
was initially to expire on May 1, 2010.  The lease allowed for early
termination, which the Company elected in February 2008.  As a result
of the early termination, the Company is responsible for reimbursing the
landlord for certain leasehold improvements over a 24 month
period.  As of March 31, 2008, the balance due is approximately
$47,000.
 
 Future minimum rental payments required
under capital and operating leases for both continuing and discontinued
operations, with non-cancelable terms in excess of one year at March 31, 2008,
together with the present value of net minimum lease payments, are as
follows:
 
 
 Capital
      Lease Payments
              
              Operating
      Lease Payments
              
              Sublease
                Income(1)Year
      ending June 30, 2008:2008,
      remaining 3  months
              $  8,000
              
              $  432,000
              
              $  
      61,0002009
              27,000
              
              1,454,000
              
              253,0002010
              15,000
              
              838,000
              
              260,0002011
      and remaining
              2,000
              
              150,000
              
              66,000Total
      future minimum lease payments
              52,000
              
              $  2,874,000
              
              $
      640,000Less:
      amounts representing interest
              (7,000)Present
      value of future minimum lease payments
              45,000Less:
      current portion
              (17,000)Capital
      lease obligation, net of current portion
              $  28,000
 
 (1) reflects the sublease on the former Accurel facility
  (b)           Employment
Agreements
  On September 27, 2007, the Company
entered into a Transition Agreement with Dr. Anthony J. Armini, the Company’s
former President and Chief Executive Officer, with a term of 24
months.  Under this Transition Agreement Dr. Armini resigned his
positions and assumed the position of Scientific Advisor.  Dr. Armini
remained the Chairman of the Board of Directors until the December 2007 annual
meeting of shareholders, at which time he left the Board.  During the
transition period, the Company will compensate Dr. Armini at the annual rate of
$250,000.  In addition, Dr. Armini may participate in the Company’s
medical and dental insurance programs.  The Company may terminate this
Transition Agreement only for cause and Dr. Armini may terminate the Transition
Agreement for any reason, with each party giving the other written
notice.  In conjunction with this agreement, Dr. Armini has been
issued a stock option for 200,000 shares of common stock at an exercise price of
$2.09 per share, of which 25,000 shares vested immediately, and the remaining
175,000 shares vest at a rate of 25,000 per quarter over the term of the
Transition Agreement.  These options were valued using the Black
Scholes method and the following assumptions:  volatility 96%, risk
free interest rate of 4.01% and expected life of 1.75 years.
 
 On December 12, 2007, the Company
entered into an employment agreement with Mr. Phillip Thomas, the Company’s
President and Chief Executive Officer, having an initial term of three years, an
annual base salary of $275,000, an annual incentive bonus program and a car
allowance.  In conjunction with this agreement, Mr. Thomas has been
issued an option for 280,000 shares of common stock at an exercise price of
$1.15 per share, of which 93,333 vested immediately, and the remaining 186,667
vest over 24 months.  These options were valued using the Black
Scholes method and the following assumptions:  volatility 82%, risk
free interest rate of 3.67% and expected life of six years.  In
addition, Mr. Thomas may participate in the Company’s employee fringe benefit
plans or programs generally available to employees of comparable status and
position. The Company may terminate his employment for any material breach of
his employment agreement at any time.   In the event the Company
terminates Mr. Thomas’ employment without cause, the Company will pay him 12
months salary on a regular payroll basis.  Under his employment
agreement, Mr. Thomas is subject to restrictive covenants, including
confidentiality provisions and a one year non-compete and non-solicitation
provision.
 
 On March 18, 2008, the Company entered
into an employment agreement with Ms. Diane Ryan, the Company’s Chief Financial
Officer, having an initial term of three years, an annual base salary of
$155,000, and an annual incentive bonus program.  In conjunction with
this agreement, Ms. Ryan has been issued an option for 50,000 shares of common
stock at an exercise price of $1.10 per share, of which 16,667 vested
immediately, and the remaining 33,333 vest over 24 months.  These
options were valued using the Black Scholes method and the following
assumptions:  volatility 80%, risk free interest rate of 3.96% and
expected term of 8.5 years.  In addition, Ms. Ryan may participate in
the Company’s employee fringe benefit plans or programs generally available to
employees of comparable status and position. The Company may terminate her
employment for any material breach of her employment agreement at any
time.  In the event the Company terminates Ms. Ryan’s employment
without cause, the Company will pay her 12 months salary on a regular payroll
basis.  Under her employment agreement, Ms. Ryan is subject to
restrictive covenants, including confidentiality provisions and a one year
non-compete and non-solicitation provision.
 
 (c)           Litigation
  From time to time, we are subject to
various claims, legal proceedings and investigations covering a wide range of
matters that arise in the ordinary course of our business activities. Each of
these matters is subject to various uncertainties.
 
 On March 23, 2005, we entered into a
Development, Distribution and Manufacturing Agreement (the “Rapiscan Agreement”)
with Rapiscan Systems, Inc. (“Rapiscan”).  Under the terms of this
agreement, we gave Rapiscan the exclusive worldwide rights to market our Quantum
SnifferTM portable
and benchtop trace detection devices under their private label.  We also
agreed to give Rapiscan the exclusive worldwide rights to distribute certain
other new security products which we may develop in the future with their
funding, as well as rights, in some circumstances, to manufacture certain
components of the private-labeled Quantum SnifferTM portable
and benchtop trace detection devices.
 
 On March 23, 2006, Rapiscan filed a
complaint against the Company and its contract assembler, Columbia Tech, in the
United States District Court for the Central District of California, regarding
the Rapiscan Agreement.  Rapiscan’s complaint against the Company alleged
claims of breach of contract and breach of warranty and requested specific
performance, declaratory relief and injunctive relief. Rapiscan’s complaint
against Columbia Tech alleged tortuous interference with contractual relations
and requested injunctive relief and declaratory relief. On April 12, 2006,
Rapiscan dismissed all claims against Columbia Tech.
 
 On March 24, 2006, the Company brought
suit in the United States District Court in the District of Massachusetts
against Rapiscan and its parent, OSI Systems, Inc. (“OSI”). The Company
requested rescission of the Rapiscan Agreement, plus damages, based on claims of
misrepresentation.  In the alternative, the Company sought termination
of the Rapiscan Agreement due to material breaches of contract and the implied
covenant of good faith and fair dealing and for damages due to Rapiscan’s breach
of contract and the implied covenant of good faith and fair dealing.
 
 In August
2006, as a result of motions made by both parties, the two lawsuits (the
“Pending Litigation”) were consolidated in the United States District Court for
the Central District of California with the Company as plaintiff.  In
late 2006, Rapiscan and OSI filed a motion to dismiss certain of the Company’s
claims.  The court dismissed the Company’s claim of breach of
fiduciary duty, but the motion to dismiss was denied in all other
respects.  OSI and Rapiscan had filed four motions for partial summary
judgment with respect to certain discrete claims.  Two of the motions
were denied in their entirety.  The third was denied in the only
material respect and granted in two immaterial respects.
  On January 4,
2008, the Company executed a Settlement Agreement (the “Settlement Agreement”)
with OSI and Rapiscan to resolve the Pending Litigation and to enter into
additional agreements.  In addition to the immediate dismissal of the
Pending Litigation, other terms of the Settlement Agreement include, (i) the
rescission of the Rapiscan Agreement, (ii) the payment by the Company of
$200,000, such payment to be made in the form of shares of the Company’s common
stock,  (iii) the granting of non-exclusive distribution rights to
Rapiscan, (iv) the payment by the Company of up to $1,000,000 in Technology
Transfer Fees, payable over time at a rate of 2% of the gross sales price
received by the Company when and if a passenger portal is sold, and (v) the
opportunity for OSI to supply certain components to the Company.  The
Company issued 221,729 shares on March 13, 2008 in settlement of the
litigation.
  On May 1, 2007, the Company entered
into an Asset Purchase Agreement (the “Evans Agreement”) to sell substantially
all of the assets (the “Transaction”) of its subsidiary, Accurel Systems
International Corporation (“Accurel), a California corporation, to Evans
Analytical Group LLC (“Evans”), a Delaware limited liability
company.  Evans acquired all of the fixed assets and accounts
receivable of Accurel.  The total purchase price of the Transaction
was approximately $12,705,000.
 
 In
connection with the Transaction, we entered into an escrow agreement (the
“Escrow Agreement”) with Evans, Accurel, and Zions First National Bank. 
Pursuant to the Escrow Agreement, Evans deposited $1,000,000 (the “Escrow
Amount”) of the total purchase price for the assets into an escrow
account.  Any valid claims for indemnification made by Evans pursuant to
the Agreement shall be drawn from this sum.  The Escrow Agreement
provided, subject to any claims of indemnifications, for a release of $500,000
on approximately each of March 31, 2008 and March 31, 2009.
 
 Also in
connection with the Transaction, we entered into a Non-competition and
Nondisclosure Agreement (the “NCD”) with Evans whereby we agreed not to engage
in any business that directly competes with the business of
Accurel.  In addition, the NCD prohibits us from disclosing any
confidential information concerning the business of Accurel.  The NCD
will remain in effect for five years from the date of its
execution.
 
 On February
22, 2008, Evans filed suit requesting rescission of the Evans Agreement, plus $8
million in damages, based on claims of misrepresentation (the “Evans
Claim”). On March 28, 2008, Evans filed a formal Claims Notice with the
escrow agent prohibiting release of any portion of the escrow to the Company as
a result of the suit filed on February 22, 2008.  Management continues
to believe the escrowed amounts are collectible, however as a result of the
Claim Notice, have classified the $1,000,000 Escrow Amount as a long-term
asset.  The Company has retained legal counsel in defense of these
claims and intends to vigorously defend the Evans Claim and the Claim
Notice.
 We may, from time to time, be involved
in other actual or potential proceedings that we consider to be in the normal
course of our business. We do not believe that any of these proceedings will
have a material adverse effect on our business.
 
 8.
              Redeemable Convertible
      Preferred Stock
 
 The following table reflects the
required redemption of the Series D Preferred Stock, issued to Laurus Master
Fund, LLP.  (“Laurus”), before the effect of the accrued
dividends:
 
 Preferred
      Stock MonthlyYear
      ending June 30:
              
              Redemption
      Schedule2008
      remaining 3 months
              
              $
              455,0002009
              
              
              2,424,000$
              2,879,000
 
 On December 28, 2006, Laurus consented
to permit the Company to defer the December 2006, January 2007, February 2007,
March 2007, April 2007, May 2007, June 2007, July 2007, and August 2007
redemptions to the end of the term. The monthly redemption of approximately
$152,000 plus accrued dividends resumed on September 1, 2007 and will continue
until the final payment date in September 2008 for approximately $2.1
million.  Subject to certain conditions, including the market price of
our common stock being above $4.57 per share, the Company has the option to pay
this amount in cash or in common stock at a fixed conversion price of $4.15 per
common share.
 
 The Company valued the Series D
Preferred Stock at issuance at its residual value of $2,700,000 based on the
fair values of the financial instruments issued in connection with this
preferred stock financing, including certain warrants, the embedded derivative
instruments and offering costs. The amounts recorded in the financial statements
represent the amounts attributed to the sale of the Series D preferred stock,
the amount allocated to warrants, the value attributed to the embedded
derivatives and issuance costs. The Company is accreting these discounts on the
carrying value of the preferred stock to its redemption value at September
1, 2008, or the actual conversion date, whichever is earlier. The accretion of
these amounts is being recorded as a preferred dividend in the period of
accretion. As of March 31, 2008, $1,974,000 was accreted . As of March 31, 2008
and June 30, 2007, the fair value of this conversion feature approximated
$97,000 and $133,000, respectively.  The value of
the embedded derivatives related to the adjustable dividend rate and the
potential default provisions were determined to be immaterial at March 31,
2008.
 
 9.
              Share-based
      compensation plans
 
 Stock
Option Plans
  As of March 31, 2008, a total of
137,003, 63,602, and 610,500 shares are available for issuance under the 1998
Stock Option Plan, the 2000 Incentive and Non-Qualified Stock Option Plan and
the 2004 Stock Option Plan, respectively.  The 1998 Stock Option plan
expires in September 2008.
 
 The following table presents the
cumulative activity of the stock option plans for the three month periods ended
September 30, 2007, December 31, 2007 and March 31, 2008:
  Shares
              
              
              Weighted
      Average
                Exercise
      PriceOutstanding
      at June 30, 2007
              
              
              1,790,738
              
              
              $
              4.66Granted
              
              
              210,000
              
              
              $
              2.09Exercised
              
              
              -
              
              
              
              -Cancelled
              
              
              (20,000
              )
              
              $
              10.15Outstanding
      at September 30, 2007
              
              
              1,980,738
              
              
              $
              4.33Granted
              
              
              635,000
              
              
              $
              1.23Exercised
              
              
              -
              
              
              
              -Cancelled
              
              
              (208,000
              )
              
              $
              4.70Outstanding
      at December 31, 2007
              
              
              2,407,738
              
              
              $
              3.48Granted
              
              
              285,000
              
              
              $
              0.90Exercised
              
              
              -
              
              
              
              -Cancelled
              
              
              (40,000
              )
              
              $
              3.07Outstanding
      at March 31, 2008
              
              
              2,652,738
              
              
              $
              3.21Options
      exercisable at end of period
              
              
              1,312,150
              
              
              $
              4.73Weighted-average
      fair value of options granted during period
              
              
              
              
              
              $
              0.61
 
 The Company recorded $168,000 and
$265,000 of stock-based compensation, which includes $4,000 and $3,000 of
compensation expense attributable to its Employee Stock Purchase Plan and an
expense of $27,000 and $131,000 of non-cash stock-based compensation related to
warrants issued to non-employees, in the three month periods ended March 31,
2008 and 2007, respectively.  The Company recorded $515,000 and
$575,000 of stock- based compensation, which includes $14,000 and $16,000 of
compensation expense attributable to its Employee Stock Purchase Plan and
expenses of $16,000 and $139,000 of non-cash stock-based compensation related to
warrants issued to non-employees, in the nine month periods ended March 31, 2008
and 2007, respectively.
 
 The total
non-cash stock-based compensation expense, included in the consolidated
statement of operations for the three and nine month periods ended March 31,
2008 and 2007, respectively, is included in the following expense
categories:
 
 Three
      months ended March 31,2008
              
              
              2007Cost
      of revenues
              
              $
              9,000
              
              
              $
              40,000Research
      and development
              
              
              21,000
              
              
              
              27,000Selling,
      general and administrative
              
              
              138,000
              
              
              
              198,000Total
              
              $
              168,000
              
              
              $
              265,000
   Nine
      months ended March 31,2008
              
              
              2007Cost
      of revenues
              
              $
              48,000
              
              
              $
              123,000Research
      and development
              
              
              58,000
              
              
              
              75,000Selling,
      general and administrative
              
              
              409,000
              
              
              
              377,000Total
              
              $
              515,000
              
              
              $
              575,000
 
 As of
March 31, 2008, there was $782,000 of total unrecognized compensation expense
related to unvested share- based compensation arrangements under the various
share-based compensation plans.  This amount is exclusive of options
to employees of the discontinued operations, which would have represented an
additional $117,000 of unrecognized compensation expense.  This
expense is expected to be recognized as follows:
 
 Period
      Ended June 30:Remaining
      3 months 2008
              
              $
              113,0002009
              
              
              402,0002010
              
              
              218,000Thereafter
              
              
              49,000Total
              
              $
              782,000
  
 The fair
value of each option award is estimated on the date of grant using the
Black-Scholes option pricing model using the assumptions noted in the following
table. Expected volatility is based on historical volatility of the Company’s
common stock. The Company uses historical data to estimate future option
forfeitures within the valuation model. The expected term of options granted is
calculated using the Company’s historical option exercise transactions as
outlined SFAS 123R and reflects the period of time that options granted are
expected to be outstanding. The risk-free rate for periods within the
contractual life of the option is based on the U.S Treasury yield in effect at
the time of grant.
  Nine
      month period ended
                March
      31, 2008
              
              Nine
      month period ended
                March  31,
      2007Stock
      Option Plan
              
              Stock
      Purchase Plan
              
              Stock
      Option Plan
              
              Stock
      Purchase PlanRisk
      free interest rate
              3.13%
      - 4.34%
              
              3.34%
              
              4.58%
      – 5.07%
              
              5.17%Expected
      dividend yield
              0%
              
              0%
              
              0%
              
              0%Expected
      lives (years)
              1.75
      – 8.5 years
              
              6
      months
              
              3.5
      - 6 years
              
              6
      monthsExpected
      volatility
              55%
      - 91%
              
              97%
              
              76%
      - 79%
              
              78%Expected
      forfeiture rate
              10%
              
              0%
              
              10%
              
              0%Contractual
      term
              5 -
      10 years
              
              6
      months
              
              5 -
      10 years
              
              6
      months
 
 Employee
Stock Purchase Plan
 
 In September 1998, the Company adopted
the 1998 Employee Stock Purchase Plan (the “1998 Plan”). The 1998 Plan provides
a method whereby employees of the Company will have an opportunity to acquire an
ownership interest in the Company through the purchase of shares of common stock
of the Company through payroll deductons. After 12 months of employment, an
employee is eligible to participate and can defer up to 10% of his or her wages
into the 1998 Plan, with a maximum of $25,000 in any calendar year. The purchase
price of the common stock is calculated at the lower of 85% of the closing price
of the stock on the first day of the plan period or the last day of the plan
period. The periods are January 1 to June 30 and July 1 to December 31.
Fractional shares are not issued. Participants may withdraw at any time by
giving written notice to the Company and will be credited the amounts of
deferrals in their account. The maximum number of shares eligible to be issued
under the 1998 Plan is 141,000. As of March 31, 2008, a total of 10,669 shares
are available for issuance under this plan.  This plan expires in
September 2008.
 
 In December 2006, the Company adopted
the 2006 Employee Stock Purchase Plan (the “2006 Plan”). The 2006 Plan provides
a method whereby employees of the Company will have an opportunity to acquire an
ownership interest in the Company through the purchase of shares of common stock
of the Company through payroll deductions. After three months of employment, an
employee is eligible to participate and can defer up to 10% of his or her wages
into the 2006 Plan, with a maximum of $25,000 in any calendar year. The purchase
price of the common stock is calculated at the lower of 85% of the closing price
of the stock on the first day of the plan period or the last day of the plan
period. The periods are January 1 to June 30 and July 1 to December 31.
Fractional shares are not issued. Participants may withdraw at any time by
giving written notice to the Company and will be credited the amounts of
deferrals in their account. The maximum number of shares eligible to be issued
under the 2006 Plan is 500,000. As of March 31, 2008, a total of 442,837 shares
are available for issuance under the 2006 Plan.
 
 Compensation
expense under the 1998 and 2006 Plans for the three month periods ended March
31, 2008 and 2007 is $4,000 and $3,000, respectively and $14,000 and $16,000,
for the nine month periods ended March 31, 2008 and 2007,
respectively.
 
 Non-qualified
options and warrants
 
 Included
in the consolidated statement of operations for the three month periods ended
March 31, 2008 and March 31, 2007, is a stock-based compensation expense of
$27,000 and $131,000, respectively, attributable to other non-employee options
and warrants.  For the nine month periods ended March 31, 2008 and March
31, 2007, the Company recorded an expense of $16,000 and $139,000, respectively,
attributable to non-employee options and warrants.
 
 10.
              Long-term Debt and Credit
      Arrangements
  MED-TEC
Payment Obligation
 
 On July 31, 2003, the Company entered
into an agreement with its former exclusive distributor of prostate seeds, to
release each other from further obligations under an original distributor
agreement.  The new agreement conveys to the Company direct marketing and
sales capabilities to sell its I-Plant Seed brachytherapy seeds for use in the
treatment of prostate cancer.  In connection with this, the Company’s
former exclusive distributor agreed to work cooperatively to transition
customers and marketing materials directly to the Company.  The distributor
also agreed not to compete with the Company for a period of three years. 
The present value of the Company’s  payment obligation was recorded as
approximately $1,007,000, using a rate of 10.24%. This amount was recorded as an
intangible asset and was amortized over its estimated useful life of 29
months.  As of March 31, 2008, the outstanding and past due principal
balance is approximately $63,000.  For the three months ended March 31,
2008 and 2007, the Company recorded approximately $2,000 and $6,000,
respectively, and $7,000 and $18,000 for the nine-month periods ended March 31,
2008 and 2007 respectively, of interest expense relating to this
transaction.
 
 Revolving
Credit Facility and Term Note with Bridge Bank
 
 On
January 3, 2007, the Company executed an Amended and Restated Loan and Security
Agreement (the “Loan Agreement”) which amended and restated the terms of a
Business Financing Agreement originally dated as of June 1, 2005 with Silicon
Valley based Bridge Bank, N.A. (the “Bank”) increasing the revolving credit
facility from $1.5 million to $5.0 million.  This revolving credit
facility (the “line of credit”) has a two year term, provides for advances of up
to 80% of the Company’s eligible accounts receivable and up to the lesser of
$1,000,000 or forty percent (40%) of eligible inventory, bears interest at the
prime rate, plus 1/2% per annum, and is collateralized by all assets of the
Company.
  In
addition, pursuant to the terms of the Loan Agreement, the Company converted
$1,600,000 of the outstanding line of credit balance into a 30 month term note
bearing an interest rate at the prime rate plus 1% per annum payable in 30 equal
monthly installments of principal of approximately $53,000, plus accrued
interest beginning on February 10, 2007.
 
 Pursuant
to the Loan Agreement, the Company issued to Bridge Bank N.A. a seven-year
warrant to purchase up to 18,939 shares of the Company’s common stock at a price
equal to $2.64 per share.  The warrants were valued using the Black
Scholes model and the following assumptions: volatility of 78%, an expected life
of  seven years, and a risk free interest rate of
4.54%.  Pursuant to ABP No 14 “Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants”, the note and warrants have been
recorded at their relative fair value.  The Company accretes the value
of the warrants, $28,000, to the term note over the life of the
note.  As of March 31, 2008, approximately $14,000 has been
amortized.
 
 The
Company was in violation of certain covenants associated with this facility at
March 31, 2008.  The Company has requested a waiver from the bank for
these covenant violations, however, cannot be certain that a waiver will be
granted.  If the
Bank does not agree to grant such a waiver, there is a risk that the bank may
call the loan or prevent the Company from taking additional advances until the
default is cured.
  As of
March 31, 2008 and June 30, 2007, this revolving credit facility had a balance
of $227,000 and $0, respectively.  As of March 31, 2008 and June 30,
2007, the term note had a balance of $552,000 and $1,299,000,
respectively.
 
 11.
              Earnings
      (loss) Per Share
  The
Company had the following potential dilutive securities outstanding on March 31,
2008: options and warrants to purchase 2,652,738 and 2,538,267 shares,
respectively, of the Company’s common stock at weighted average exercise prices
of $3.21 and $5.57 per share, respectively, and Series D Preferred Stock
convertible into an aggregate of 693,684 shares of the Company’s common stock.
Such potential dilutive securities were not included in the calculation of
diluted loss per share in the period ended March 31, 2008 because the inclusion
thereof would be antidilutive.
 
 12.
              Discontinued
      Operations
 
 On May
1,2007,
the Company completed the sale of its Accurel subsidiary to Evans (“Asset
Sale”). The Asset Sale was completed in accordance with the terms and conditions
of the Purchase Agreement. As consideration for the Asset Sale, the Company
received cash proceeds of approximately $12,705,000 of which $1,000,000 was
placed in escrow. At June 30, 2007, the Company determined that the proceeds,
less the related transaction costs of approximately $1,794,000 in cash fees and
expenses, taxes of $197,000, and $390,000 in a non-cash charge for three year
warrants issued, were less than the book value of the net assets transferred of
$11,570,000 and therefore a loss on the sale of Accurel of $1,246,000 was
recorded in the fourth quarter in the year ended June 30, 2007 as a component of
the loss from discontinued operations.  In previous financial
statements the Accurel subsidiary was part of the Semiconductor business
segment.
 
 During
the three months ended March 31, 2008, the Company’s Board of Directors
committed to a plan for management to actively pursue buyers for Core Systems,
Inc., the remaining portion of the semiconductor business segment, and for its
medical business segment. This strategic decision will enable the Company to
focus all of its efforts on providing products for the growing security
marketplace.  It is expected that both of these business units will be
sold prior to December 31, 2008.
 
 In accordance with Statement of
Financial Accounting Standards No.144, “Accounting for the Impairment or
Disposal of Long-Lived Assets,” the March 31, 2008 financial statements have
been prepared and historical statements of operations have been reclassified to
present the operating results of Accurel, Core Systems, Inc., and its medical
segments, (the “Business Units”), as income (loss) from discontinued operations
in the accompanying Condensed Consolidated Statements of
Operations.  The assets and liabilities of Core Systems, Inc and the
medical segment have been classified as held for sale in the accompanying
Condensed Consolidated Balance Sheets. The Company has clearly (i) determined
that the  Business Units’ operations and cash flows will be eliminated
from its ongoing operations, (ii) determined that the Business Units operated as
separate components of its aggregated business as, historically, management
reviewed separately the financial results and cash flows of these businesses
apart from its ongoing continuing operations, and (iii) determined that it will
have no further significant continuing involvement in these operations after the
sale. The Company has signed non-binding term sheets with two different
companies to sell the majority of its Medical segment assets.  One of
these agreements provides that the Company will provide limited consulting
services to the buyer for a period that is anticipated to be six
months.  The consulting services cash flows are not direct cash flows
since the Company will not be (a) recognizing revenues or costs that likely
would have been generated by the disposed component absent the disposal
transaction or (b) continuing any of the revenue-producing or cost-generating
activities through active involvement with the disposed component.
 
 
 Condensed results of operations
relating to Accurel for the three and nine months ended March 31, 2007 are as
follows:
 
 Three
      Months Ended
                March
      31, 2007
              
              
              Nine
      months Ended
                March
      31, 2007Revenues:
              
              $
              2,187,000
              
              
              $
              6,763,000Gross
      profit
              
              
              596,000
              
              
              
              2,051,000Operating
      income
              
              
              86,000
              
              
              
              645,000Loss
      on sale of Accurel
              
              
              (649,000
              )
              
              
              (649,000
              )Loss
      from discontinued  operations
              
              $
              (628,000
              )
              
              $
              (139,000
              )
 
 
 Condensed results of operations
relating to Core Systems, Inc.  reported as the Semiconductor segment,
for the three and nine months ended March 31, 2008 and 2007 are as
follows:
 
 
 Three
      Months Ended March 31,
              
              
              Nine
      Months Ended March 31,2008
              
              
              2007
              
              
              2008
              
              
              2007Revenues:
              
              $
              1,598,000
              
              
              $
              1,898,000
              
              
              $
              4,689,000
              
              
              $
              5,436,000Gross
      profit
              
              
              310,000
              
              
              
              341,000
              
              
              
              114,000
              
              
              
              740,000Operating
      (loss) income
              
              
              714,000
              
              
              
              (64,000
              )
              
              
              (2,403,000
              )
              
              
              (1,065,000
              )Income
      (loss) from discontinued operations
              
              $
              714,000
              
              
              $
              (63,000
              )
              
              $
              (2,403,000
              )
              
              $
              (1,064,000
              )
 
  Included in
income (loss) from discontinued operations for the three and nine month periods
ended March 31, 2008 is a reduction in expense of  $737,000 and an
expense of $1,487,000, respectively, relating to an appraisal of goodwill
and  long-lived assets.  Initially the Company recorded an
approximate $2.2 million impairment charge in the quarter ended December 31,
2007 based on a preliminary analysis. Subsequently management has further
analyzed the information required to complete their impairment analysis and have
reduced their preliminary estimate of impairment of goodwill, intangible and
long-lived assets by approximately $700,000. The recovery of this previous
impairment charge has been recorded in loss from discontinued operations in the
three and nine months ended March 31, 2008.
 Condensed results of operations
relating to the Medical segment for the three and nine months ended March 31,
2008 and 2007 are as follows:
 
 Three
      Months Ended March 31,
              
              Nine
      Months Ended March 31,2008
              
              2007
              
              2008
              
              
              2007Revenues:
              $
              169,000
              
              $
              897,000
              
              $
              462,000
              
              
              $
              3,095,000Gross
      profit (loss)
              
              (184,000
              )
              
              39,000
              
              
              (570,000
              )
              
              
              2,642,000Operating
      (loss) income
              
              (208,000
              )
              
              (119,000
              )
              
              (675,000
              )
              
              
              (92,000)(Loss)
      income from discontinued operations
              $
              (208,000
              )
              $
              (119,000
              )
              $
              (675,000
              )
              
              $
              (92,000)
 The
discontinued assets and liabilities of Core Systems, Inc. are as
follows:
  Assets of discontinued
      operations:March
      31, 2008
                
                
                June
      30, 2007Accounts
      receivable, net
                
                $
                1,163,000
                
                
                
                1,005,000Inventory,
      net
                
                
                207,000
                
                
                
                228,000Other
      current assets
                
                
                5,000
                
                
                
                43,000Total
      Current Assets of Discontinued Operations
                
                
                1,375,000
                
                
                
                1,276,000Goodwill
                
                
                1,195,000
                
                
                
                2,062,000Intangible
      assets, net
                
                
                32,000
                
                
                
                77,000Fixed
      assets and equipment, net
                
                
                773,000
                
                
                
                1,709,000Other
      non-current assets of
                
                
                25,000
                
                
                
                75,000Total
      Non-Current Assets of Discontinued Operations
                
                
                2,025,000
                
                
                
                3,923,000Total
      Assets of Discontinued Operations
                
                $
                3,400,000
                
                
                
                5,199,000Liabilities of discontinued
      operations:Accounts
      payable and accrued expenses
                
                $
                828,000
                
                
                
                783,000Deferred
      revenue
                
                
                10,000
                
                
                
                10,000Current
      portion of capital leases
                
                
                5,000
                
                
                
                3,000Total
      Current Liabilities of Discontinued Operations
                
                
                843,000
                
                
                
                796,000Long-term
      portion of Capital leases
                
                
                2,000
                
                
                
                4,000Total
      Non-Current Liabilities of Discontinued Operations
                
                
                2,000
                
                
                
                4,000Total
      Liabilities of Discontinued Operations
                
                $
                845,000
                
                
                $
                800,000
 The
discontinued assets and liabilities of the Medical segment are as
follows:
  Assets of discontinued
      operations:March
      31, 2008
                
                
                June
      30, 2007Accounts
      receivable, net
                
                $
                48,000
                
                
                $
                540,000Inventory,
      net
                
                
                297,000
                
                
                
                255,000Total
      Current Assets of Discontinued Operations
                
                
                345,000
                
                
                
                795,000Fixed
      assets and equipment, net
                
                
                558,000
                
                
                
                683,000Total
      Non-Current Assets of Discontinued Operations
                
                
                558,000
                
                
                
                683,000Total
      assets of Discontinued Operations
                
                $
                903,000
                
                
                
                1,478,000Liabilities of Discontinued
      Operations:Accounts
      payable and accrued expenses
                
                $
                99,000
                
                
                
                315,000Total
      Current Liabilities of Discontinued Operations
                
                
                99,000
                
                
                
                315,000Total
      Liabilities of Discontinued Operations
                
                $
                99,000
                
                
                $
                315,000
  13.           Income
Taxes
 
 The
Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No.
48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on July 1,
2007.  FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, “Accounting for Income Taxes.”  FIN 48 prescribes a
two-step process to determine the amount of tax benefit to
recognize.  First, the tax position must be evaluated to determine the
likelihood that it will be sustained upon examination by a tax
authority.  If the tax position is deemed “more-likely-than-not” to be
sustained, the tax position is then assessed to determine the amount of benefit
to recognize in the financial statements.  The amount of the benefit
that may be recognized is the largest amount that has a greater than 50 percent
likelihood of being realized upon ultimate settlement.  If the tax
position does not meet the “more-likely-than-not” threshold, then it is not
recognized in the financial statements.  The Company’s adoption of FIN
48 as of July 1, 2007 did not have a material impact on the Company’s financial
position or results of operations.
 
 The
Company has reviewed the tax positions to taken, or to be taken, in its tax
returns for all tax years currently open to examination by taxing authority in
accordance with the recognition and measurement standards of FIN
48.  At March 31, 2008, there is no aggregate tax effect of
differences between tax return positions and the benefits recognized in our
financial statements.
 
 14.
              Recent
      Accounting Pronouncements
  In December
2007, the FASB issued Statement of Financial Accounting Standards (“FAS”) No.
141 (revised 2007), “Business
Combinations” (“FAS 141(R)”), which replaces FAS No.141, “Business Combinations”. FAS
141(R) retains the underlying concepts of FAS 141 in that all business
combinations are still required to be accounted for at fair value under the
purchase method of accounting, but FAS 141(R) changed the method of applying the
purchase method in a number of significant aspects. FAS 141(R) is effective on a
prospective basis for all business combinations for which the acquisition date
is on or after the beginning of the first fiscal year subsequent to December 15,
2008, with the exception of the accounting for valuation allowances on deferred
taxes and acquired tax contingencies. FAS 141(R) amends FAS 109 such that
adjustments made to valuation allowances on deferred taxes and acquired tax
contingencies associated with acquisitions that closed prior to the effective
date of FAS 141(R) would also apply the provisions of FAS 141(R). The Company is
currently analyzing the impact, if any, of this standard.
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51”(“FAS 160”), which establishes accounting and reporting standards
for ownership interests in subsidiaries held by parties other than the parent,
the amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. FAS 160 also establishes reporting requirements that provide
sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. FAS 160
is effective for fiscal years beginning after December 15, 2008.  The
Company is currently assessing the potential impact that adoption of SFAS
No. 160 would have on our financial statements.
 In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, “Fair Value Measurements”,(“SFAS 157”). SFAS 157
defines fair value, establishes a framework for measuring the fair value of
assets and liabilities, and expands disclosure requirements regarding the fair
value measurement. SFAS 157 does not expand the use of fair value measurements.
This statement, as issued, is effective for financial statements issued for
fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. FASB Staff Position (FSP) FAS No. 157-2 was issued in
February 2008 and deferred the effective date of SFAS 157 for nonfinancial
assets and liabilities to fiscal years beginning after November 2008. As such,
the Company adopted SFAS 157 as of January 1, 2008 for financial assets and
liabilities only. There was no significant effect on the Company’s financial
statements. As of March 31, 2008, the Company’s financial assets subject to SFAS
157 consisted of held to maturity investments in marketable securities and
investments in non-publicly traded companies; financial liabilities consisted of
derivatives for forward contracts. The Company determined fair value for the
investments in marketable securities and the derivative liabilities based on
quoted market prices in active markets (i.e. Level 1 as defined under SFAS 157);
fair value for investments in non-publicly traded companies was based on third
party valuation models (i.e. Level 2 as defined under SFAS 157). The Company
does not believe that the adoption of SFAS 157 to non-financial assets and
liabilities will significantly effect its financial
statements.
 
 15.
              Subsequent
      events
 
 On April 10, 2008 (the “Closing Date”),
the Company entered into a definitive agreement (the “Merger Agreement”) to
acquire all of the capital stock of Ion Metrics, Inc, a California corporation
(“IMI”). The transaction was structured as a reorganization of IMI with and into
a newly formed, wholly-owned subsidiary of the Company (the “Transaction”). As
part of the Transaction, the Company will issue to the former stockholders of
IMI (the “IMI Stockholders”) consideration consisting of 2,000,000 shares of the
Company’s common stock, par value $0.10 per share (“Common Stock”).
 
 The IMI Stockholders have agreed not to
sell any of their shares of common stock for a period of 18 months from the
Closing Date (the “Lock-up Period”); provided however for the period from six to
18 months from the Closing Date, each holder may sell, in any 3 month period,
the greater of (a) 1% of the outstanding shares of the same class being sold or
(b) if the class is listed on a stock exchange or quoted on the American Stock
Exchange, the greater of (i) one percent (1%) of the outstanding shares of such
class or (ii) the average reported weekly trading volume during the four weeks
preceding the sale.
 
 In connection with the Transaction, the
Company entered into an escrow agreement (the “Escrow Agreement”) with IMI and
ComputerShare Trust Company.  The Company deposited 400,000 shares of
common stock, representing 20% of the purchase price, into an escrow
account.  Any valid claims for indemnification made by the Company pursuant
to the Merger Agreement shall be paid from these shares.  The Escrow
Agreement provides, subject to any claims of indemnifications, for a release of
the shares on April 10, 2009.
 
 As part of the closing, Said
Boumsellek, the former President of IMI, and Robert Ferran, the former Chief
Scientist of IMI, have entered into three year employment agreements with the
Company and Thomas Kuehn, a former board member of IMI has entered into a one
year consulting agreement with the Company.
 
 The Transaction also included board
observer rights which permit a designee of the IMI Stockholders to attend
Company board meetings.  This right expires upon the termination of
the Lock-Up Period.
 
 The Company entered into an agreement
with Ferran Scientific (the “FS Agreement”) whereby the Company assumed certain
IMI obligations and rights of IMI.   The FS Agreement also
included modifications to these assumed obligations including the deferral of
payment obligations for a period up to 12 months from the Closing
Date.  The Company also assumed an obligation to pay Ferran Scientific
a minimum of $500,000 in royalty payments over the next eight
years.
 
 
 ITEM
2.                      MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 
 OVERVIEW
 
 The
following discussion and analysis should be read in conjunction with the safe
harbor statement and the risk factors contained in Item IA of Part II of this
Quarterly Report on Form 10-Q, in our Annual Report on Form 10-K for the year
ended June 30, 2007, and in our other filings with the Securities and Exchange
Commission. Readers should also be cautioned that results of any reported period
are often not indicative of results for any future period.
 
 Over the
past 23 years, Implant Sciences Corporation has developed technologies using ion
beam technology and thin film coatings. Initially this technology was used in
semiconductor wafer processing, the modification of orthopedic joint implant
surfaces to reduce polyethylene wear generation and the manufacturing of
products for brachytherapy treatments.  The latest application of our
ion beam technology includes the manufacturing of trace explosives detection
equipment.
 
 Today, the Company is focused on the
security marketplace by providing systems and sensors for the homeland security
market and related industries and has both developed and acquired technologies
using ion mobility spectrometry to develop a product line for use in explosives
trace detection.  The Company is currently in the process of divesting
all non-security related assets.
 
 In
October 2004 and March 2005, the Company acquired two California semiconductor
related companies, Core Systems (“Core”) and Accurel Systems International
(“Accurel”), respectively.  In May 2007, we sold our Accurel
subsidiary for a total purchase price of approximately
$12,705,000.  Other applications of our ion beam technology had been
in the area of temporary brachytherapy products. In June 2007, we sold certain
assets associated with this product line and divested the prostate seed and
medical software businesses.
 
 In February 2008, the Company’s Board
of Directors committed to a plan for management to actively pursue a buyer for
its Semiconductor Reporting Unit.  In March 2008, the Company notified
its medical coating customers of its intention to discontinue these services by
the end of calendar 2008.  In addition, the Company signed has signed
non-binding term sheets with two different companies to sell the majority of its
remaining assets relating to its former brachytherapy business.  As a
result, both its Semiconductor and Medical Reporting Units are being presented
as discontinued operations in the accompanying financial
statements.
 
 Management’s discussion and analysis of
financial condition and results of operations are based on the Company’s
continuing operations.
 
 RESULTS
OF OPERATIONS
 
 The following is a discussion and
analysis of the financial condition and results of operation of the Company for
the three month period ended March 31, 2008 and 2007. It should be read in
conjunction with the financial statements and notes thereto appearing elsewhere
herein.
 
 Three
Month Period Ended March 31, 2008 vs. March 31, 2007
 
 Security products revenues for the
three months ended March 31, 2008 were $787,000 as compared to $1,121,000 in the
three months ended March 31, 2007, a decrease of $344,000 or 30%.  The
decrease in security product revenue is primarily a result of a decrease in
government contract revenue as more of the Company’s resources were focused on
internally funded research projects in the three month period ended March 31,
2008 as compared with the comparable prior year period.  This decrease
in government contract revenue was partially offset by an increase in the number
of units of our explosives detection products in the quarter ended March 31,
2008 as compared with the quarter ended March 31, 2007.
 
 Cost of Revenues. Security
products cost of revenues for the three months ended March 31, 2008 were
$581,000 as compared to $780,000 in the prior three months period ended March
31, 2007, a decrease of $199,000 or 26%.  The decrease in cost of revenues
relates to the decline in government contract revenue and the associated direct
expenses.  This decrease was offset by an increase in the variable
costs related to increased unit sales of our trace explosives
products.
 
 Gross
Margins.Security products had a gross margin of $206,000 or
26% of revenue for the three month period ended March 31, 2008 as compared
with a gross margin of $341,000 or 30% in the corresponding prior year
period.  The decrease in gross margin is a result of  the
loss of gross margin provided by government contract revenue  combined
with an insufficient volume of security product unit sales to cover the high
fixed costs associated with supporting this product line.
 
 Research and Development.
Research and development expense for the three months ended March 31, 2008 was
$822,000 as compared to $326,000 for the comparable prior year period, an
increase of $496,000 or 152%.  The Company continues to expend funds
to expand its staff to further the development of new products in the areas of
explosives detection, as well to prepare for certain government laboratory
acceptance testing.  In addition, the increase in research and
development expenses relates to the decrease in volume and timing of customer
funded programs, primarily through government grants and
contracts.  The Company focused additional resources on its internally
funded research and development programs in the three months ended March 31,
2008 as compared with the three months ended March 31, 2007.  The
Company charges its research and development personnel to cost of revenues for
work performed on these contracts and grants. Research and development expenses
prior to starting the government contracts are charged to operating
expenses.
 
 Selling, General and
Administrative. Selling, general and administrative expense for the three
months ended March 31, 2008 was $1,328,000 as compared to $977,000 for the
comparable prior year period, an increase of $351,000, or 36%.  The
majority of this increase is directly related to the costs associated with the
additions to the Company’s senior management team combined with the expenses
related to consultants hired to assist management with its investor relations
and Sarbanes-Oxley compliance.
 
 Other Income and Expense,
Net. For the three months ended March 31, 2008, we recorded other
expense, net of $90,000 as compared to $120,000, in the comparable prior year
period, a decrease of $30,000 or 25%.  Interest expense in the current year
period was $22,000 compared to $226,000 in the prior year
period.  This is a result of lower notes payable balances in 2008 as
compared with 2007.  During the quarter ended March 31, 2007 the
Company had an $1,500,000 outstanding short term note payable to Laurus Master
Fund, LLP.  This note was repaid in May 2007.  The reduction
in interest expense was offset by an increase in expenses to mark to market the
embedded derivatives associated with the Series D Preferred
Stock.  For the three months ended March 31, 2008, the company
recognized an expense of $97,000 as compared to recognizing income of $95,000
for the three months ended March 31, 2007, related to this
derivative.
 
 Loss from Continuing
Operations.Loss from continuing operations for the three
months ended March 31, 2008 was $2,034,000 as compared with $1,082,000 for the
comparable prior year period, an increase in net loss of $952,000, or
88%.  The increase in net loss is primarily the result of the increase
in operating expenses and a reduction of revenue.
 
 Preferred distribution, dividends and
accretion on the Series D Redeemable Convertible Preferred Stock were $249,000
in the three months ended March 31, 2008 as compared to $277,000 in the
comparable prior year period.
 
 Income (Loss) from Discontinued
Operations.Income  from discontinued operations for the three
months ended March 31, 2008 was $506,000 as compared a loss of $810,000 in the
corresponding prior year period a decrease of $1,316,000.  In the
period ended March 31, 2008, discontinued operations include the Company’s
semiconductor and medical reporting units, which are being reported as held for
sale.  The semiconductor reporting unit reflects only the Company’s
Core subsidiary.  However, in the three month period ended March 31,
2007, discontinued operations includes both the Core and Accurel subsidiaries,
the medical reporting unit and $649,000 adjustment relating to the loss on sale
of Accurel in May 2007.  In addition, the Company completed a formal
appraisal of the goodwill and long lived assets relating to the Semiconductor
Reporting Unit, pursuant to an impairment occurring in the second quarter of
fiscal 2008.  As a result, in the quarter ended March 31, 2008, the
Company recognized a reduction in impairment expense of $737,000 reflecting the
true–up of the $2,224,000 impairment initially estimated in the quarter ended
December 31, 2007.
 
 Nine
Month Period Ended March 31, 2008 vs. March 31, 2007
 
 Revenues for the nine months ended
March 31, 2008 were $2,505,000 as compared to $3,507,000 in the nine months
ended March 31, 2007, a decrease of $1,002,000 or 29%.  The decrease
in security product revenue in the nine month period ended March 31, 2008 as
compared with the comparable prior year period is primarily due to a decline in
revenue generated from government research and development
contracts.  This decrease was offset by a 40% increase in revenue
related to unit sales of our trace explosives detectors.
 
 Cost of Revenues. Cost of
revenues for the nine months ended March 31, 2008 was $1,809,000 as compared to
$2,560,000 in the corresponding prior year period, a decrease of $751,000 or
30%.  The decrease in cost of revenues for the nine months ended March
31, 2008 as compared to the corresponding prior year period relate to the
decline in direct costs relating to government research and development
contracts, offset by the increased variable costs associated with the sale of
our trace explosives detectors.
 
 Gross Margins
..Gross margins for the nine months ended March 31, 2008 were
$696,000 as compared to $947,000 in the corresponding prior year period, a
decrease of $251,000 or 27%.   The decrease in gross margin is a
result of the loss of gross margin contributed by government contract revenue
combined with an insufficient volume of security product unit sales to cover the
high fixed costs associated with supporting this product line.
 
 Research and
Development.  Research and development expense for the nine
months ended March 31, 2008 was $2,135,000 as compared to $1,212,000 for the
comparable prior year period, an increase of $923,000, or 76%. The Company
continues to expend funds to expand its staff to further the development of new
products in the areas of explosives.  The increase in research and
development expenses relates to the decrease in volume and timing of customer
funded programs, primarily through government grants and
contracts.  The Company focused more resources on its internal
research and development programs in the nine months ended March 31, 2008 as
compared with the nine months ended March 31, 2007.  The Company
charges its research and development personnel to cost of revenues for work
performed on these contracts and grants. Research and development expenses prior
to starting the government contracts are charged to operating
expenses.
 
 Selling, General and
Administrative. Selling, general and administrative expense for the nine
months ended March 31, 2008 was $4,185,000 as compared to $2,722,000 for the
comparable prior year period, an increase of $1,463,000, or 54%. The majority of
this increase is directly related to the costs associated with the additions to
the Company’s senior management team combined with the expenses related to
consultants hired to assist management with its investor relations and
Sarbanes-Oxley compliance.
 
 Other Income and Expense,
Net. For the nine months ended March 31, 2008, we recorded other income,
net, of $156,000 as compared to $382,000, in the comparable prior year period, a
decrease of $226,000 or 59%. The decrease in other income and expenses, net, is
primarily the result of a decrease of $764,000 of other income related to
marking to market the embedded derivatives associated with the Series D
Preferred Stock.  Interest income increased to $193,000 for the nine
month period ending March 31, 2008 as compared to $22,000 in the prior year
period, an increase of $171,000 as a result of investing the cash proceeds from
the sale of Accurel in May 2007.  Interest expense in the current year
period was $82,000 compared to $282,000 in the prior year period as the Company
continues to pay down its debt.
 
 Loss from Continuing
Operations.Loss from continuing operations for the nine
months ended March 31, 2008 was $5,468,000 as compared with $2,605,000 for the
comparable prior year period, an increase in net loss of $2,863,000, or
110%.  The increase in net loss is primarily the result of the
reduction in other income related to the marking to market of the embedded
derivative associated with the Series D Preferred Stock combined with the
additional expenses relating to the expansion of the executive management,
research and development and sales and marketing staff.
 
 Preferred distribution, dividends and
accretion on the Series D Redeemable Convertible Preferred Stock were $845,000
in the nine months ended March 31, 2008 as compared to $658,000 in the
comparable prior year period.
 
 Loss from Discontinued
Operations.Loss from discontinued operations for the nine
months ended March 31, 2008 was $3,078,000 as compared with a loss of $1,295,000
in the corresponding prior year period.  The apparent increase in loss
is the result of including the positive nine month results from the Accurel
operations in the prior year period, which are not included in the current
period.  The Company sold the assets of its Accurel subsidiary on May
1, 2007.
 
 LIQUIDITY
AND CAPITAL RESOURCES
  As of March
31, 2008, the Company had approximately $2,421,000 in the form of cash and cash
equivalents. During the nine months ended March 31, 2008, operating activities
used cash of approximately $4,732,000. Net cash used by operating activities
primarily reflects the loss from continuing operations of $5,468,000 and the
loss from discontinued operations of $3,078,000, a $404,000 decrease in accounts
payable, partially offset by non-cash expenses of $515,000 of share-based
compensation and $127,000 of depreciation expense, and a $147,000 decrease in
accounts receivable.  The Company has approximately $566,000 of raw
materials and finished goods inventories related to its handheld explosives
detection product.  This inventory was acquired in anticipation of
future shipments of this product to customers.  Orders for the
explosives detection product to date have typically been from distributors to
foreign governments or agencies of foreign governments.  The sales
cycle to these entities can take a number of months to close the order, set up
letters of credit from the customer covering the payment, and obtain the
necessary export licenses and other required documentation.  Investing
activities used cash of $395,000. Financing activities used cash of $2,071,000
and consist primarily of $1,068,000 in cash payments on bank loans and capital
leases along with $1,282,000 in cash dividends and payments to the holders of
the Series D Preferred Stock, offset by $52,000 of stock related
issuances.
 
 The
Company currently has a $5.0 million revolving credit facility (the “line of
credit”) with Silicon Valley based Bridge Bank, N.A. (the
“Bank”).  This line of credit, which expires in December 2008,
provides for advances of up to 80% of the Company’s eligible accounts receivable
and up to the lesser of $1,000,000 or 40% of eligible inventory, bears interest
at the prime rate, plus 1/2% per annum, and is collateralized by all assets of
the Company.  In addition, the Company has a 30-month term loan with
the Bank, bearing an interest rate at the prime rate plus 1% per annum payable
in 30 equal monthly installments of principal, plus all accrued interest
beginning on February 10, 2007.
  Since May
1999, we have been developing several explosive detection systems that could be
used in airports, public and government buildings, and sporting event
facilities. The systems use our proprietary technology, which includes the use
of a photon-based, non-radioactive ion source in combination with ion mobility
spectrometry, to electronically detect minute quantities of explosive vapor
molecules.
 
 This project is currently being
undertaken by both our internal scientists and outside contractors. The
development of new applications is typically funded through government grants or
internal funding. Since March 2000, we have received 17 contracts totaling over
$12 million for detection of toxic chemicals or explosives from agencies such as
the Departments of the Army, Air Force, Marine Corps, Navy and the Department of
Homeland Security.
 
 Consistent with our policy to protect
our proprietary technologies, we have been awarded six patents and have
submitted six additional patent applications to the United States Patent and
Trademark Office. These patents and applications cover specific design
configurations that are responsible for our improved vapor detection
sensitivity.
 
 We are
now manufacturing several versions of our explosives detection systems,
including: (i) a bench-top unit, which can be used to screen passengers and
carry-on baggage in airports and (ii) a portable system, which can be used to
clear buildings, aircrafts, or ships where hidden explosivesare believed to
exist.  We are currently selling our portable and bench-top version of
these products both domestically and internationally. We plan to market these
systems to government agencies for use in airports, government buildings and
facilities and elsewhere.
 
 We are currently expending significant
resources to develop the next generation of our current products and to develop
new products. Although we continue to fund as much research and development as
possible through government grants and contracts in accordance with the
provisions of the respective grant awards, we will require additional funding in
order to continue the advancement of the commercial development and
manufacturing of the explosives detection system. We will attempt to obtain such
financing by: (i) government grants, (ii) private financing, or (iii) strategic
partnerships. However, there can be no assurance that we will be successful in
our attempts to raise such additional financing.
 
 We will require substantial funds for
further research and development, regulatory approvals, and the marketing of our
explosives detection products. Our capital requirements depend on numerous
factors, including but not limited to; the progress of our research and
development programs; the cost of filing, prosecuting, defending and enforcing
any intellectual property rights; competing technological and market
developments; changes in our development of commercialization activities and
arrangements; and the hiring of additional personnel, and acquiring capital
equipment.
 
 Based on the current sales, expense and
cash flow projections, advances on the Company’s line of credit and the proceeds
from the sale of certain assets, management believes it has plans in place to
fund operations for the next several months.  Because there can
be no assurances that sales will materialize as forecasted, and/or that
management will be successful in executing these plans, management will continue
to closely monitor and attempt to control costs at the Company and will continue
to actively seek the needed capital through government grants and awards,
strategic alliances, private financing sources, and through its lending
institutions. Future expenditures for research and product development are
discretionary and can be adjusted as can certain selling, general and
administrative expenses, based on the availability of cash.  The
financial statements do not include any adjustments relating to the
recoverability and classification of asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
 
 Critical
Accounting Policies
  Our
significant accounting policies are described in Note 2 to the financial
statements included in  our Annual Report on Form 10-K as of June 30,
2007.  Our discussion and analysis of our financial condition and
results of operations are based upon the financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States.  The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities.  On an on-going basis, we evaluate our estimates,
including those related to bad debts, product returns, inventories, investments,
intangible assets and warranty obligations.  We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources.  In the past, actual results
have not been materially different from our estimates.  However,
results may differ from these estimates under different assumptions or
conditions.  In accordance with SFAS No. 142 (“Goodwill and Other
Intangible Assets”), goodwill and other intangible assets with indefinite lives
are no longer amortized, but rather such assets are subject to annual impairment
reviews or more frequently, if events or circumstances indicate that they may be
impaired.
  
 Recent
      Accounting Pronouncements
 
 In December 2007, the FASB issued
Statement of Financial Accounting Standards (“FAS”) No. 141 (revised 2007),
“Business Combinations”
(“FAS 141(R)”), which replaces FAS No.141, “Business Combinations”. FAS
141(R) retains the underlying concepts of FAS 141 in that all business
combinations are still required to be accounted for at fair value under the
purchase method of accounting, but FAS 141(R) changed the method of applying the
purchase method in a number of significant aspects. FAS 141(R) is effective on a
prospective basis for all business combinations for which the acquisition date
is on or after the beginning of the first fiscal year subsequent to December 15,
2008, with the exception of the accounting for valuation allowances on deferred
taxes and acquired tax contingencies. FAS 141(R) amends FAS 109 such that
adjustments made to valuation allowances on deferred taxes and acquired tax
contingencies associated with acquisitions that closed prior to the effective
date of FAS 141(R) would also apply the provisions of FAS 141(R). The Company is
currently analyzing the impact, if any, of this standard.
 
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51”(“FAS 160”), which establishes accounting and reporting standards
for ownership interests in subsidiaries held by parties other than the parent,
the amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. FAS 160 also establishes reporting requirements that provide
sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. FAS 160
is effective for fiscal years beginning after December 15, 2008.  The
Company is currently assessing the potential impact that adoption of SFAS
No. 160 would have on our financial statements.
  In September
2006, the FASB issued Statement of Financial Accounting Standards No. 157,
“Fair Value Measurements”,(“SFAS 157”). SFAS 157 defines fair value, establishes a framework for
measuring the fair value of assets and liabilities, and expands disclosure
requirements regarding the fair value measurement. SFAS 157 does not expand the
use of fair value measurements. This statement, as issued, is effective for
financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. FASB Staff Position (FSP)
FAS No. 157-2 was issued in February 2008 and deferred the effective date of
SFAS 157 for nonfinancial assets and liabilities to fiscal years beginning after
November 2008. As such, the Company adopted SFAS 157 as of January 1, 2008 for
financial assets and liabilities only. There was no significant effect on the
Company’s financial statements. As of March 31, 2008, the Company’s financial
assets subject to SFAS 157 consisted of held to maturity investments in
marketable securities and investments in non-publicly traded companies;
financial liabilities consisted of derivatives for forward contracts. The
Company determined fair value for the investments in marketable securities and
the derivative liabilities based on quoted market prices in active markets (i.e.
Level 1 as defined under SFAS 157); fair value for investments in non-publicly
traded companies was based on third party valuation models (i.e. Level 2 as
defined under SFAS 157). The Company does not believe that the adoption of SFAS
157 to non-financial assets and liabilities will significantly effect its
financial statements.
    ITEM
3.                   QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 Not
required.
 
 ITEM
4.                   CONTROLS
AND PROCEDURES
 
 EVALUATION
OF OUR DISCLOSURE CONTROLS AND INTERNAL CONTROLS
  As of the end of the period covered by
this quarterly report, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures ("Disclosure Controls") and
our internal controls and procedures for financial reporting ("Internal
Controls"). This evaluation (the "Controls Evaluation") was done under the
supervision and with the participation of our management, including our Chief
Executive Officer ("CEO") and Chief Financial Officer ("CFO"). Rules adopted by
the Securities and Exchange Commission (“SEC”) require that  we
present the conclusions of our CEO and the CFO about the effectiveness of our
Disclosure Controls and Internal Controls based on and as of the date of the
Controls Evaluation.
 
 CEO AND
CFO CERTIFICATIONS
  Appearing as exhibits to this Quarterly
Report are "Certifications" of the CEO and the CFO. The Certifications are
required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (the "Section
302 Certifications"). This section of the Quarterly Report contains information
concerning the Controls Evaluation referred to in the Section 302 Certifications
and this information should be read in conjunction with the Section 302
Certifications for a more complete understanding of the topics
presented.
 
 DISCLOSURE
CONTROLS AND INTERNAL CONTROLS
  Disclosure Controls are procedures that
are designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934
("Exchange Act"), such as this Quarterly Report, is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. Disclosure Controls are also designed with the objective of ensuring that
such information is accumulated and communicated to our management, including
the CEO and CFO, as appropriate, to allow timely decisions regarding required
disclosure. Internal Controls are procedures which are designed with the
objective of providing reasonable assurance that (1) our transactions are
properly authorized, recorded and reported; and (2) our assets are safeguarded
against unauthorized or improper use, to permit the preparation of our financial
statements in conformity with generally accepted accounting
principles.
 
 LIMITATIONS
ON THE EFFECTIVENESS OF CONTROLS
  Our management, including the CEO and
CFO, has concluded that our disclosure controls and procedures are designed to
provide reasonable assurance of achieving their objectives and have concluded
that the controls and procedures are effective at that reasonable assurance
level.
 
 SCOPE OF
THE CONTROLS EVALUATION
  The CEO’s and CFO’s evaluation of our
Disclosure Controls and Internal Controls included a review of the controls'
objectives and design, the controls’ implementation by us and the effect of the
controls on the information generated for use in this Quarterly Report. In the
course of the Controls Evaluation, management sought to identify data errors,
controls problems or acts of fraud and to confirm that appropriate corrective
action, including process improvements, were being undertaken. This type of
evaluation will be done on a quarterly basis so that the conclusions concerning
controls effectiveness can be reported in our Quarterly Reports on Form 10-Q and
Annual Report on Form 10-K. The overall goals of these various review and
evaluation activities are to monitor our Disclosure Controls and Internal
Controls and to make modifications as necessary; our intent in this regard is
that the Disclosure Controls and the Internal Controls will be maintained as
dynamic systems that change (including with improvements and corrections) as
conditions warrant.
  Among other matters, management sought
in its evaluation to determine whether there were any "significant deficiencies"
in our Disclosure Controls or our Internal Controls.  A “significant
deficiency” is a deficiency or a combination of deficiencies, in internal
control over financial reporting, that is less severe than a material weakness,
yet important enough to merit attention by those responsible for oversight of
the Company’s financial reporting.  In the final standard a “material
weakness” is defined as “a deficiency, or a combination of deficiencies in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Company’s annual or interim
financial statements will not be prevented or detected on a timely
basis.”
 
 Changes
in Internal Control over Financial Reporting
 
 There were no changes to the Company’s
internal control over financial reporting during the quarter ended March 31,
2008, that has materially affected, or are reasonably likely to materially
affect the Company’s internal control over financial reporting.
 
 CONCLUSIONS
  Based upon the Controls Evaluation, our
CEO and CFO have concluded that, as of the end of the period covered by this
quarterly report, our Disclosure Controls are effective to provide reasonable
assurance that our financial statements are fairly presented in conformity with
generally accepted accounting principles.
  In June 2007, our independent
auditors reported to our Audit Committee certain matters involving internal
controls that our independent auditors considered to be a significant
deficiency.  A significant deficiency is a deficiency or combination
of deficiencies in internal control over financial reporting, that is less
severe than a material weakness yet important enough to merit attention by those
responsible for oversight of the company’s financial reporting.
 
 The reportable condition related
primarily to the analysis conducted in regards to the annual goodwill impairment
testing
 
 The reportable condition has been
discussed in detail among management, our Audit Committee and our independent
auditors, and we are committed to addressing and resolving these matters fully ,
by putting in place the personnel, processes, technology and other resources
appropriate to improve the communication between our subsidiary and the parent
company as well as to provide better forecasting models.  As part of
this commitment, in the second quarter of our fiscal year ending June 30, 2008,
we began by educating the staff and revising the internal forecasting and
reporting procedures to ensure that changes are provided in a timely manner to
management.  Although management will continue to evaluate these
procedures to improve the process, management is confident that our financial
statements for the year ended June 30, 2007 fairly present, in all material
respects, our financial condition and results of operations.
 
 PART
II                      OTHER
INFORMATION
 
 Item
1.                                Legal
Proceedings
 
 On March 23, 2005, we entered into a
Development, Distribution and Manufacturing Agreement (the “Rapiscan Agreement”)
with Rapiscan Systems, Inc. (“Rapiscan”).  Under the terms of this
agreement, we gave Rapiscan the exclusive worldwide rights to market our Quantum
SnifferTM portable
and benchtop trace detection devices under their private label.  We also
agreed to give Rapiscan the exclusive worldwide rights to distribute certain
other new security products which we may develop in the future with their
funding, as well as rights, in some circumstances, to manufacture certain
components of the private-labeled Quantum SnifferTM portable
and benchtop trace detection devices.
 
 On March 23, 2006, Rapiscan filed a
complaint against the Company and its contract assembler, Columbia Tech, in the
United States District Court for the Central District of California, regarding
the Rapiscan Agreement.  Rapiscan’s complaint against the Company alleged
breach of contract and breach of warranty and requested specific performance,
declaratory relief and injunctive relief. Rapiscan’s complaint against Columbia
Tech alleged  tortuous interference with contractual relations and
requested injunctive relief and declaratory relief. On April 12, 2006, Rapiscan
dismissed all claims against Columbia Tech.
 
 On March 24, 2006, the Company brought
suit in the United States District Court in the District of Massachusetts
against Rapiscan and its parent, OSI Systems, Inc. (“OSI”). The Company
requested rescission of the Rapiscan Agreement, plus damages, based on claims of
misrepresentation.  In the alternative, the Company sought termination
of the Rapiscan Agreement due to material breaches of contract and the implied
covenant of good faith and fair dealing and for damages due to Rapiscan’s breach
of contract and the implied covenant of good faith and fair
dealing.
 
 In August
2006, as a result of motions made by both parties, the two lawsuits (the
“Pending Litigation”) have been consolidated in the United States District Court
for the Central District of California with the Company as
plaintiff.  In late 2006, Rapiscan and OSI filed a motion to dismiss
certain of the Company’s claims.  The court dismissed the Company’s
claim of breach of fiduciary duty, but the motion to dismiss was denied in all
other respects.  OSI and Rapiscan had filed four motions for partial
summary judgment with respect to certain discrete claims.  Two of the
motions were denied in their entirety.  The third was denied in the
only material respect and granted in two immaterial respects.
 
 On
January 4, 2008, the Company executed a Settlement Agreement (the “Settlement
Agreement”) with OSI and Rapiscan to resolve the Pending Litigation and to enter
into additional agreements.  In addition to the immediate dismissal of
the Pending Litigation, other terms of the Settlement Agreement include, (i) the
rescission of the Rapiscan Agreement, (ii) the payment by the Company of
$200,000, such payment to be made in the form of shares of the Company’s common
stock,  (iii) the granting of non-exclusive distribution rights to
Rapiscan and OSI, (iv) the payment by the Company of up to $1,000,000 in
Technology Transfer Fees, payable over time at a rate of 2% of the gross sales
price received by the Company when a passenger portal is sold, and (v) the
opportunity for OSI to supply certain components to the Company.
 
 On May 1, 2007, the Company entered
into an Asset Purchase Agreement (the “Evans Agreement”) to sell substantially
all of the assets (the “Transaction”) of its subsidiary, Accurel Systems
International Corporation (“Accurel), a California corporation, to Evans
Analytical Group LLC (“Evans”), a Delaware limited liability
company.  Evans acquired all of the fixed assets and accounts
receivable of Accurel.  The total purchase price of the Transaction
was approximately $12,705,000.
 
 In
connection with the Transaction, we entered into an escrow agreement (the
“Escrow Agreement”) with Evans, Accurel, and Zions First National Bank. 
Pursuant to the Escrow Agreement, Evans deposited $1,000,000 (the “Escrow
Amount”) of the total purchase price for the assets into an escrow
account.  Any valid claims for indemnification made by Evans pursuant to
the Agreement shall be drawn from this sum.  The Escrow Agreement
provides, subject to any claims of indemnifications, for a release of $500,000
on approximately each of March 31, 2008 and March 31,
2009.
 
 Also in
connection with the Transaction, we entered into a Non-competition and
Nondisclosure Agreement (the “NCD”) with Evans whereby we agreed not to engage
in any business that directly competes with the business of
Accurel.  In addition, the NCD prohibits us from disclosing any
confidential information concerning the business of Accurel.  The NCD
will remain in effect for five years from the date of its
execution.
 
 On
February 22, 2008, Evans filed suit requesting rescission of the Evans
Agreement, plus $8 million in damages, based on claims of misrepresentation (the
“Evans Claim”). On March 28, 2008, Evans filed a formal Claims Notice with
the escrow agent prohibiting release of any portion of the escrow to the Company
as a result of the suit filed on February 22, 2008.  Management
continues to believe the escrowed amounts are collectible, however as a result
of the Claim Notice, have classified the $1,000,000 Escrow Amount as a long-term
asset.  The Company has retained legal counsel in defense of these
claims and intends to vigorously defend the Evans Claim and the Claim
Notice.
 We may, from
time to time, be involved in other actual or potential proceedings that we
consider to be in the normal course of our business. At this time, we do not
believe that any of these proceedings will have a material adverse effect on our
business.
  Item
1a.                                Risk
Factors
  This
report contains forward-looking statements that involve risks and uncertainties,
such as statements of our objectives, expectations and intentions. You should
consider carefully all of the material risks described in our Annual Report
on Form 10-K for the fiscal year ended June 30, 2007, as well as the cautionary
statements made elsewhere in the Annual Report and in this report, before making
a decision to invest in our securities. Such cautionary statements are
applicable to all forward-looking statements wherever they appear in this
report. If any of the events described therein occur, our business, financial
conditions and results of operations may be materially adversely affected. In
that event, the trading price of our securities could decline, and you could
lose all or part of your investment.
  Except as
set forth below, there have been no material changes to the risk factors
previously disclosed in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 2007.
 
 We
do not operate at a profit and do not expect to be profitable for some
time.
 
 During
the twelve months ended June 30, 2007, we had losses from continuing operations
ofapproximately
$9,924,000. During the three months and nine months ended March 31, 2008, we had
losses from continuing operations of $2,034,000 and $5,468,000,
respectively.  We plan to further increase our expenditures to
complete the development and commercialization of our new products, and to
broaden our sales and marketing capabilities. Asa result, we believe
that we will likely continue to incur losses over the next several quarters. Our
accumulated deficit as of June 30, 2007 was approximately $47,927,000. At March
31, 2008, our accumulated deficit was approximately $57,317,000 and we had
working capital of $771,000. The Company has a term loan with a bank, which
matures in August 2009, having an unpaid balance of approximately
$552,000.  Management continually evaluates plans to reduce its
operating expenses and increase its cash flow from operations. Failure of the
Company to achieve its projections may require the Company to seek additional
financing or discontinue operations.
 
 Based on
the current sales, expense and cash flow projections, the proceeds from our
revolving credit facility, the anticipated sale of Core Systems and certain
other assets, and management’s plan to seek additional capital through private
financing sources, management believes there are plans in place to sustain
operations for at least the next twelve months.  However, there can be
no assurance that management will be successful in executing these plans. These
plans depend on a substantial increase in sales of the Company’s handheld trace
explosives detector product and the sale of Core. Unanticipated decreases in
operating revenues, unanticipated decreases in the market value of our common
stock, delays in government funding of grants, increases in expenses or further
delays in product development may adversely impact our cash position and require
further cost reductions.  No assurance can be given that we will be
able to operate profitably on a consistent basis.
 
 There
are risks relating to our 2007 sale of the assets of our Accurel subsidiary to
Evans.
 
 On May 1, 2007, the Company entered
into an Asset Purchase Agreement (the “Evans Agreement”) to sell substantially
all of the assets (the “Transaction”) of its subsidiary, Accurel Systems
International Corporation (“Accurel), a California corporation, to Evans
Analytical Group LLC (“Evans”), a Delaware limited liability
company.  Evans acquired all of the fixed assets and accounts
receivable of Accurel.  The total purchase price of the Transaction
was approximately $12,705,000.
 
 On February 22, 2008, Evans filed
suit requesting rescission of the Evans Agreement, plus damages, based on claims
of misrepresentation. On March 28, 2008, Evans filed a formal Claims Notice with
the escrow agent prohibiting release of any portion of the escrow to the Company
as a result of the suit filed on February 22, 2008.  The Company has
retained legal counsel in defense of these claims.
 
 Should
the Company be unsuccessful in defending this matter, it may have a material
adverse effect on its business, assets and results of operations.
 
 Notice
of Non-Compliance with Certain American Stock Exchange Continued Listing
Standards.
 
 The
Company has been notified by the American Stock Exchange (the "Exchange") of
non-compliance with several continued listing standards and maybe subject
delisting if we do not regain compliance within a timeframe agreed to by the
Exchange. Specifically, the Company is not in compliance with Section
1003(a)(ii) of the Exchange’s Company Guide with stockholders equity of less
than $4,000,000 and losses from continuing operations and net losses in three
out of its four most recent fiscal years and Section 1003(a)(iii) of the Company
Guide with stockholders equity of less than $6,000,000 and losses from
continuing operations and net losses in its five most recent fiscal years. On
May 9, 2008, the Company submitted to the Exchange its plan to regain compliance
with these listing requirements by October 9, 2009. If the Company’s plan is not
accepted by the Exchange, or if the plan is accepted but the Company is then
unable to re-establish compliance with the applicable listing requirements, our
common stock will be subject to delisting, which will substantially limit our
stock's liquidity and impair our ability to raise capital.
 
 The
Company is currently in Violation of Certain of its Loan Covenants
 
 As of March 31, 2008, the Company is in
violation of its minimum current ratio and its minimum net worth financial
covenants associated with the Amended and Restated Loan and Security Agreement
with Bridge Bank, N.A.  The Company has requested a waiver from Bridge
Bank but cannot be certain a waiver will be granted.  If the Bank does
not agree to grant such a waiver, there is a risk that the bank may call the
loan or prevent the Company from taking additional advances until the default is
cured.
 
 An
investment in our securities involves a high degree of risk. There have been no
material changes to the risk factors previously disclosed in the Company's
Annual Report on Form 10-K for the fiscal year ended June 30, 2007. You should
consider carefully all of the material risks described in the Form 10-K,
before making a decision to invest in our securities. If any of the events
described therein occur, our business, financial conditions and results of
operations may be materially adversely affected. In that event, the trading
price of our securities could decline, and you could lose all or part of your
investment.
  
 Item
2.                                Unregistered
Sales of Equity Securities and Use of Proceeds
 
 Not applicable
 
 Item
3.                                Defaults
Upon Senior Securities
 
 
 At March
31, 2008, the Company was in violation of certain covenants under its Amended
and Restated Loan and Security Agreement with Bridge Bank, N.A. These covenants
related to minimum current ratio and tangible net worth.  The Company
has requested a waiver from Bridge Bank for these covenant violations, however,
the Company cannot be certain that a waiver will be granted.  As of
March 31, 2008 the revolving credit line and the term note issued under this
facility had balances of $227,000 and $552,000, respectively.
 
 
 Item
4.                                Submission
of Matters to a Vote of Security Holders
 
 
 Item
5.                                Other
Information
 
 None


Item
6.                                Exhibits








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




Exhibit
      No.
            
            Description2.1
            
            Agreement
      and Plan of Merger and Reorganization, dated April 10, 2008, by and among
      the Company, IMX Acquisition Corp., Ion Metrics, Inc., Robert J. Ferran,
      Said Boumsellek, Thomas Kuehn, Karen Lee Ferran and David J. Ferran (filed
      as an Exhibit to the Company’s Form 8-K dated April 15, 2008 and
      incorporated herein by reference).10.1
            
            Employment
      Agreement dated February 29, 2008, between Diane J. Ryan and Implant
      Sciences Corporation (filed as an Exhibit to the Company’s Form 8-K dated
      March 18, 2008 and incorporated herein by reference).31.1
            
            Certification
      of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
            
            Certification
      of the Chief Financial Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
            
            Certification
      of the Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.32.2
            
            Certification
      of the Chief  Financial Officer Pursuant to 18 U.S.C. 1350, as
      adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.








(b)  Reports
on Form 8-K





Current
Report on Form 8-K dated February 12, 2008, filed on February 19, 2007, relating
to the signing of a term sheet relating to the acquisition of Ion Metrics,
Inc.





Current
Report on Form 8-K dated February 20, 2008, filed on February 20, 2008,
regarding the filing of a press release relating to the quarter ended December
31, 2007, financial results.





Current
Report on Form 8-K dated March 18, 2008, filed on March 24, 2008, relating to
the execution of an employment agreement between the Company and Diane J. Ryan,
Chief Financial Officer.





Current
Report on Form 8-K dated April 15, 2008, filed on April 15, 2008, regarding the
receipt of a warning letter from the American Stock Exchange December 29, 2006
regarding non-compliance with certain continuing listing
requirements.





Current
Report on Form 8-K dated April 15, 2008, filed on April 16, 2008, regarding the
signing of definitive agreements relating to the acquisition of Ion
Metrics.  .





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: May
20,
2008                                                                                                /s/ Phillip C.
Thomas


Phillip C. Thomas


President and
CEO





Date: May
20,
2008                                                                                                /s/ Diane J.
Ryan


Diane J. Ryan


Chief Financial
Officer