**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10-K**
 
 [X]
              Annual
                  report pursuant to section 13 or 15(d) of the Securities Exchange
                  Act of
                  1934. For the fiscal year ending June 30, 2006.[
                  ]
              Transition
                  report pursuant to Section 13 or 15(d) of the Securities Exchange
                  Act of
                  1934. For the transition period from _____to_____.Commission
                  file number 000-25839
  **IMPLANT
        SCIENCES CORPORATION**
 (Exact
        name of registrant as specified in its charter)
 
 **Massachusetts**
              
              **04-2837126**(State
                  or other jurisdiction
                of
                  incorporation or organization)
              
              (IRS
                  Employer
                Identification
                  number)107
                  Audubon Road, #5 Wakefield, MA
              
              01880(Address
                  of Principal Executive Offices)
              
              (Zip
                  Code)
 **781-246-0700**
 (Registrant’s
        Telephone Number, Including Area Code)
 
 Securities
        registered pursuant to Section 12(b) of the Act:
 
 **Title
        of Each Class**    **Name
        of Each Exchange on Which Registered**
 Common
        Stock, $.10
        par value    American
        Stock Exchange
  Indicate
        by check mark if the registrant is a well-known seasoned issuer, as defined
        in
        Rule 405 of the Securities Act. YES
        ___
        NO  **X**
 
 Indicate
        by check mark if registrant is not required to file reports pursuant to Section
        13 or Section 15 (d) of the Act. YES ___ NO  **X**
 
 Indicate
        by check mark whether the registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports) and (2) has been subject to such filing requirements
        for
        the past 90 days.
 YES  **X**  NO
        ___
 
 Check
        if
        there is no disclosure of delinquent filers in response to Item 405 of
        Regulation S-K contained in this form, and no disclosure will be contained,
        to
        the best of registrant’s knowledge, in definitive proxy or information
        statements incorporated by reference in Part III of this Form 10-K or any
        amendment to this Form 10-K.
 No
        Disclosure X
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer or a non-accelerated filer.
 Large
        Accelerated Filer ____  Accelerated
        Filer ____  Non-Accelerated
        Filer  **X**
 
 Indicate
        by checkmark whether the Registrant is a shell company (as defined in Rule
        12B-2
        of the Exchange Act)
 YES
        ___
        NO  **X**
 
  The
        aggregate market value of the voting stock held by non-affiliates of the
        registrant was approximately $30,541,000 as of October 11, 2006 (based on
        the
        closing price for such stock as of October 11, 2006).
 
 Indicate
        the number of shares outstanding of each of the issuer's classes of common
        stock:
 
 Class
              Outstanding
                  at October 11, 2006Common
                  Stock, $.10 par value
              11,800,811
 
 
  **PART
        1**
 
 **SPECIAL
        NOTE ON FORWARD LOOKING STATEMENTS**
 
 *In
        addition to historical information, this Annual Report on Form 10-K contains
        forward looking statements within the meaning of the Private Securities
        Litigation Reform Act of 1995. The words “believe,” “expect,” “anticipate,”
“project,” “estimate,” “forecast,” and similar expressions, among others,
        identify forward looking statements. The forward-looking statements are subject
        to certain risks and uncertainties that could cause actual results to differ
        materially from those reflected in such forward-looking statements. Factors
        that
        might cause such a difference include, but are not limited to, those discussed
        in the sections entitled “Business,” “Risk Factors,” and “Managements Discussion
        and Analysis of Financial Condition and Results of Operations.” Readers are
        cautioned not to place undue reliance on these forward-looking statements,
        which
        reflect management’s opinions only as of the date thereof. We undertake no
        obligation to revise or publicly release the results of any revision of these
        forward-looking statements. Readers should carefully review the risk factors
        described in the Annual Report and in other documents that we file from time
        to
        time with the Securities and Exchange Commission.*
  **ITEM
        1.**  **OUR
        BUSINESS**
  Over
        the
        past twenty two years, Implant Sciences Corporation (the "Company"),
        incorporated in August 1984, has both developed and acquired technologies
        using
        ion implantation and thin film coatings for medical device applications and
        semiconductor wafer processing. The Company uses its proprietary processes
        and
        equipment when manufacturing its medical devices for radiation therapy and
        when
        modifying orthopedic joint implant surfaces to reduce polyethylene wear
        generation. This technology has further evolved to include new applications
        in
        the area of trace explosives detection products.
 
 Since
        May
        1999, we have been performing research to develop and improve a trace explosives
        detector, which could be used to detect hidden bombs in airports and other
        public places. This is the latest application of our ion source technology.
        At
        present, we have developed both portable and bench-top systems for use in
        airports and Department of Defense facilities and have marketed and sold
        these
        products both domestically and internationally, primarily in Asia. In fiscal
        2006, as part of a plan to reduce manufacturing costs, we transitioned the
        production of our portable system to a contract manufacturer. As we continue
        to
        sell and deliver our security products, we work both independently and in
        conjunction with various government agencies, to develop the next generation
        of
        trace explosives detectors and to identify new applications for our proprietary
        technology. We currently have five issued United States patents and four
        United
        States patents pending covering our explosives detection technologies and
        processes.
 
 Other
        applications of our ion beam technology have been in the area of temporary
        brachytherapy products. In May 1999, we received Food and Drug Administration
        510(k) clearance to market our I-Plant TM Iodine-125 radioactive seed for the treatment of prostate cancer and in 2001
        recognized our first sale. This marked a major milestone for the Company
        by
        commercializing a product derived from a research and development program
        as
        well as representing a critical stage in our growth from a provider of ion
        implantation services for semiconductor and orthopedic applications to a
        manufacturer and seller of product in the form of radioactive prostate seeds.
 
 Most
        recently, our semiconductor business has experienced substantial growth.
        This
        growth came through the acquisition of two California semiconductor companies,
        Core Systems and Accurel Systems in fiscal 2005. Through these acquisitions,
        we
        have more than doubled our semiconductor capacity and are now able to offer
        diagnostic services, semiconductor equipment and refurbishment services to
        semiconductor manufacturers, research laboratories and universities.
 
 We
        currently have twelve issued United States patents and five United States
        patents pending covering our semiconductor and medical technologies and
        processes.
 
 **Technologies**
 
 *General.* We
        use
        two core technologies, ion implantation and thin film coatings. With respect
        to
        each core technology, we have developed proprietary processes and equipment
        for
        the purpose of improving or altering the surfaces of medical implants and
        semiconductor wafers.
  
 Ion
        implantation and thin film coatings are techniques first developed in the
        1970’s
        to improve the functional surface properties of metals, ceramics and polymers,
        such as friction, wear, wetability and hardness. Ion implantation was initially
        developed as a means to dope semiconductors in the fabrication of integrated
        circuits. The accuracy, cleanliness and controllability of this process have
        made it the standard for semiconductor manufacturing. Ion implantation is
        generally preferred over other surface modification methods because it does
        not
        delaminate, does not require high temperatures and does not deform or alter
        the
        dimensions of the treated surface.
 
 Thin
        film
        coatings were initially developed to interconnect transistors on semiconductor
        chips. Thin films modify surfaces by layering a desired metal or ceramic
        coating
        on the substrate material. Common thin film coating techniques include chemical
        vapor deposition and physical vapor deposition.
 
 *Ion
        Implantation.* Ion
        implantation is a process by which ions (electrically charged atoms) are
        accelerated to high velocity in a vacuum and directed toward a substrate
        or
        target material. The atoms become embedded just below the surface of the
        material producing an alloy composed of the atoms and the substrate material
        in
        the near-surface region of the target material. This surface alloy may have
        new
        mechanical, electrical, chemical, optical and other properties. We believe
        our
        proprietary technology, including high current ion sources and specialized
        component holding fixtures, provides higher ion implant doses and higher
        beam
        power and yields superior surface characteristics at lower cost than
        commercially available equipment.
 
 Ion
        implantation can be used to embed single isotopes of radioactive or
        non-radioactive elements into components. We are using our proprietary equipment
        to manufacture radioactive seed implants for the treatment of prostate cancer
        and other carcinomas which can be manufactured without expensive cyclotrons
        or
        linear accelerators and without hazardous radioactive wet chemistry, the
        methods
        currently employed by existing suppliers.
  
 *Thin
        Film Coatings.* A
        thin
        film coating is grown upon a substrate in a vacuum by the gradual deposition
        of
        atoms on the substrate. Our proprietary unbalanced magnetron sputtering process
        results in coatings that are extremely dense and free of voids, yielding
        good
        contrast and sharp edges under x-ray or fluoroscopic examination. These coatings
        usually consist of gold or platinum for radiopaque applications. Our proprietary
        manufacturing process allows for efficient utilization of precious metals
        and
        for cost effective recovery and recycling of these precious metals. We are
        also
        developing processes to coat stents, guidewires and catheters used in
        interventional cardiology procedures with substances, usually gold or platinum,
        that allow those stents, guidewires and catheters to be visible under x-ray
        observation during a procedure. We believe other techniques for applying
        thin
        film coatings are less desirable for medical device applications because
        of
        their inability to apply a dense coating, while continuing to be flexible
        and
        adhering to the substrate.
 
 *Trace
        Explosives Detection.* We
        have
        developed an instrument, which can detect the vapor from trace amounts of
        explosive compounds including plastic explosives such as RDX, the compound
        commonly found in C4 explosives. The system works by ionizing explosive
        molecules in an air sample and then detecting the ionized molecules of the
        explosive using ion mobility spectrometry. The instrument has successfully
        detected molecules of five different types of explosives in the air at the
        parts
        per trillion concentrations. We believe this technology will provide commercial
        systems with improved sensitivity and capabilities than equipment presently
        available.
  **Medical
        Products**
 
 *Permanent
        Implants for the Treatment of Prostate Cancer*
 
 *General.* The
        alternatives generally presented to patients diagnosed with early stage prostate
        cancer are surgical removal of the prostate (radical prostatectomy) or external
        beam radiation. Both techniques frequently have significant side effects
        including impotence and incontinence. Brachytherapy has been an increasingly
        popular treatment technique whereby radioactive seeds (each of which is
        approximately half the size of a grain of rice) are permanently implanted
        into
        the prostate. This technique allows the delivery of highly concentrated yet
        confined doses of radiation directly to the prostate. Surrounding healthy
        tissues and organs are spared significant radiation exposure. Advances in
        transrectal ultrasound and computed tomography imaging equipment provide
        detailed and precise measurements of prostate size and shape, for seed
        distribution and placement.
  
 *Prostate
        Seeds.* We
        have
        developed, and been granted six United States patents covering radioactive
        seeds, implants and methods of manufacturing radioactive seed implants by
        a
        proprietary process and other brachytherapy applications. We have received
        Food
        and Drug Administration 510(k) clearance to market our I-Plant TM Iodine-125 radioactive seed for the treatment of prostate cancer. Our 510(k)
        clearance permits treatment of any localized tumors treatable by temporary
        or
        permanent brachytherapy. A twelve-year study conducted by the Northwest
        Hospital, Seattle, Washington shows that this treatment has a twelve-year
        disease-free survival rate equal to surgical removal of the prostate and
        may be
        superior to other early stage treatments, with a substantial reduction in
        the
        negative side effects of impotence and incontinence, frequently associated
        with
        surgery and external beam radiation treatment. The National Cancer Institute
        and
        American Cancer Society have reported that sexual impotency after implantation
        of radioactive seeds has been 10 - 30%, which compares with rates of 65 -
        90%
        for radical prostatectomy and 40 - 60% for external beam radiation therapy.
        Our
        production method, involving a proprietary dry fabrication process, does
        not use
        radioactive wet chemistry. On July 28, 1999 we received our Radioactive Sealed
        Source Registration Certificate, a Nuclear Regulatory Commission requirement
        administered by the Commonwealth of Massachusetts as a Nuclear Regulatory
        Commission Agreement State. These seeds have been on sale in the U.S. for
        six
        years.
 
 *Manufacturing.* Management
        believes that the Company's manufacturing process results in lower capital
        equipment and manufacturing assembly costs and is less hazardous than the
        manufacturing processes used by our competitors. Other radioactive prostate
        seed
        manufacturers use radioactive wet chemistry during seed assembly for Iodine-125
        products. Our dry process, for which we have two patents issued, uses a dry
        fabrication process, and we believe it requires fewer personnel and yields
        faster throughput. Following seed core ion implantation, we send the cores
        to a
        nuclear reactor for activation. Using this dry fabrication process, seed
        cores
        can be fabricated and inventoried in large quantities and activated only
        when
        ordered. Due to the short half-life of Iodine-125 (approximately 60 days),
        the
        competition must assemble and ship seeds on a tight schedule so they can
        be
        implanted into the patient at the appropriate radioactive strength. We maintain
        multiple source vendors for our raw materials supplies in the construction
        of
        our radioactive prostate seeds, including Trace Sciences International, Wheaton
        USA Products, Alfa Aesar, Mick Radio Nuclear, Quartz Plus and Braxton
        Manufacturing.
 
 *Sales.* Since
        August 2003, the Company has used its own direct sales force and several
        independent sales representatives to sell prostate seeds to many different
        customers.
 
 *Treatment
        Planning Software*
 
 *General.* In
        May
        2005, Implant Sciences acquired proprietary treatment planning technology
        from
        Rosses Medical Systems, Inc. The Company is investing resources to enhance
        the
        capabilities of this product to include a new module which aids the physician
        in
        making 2 and 3 dimensional maps of the stage, grade and location of cancer
        within the prostate gland. This “Pathology Mapping Module TM ”
is
        in
        addition to the standard treatment planning function used for prostate
        brachytherapy and will provide for image guided, focal treatment for the
        disease. The product is being marketed as I-Plant TM TPS.
 
 *Sales.* This
        product is presently being sold by our direct sales force.
 
 *Breast
        Cancer Radiation Treatment*
  *General* .
        Early
        stage breast cancer is commonly treated by lumpectomy followed by a course
        of 35
        sessions of external beam radiation to the whole breast over a seven week
        term.
        Over the past several years, Accelerated Partial Breast Irradiation (APBI)
        has
        been increasing in popularity with patients because it can be completed in
        four
        to five days on an outpatient basis and has shown equal efficacy with good
        cosmetic outcomes. Approximately 600 to 1,000 patients have already been
        treated
        using this new temporary brachytherapy technique. Currently this treatment
        is
        performed using a conventional HDR (High Dose Radiation) system using an
        iridium
        -192 radioactive source. A significant drawback of the currently used iridium
        -192 source is that the treatments must be performed in a heavily concrete
        shielded room to prevent the very penetrating iridium -192 gamma rays
        irradiating people in hallways and adjacent rooms. A very small percentage
        of
        U.S. hospitals currently have such dedicated HDR concrete shielded rooms
        for
        brachytherapy. The Company has developed a new lower energy source, ytterbium
        -169 which can deliver the same therapeutic dose to the lumpectomy cavity
        and
        does not require a concrete shielded treatment room. The procedure can be
        done
        in an ordinary treatment room with some portable shielding around the patient
        using a conventional afterloader system. This source assembly has received
        a
        510(k) pre-market clearance from the FDA and does not require clinical trials
        prior to commercial sales.
  
 *Manufacturing.*  The
        Company will manufacture the ytterbium -169 source material in-house using
        several nuclear reactors as subcontractors. Versions of the Yb-169 source
        assembly will be designed to fit all afterloader systems presently on the
        market.
  *Sales.*  We
        expect
        that the source wires will be sold by the manufacturers of the afterloaders
        or
        through direct selling efforts. This new product will be purchased by the
        Radiation Oncology Department of hospitals which is the same customer our
        existing prostate seed salesmen call on.
 
 *Orthopedic
        Total Joint Replacements*
  *General.* We
        provide surface engineering technology to manufacturers of orthopedic hip
        and
        knee total joint replacements.  The majority of existing hip and knee joint
        replacements are made of a cobalt chromium femoral component that articulates
        against a polyethylene component.  While offering excellent
        biocompatibility and superior wear resistance over prior alloys and designs
        and
        potentially longer average life than prior alloys, cobalt chromium devices
        still
        suffer from particle generation where the metal and polyethylene components
        articulate against each other.  This particle generation has been
        identified as the primary cause of implant loosening due to osteolysis requiring
        repeat surgery.
  *Orthopedics.* We
        implant cobalt chromium components of total joint replacements manufactured
        by
        our customers with nitrogen ions.  Nitrogen ion implantation of these
        components reduces polyethylene wear by modifying the native oxide present
        in
        cobalt chromium alloys.  Laboratory tests and clinical studies have shown
        that nitrogen ion implanted cobalt chromium components offer superior
        performance over untreated components, significantly reducing wear and slowing
        the incidence of osteolysis which ultimately leads to revision
        surgery.
  *Manufacturing.* We
        believe we now operate one of the highest beam-current ion implanters used
        in
        the medical field.  This equipment has higher throughput and lower cost
        than equipment with a lower beam-current.  For our new second-generation
        orthopedic coating, this equipment can provide a ceramic coating with superior
        characteristics due to its patented “blended interface” process.  We
        maintain multiple source vendors for our gas supplies, the primary raw material
        used in the ion implantation process in providing this service, including
        Praxair and Matheson.
  *Sales.* We
        currently implant cobalt chromium components of total joint replacements
        made by
        our customers with nitrogen ions and are developing ceramic ion beam synthesis
        techniques for total joint replacements.  We receive untreated cobalt
        chromium total joint replacements from our customers and implant them at
        our
        facility.  We then invoice and ship the implanted total joint replacements
        to our customers.  We maintain one major customer which accounted for 6%
        and 13% of total revenues in the year ended June 30, 2006 and 2005,
        respectively.
  *Markets.* Osteoarthritis
        is a natural result of the aging process and is the predominant cause of
        the
        need for joint replacement.  We believe that longer life expectancy as well
        as the growth in the number of people over age 50 will cause the demand for
        total joint replacement to increase.  According to the American Academy of
        Orthopedic Surgeons, the hip and knee total joint replacement market was
        estimated to be 650,000 procedures in the United States.  We treat
        approximately 60,000 units each year using our ion implantation process for
        the
        Stryker-Orthopaedics Division of Stryker Corporation.  Our next generation
        surface treatment using ion beam synthesized ceramic has been shown to decrease
        wear debris generation by two-thirds, which we believe will reduce osteolysis
        and thereby reduce the need for revision surgery.
  *Radiopaque
        and other Coatings.* We
        have
        developed proprietary methods for applying radiopaque coatings onto a variety
        of
        medical devices manufactured by our customers in order to increase the
        visibility of such devices during interventional cardiology and other
        catheter-based procedures.  These biocompatible coatings are deposited
        using a proprietary unbalanced magnetron sputtered coating process.  The
        resulting coating is extremely dense and free of voids yielding good contrast
        and sharp edges under x-ray or fluoroscopic examination.  We use this
        process to coat stents and other vascular access devices. Additionally, we
        have
        developed a well adhered conductive coating used as electrodes in neural
        stimulation applications.
 
 
 **Security
        Products**
 
 *Trace
        Explosives Detection Equipment*
 
 *General.* We
        are
        developing several explosive detection systems that could be used in airports,
        public and government buildings, and sporting event facilities. The systems
        use
        our proprietary technology, which includes the use of laser beams in combination
        with ion mobility spectrometry, to electronically detect minute quantities
        of
        explosive vapor molecules in the air.
 
 This
        research has been ongoing since May 1999. This project was undertaken in
        response to the interest in ion beam phenomena by our research personnel
        who are
        constantly researching new applications for this technology. The development
        of
        new applications is typically funded through government grants or internal
        funding.
 
 The
        Department of Transportation has stated that the U.S. could spend between
        $1.9
        billion and $2.5 billion on equipment for the detection of bulk and trace
        amounts of explosives. However, we do not know how much will be allocated
        to
        each of trace and bulk equipment or how much allocated to equipment for the
        detection of trace amounts of explosives will be allocated to devices like
        ours.
 
 In
        June
        2000, we developed our first experimental device, which demonstrated sensitivity
        to the explosive TNT. In June 2001, we developed a second-generation prototype
        with increased sensitivity and selectivity. This device was able to detect
        and
        specify an increasing number of compounds within various explosive materials.
        The explosives that have been tested to date are TNT, RDX, PETN, EGDN, and
        DNT.
        RDX is the primary component of C3 and C4 explosives, such as Detasheet and
        Semtex, as well as certain types of black powder explosives. We believe these
        explosives represent the majority of the explosives presently used in terrorist
        activities. During fiscal 2005, the Company began taking orders for, and
        shipping, product previously under development.
 
 The
        electronic detection system detects microscopic quantities of explosive
        molecules in the air. The device does not use any radioactive materials and
        does
        not produce a danger to personnel operating the device or scanned by the
        device.
        The device is a sensor that receives signals that are already in the
        environment. Our electronic detection system uses a sensor that does not
        require
        physical contact to screen the article to detect trace residues. Since our
        device does not use a radioactive source, management believes it is safer
        than
        trace explosives residue detection systems currently in use.
 
 Consistent
        with our policy to protect our proprietary technologies, we have been awarded
        five patents and submitted four additional patent applications to the United
        States Patent and Trademark Office. These patent applications will cover
        specific design configurations that are responsible for our improved vapor
        detection sensitivity. The Company has outsourced the manufacturing of our
        current trace explosives detector products to a contract manufacturer.
 
 **Semiconductor
        Products**
 
 *Semiconductor
        Ion Implantation*
 
 *General.* We
        supply
        ion implantation and analytical services to numerous semiconductor
        manufacturers, research laboratories, and research universities. Ion
        implantation of electronic dopants into silicon, the process by which silicon
        is
        turned into a semiconductor, is an integral part of the integrated circuit
        fabrication process. While many of our customers have their own ion implantation
        equipment, they often use our services and specialized expertise for research
        and new product development because they do not want to interfere with
        production or because they are unable to perform the services
        themselves.
 
 In
        October 2004, we acquired Core Systems and doubled our semiconductor ion
        implantation equipment and capacity. This acquisition enabled us to expand
        our
        revenue base by affording us the opportunity to service a new pool of customers
        not available to us in the past as our existing ion implantation equipment
        limited our processing capabilities. In addition, through this acquisition,
        new
        revenue opportunities were gained the areas of semiconductor equipment
        refurbishing services and the sale of source conditioning equipment.
 
 We
        further expanded our semiconductor business through the acquisition of Accurel
        Systems in March 2005. Through this acquisition, we are able to offer analytical
        and failure analysis diagnostic services to the manufacturers of semiconductor
        products. The Company believes that through the consolidation of our processing
        efforts and complimentary services these acquisitions provide, we will be
        able
        to expand our semiconductor implantation services to include high volume
        production customers while continuing to service our existing R & D and
        pilot production customers, both domestically and internationally.
 
 
 **Marketing
        and Sales**
 
 Our
        marketing and sales methods vary according to the characteristics of each
        of our
        main business areas. Sales and marketing to the medical device markets are
        through our own direct sales force and several independent sales
        representatives. Our semiconductor segment includes implant services and
        implant
        diagnostic services. Our Vice President, General Manager of Core Systems,
        along
        with an inside sales staff and several independent sales representatives,
        are
        responsible for semiconductor ion implantation services, including disk
        refurbishment and source conditioner sales. The President of Accurel Systems
        is
        responsible for sales of our semiconductor analytical services. Our Vice
        President of Security Products Sales and Marketing is responsible for sales
        and
        marketing of our trace explosives technology, assisted by an inside sales
        staff
        and international sales reps. Sales of our brachytherapy products are the
        responsibility of our Director of Brachytherapy Products. The Company uses
        both
        inside direct sales personnel and independent sales representatives to sell
        our
        products. The solicitation and proposal process for research and development
        contracts and grants are conducted by our President, our Chief Scientist,
        and
        our scientific staff.
 
 *Medical
        Sales and Marketing*
 
 To
        promote sales of our radioactive prostate seeds and treatment planning systems,
        we exhibit at various medical trade shows, including the American Association
        of
        Physicists in Medicine (AAPM) show and the American Society for Therapeutics
        Radiology and Oncology (ASTRO) show, which are attended by the vast majority
        of
        our potential customers. Sales are then concluded by our Director of
        Brachytherapy Products and several independent sales representatives.
 
 In
        the
        business of ion implantation for total joint replacements, we concentrate
        on
        identifying and serving leading manufacturers. Where possible, we attempt
        to
        become the sole provider of devices or surface engineering services to each
        such
        manufacturer. Our marketing and sales efforts require considerable direct
        contact and typically involve a process of customer education in the merits
        of
        our technology. We accomplish this by first researching customer needs,
        delivering scientific papers at orthopedic and biomaterial conferences, and
        through presentations at customer sites. Our research and development programs,
        both independent and in conjunction with a customer specific need, as well
        as
        our patent portfolio, are integral components of the marketing process.
 
 To
        promote sales of our radiopaque coatings, we attend trade shows, use press
        releases and call customers who we believe have an application for our
        technology. Once a customer's interest is established, the sales process
        proceeds with an initial demonstration project funded by the customer. A
        set of
        developmental runs are then performed to determine project feasibility and
        to
        roughly optimize a parameter set for deposition. After testing the samples
        generated, and considering cost estimates for production quantities, the
        customer may authorize us to proceed to pilot production.
 
 In
        pilot
        production, typically, several hundred units are produced in a manner equivalent
        to the envisioned full production method. Pilot production may be done on
        an
        existing piece of equipment with customer/device specific fixturing, or on
        a
        prototype machine, depending on the complexity of the process and device.
        Samples made in pilot production are fabricated into complete devices and
        used
        by the customer for further testing, clinical studies, FDA submissions, and
        marketing and sales efforts.
 
 *Semiconductor
        Sales and Marketing*
 
 Since
        semiconductor ion implantation is a standard process in all integrated circuit
        fabrication, customers usually know what they want and little education is
        necessary. Our services are promoted and sold through trade shows, advertising
        in trade magazines, direct mailings and press releases. Most of our specialty
        implant sales are between $600 and $2,500 per order and take less than one
        day
        to complete. The entire sales effort is often conducted by telephone. Our
        sales
        range from production customers to outsourced customer-specified ion
        implantation services, which the customer's own ion implantation department
        is
        unable or unwilling to perform, to small research projects. Production implant
        sales are usually through long-term blanket purchase orders where our services
        are integrated seamlessly into our customer’s production line.
 
 Semiconductor
        analytical services are promoted through Accurel Systems. These sales are
        promoted through trade shows, and a direct sales force dedicated to this
        product
        line.
 
 *Government
        Contracts*
 
 Research
        and development contracts from the U.S. government must be won through a
        competitive proposal process which undergoes peer review. We are in frequent
        contact with the National Institutes of Health, the Department of Defense,
        the
        Department of Homeland Security and other agencies at technical conferences
        to
        stay informed of the government's needs. We believe our management and senior
        scientific staff have earned a strong reputation with these and other agencies.
        To date we have been awarded research and development contracts by the National
        Institute of Health, the Department of Defense, the National Science Foundation,
        the National Aeronautics and Space Administration, the Environmental Protection
        Agency and the Department of Homeland Security.
 
 
 **Research
        and Development**
 
 Our
        technical staff consists of 50 scientists and engineers, including three
        with
        Ph.D. degrees, and the remaining with Masters Degrees, Bachelor Degrees or
        with
        expertise in physical sciences and engineering. All of our existing and planned
        products rely on proprietary technologies developed in our research and
        development laboratories. Our research and development efforts may be
        self-funded, funded by corporate partners or by awards under the Small Business
        Innovative Research and other programs of the U.S. government. Under the
        Small
        Business Innovative Research program, we retain the right to patent anything
        developed pursuant to the program, however, the U.S. government retains a
        royalty free license to use the technology. We have obtained over $12 million
        in
        U.S. government grants and contracts over the past 18 years. Each research
        and
        development agreement with our corporate partners defines the rights to these
        agreements.
 
 We
        spent
        approximately $4,088,000, $3,633,000 and $3,841,000 on research and development
        in the fiscal years ended June 30, 2006, 2005 and 2004, respectively.
        Approximately $2,775,000, $1,691,000 and $2,210,000 of these research and
        development activities represents research and development costs that were
        directly sponsored by customers primarily in the form of government contracts
        and grants during 2006, 2005 and 2004, respectively.
 
 **Patents
        and Proprietary Technology**
 
 It
        is our
        policy to protect our proprietary position by, among other methods, filing
        United States and foreign patent applications. We currently have seventeen
        issued United States patents and nine United States patent applications pending.
        Of the seventeen patents issued, five are of material importance to us and
        are
        in the explosives detection. These five material patents expire in the years
        2021 through 2023.
 
 We
        intend
        to seek further patents on our technologies, if appropriate. However, there
        can
        be no assurance that patents will be issued for any of our pending or future
        applications or that any claim allowed from such applications will be of
        sufficient scope or strength, or be issued in all countries where we sell
        our
        products and services, to provide meaningful protection or any commercial
        advantage to us.
 
 We
        also
        rely on unpatented proprietary technology, trade secrets and know-how and
        we do
        not know if others will independently develop substantially equivalent
        proprietary information, techniques or processes, that such technology or
        know-how will not be disclosed or that we can meaningfully protect our rights
        to
        such unpatented proprietary technology, trade secrets or know-how. Although
        we
        have entered into non-disclosure agreements with our employees and consultants,
        we cannot be sure such non-disclosure agreements will provide adequate
        protection for our trade secrets or other proprietary know-how.
 
 **Government
        Regulation and Environmental Matters**
 
 Medical
        devices incorporating our technologies, such as radioactive prostate seeds
        and
        interventional cardiology devices are subject to FDA regulation. The burden
        of
        securing FDA clearance or approval for these core business medical devices
        rests
        with our medical device manufacturers or licensees. We have received Food
        and
        Drug Administration 510(k) clearance to market our I-Plant TM Iodine-125 radioactive seed for the treatment of prostate cancer.
 
 In
        the
        510(k) clearance procedure, a company must show that its new product is
“substantially equivalent” to a medical device that is currently approved for
        use. This process requires an application to the FDA. If the FDA determines
        that
        a product is in fact substantially equivalent to a product that has already
        been
        approved for use, the FDA grants 510(k) clearance for the sale of the new
        product. This process is quicker and less expensive than obtaining approval
        for
        an entirely new product. We obtained 510(k) clearance for our
        I-Plant TM prostate
        seed product in May 1999. All of our presently contemplated new medical products
        require a 510(k) clearance only.
  Our
        medical device manufacturing facility operates under the FDA Quality Control
        Regulations. Our facility, located in Wakefield, Massachusetts, was registered
        with the FDA in July 2000 prior to the introduction and commercial sales
        of our
        radioactive prostate seed product. Our facility is subject to the FDA’s
        inspection at any time. The FDA has inspected Implant Sciences’ medical
        manufacturing facilities and found its Quality System to meet their
        requirements. The FDA regulates the medical device industry and has the
        authority to demand corrective action(s) for any deficiencies in adherence
        to
        Quality System Regulations, order product recalls, and can require that a
        factory cease operations until it is brought into compliance with these
        regulations. Implant Sciences’ Quality Systems Manager ensures adherence to the
        FDA’s Quality System Regulations as well as to the ISO 9001 standard.
 
 In
        addition to FDA regulation, certain of our activities are regulated by, and
        require approvals from, other federal and state agencies such as the
        Massachusetts Department of Public Health, the Department of Transportation
        and
        the Federal Aeronautics Administration.
 
 In
        order
        to ship our radioactive prostate seed product from our facility, we are required
        to obtain a radioactive sealed source registration from the Massachusetts
        Department of Public Health.  We obtained this certificate prior to the
        commencement of the commercial sales of our radioactive prostate seed product
        in
        the first half of fiscal 2001.  This certificate requires no maintenance or
        renewal as long as the design of the radioactive prostate seed is not
        changed.  The Massachusetts Department of Public Health can, however,
        terminate this certification in the event of an accident that would require
        a
        redesign of the product.  On July 28, 1999, we received our Radioactive
        Sealed Source Registration Certificate, a Nuclear Regulatory Commission
        requirement, administered by the Commonwealth of Massachusetts as a Nuclear
        Regulatory Commission Agreement State.
 
 The
        State
        Radiation Control Program issued to us a license to manufacture and distribute
        our radioactive prostate seed product.  The State Radiation Control Program
        performs periodic inspections of our facility.  Since the commencement of
        commercial sales of our radioactive prostate seed product in the first half
        of
        fiscal 2001, the State Radiation Control Program has performed two inspections
        of the facility and identified no violations or deficiencies.
 
 Furthermore,
        our use, management, transportation, and disposal of certain chemicals and
        wastes are subject to regulation by several federal and state agencies depending
        on the nature of the chemical or waste material. Certain toxic chemicals
        and
        products containing toxic chemicals require special reporting to the United
        States Environmental Protection Agency and/or its state counterparts. We
        are not
        aware of any specific environmental liabilities that we could incur. Our
        future
        operations may require additional approvals from federal and/or state
        environmental agencies, the cost and effects of which cannot be determined
        at
        this time.
 
 
 **Competition**
 
 In
        radioactive products, such as prostate seed implants, radioactive brachytherapy
        devices and coronary stents, we expect to compete with Oncura Corp., Theragenics
        Corp., and North American Scientific, Inc., all of which serve substantially
        the
        entire radioactive prostate seed market. The number and types of procedures
        being performed on the prostate are increasingly drawing new entrants into
        the
        market. We believe that competition, and, in turn, pricing pressures may
        increase. Many of our competitors have substantially greater financial,
        technical and marketing resources than we do.
 
 Many
        medical device manufacturers have developed or are engaged in efforts to
        develop
        internal surface modification technologies for use on their own products.
        Most
        companies that market surface modification to the outside marketplace are
        divisions of organizations with businesses in addition to surface modification.
        Many of our existing and potential competitors (including medical device
        manufacturers pursuing coating solutions through their own research and
        development efforts) have substantially greater financial, technical and
        marketing resources than we do.
 
 With
        respect to ion implantation of orthopedic implants, we primarily compete
        with
        Spire Corporation. Competition within the orthopedic implant industry is
        primarily conducted on the basis of service and product design. Price
        competition has abated somewhat in the case of first time and more youthful
        patients where higher-cost and more durable reconstructive devices are
        preferred. We attempt to differentiate ourselves from our competition by
        providing what we believe are high value-added solutions to surface
        modification. We believe that the primary factors customers consider in choosing
        a particular surface modification technology are performance, ease of
        manufacturing, ability to produce multiple properties from a single process,
        compliance with manufacturing regulations, customer service pricing, turnaround
        time, and the ability to work with a variety of materials. We believe that
        our
        process competes favorably with respect to these factors. We believe that
        the
        cost and time required to acquire equipment and technical engineering talent,
        as
        well as to obtain the necessary regulatory approvals, significantly reduces
        the
        likelihood of a manufacturer changing the coating process it uses after a
        device
        has been approved for marketing.
 
 Our
        competition in the semiconductor industry consists primarily of one company:
        Innovion Corporation. This company is located in San Jose, California and
        primarily serves the silicon wafer production needs of semiconductor factories
        in their local area. We serve both east and west coast factories with silicon
        production and research and development laboratories worldwide.
 
 In
        the
        trace explosives detection industry, Ion Track Division of General Electric
        and
        the Barringer Division of Smiths Plc. are our two primary competitors. These
        two
        companies also use ion mobility spectrometry; however, they use a radioactive
        Nickel-63 source to ionize the explosive molecules. This technology differs
        from
        our technology in that we do not use a radioactive source to ionize the
        explosive molecules in the air. We believe our technology provides our device
        with greater capabilities and less regulatory restrictions.
 
 Many
        of
        our competitors and potential competitors have substantially greater capital
        resources than we do and also have greater resources and expertise in the
        areas
        of research and development, obtaining regulatory approvals, manufacturing
        and
        marketing. There can be no assurance that our competitors and potential
        competitors will not succeed in developing, marketing and distributing
        technologies and products that are more effective than those developed and
        marketed by us or that would render our technology and products obsolete
        or
        noncompetitive. Additionally, there is no assurance that we will be able
        to
        compete effectively against such competitors and potential competitors in
        terms
        of manufacturing, marketing and sales.
 
 **Product
        Liability and Insurance**
 
 Our
        business entails the risk of product liability claims. Although we have not
        experienced any product liability claims to date, there can be no assurance
        that
        such claims will not be asserted or that we will have sufficient resources
        to
        satisfy any liability resulting from such claims. We currently have product
        liability insurance coverage on our medical device products. There can be
        no
        assurance that product liability claims will not exceed such insurance coverage
        limits, that such insurance will continue to be available on commercially
        reasonable terms or at all, or that a product liability claim would not
        materially adversely affect the business, financial condition or our results
        of
        operations.
 
 **Employees**
 
 As
        of
        June 30, 2006, we had 150 full time employees. We believe we maintain good
        relations with our employees. None of our employees are represented by a
        union
        or covered by a collective bargaining agreement.
 **Geographic
          Areas**
 
 The
          majority of the Company’s revenues are derived from domestic sales. During the
          fiscal year ended June 30, 2006, foreign sales represented 17% of total
          revenue,
          with the majority of these sales coming from Asia. In fiscal 2006, the
          Company
          had one customer from China representing 10% of the Company’s annual revenue.
          For each of the fiscal years ended June 30, 2005 and 2004, foreign sales
          represented less than 5% of total revenue.
 **ITEM
        1A.**  **RISK
        FACTORS**
 
 This
        Report on Form 10-K contains certain forward-looking statements that are
        based
        on current expectations. In light of the important factors that can materially
        affect results, including those set forth in this paragraph and below, the
        inclusion of forward-looking information herein should not be regarded as
        a
        representation by the Company or any other person that the objectives or
        plans
        of the Company will be achieved. The Company has received a qualified opinion
        that it is a going concern. The Company may encounter competitive,
        technological, financial and business challenges making it more difficult
        than
        expected to continue to develop and market its products; the market may not
        accept the Company's existing and future products; the Company may be unable
        to
        retain existing key management personnel; the Company has pending litigation;
        the Company has net losses; the Company may not be able to raise additional
        capital; and there may be other material adverse changes in the Company's
        operations or business. Assumptions relating to budgeting, marketing, and
        other
        management decisions are subjective in many respects and thus susceptible
        to
        interpretations and periodic revisions based on actual experience and business
        developments, the impact of which may cause the Company to alter its marketing,
        or other budgets, which may in turn affect the Company's financial position
        and
        results of operations. The reader is therefore cautioned not to place undue
        reliance on forward-looking statements contained herein, which speak solely
        as
        of the date of this Form 10-K. The Company assumes no responsibility to update
        any forward-looking statements as a result of new information, future events,
        or
        otherwise.
 
 The
        following factors should be considered carefully in evaluating the Company
        and
        its business:
  **The
        Company has received a modified audit opinion on its ability to continue
        as a going concern.**
 
 The
        audit
        report our independent registered public accounting firm issued on our audited
        financial statements for the fiscal year ended June 30, 2006 contains a
        modification regarding our ability to continue as a going concern. This
        modification indicates that there is substantial doubt on the part of our
        independent registered public accounting firm that we can continue as a going
        concern in that we did not have sufficient cash and liquid assets at June
        30,
        2006, to cover our operating capital requirements for the next twelve-month
        period and if sufficient cash cannot be obtained we would have to substantially
        alter our operations, or we may be forced to discontinue operations.  Such
        an opinion from our independent
        registered public accounting firm may
        limit
        our ability to access certain types of financing, or may prevent us from
        obtaining financing on acceptable terms.
 
 **We
        do not operate at a profit and do not expect to be profitable for some time.**
  During
        the twelve months ended June 30, 2006, we had a net loss of **** approximately
        $7,084,000 and a net loss applicable to common shareholders of approximately
        $8,173,000. We plan to further increase our expenditures to **** complete
        the development and commercialization of our new products, to ensure compliance
        with the Food and Drug Administration's **** Quality
        System Regulations and to broaden our sales and marketing capabilities.
        As **** a
        result,
        we believe that we will likely incur losses over the next several **** quarters.
        Our accumulated deficit as of June 30, 2006 is approximately $36,290,000.
  **Intense
        competition and rapid technological change could harm our financial
        performance.**
  The
        medical device industry is characterized by rapidly evolving
        technology **** and
        intense competition. In our radioactive products, such as prostate seed implants
        and radioactive brachytherapy devices, we compete with many other companies
        selling similar products with certain of such companies serving substantially
        the entire radioactive prostate seed market. In our semiconductor market
        we
        compete with many companies, including companies that have in-house capabilities
        to implant, diagnose and repair their own wafers. In our explosives detection
        equipment market, we compete with many companies, including companies that
        have
        substantially greater capital resources, greater research and development,
        manufacturing and marketing resources and experience and greater name
        recognition than we do. In addition, we expect new entrants into our
        markets.  There can be no assurance that our competitors will not succeed
        in developing or marketing technologies and products that are more effective
        than our products or that would render our products obsolete or noncompetitive.
        Moreover, there can be no assurance that we will be able to price our products
        and services at or below the prices of competing products and technologies
        in
        order to facilitate market acceptance. In addition, new procedures and
        medications could be developed that replace or reduce the importance of
        procedures that use our products. Accordingly, our success will depend, in
        part,
        on our ability to respond quickly to medical and technological changes through
        the development and introduction of new products and enhancements. Product
        development involves a high degree of risk, and there can be no assurance
        that
        our new product development efforts will result in any commercially successful
        products. Our failure to compete or respond to technological change in an
        effective manner would have a material adverse affect on our business and
        results of operations.
  **Our
        medical products and technologies may not be accepted by the medical community
        which could harm our financial performance.**
  There
        can
        be no assurance that our radioactive prostate seeds, brachytherapy sources,
        orthopedic implant coatings, or radiopaque coatings will achieve acceptance,
        or
        continue to receive acceptance, by the medical community and market acceptance
        generally. The degree of market acceptance for our products and services
        will
        also depend upon a number of factors, including the receipt and timing of
        regulatory approvals and the establishment and demonstration in the medical
        community and among health care payers of the clinical safety, efficacy and
        cost
        effectiveness of our products. Certain of the medical indications that can
        be
        treated by our devices or devices treated using our coatings can also be
        treated
        by other medical procedures. Decisions to purchase our products will primarily
        be influenced by members of the medical community, who will have the choice
        of
        recommending medical treatments, such as radiotherapeutic seeds, or the more
        traditional alternatives, such as surgery and external beam radiation therapy.
        Many alternative treatments currently are widely accepted in the medical
        community and have a long history of use. There can be no assurance that
        our
        devices or technologies will be able to replace such established treatments
        or
        that physicians, health care payers, patients or the medical community in
        general will accept and utilize our devices or any other medical products
        that
        may be developed or treated by us even if regulatory and reimbursement approvals
        are obtained. Long-term market acceptance of our products and services will
        depend, in part, on the capabilities, operating features and price of our
        products and technologies as compared to those of other available products
        and
        services. Failure of our products and technologies to gain market acceptance
        would have a material adverse effect on our business and results of operations.
  
 **Our
        explosives detection products and technologies may not be accepted by government
        agencies, airports or airlines which could harm our future financial
        performance.**
 
 There
        can
        be no assurance that our explosives detection systems will achieve acceptance
        by
        the domestic and international airports, government agencies and airlines,
        and
        market acceptance generally. The degree of market acceptance for our explosives
        detection products and services will also depend upon a number of factors,
        including the receipt and timing of regulatory approvals and the establishment
        and demonstration of the ability of our proposed device to detect trace
        explosives residues on personnel, baggage and other cargo prior to embarking
        on
        aircraft.
 
 **Our
        future profitability depends on whether our products can successfully compete
        in
        the** **commercial** **marketplace.**
  We
        currently market radioactive prostate seeds. We also provide ion implantation
        services for ion implantation of semiconductors and medical devices. We also
        provide diagnostic services on semiconductor wafers. We plan to market
        radiopaque coatings, and explosive detection systems that may require
        substantial further investment in research, product development, preclinical
        and
        clinical testing and governmental regulatory approvals prior to being marketed
        and sold. Our ability to increase revenues and achieve profitability and
        positive cash flow will depend, in part, on our ability to complete such
        product
        development efforts, obtain such regulatory approvals, and establish
        manufacturing and marketing programs and gain market acceptance for such
        proposed products.
  The
        market for explosive detection systems is intensely competitive and is
        characterized by continuously developing technology and frequent introductions
        of new products and features. We expect competition to increase as other
        companies introduce additional and more competitive products in the explosive
        detection systems market as we develop the capabilities and enhancements
        of our
        trace detection systems. Each of our competitors may have substantially greater
        financial resources than us.
  We
        believe that our ability to compete in the explosive detection systems market
        is
        based upon such factors as: product performance, functionality, quality and
        features; quality of customer support services, documentation and training;
        and
        the capability of the technology to appeal to broader applications beyond
        the
        inspection of passengers, baggage, and cargo carried on airlines. Although
        we
        believe that our currently developed product has all of the capabilities
        to meet
        the United States government’s decree that all passengers, baggage, and cargo
        carried on airlines must be screened thoroughly, certain of our competitors
        may
        have an advantage over our existing technology with respect to these factors.
        There can be no assurance that we will be successful in convincing potential
        customers that our products will be superior to other systems given all of
        the
        necessary performance criteria, that new systems with comparable or greater
        performance, lower price and faster or equivalent throughput will not be
        introduced, or that, if such products are introduced, customers will not
        delay
        or cancel potential orders for us yet to be commercialized system. Further,
        there can be no assurance that we will be able to bring to commercialization
        and
        further enhance our product to better compete on the basis of cost, throughput,
        accommodation of detection of passengers, baggage or other cargo carried
        onto
        airlines, or that we will otherwise be able to compete successfully with
        existing or new competitors.
  Our
        product development efforts are subject to the risks inherent in the development
        of such products. These risks include the possibility that development costs
        will be much greater than currently anticipated, that our products will be
        found
        to be ineffective or unsafe, or will otherwise fail to receive necessary
        regulatory approvals; that the products will be difficult to manufacture
        on a
        large scale or be uneconomical to market; that the proprietary rights of
        third
        parties will interfere with our product development; or that third parties
        will
        market superior or equivalent products which achieve greater market acceptance.
        Furthermore, there can be no assurance that we will be able to conduct our
        product development efforts within the time frames currently anticipated
        or that
        such efforts will be completed successfully.
  **There
        are risks relating to our Development, Distribution and Manufacturing Agreement
        with Rapiscan Systems, Inc.**
 
 In
        March
        of 2005, we entered into a Development, Distribution and Manufacturing Agreement
        (the “Agreement”) with Rapiscan Systems, Inc. (“Rapiscan”).  Under the
        terms of this agreement, we gave Rapiscan the exclusive worldwide rights
        to
        market our Quantum
        Sniffer TM  portable
        and benchtop trace detection devices under their private label.  We also
        agreed to give Rapiscan the exclusive worldwide rights to distribute certain
        other new security products which we may develop in the future with their
        funding, as well as rights, in some circumstances, to manufacture certain
        components of the Quantum
        Sniffer TM  portable
        and benchtop trace detection devices.
  In
        March
        2006, the Company brought suit against Rapiscan and its parent, OSI Systems,
        Inc. The Company is requesting rescission of the Agreement, for lack of
        performance and other grounds or in the alternative, termination of the
        Agreement due to material breaches of contract and implied covenant of good
        faith and fair dealing and for damages. Should the Company be unsuccessful
        in
        prosecuting its lawsuit, it could have a material adverse effect on our business
        and results of operations.
  In
        March
        2006, the Company received notice that Rapiscan filed a complaint against
        the
        Company regarding the Agreement. Rapiscan’s complaint is based upon claims of
        breach of contract, breach of warranty and tortuous interference with
        contractual relations and is requesting a decree for specific performance,
        declaratory relief and injunctive relief. Should the Company be unsuccessful
        in
        defending itself in the lawsuit, it could have a material adverse effect
        on our
        business and results of operations.
  **Limitations
        on our ability to protect our intellectual property or continue to use our
        intellectual property could harm our financial
        performance.**
  Our
        ability to compete effectively will depend, to a significant extent, on our
        ability to operate without infringing the intellectual property rights of
        others. Many participants in the medical device area aggressively seek patent
        protection and have increasing numbers of patents, and have frequently
        demonstrated a readiness to commence litigation based on patent infringement.
        Third parties may assert exclusive patent rights to technologies that are
        important to us.
  Although
        we have seventeen United States patents issued and nine United States patent
        applications pending for our technology and processes, our success will depend,
        in part, on our ability to obtain the patents applied for and maintain trade
        secret protection for our technology and operate without infringing on the
        proprietary rights of third parties. The validity and breadth of claims in
        medical technology patents involve complex legal and factual questions and,
        therefore, may be highly uncertain. No assurance can be given that any pending
        patent applications or any future patent application will issue as patents,
        that
        the scope of any patent protection obtained will be sufficient to exclude
        competitors or provide competitive advantages to us, that any of our patents
        will be held valid if subsequently challenged or that others will not claim
        rights in or ownership of the patents and other proprietary rights held by
        us.
  
 **Our
        medical device products and services are subject to extensive government
        regulation. If we fail to obtain or are delayed in obtaining the approval
        of the
        necessary federal and state government agencies, our business could be
        materially affected.**
  The
        manufacture and sale of our medical device products and services are subject
        to
        extensive regulation principally by the Food and Drug Administration in the
        United States and corresponding foreign regulatory agencies in each country
        in
        which we sell our products. These regulations affect product approvals, product
        standards, packaging requirements, design requirements, manufacturing and
        quality assurance, labeling, import restrictions, tariffs and other tax
        requirements. Securing Food and Drug Administration authorizations and approvals
        requires submission of extensive clinical data and supporting information.
        In
        most instances, the manufacturers or licensees of medical devices that are
        treated by us will be responsible for securing regulatory approval for medical
        devices incorporating our technology. However, we plan on preparing and
        maintaining Device Master Files which may be accessed by the Food and Drug
        Administration. There can be no assurance that our medical device manufacturers
        or licensees will be able to obtain regulatory clearance or approval for
        devices
        incorporating our technology on a timely basis, or at all. Regulatory clearance
        or approvals, if granted, may include significant limitations of the indicated
        uses for which the product may be marketed. In addition, product clearance
        or
        approval could be withdrawn for failure to comply with regulatory standards
        or
        the occurrence of unforeseen problems following initial marketing. Changes
        in
        existing regulations or adoption of new governmental regulations or policies
        could prevent or delay regulatory approval of products incorporating our
        technology or subject us to additional regulation.
  In
        addition to Food and Drug Administration regulation, certain of our activities
        are regulated by, and require approvals from, other federal and state agencies.
        The use, management, transportation, and disposal of certain materials and
        wastes are subject to regulation by several federal and state agencies depending
        on the nature of the materials or waste material. Certain toxic chemicals
        and
        products containing toxic chemicals may require special reporting to the
        United
        States Environmental Protection Agency and/or its state counterparts. Our
        future
        operations may require additional approvals from federal and/or state
        environmental agencies. There can be no assurance that we will be able to
        obtain
        necessary government approvals, or that we will be able to operate with the
        conditions that may be attached to future regulatory approvals. Moreover,
        there
        can be no assurance that we will be able to maintain previously-obtained
        approvals. While it is our policy to comply with applicable regulations,
        failure
        to comply with existing or future regulatory requirements and failure to
        obtain
        or maintain necessary approvals could have a material adverse effect on our
        business, financial condition, and results of operations.
  Failure
        or delay of our medical device manufacturers in obtaining Food and Drug
        Administration and other necessary regulatory clearance or approval, the
        loss of
        previously obtained clearance or approvals, as well as failure to comply
        with
        other existing or future regulatory requirements could have a material adverse
        effect on our business, financial condition and results of operations.
  Because
        certain of our products utilize radiation sources, their manufacture,
        distribution, transportation, import/export, use and disposal will also be
        subject to federal, state and/or local laws and regulations relating to the
        use,
        handling, procurement and storage of radioactive materials. We must also
        comply
        with United States Department of Transportation regulations on the labeling
        and
        packaging requirements for shipment of radiation sources to hospitals or
        other
        users of our products. We expect that there will be comparable regulatory
        requirements and/or approvals in markets outside the United States. If any
        of
        the foregoing approvals are significantly delayed or not obtained, our business
        could be materially adversely affected.
  **We
        depend on third party reimbursement to our customers for market acceptance
        of
        our medical products. If third party payors fail to provide appropriate levels
        of reimbursement for our products, our profitability would be adversely
        affected.**
  Medicare,
        Medicaid and other government insurance programs, as well as private insurance
        reimbursement programs greatly affect suppliers of health care products.
        Several
        of the products being developed, produced or processed by us, including our
        orthopedic implants, prostate seeds, and interventional cardiology instruments
        and devices, are currently being reimbursed by third party payers. Our customers
        rely on third-party reimbursements to cover all or part of the costs of most
        of
        the procedures in which our products are used. Third party payers (including
        health maintenance organizations) may affect the pricing or relative
        attractiveness of our products by regulating the maximum amount of reimbursement
        provided by such payers to the physicians, hospitals and clinics using our
        devices, or by taking the position that such reimbursement is not available
        at
        all. The amounts of reimbursement by third party payers in those states that
        do
        provide reimbursement vary considerably.
  Alternatively,
        a diagnostic-related group may be assigned that does not reflect the costs
        associated with the use of our devices or devices treated using our services,
        resulting in limited reimbursement. If, for any reason, the cost of using
        our
        products or services was not to be reimbursed by third party payers, our
        ability
        to sell our products and services would be materially adversely affected.
        In the
        international market, reimbursement by private third party medical insurance
        providers and governmental insurers and providers varies from country to
        country. In certain countries, our ability to achieve significant market
        penetration may depend upon the availability of third party governmental
        reimbursement.
  **Product
        liability claims could damage our reputation and hurt our financial
        results.**
  To
        date
        no product liability claims have been asserted against us; however, the testing,
        marketing and sale of implantable devices and materials entail an inherent
        risk
        that product liability claims will be asserted against us, if the use of
        our
        devices is alleged to have adverse effects on a patient, including exacerbation
        of a patient's condition, further injury, or death. A product liability claim
        or
        a product recall could have a material adverse effect on our business. Certain
        of our devices are designed to be used in treatments of diseases where there
        is
        a high risk of serious medical complications or death.
  Although
        we have obtained product liability insurance coverage on medical products,
        there
        can be no assurance that in the future we will be able to obtain such coverage
        on acceptable terms or that insurance will provide adequate coverage against
        any
        or all potential claims. Furthermore there can be no assurance that we will
        avoid significant product liability claims and the attendant adverse publicity.
        Any product liability claim or other claim with respect to underinsured
        liabilities could have a material adverse effect on our business and results
        of
        operations.
  
 **If
        our contract manufacturer cannot provide the services we require, our ability
        to
        manufacture our products could be harmed.**
  We
        rely
        on a single contract manufacturer to provide manufacturing services for our
        explosives detection products. If these services become unavailable, we would
        be
        required to identify and enter into an agreement with a new contract
        manufacturer or take the manufacturing in house. The loss of our contract
        manufacturer could significantly disrupt production as well as increase the
        cost
        of production, thereby also increasing the prices of our products. These
        changes
        could have a material adverse effect on our business and results of operations.
  **If
        we were to lose the services of either our president or our chief scientist,
        our
        business would be adversely affected.**
  We
        are
        substantially dependent, for the foreseeable future, upon our Chairman of
        the
        Board, President and Chief Executive Officer, Dr. Anthony J. Armini and our
        Vice
        President and Chief Scientist, Dr. Stephen N. Bunker, both of whom currently
        devote their full time and efforts to management. We have entered into an
        employment agreement with each of these officers. If we were to lose the
        services of Dr. Armini or Dr. Bunker for any significant period of time,
        our
        business would be materially adversely affected.
 
 **We
        will be required to redeem the Series D Preferred for cash if the five day
        average market price of our common stock, prior to a redemption date, is
        less
        than 110% of the fixed conversion price.**
  We
        will
        be required to redeem the Series D Preferred for cash if the following
        conditions are not met: (1) the shares must be issued pursuant to an effective
        registration statement, (2) the average closing market price of the common
        stock
        for the five trading days immediately preceding a payment date must exceed
        the
        fixed conversion price of $4.15 by 110% and no one day’s closing price may be
        less than the fixed conversion price, and (3) the conversion dollar value
        may
        not exceed the aggregate of the prior 22 trading days’ dollar volume. We cannot
        be certain that we will be able to redeem the monthly payment in shares of
        common stock on a redemption date given the fixed conversion price of the
        preferred stock and the associated market price of the common stock on a
        redemption date. If we are required to redeem monthly payments in cash, this
        will reduce our working capital necessary for our operations.  Failure of
        our ability to convert preferred shares into common shares will have a material
        adverse affect on our cash resources.  We may be required to reduce or
        curtail certain operations and research and development projects to improve
        our
        cash resources.
  **If
        third party credit is unavailable, our working capital could be restricted;
        restrictions on our ability to raise additional capital under certain
        circumstances.**
  Currently,
        we rely on cash generated from our operations, private equity financing and
        third party credit for working capital purposes. If such financing is no
        longer
        available at acceptable rates, we would be required to reduce or curtail
        our
        operations and research and development projects. This would have a material
        adverse effect on our business and results of operations.
  Further,
        from March 4, 2005 and for a period 24 months thereafter, we are prohibited
        from
        issuing or selling any debt or equity securities that are convertible into,
        exchangeable or exercisable for, or include the right to receive additional
        shares of our common stock either:
  ·
            At
                a conversion, exercise or exchange rate or other price that is based
                upon
                and/or varies with the trading prices of or quotations for the shares
                of
                our common stock at any time after the initial issuance of such debt
                or
                equity securities, or  ·
            With
                a conversion, exercise or exchange price that is subject to being
                reset at
                some future date after the initial issuance of such debt or equity
                security or upon the occurrence of specified or contingent events
                directly
                or indirectly related to our business or the market for our common
                stock.  To
        the
        extent that these prohibitions affect our ability to raise additional capital
        from potential future investors, we would be required to reduce or curtail
        our
        operations and research and development projects. This would have a material
        adverse effect on our business and results of operations.
 
 **ITEM
        1B**  **UNRESOLVED
        STAFF COMMENTS**
 
 At
        this
        time, the Company has an open comment letter from the Securities and Exchange
        Commission relating to a registration statement on Form S-3 filed on November
        22, 2005 to which we responded orally and in writing most recently on February
        24, 2006. Subsequent, the Company will be filing an amendment to this S-3
        registration to address their comments. We believe that the remaining comments
        are not material.
 
 
 **ITEM
                  2.**
              **PROPERTIES**
 
 We
        operate out of four separate locations. Our corporate offices are located
        in an
        approximately 51,000 square foot leased facility in Wakefield, Massachusetts.
        The facility is located approximately 15 miles north of Boston in a modern
        and
        well maintained business park. Our current lease expires in December 2008.
        In
        addition to our corporate offices, this facility houses all of our research
        and
        development, brachytherapy manufacturing, as well as semiconductor wafer
        processing.
 
 Our
        second location is in Sunnyvale, California, just outside of San Jose. This
        is
        where our Core Systems division is located. We conduct our semiconductor
        wafer
        processing and semiconductor equipment refurbishing services and sales in
        an
        approximately 35,000 square foot leased facility. This facility, specifically
        designed to perform semiconductor services, is well maintained to ensure
        the
        integrity of the product produced. This lease expires in December
        2009.
 
 Our
        third
        location, also located in Sunnyvale, CA, is Accurel Systems. This location,
        leased in a modern and well maintained business park, consists of a total
        of
        approximately 20,000 square feet. This lease expires in September 2010. We
        conduct our semiconductor analytical services at this location.
 
 Our
        fourth location located in Austin, TX, is a satellite office of Accurel Systems.
        This location, in a small business park, consists of a total of approximately
        1,250 square feet. The lease expires in September 2006. The Company is currently
        negotiating terms on a new lease.
 
 I**TEM
                  3.**
              **LEGAL
                  PROCEEDINGS**
 
 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
        or
        about March 8, 2006, the Company commenced an arbitration under the Rules
        of the
        American Arbitration Association against Respondents Majid Ghafghaichi (“Majid”)
        and Vahe Sarkissisian (“Vahe”), seeking a total of $3,994,000 for
        indemnification of various “Losses,” as defined in, and expressly allowed
        pursuant to, a Stock Purchase Agreement dated March 9, 2005 (the “Agreement”),
        between the Company, as the purchaser, Accurel Systems International Corporation
        (“Accurel), and  Majid and Vahe, as the sellers of 100% of the issued and
        outstanding shares of Accurel stock.
 
 More
        specifically, there are four claims asserted by the Company against Respondents:
        (1) Damages of $3.4 million resulting from misrepresentations concerning
        the
        loss of business from a key Accurel customer; (2) unauthorized withdrawals
        in
        the amount of approximately $276,000 from Accurel by the Respondents prior
        to
        the closing; (3) approximately $49,000 of disallowed transaction expenses
        that
        the Respondents improperly received; and (4) undisclosed net liabilities
        totaling approximately $269,000.
 
 Respondents
        have asserted counterclaims seeking “an aggregate amount in excess of
        $1,750,000,” based on the allegedly “late payment” to Respondents of Company
        stock and a Secured Promissory Note as part of the consideration for their
        sale
        of Accurel stock.  The Company has filed a detailed denial of all
        counterclaims.
 
 The
        arbitration is now in the discovery phase, and the hearings are scheduled
        for
        February, 2007.
 
 At
        this
        early stage of the proceedings, particularly before the commencement of
        depositions, it is difficult to assess the final outcome of this arbitration.
        However, the Company believes that the counterclaims have no merit, and will
        vigorously defend such counterclaims.
 
 On
        March
        23, 2005, we entered into a Development, Distribution and Manufacturing
        Agreement (the “Rapiscan Agreement”) with Rapiscan Systems, Inc.
        (“Rapiscan”).  Under the terms of this agreement, we gave Rapiscan the
        exclusive worldwide rights to market our Quantum
        Sniffer TM  portable
        and benchtop trace detection devices under their private label.  We also
        agreed to give Rapiscan the exclusive worldwide rights to distribute certain
        other new security products which we may develop in the future with their
        funding, as well as rights, in some circumstances, to manufacture certain
        components of the Quantum
        Sniffer TM  portable
        and benchtop trace detection devices.
 
 On
        March
        24, 2006, the Company brought suit in the United States District Court in
        the
        District of Massachusetts against Rapiscan and its parent, OSI Systems, Inc.
        (“OSI”). The Company is requesting rescission of the Rapiscan Agreement, for
        lack of performance and other grounds. In the alternative, the Company is
        seeking termination of the Rapiscan Agreement due to material breaches of
        contract and 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.
 
 On
        March
        27, 2006, the Company received notice that Rapiscan filed a complaint against
        the Company and its contract manufacturer, Columbia Tech, in the United States
        District Court for the Central District of California, regarding the Rapiscan
        Agreement. Rapiscan’s complaint against the Company is based upon claims of
        breach of contract and breach of warranty and is requesting a decree for
        specific performance, declaratory relief and injunctive relief. Rapiscan’s
        complaint against Columbia Tech is based upon injunctive relief, declaratory
        relief and tortuous interference with contractual relations. On April 12,
        2006,
        Rapiscan dismissed all claims against Columbia Tech.
 
 As
        of
        August 18, 2006, as a result of motions made by both parties, the two lawsuits
        have been consolidated in the United States District Court for the Central
        District of California with the Company as plaintiff. Presently, discovery
        is in
        process. Rapiscan and OSI have filed a motion to dismiss certain of the
        Company’s claims. The Company has not yet responded to the motion. It is
        expected that the Court will hear and rule on the motion in October
        2006.
  Should
        the Company be unsuccessful in prosecuting this matter, it may have a material
        adverse effect on its business and results of operations. No revenue has
        been
        recorded related to the Rapiscan Agreement.
  We
        may,
        from time to time, be involved in other actual or potential proceedings that
        we
        consider to be in the normal course of our business. We do not believe that
        any
        of these proceedings will have a material adverse effect on our
        business.
 **ITEM
          4.**  **SUBMISSION
          OF MATTERS TO A VOTE TO SECURITY HOLDERS**
 
 No
          matters were submitted to a vote of security holders during the fourth
          quarter
          of fiscal year ended June 30, 2006.
 
 **PART
        II**
  
  **ITEM
                  5.**
              **MARKET
                  FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER
                  MATTERS**
 
 **Market
        Price**
 
 As
        of
        June 30, 2006, our common stock, $0.10 par value, was traded on the American
        Stock Exchange under the symbol IMX. The following sets forth the range of
        high
        and low closing sales prices on the American Stock Exchange: ****
  
 **High**
              
              **Low****Fiscal
                  Year Ended June 30, 2005:**Quarter
                  ended September 30
              $11.99
              
              $7.45Quarter
                  ended December 31
              11.30
              
              8.85Quarter
                  Ended March 31
              10.75
              
              5.60Quarter
                  ended June 30
              5.97
              
              2.45**Fiscal
                  Year Ended June 30, 2006:**Quarter
                  ended September 30
              9.70
              
              2.92Quarter
                  ended December 31
              6.28
              
              3.11Quarter
                  Ended March 31
              4.65
              
              3.38Quarter
                  ended June 30
              4.07
              
              3.07
 
  At
        October 5, 2006, the closing sales price of our common stock was $3.00 and
        there
        were approximately 4,000 shareholders of record.
  **Equity
        Compensation Plan Disclosure**
 
 The
        following table sets forth certain information as of June 30, 2006 regarding
        securities authorized for issuance under our equity compensation
        plans.
  Plan
                  Category
              
              Number
                  of securities to be issued upon exercise of outstanding options,
                  warrants
                  and rights
              
              Weighted-average
                  exercise price of outstanding options, warrants and rights
              
              Number
                  of securities remaining available for future issuance under equity
                  compensation plansEquity
                  Compensation Plans Approved by Shareholders
              
              1,836,551
              
              $5.41
              
              649,157Equity
                  Compensation Plans Not Approved by Shareholders
              
              -
              
              -
              
              -Total
              
              1,836,551
              
              $5.41
              
              649,157
 
 **Dividends**
  We
        have
        never declared or paid any cash dividends on our common stock. We currently
        anticipate that we will retain all future earnings for the expansion and
        operation of our business, and do not anticipate paying cash dividends in
        the
        foreseeable future.
 
 
 **Sales
        of Unregistered Securities**
  A ll
        of the
        offers and sales referred to above were in private offerings to accredited
        investors (as such term is defined in Regulation D) in reliance upon the
        exemption provided by Section 4(2) of the Securities Act and Regulation D
        promulgated under such act by the Commission. Each of the purchasers was
        furnished with information about us and had the opportunity to verify such
        information. Additionally, we obtained a representation from each purchaser
        of
        such purchaser's intent to acquire the securities for the purpose of investment
        only, and not with a view toward the subsequent distribution thereof. The
        securities bear appropriate legends and we have issued stop transfer
        instructions to our transfer agent.
 
 On
        July
        6, 2005, the Company executed a $3.0 million secured term note payable to
        Laurus
        Master Fund, Ltd. (“Laurus”). The Company received $3,000,000 in gross proceeds,
        less a management fee of $135,000 and related transaction costs of approximately
        $32,000. The term note was collateralized by substantially all of the Company’s
        assets, had a 4-month term and bore interest at a rate equal to the prime
        rate
        plus once percent (1%). In connection with the financing, on September 30,
        2005,
        the Company issued Laurus a warrant to purchase up to 250,000 shares of the
        Company’s common stock at a price equal to $3.75 per share. The warrants were
        valued using the Black Scholes model and the following assumptions: volatility
        of 67%, expected life of 5 years and a risk free interest rate of 3.77%.
        Net
        proceeds from the financing were used for increasing the capacity of the
        Quantum
        SnifferTM production line, increasing unit inventories and the repayment of
        certain indebtedness due and owed by the Company to the former shareholders
        of
        Accurel in connection with the acquisition of this wholly-owned subsidiary.
 
 On
        September 30, 2005, the Company issued 500,000 shares of Series D Convertible
        Redeemable Preferred Stock (“Series D”) having a stated value of $10 per share,
        pursuant to a Securities Purchase Agreement with Laurus. The Company received
        $5,000,000 in gross proceeds, less a management and placement agent fee of
        approximately $90,000, and related transaction costs of approximately $27,000.
        The Company utilized the proceeds to repay the $3 million term note with
        Laurus
        signed on July 7, 2005. The Series D has a dividend equal to the prime rate
        plus
        one percent (1%) (9.25% at June 30, 2006) and provides for redemption over
        a
        thirty-six month period pursuant to an amortization schedule. The monthly
        redemption amount of approximately $152,000 may be paid in cash or common
        shares
        at the option of the Company, subject to certain restrictions, commencing
        on
        January 1, 2006, at a fixed conversion price of $6.80 per common share. The
        Company also issued to Laurus a warrant to purchase 50,000 shares of common
        stock at $10.20 per share. The warrants were valued using the Black Scholes
        model and the following assumptions: volatility of 80%, an expected life
        5
        years, and a risk free interest rate of 4.12%. The Securities Purchase Agreement
        with Laurus provides for a security interest in substantially all of the
        Company’s assets and provides Laurus a right of first refusal on future
        financing arrangements during the term of the agreement. In the event Laurus
        declines to exercise its right of first refusal, it agreed to enter into
        such
        documentation as shall be reasonable requested by the Company in order to
        subordinate its rights under the Series D to the subsequent financier. Net
        cash
        proceeds from this financing were $1,883,000 (which included repayments of
        $3,000,000 of principal related to the July 6, 2005 term note and $117,000
        of
        issuance costs).
 
 On
        May
        31, 2006, the Company amended the Series D and the Certificate of Vote of
        Directors Establishing a Class or Series of Stock. The terms of the amendment
        permit the Company to defer approximately $455,000 of cash payments,
        representing the January 2006, February 2006 and March 2006 amortization
        payments, and to defer the October 2006 amortization payment, should such
        payment be required in cash, to the mandatory redemption date of September
        30,
        2008. In consideration, the Company has agreed to the conversion of the April
        2006, May 2006, June 2006, July 2006, August 2006 and September 2006
        amortization payments into 261,233 shares of Common Stock of the Company
        at a
        conversion price of $3.48 per share, representing a reduction in principal
        of
        approximately $909,000, and to reduce the Fixed Conversion Price of the
        remaining Series D stock from $6.80 per share to $4.15 per share. In addition,
        Laurus was granted a warrant to purchase 150,000 shares of the Company’s common
        stock at an exercise price of $4.26 per share. The warrants were valued using
        the Black Scholes model and the following assumptions: volatility of 79%,
        an
        expected life 5 years, and a risk free interest rate of 4.89%.
 
 The
        amendment of the Series D, as described above, was accounted for as an
        extinguishment of debt in accordance with EITF 96-19 "Debtor's Accounting
        for a
        Modification or Exchange of Debt Instruments." The Company determined a
        substantial difference in the net present value of the cash flows under the
        terms of the amendment was more than 10 percent different from the present
        value
        of the remaining cash flows under the terms of the original Series D agreement.
        Due to the substantial difference, the Company determined an extinguishment
        of
        debt had occurred with the amendment, and as such, it was necessary to reflect
        the Series D at its fair market value. Accordingly, the following table shows
        the basis for the Series D extinguishment:
 Extinguishment
                    of Series D debt instrument at May 31, 2006:Redemption
                    payments
                    due
                
                $909,000Unamortized
                    discount of warrants, derivative value of preferred stock conversion
                    and
                    issue costs
                
                266,000Derivatives
                    related to the preferred stock features
                
                578,000Subtotal
                
                $1,753,000Record
                    New Series D debt instrument at May 31, 2006:Fair
                    value of redemption payments made
                
                $1,011,000Issuance
                    of 150,000 warrants
                
                375,000Unamortized
                    discount of warrants, derivative value of preferred stock conversion
                    and
                    issue costs
                
                266,000Derivatives
                    related to the preferred stock features
                
                1,395,000Subtotal
                
                $3,047,000Loss
                    on extinguishment of Series D debt instrument
                
                $1,294,000
 
 The
        $1,294,000 aggregate loss from these transactions, accounted for as an
        extinguishment of debt, is included in Other expenses for the year ended
        June
        30, 2006.
 
  
  **ITEM
        6.**  **SELECTED
        FINANCIAL DATA**
 
 The
        selected financial data presented below is derived from our consolidated
        financial statements and should be read in connection with those
        statements.
  **Year
                  ended June 30,****2002**
              **2003**
              **2004**
              **2005**
              **2006****Consolidated
                  Statements of Operations Data:**Revenues
              $
                  6,621,000
              $
                  6,696,000
              $
                  8,566,000
              $12,286,000
              $26,391,000Cost
                  of revenue
              5,185,000
              5,363,000
              6,186,000
              12,056,000
              22,044,000Research
                  and development
              1,302,000
              1,776,000
              1,631,000
              1,942,000
              1,313,000Selling,
                  general and administrative
              2,314,000
              2,326,000
              4,599,000
              5,524,000
              8,933,000Impairment
                  of goodwill
              -
              -
              -
              -
              457,000Other
                  income (expense)
              (14,000)
              -
              (162,000)
              (169,000)
              (728,000)Net
                  loss
              (2,194,000)
              (2,769,000)
              (4,012,000)
              (7,405,000)
              (7,084,000)Preferred
                  distribution
              (530,000)
              (891,000)
              (2,527,000)
              (1,183,000)
              (1,089,000)Net
                  loss applicable to common shareholders
              $(2,724,000)
              $(3,660,000)
              $(6,539,000)
              $(8,588,000)
              $(8,173,000)Net
                  loss per share applicable to common shareholders, basic and
                  diluted
              $
                  (0.45)
              $
                  (0.58)
              $
                  (0.89)
              $
                  (0.91)
              $
                  (0.72)Weighted
                  average common shares outstanding used in computing basic and diluted
                  loss
                  per share
              6,083,370
              6,310,748
              7,317,677
              9,412,548
              11,325,842**June
                  30,****2002**
              **2003**
              **2004**
              **2005**
              **2006****Consolidated
                  Balance Sheet Data:**Cash
                  and cash equivalents
              $
                  1,014,000
              $
                  959,000
              $
                  6,906,000
              $
                  1,549,000
              $
                  2,204,000Working
                  capital (deficit)
              1,051,000
              (272,000)
              8,253,000
              (764,000)
              2,259,000Goodwill
              -
              -
              -
              12,213,000
              11,666,000Total
                  assets
              6,461,000
              7,297,000
              15,224,000
              32,228,000
              30,799,000Total
                  liabilities
              1,641,000
              2,703,000
              2,054,000
              8,844,000
              8,303,000Preferred
                  stock
              -
              966,000
              670,000
              -
              2,568,000Total
                  stockholders' equity
              $
                  4,820,000
              $
                  3,628,000
              $
                  12,500,000
              $23,384,000
              $19,928,000
    **Quarterly
                  Financial Data****Fiscal
                  2006 Quarter Ended****September
                  30**
              
              **December
                  31**
              
              **March
                  31**
              
              **June
                  30**Revenues
              $
                  4,672,000
              
              $
                  7,540,000
              
              $6,548,000
              
              $7,631,000Gross
                  margin
              (6,000)
              
              1,474,000
              
              1,006,000
              
              1,873,000Loss
                  from operations
              (2,245,000)
              
              (1,683,000)
              
              (1,143,000)
              
              (1,285,000)Net
                  loss
              (2,367,000)
              
              (933,000)
              
              (1,264,000)
              
              (2,520,000)Net
                  loss applicable to common shareholders
              (2,367,000)
              
              (1,320,000)
              
              (1,655,000)
              
              (2,831,000)Net
                  loss per common share
              $
                  (0.22)
              
              $
                  (0.12)
              
              $
                  (0.15)
              
              $
                  (0.23)Weighted
                  average shares outstanding
              10,962,703
              
              11,379,275
              
              11,379,275
              
              11,582,115**Fiscal
                  2005 Quarter Ended****September
                  30**
              
              **December
                  31**
              
              **March
                  31**
              
              **June
                  30**Revenues
              $
                  2,274,000
              
              $
                  2,541,000
              
              $
                  2,862,000
              
              $
                  4,609,000Gross
                  margin
              468,000
              
              (439,000)
              
              (19,000)
              
              220,000Loss
                  from operations
              (1,178,000)
              
              (1,997,000)
              
              (2,198,000)
              
              (1,869,000)Net
                  loss
              (1,191,000)
              
              (2,028,000)
              
              (2,267,000)
              
              (1,919,000)Net
                  loss applicable to common shareholders
              (1,475,000)
              
              (2,311,000)
              
              (2,882,000)
              
              (1,920,000)Net
                  loss per common share
              $
                  (0.17)
              
              $
                  (0.26)
              
              $
                  (0.30)
              
              $
                  (0.18)Weighted
                  average shares outstanding
              8,466,559
              
              8,882,786
              
              9,618,367
              
              10,704,928
  
  **ITEM
        7.**  **MANAGEMENT’S
        DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
        OPERATIONS**
  **OVERVIEW**
  Over
        the
        past twenty two years, Implant Sciences Corporation has both developed and
        acquired technologies using ion implantation and thin film coatings. Initially
        this technology was used in semiconductor processing but soon expanded to
        include various medical device applications including the modification of
        orthopedic joint implant surfaces to reduce polyethylene wear generation
        and the
        manufacture of products for radiation therapy treatments. Our latest application
        of this technology includes the manufacturing of trace explosives detection
        equipment.
 
 We
        currently provide ion implantation and analytical services to numerous
        semiconductor manufacturers, research laboratories and universities. The
        application of our ion implantation technologies to modify the surfaces of
        orthopedic joint implants is being applied primarily to product manufactured
        by
        the Stryker-Orthopaedics Division of Stryker Corporation.
 
 In
        October 2004 and March 2005, we acquired two California semiconductor companies.
        Through these acquisitions, we have more than doubled our semiconductor capacity
        and are now able to offer diagnostic services and semiconductor equipment
        refurbishment services to semiconductor manufacturers, research laboratories
        and
        universities.
 
 Other
        applications of our ion beam technology have been in the area of temporary
        brachytherapy products. In May 1999, we received Food and Drug Administration
        510(k) clearance to market our I-Plant TM Iodine-125 radioactive seed for the treatment of prostate cancer and in 2001
        recognized our first sale.
 
 Since
        May
        1999, we have been performing research to develop a trace explosives detector,
        which could be used to detect hidden bombs in airports and other public places.
        This technology is yet another application of our ion source technology.
        At
        present, we have developed both portable and bench-top systems for use in
        airports and Department of Defense facilities and have successfully marketed
        these products both domestically and internationally. In fiscal 2006, as
        part of
        a plan to reduce manufacturing costs, we transitioned the production of these
        products to a contract manufacturer. As we continue to sell and deliver these
        products, we work both independently and in conjunction with various government
        agencies, to develop the next generation of trace explosives detectors and
        identify new applications for our proprietary technology.
 
 On
        October 15, 2004, the Company acquired Core Systems Incorporated (“Core”) and on
        March 9, 2005, the Company acquired Accurel Systems International Corporation
        (“Accurel”). The results of operations, of the acquired companies, are part of
        the Company’s semiconductor business segment. The results of operations for the
        acquired companies are included in the Company’s results of operations since the
        date of their respective acquisition. As such, the results of operations
        for the
        years ended June 30, 2006 and 2005 are not comparable.
 
 On
          or
          about March 8, 2006, the Company commenced an arbitration under the Rules
          of the
          American Arbitration Association against Respondents Majid Ghafghaichi
          (“Majid”)
          and Vahe Sarkissisian (“Vahe”), seeking a total of $3,994,000 for
          indemnification of various “Losses,” as defined in, and expressly allowed
          pursuant to, a Stock Purchase Agreement dated March 9, 2005 (the “Agreement”),
          between the Company, as the purchaser, Accurel Systems International Corporation
          (“Accurel), and  Majid and Vahe, as the sellers of 100% of the issued and
          outstanding shares of Accurel stock.
 
 More
          specifically, there are four claims asserted by the Company against Respondents:
          (1) Damages of $3.4 million resulting from misrepresentations concerning
          the
          loss of business from a key Accurel customer; (2) unauthorized withdrawals
          in
          the amount of approximately $276,000 from Accurel by the Respondents prior
          to
          the closing; (3) approximately $49,000 of disallowed transaction expenses
          that
          the Respondents improperly received; and (4) undisclosed net liabilities
          totaling approximately $269,000.
 
 Respondents
          have asserted counterclaims seeking “an aggregate amount in excess of
          $1,750,000,” based on the allegedly “late payment” to Respondents of Company
          stock and a Secured Promissory Note as part of the consideration for their
          sale
          of Accurel stock.  The Company has filed a detailed denial of all
          counterclaims.
 
 The
          arbitration is now in the discovery phase, and the hearings are scheduled
          for
          February, 2007.
 
 At
          this
          early stage of the proceedings, particularly before the commencement of
          depositions, it is difficult to assess the final outcome of this arbitration.
          However, the Company believes that the counterclaims have no merit, and
          will
          vigorously defend such counterclaims
 
 On
        March
        24, 2006, the Company brought suit in the United States District Court in
        the
        District of Massachusetts against Rapiscan and its parent, OSI Systems, Inc.
        (“OSI”). The Company is requesting rescission of the Rapiscan Agreement, for
        lack of performance and other grounds. In the alternative, the Company is
        seeking termination of the Rapiscan Agreement due to material breaches of
        contract and 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.
 
 On
        March
        27, 2006, the Company received notice that Rapiscan filed a complaint against
        the Company and its contract manufacturer, Columbia Tech, in the United States
        District Court for the Central District of California, regarding the Rapiscan
        Agreement. Rapiscan’s complaint against the Company is based upon claims of
        breach of contract and breach of warranty and is requesting a decree for
        specific performance, declaratory relief and injunctive relief. Rapiscan’s
        complaint against Columbia Tech is based upon injunctive relief, declaratory
        relief and tortuous interference with contractual relations. On April 12,
        2006,
        Rapiscan dismissed all claims against Columbia Tech.
 
 As
        of
        August 18, 2006, as a result of motions made by both parties, the two lawsuits
        have been consolidated in the United States District Court for the Central
        District of California with the Company as plaintiff. Presently, discovery
        is in
        process. Rapiscan and OSI have filed a motion to dismiss certain of the
        Company’s claims. The Company has not yet responded to the motion. It is
        expected that the Court will hear and rule on the motion in October
        2006.
  Should
        the Company be unsuccessful in prosecuting this matter, it may have a material
        adverse affect on its business and results of operations.
 
 The
        Company manages its business and reports results from operations for three
        business segments: Medical, which includes radioactive seeds, orthopedic
        coatings, medical related government contracts and other related activities;
        Security Products, which includes development contracts and product sales
        related to the Company’s trace explosives detection products; and Semiconductor,
        which includes ion implantation, disk refurbishment, source conditioning
        equipment and semiconductor analytical services.
 
 
 **RESULTS
        OF OPERATIONS**
  The
        following is a discussion and analysis of the financial condition and results
        of
        operation of the Company for the years ended June 30, 2006, 2005 and 2004.
        It
        should be read in conjunction with the financial statements and notes thereto
        appearing elsewhere herein.
 
 *Revenues.* Total
        revenues for the year ended June 30, 2006 were $26,391,000 as compared to
        $12,286,000 and $8,566,000 for the prior year periods ended June 30, 2005
        and
        2004, respectively. Our revenues by business segment are as
        follows:
 June
                    30, 2006Medical
                Semiconductor
                Security
                Total$4,464,000
                $15,056,000
                $6,871,000
                $26,391,000June
                    30, 2005Medical
                Semiconductor
                Security
                Total$4,146,000
                $6,630,000
                $1,510,000
                $12,286,000June
                    30, 2004Medical
                Semiconductor
                Security
                Total$4,957,000
                $1,022,000
                $2,587,000
                $8,566,000
 Revenues
        for the year ended June 30, 2006 were $26,391,000 as compared to $12,286,000
        in
        the year ended June 30, 2005, an increase of $14,105,000 or 115%. The increase
        came from all three of our business segments. Our Semiconductor business
        segment
        increased $8,426,000 or 127%, our Security Products (previously referred
        to as
        Explosives Detection) business segment increased $5,361,000 or 355% and our
        Medical business segment increased $318,000 or 8%. Fiscal 2006 was the first
        year that revenues from Core and Accurel were included for the full fiscal
        year.
        Core was acquired on October 15, 2004 and Accurel was acquired on March 9,
        2005.
        Fiscal 2005 results included revenues only from the respective dates of
        acquisition. Core and Accurel revenues in the year ended June 30, 2006 were
        $13,432,000 as compared with $5,838,000 for the comparative prior year period,
        accounting for $7,594,000 of the increase in revenues. The increase in Security
        products revenue is primarily attributable to the first significant commercial
        quantities of our hand held explosives detection devices being sold in fiscal
        2006 and from the performance of a significant government contract granted
        by
        the Transportation Security Administration. In addition, included in the
        fiscal
        2006 results was $328,000 of security product revenues previously deferred
        from
        fiscal 2005, pending final customer acceptance. The increase in our Medical
        business segment is primarily from our Seeds business. Revenue from seeds
        and
        treatment planning systems increased $396,000 in the year ended June 30,
        2006
        over the previous year.
 
 Total
        revenues for the year ended June 30, 2005 were $12,286,000 as compared to
        $8,566,000 in the year ended June 30, 2004 an increase of $3,720,000 or 43%.
        The
        increase is primarily attributable to revenues from Core and Accurel since
        their
        acquisitions on October 15, 2004 and March 9, 2005 respectively, results
        from
        Core and Accurel were not included in the previous year. Revenues from Core
        and
        Accurel totaled approximately $5,838,000 for the year ended June 30, 2005
        and $0
        for the year ended June 30, 2004. Core and Accurel are included in our
        semiconductor segment.
 
 Revenues
        for the year ended June 30, 2005 from the Company’s security products business
        declined to $1,510,000 as compared to $2,587,000 for the comparable prior
        year,
        a decrease of $1,077,000 or 42%. This decrease is attributable to the completion
        of certain government contracts. Security product contract revenues were
        $1,294,000 and $2,463,000 for the years ended June 30, 2005 and 2004,
        respectively. The Company has been transitioning the security products business
        from primarily a contracts/development business to a product sales business.
        To
        that extent we have established strategic sales and distribution relationships
        both domestically and internationally. For the year ended June 30, 2005,
        the
        Company had deferred $328,000 of security product revenues, pending final
        customer acceptance.
 
 Revenues
        for the medical business unit were $4,146,000 for the year ended June 30,
        2005
        as compared to $4,957,000 for the year ended June 30, 2004, a decrease of
        $811,000 or 16%. Seeds revenues were $1,684,000 as compared to $2,744,000
        for
        the prior year, a decrease of $1,060,000, or 39%. The decrease in revenues
        from
        seeds was primarily due from a pattern of decreasing volumes that started
        last
        year. Management believes the seed volumes have stabilized and are taking
        steps
        to achieve higher seed volumes in the coming year, including the benefits
        of
        selling our treatment planning software to our customers.
 
 Revenues
        from medical and industrial coatings were $2,018,000 as compared to $1,707,000
        for the prior year, an increase of $287,000, or 17%. While revenue from
        orthopedic related coatings remains virtually unchanged from the prior year
        period, we recognized a $247,000, or nearly 500% increase, in our non-orthopedic
        related medical coatings. This increase was related to certain new customers
        transitioning from research and development projects to the beginning stages
        of
        production. We expect to see continued growth in this area. Medical contract
        sales decreased $62,000 to $444,000 as compared to $506,000 in the prior
        year
        due to the completion of certain contracts.
 
 
 *Cost
        of Revenues* .
        Cost of
        revenues for the year ended June 30, 2006 was $22,044,000 as compared to
        $12,056,000 and $6,186,000 for the prior year periods ended June 30, 2005
        and
        2004, respectively. The cost of revenues by business segment is as
        follows:
 
 Year
                  Ended June 30, 2006Medical
              Semiconductor
              Security
              Total$3,869,000
              $11,953,000
              $6,222,000
              $22,044,000Year
                  Ended June 30, 2005Medical
              Semiconductor
              Security
              Total$3,821,000
              $6,316,000
              $1,919,000
              $12,056,000Year
                  Ended June 30, 2004Medical
              Semiconductor
              Security
              Total$3,822,000
              $1,280,000
              $1,084,000
              $6,186,000
 
 Total
        cost of revenues for the year ended June 30, 2006 were $22,044,000 as compared
        to $12,056,000 for the prior year period, an increase of $9,988,000 or 83%.
        Cost
        of revenues for our semiconductor business segment was $11,953,000 for the
        year
        ended June 30, 2006 as compared to $6,316,000 for the prior year period an
        increase of $5,637,000 or 89%. Fiscal year 2006 was the first year that the
        results of Core and Accurel were included in our operations for a full fiscal
        year. Core was acquired on October 15, 2004 and Accurel was acquired on March
        9,
        2005. Cost of revenues for Core and Accurel were $10,086,000 for the year
        ended
        June 30, 2006 as compared to $4,807,000 for the prior year, an increase of
        $5,279,000 or 110%. Cost of revenues for our security products segment was
        $6,222,000 for the year ended June 30, 2006 as compared to $1,919,000 for
        the
        prior year period. Most of the increase is attributable to materials and
        manufacturing costs associated with the sales of our hand held explosives
        detection devices.
 
 The
        cost
        of revenues for the year ended June 30, 2005 was $12,056,000 as compared
        to
        $6,186,000 for the prior year period ended June 30, 2004. The overall increase
        in cost of revenues is primarily a result of costs attributable to Core and
        Accurel since their acquisition on October 15, 2004 and March 9, 2005,
        respectively. Cost of revenues at Core and Accurel totaled $4,807,000 as
        compared to $0 in the prior year period. Core and Accurel are included in
        our
        semiconductor segment. In addition, our cost of revenues also increased due
        to
        our efforts to ramp up our security product manufacturing capability as we
        transition from primarily contract revenues to higher volumes of product
        sales
        related to the security product business segment. The cost of our security
        product revenues were $1,919,000 compared to $1,084,000 in the prior year,
        an
        increase of $835,000 or 77%. During the year ended June 30, 2005, we wrote
        off
        $342,000 to cost of revenues, of equipment, that was determined by management,
        to have no future value. This equipment was originally purchased or built
        for
        very specific applications or technologies that in management’s judgment no
        longer justify additional expenditure and no other use for this equipment
        exists. Most of the equipment write offs were attributable to the medical
        segment.
 
 *Gross
        Margins*
 
 **Year
                  ended June 30, 2006******
              **Medical**
              ****
              **Semiconductor**
              ****
              **Security**
              ****
              **Total**Sales
              $4,464,000
              
              $15,056,000
              
              $6,871,000
              
              $26,391,000COS
              $3,869,000
              
              $11,953,000
              
              $6,222,000
              
              $22,044,000Margin
                  %
              13%
              
              21%
              
              9%
              
              16%**Year
                  ended June 30, 2005******
              **Medical**
              ****
              **Semiconductor**
              ****
              **Security**
              ****
              **Total**Sales
              $4,146,000
              
              $6,630,000
              
              $1,510,000
              
              $12,286,000COS
              $3,821,000
              
              $6,316,000
              
              $1,919,000
              
              $12,056,000Margin
                  %
              8%
              
              5%
              
              -27%
              
              2%**Year
                  ended June 30, 2004******
              **Medical**
              ****
              **Semiconductor**
              ****
              **Security**
              ****
              **Total**Sales
              $4,957,000
              
              $1,022,000
              
              $2,587,000
              
              $8,566,000COS
              $3,822,000
              
              $1,280,000
              
              $1,084,000
              
              $6,186,000Margin
                  %
              23%
              
              -25%
              
              58%
              
              28%
 
 Overall
        gross margins were 16% of revenues in the year ended June 30, 2006 as compared
        to 2% in the prior year. The increase in gross margins comes from all of
        our
        business segments. Semiconductor gross margins were 21% for the year ended
        June
        30, 2006 as compared to 5% for the prior year period. This improvement is
        primarily due to the inclusion of Accurel for the entire year in our fiscal
        2006. Accurel is a service business and is characterized by relatively low
        variable costs so increased revenues beyond the level needed to cover fixed
        costs will have a significant impact on gross margins. Security products
        gross
        margins were 9% for the year ended June 30, 2006 as compared to a gross margin
        loss of 27% in the prior year period. The improvement in security products
        margin is due to the manufacturing and sale of handheld trace explosives
        detection devices which covered the cost of our manufacturing organization
        built
        during the prior year. Once the initial handheld explosives detector production
        run was completed, and the manufacturing process was proven, manufacturing
        was
        transitioned to a contract manufacturer allowing the Company to reduce its
        manufacturing overhead. The medical segment gross margins were 13% for the
        year
        ended June 30, 2006 compared to 8% for the prior year period. The improvement
        in
        gross margin came from manufacturing efficiencies gained in our seeds operations
        primarily from increased volumes and cost reductions.
 
 
 Overall
        gross margins were 2% of revenues in the year ended June 30, 2005 as compared
        to
        28% of revenues in the period ended June 30, 2004. The decrease in the gross
        margin percentage is attributable to relatively high fixed costs in our medical
        products segment that cannot be easily adjusted for the decrease in revenues,
        which the Company experienced. Medical segment gross margins were $325,000,
        or
        8% of revenues, for the year ended June 30, 2005 as compared to $1,135,000,
        or
        23% of revenues, for the prior year period. In addition, the transition from
        contract/development work in the security product segment created a situation
        in
        which the Company had declining revenues due to completion of major contracts,
        at the same time the Company was building its product manufacturing capability.
        The result of this transition was a gross margin loss of $409,000, or 27%,
        of
        sales for the security product segment, for the year ended June 30, 2005
        as
        compared to gross margins of $1,503,000, or 58%, in the prior year period.
        Semiconductor margins were 5% of revenues as compared to a gross margin loss
        of
        25% in the prior year period. This turnaround is attributable to Accurel
        since
        its acquisition by the Company on March 9, 2005.
  *Research
        and Development* .
        Research and development expense for the year ended June 30, 2006 was $1,313,000
        as compared to $1,942,000 for the comparable prior year period, a decrease
        of
        $629,000, or 32%. These expenses include $122,000 and $241,000 of stock-based
        compensation expense, respectively. The decrease in research and development
        expenses relates to the increase in customer funded programs, primarily through
        government grants and contracts, performed in fiscal 2006. The Company charges
        its research and development personnel to cost of revenues for work performed
        on
        these contracts and grants. A total of $692,000 of research and development
        personnel costs were charged to cost of sales in the year ended June 30,
        2006 as
        compared to $459,000 in the prior year period. In addition other costs
        associated with unfunded research and development projects in the prior fiscal
        year were expensed to research and development.
 
 Research
        and development expense for the year ended June 30, 2005 was $1,942,000 as
        compared to $1,631,000 for the comparable prior year period ended June 30,
        2004,
        an increase of $311,000, or 19%. These expenses include $241,000 and $300,000
        of
        stock-based compensation expense, respectively. The Company continued to
        expend
        funds to further the development of new products in the areas of explosives
        and
        toxic substance detection and temporary brachytherapy areas.
 
 *Selling,
        General and Administrative* .
        Selling, general and administrative expense for the year ended June 30, 2006
        was
        $8,933,000 as compared to $5,524,000 for the comparable prior year period,
        an
        increase of $3,409,000, or 62%. This increase is primarily related to $1,547,000
        of additional selling, general and administrative expenses incurred due to
        the
        inclusion of Core and Accurel for the full twelve month period in fiscal
        2006.
        Core and Accurel were acquired on October 15, 2004 and March 9, 2005,
        respectively, and the prior year includes their costs from the day of
        acquisition. Selling, general and administrative also included $1,264,000
        of
        share based compensation, measured at fair value, due to the adoption of
        SFAS
        123-R “Accounting for Stock-Based Compensation (“SFAS 123R”) in fiscal 2006 as
        compared to $135,000 of non-cash stock based compensation in the prior year
        period measured at fair value. During the year ended June 30, 2006 we also
        recorded a $457,000 impairment charge to write down goodwill associated with
        the
        acquisition of Core.
 
 Selling,
        general and administrative expenses for the year ended June 30, 2005 was
        $5,524,000 as compared to $4,599,000 for the comparable prior year period
        ended
        June 30, 2004, an increase of $925,000, or 20%. This increase is primarily
        related to $1,260,000 of additional selling, general and administrative expenses
        incurred since the acquisition of Core Systems and Accurel Systems on October
        15, 2004 and March 9, 2005, combined with increased spending for legal,
        accounting and consulting services. This increase was offset by a $1,144,000
        or
        89% reduction of non-cash, stock based compensation, to $135,000 in the twelve
        month period ending June 30, 2005, as compared with $1,279,000 during the
        twelve
        month period ended June 30, 2004. Additional increases in selling, general
        and
        administrative expenses included an increase of $339,000 related to salaries
        and
        employee related expenses, reflecting new hires during the year; an increase
        in
        rent expense of $171,000 due to expansion of floor space and; an increase
        in
        audit and tax fees of $153,000.
 
 *Other
        Income and Expenses, Net* .
        For the
        year ended June 30, 2006, we recorded other expense, net, of $728,000 as
        compared to $169,000, in the comparable prior year period an increase of
        $559,000 or 331%. Other income and expense includes a loss of $359,000
        representing the Company’s share of losses attributable to its investment in
        CorNova, an unconsolidated subsidiary accounted for under the equity method
        of
        accounting. Other income and expense also includes a $1,121,000 gain due
        to the
        change in the value of the embedded derivatives associated with the Series
        D
        Redeemable Convertible Preferred Stock, since its issuance on September 30,
        2005, and a loss on the modification of the Series D Redeemable Convertible
        Preferred Stock, accounted for as an extinguishment of debt under EITF 96-19
        of
        $1,294,000.
 
 For
        the
        year ended June 30, 2005, we recorded other expense, net, of $169,000 as
        compared to $162,000, in the period ended June 30, 2004.
 
 *Net
        Loss.* Net loss
        for the year ended June 30, 2006 was $7,084,000 as compared with $7,405,000
        for
        the comparable prior year period, a decrease in net loss of $321,000, or
        4%. The
        decrease in net loss is primarily due to reduced loss from operations of
        $880,000 offset by an increase in other expenses of $559,000. The fiscal
        2006
        net loss includes $2,493,000 of SFAS 123R share-based compensation and other
        non-cash compensation compared to $378,000 of non-cash compensation in the
        prior
        year period. The Company adopted FAS123R in the current fiscal year using
        the
        modified prospective method. These additional expenses were offset by improved
        results from the semiconductor and security product segments.
 
 Preferred
        distribution, dividends and accretion on Series D Redeemable Convertible
        Preferred Stock were $1,089,000 in the year ended June 30, 2006 as compared
        to
        $1,183,000 in the year ended June 30, 2005. The Company issued Series D
        Redeemable Convertible Preferred Stock on September 30, 2005. All previous
        issues of preferred stock had been converted to common in the prior year
        period.
 
 Net
        loss
        for the year ended June 30, 2005 was $7,405,000 as compared with $4,012,000
        for
        the prior year period ended June 30, 2004, an increase in net loss of
        $3,393,000, or 85%. The increase in net loss is primarily due to losses in
        the
        security products segment due to the completion of certain government contracts
        early in the year and costs related to increasing our manufacturing capability
        ahead of expected product orders. Preferred distribution, dividends and
        accretion on Series D Redeemable Convertible Preferred Stock were $1,183,000
        in
        the year ended June 30, 2005 as compared to $2,527,000 in the year ended
        June
        30, 2004. This decrease is attributable to the conversion of preferred stock
        to
        common stock during the periods shown. All outstanding preferred stock had
        been
        converted as of June 30, 2005.
 
 
 **LIQUIDITY
        AND CAPITAL RESOURCES**
 
 **Year
                  Ended June 30,******
              **2006**
              ****
              **2005**
              ****
              **2004**Cash
                  and cash equivalents
              $
                  2,204,000
              
              $
                  1,549,000
              
              $
                  6,906,000Cash
                  used by operating activities
              (2,199,000)
              
              (3,329,000)
              
              (2,647,000)Cash
                  used in investing activities
              (652,000)
              
              (8,217,000)
              
              (500,000)Cash
                  provided by financing activities
              3,506,000
              
              6,189,000
              
              9,094,000Net
                  increase (decrease) in cash and cash equivalents
              $
                  655,000
              
              $
                  (5,357,000)
              
              $
                  5,947,000
 
 
 As
        of
        June 30, 2006, the Company had approximately $2,204,000 in the form of cash
        and
        cash equivalents. During the year ended June 30, 2006, operating activities
        used
        cash of approximately $2,199,000. Net cash used by operating activities
        primarily reflects the $7,084,000 net loss, increased by a non-cash gain of
        $1,121,000 related to the change in fair value of derivatives, and reduced
        by
        non-cash charges of offset by $3,053,000 in depreciation and amortization,
        $2,493,000 of non-cash compensation expense, $1,294,000 loss on the
        extinguishment of Series D, and $859,000 in other non-cash charges to
        operations. In addition the Company invested $1,045,000 in inventory, accounts
        receivable and other current assets while paying down liabilities by $648,000.
        During the year ended June 30, **** 2006,
        investing activities used cash of approximately $652,000, which was primarily
        for equipment and other fixed assets. During the year ended June 30, 2006,
        financing activities provided approximately $3,506,000 in cash. Net cash
        provided by financing activities primarily includes net proceeds from the
        issuance of Series D Redeemable Convertible Preferred Stock of $4,727,000
        and
        $1,000,000 from a revolving credit facility with a bank. Net cash provided
        by
        financing was offset by payments on our debt of $2,061,000 which includes
        the
        payoff of a $1,650,000 short term note associated with the acquisition of
        Accurel.
 
 As
        of
        June 30, 2005, the Company had approximately $1,549,000 in the form of cash
        and
        cash equivalents. During the year ended June 30, 2006, operating activities
        used
        cash of approximately $3,329,000. Net cash used by operating activities
        primarily reflects the $7,405,000 net loss offset by $3,010,000 in depreciation
        and other non-cash expenses. In addition the Company invested $549,000 in
        inventory as it begins its production of the trace explosives detection product
        and paid down its liability to Med-Tec by $258,000. The Company realized
        cash of
        $433,000 by lowering its accounts receivables due to timely payments from
        government contracts and $59,000 from reduced prepaid expenses. Accounts
        payables and accruals increased $435,000 reflecting the increase in operating
        activities. Cash flows from deferred revenues increased by $714,000 primarily
        due to payments received by the Company, for products and services not
        recognized by the Company as revenues, until final acceptance by the customer.
        During the year ended June 30, **** 2005,
        investing activities used cash of approximately $8,217,000, which was primarily
        attributable to $8,829,000 used in the acquisition of Core and Accurel offset
        by
        $1,400,000 realized from the sale of acquired assets. During the year ended
        June
        30, 2005, financing activities provided approximately $6,189,000 in cash.
        Net
        cash provided by financing activities primarily includes net proceeds from
        a
        private placement of $7,289,000 and $1,037,000 from the exercise of options
        and
        warrants. Net cash provided by financing was offset by payments on our long
        term
        debt of $2,083,000 including $1,170,000 of debt paid off by the Company
        associated with the acquired assets that were sold
 
 On
        July
        6, 2005, the Company executed a $3.0 million secured term note payable to
        Laurus
        Master Fund, Ltd. (“Laurus”). The Company received $3,000,000 in gross proceeds,
        less a management fee of $135,000 and related transaction costs of approximately
        $32,000. The term note was collateralized by substantially all of the Company’s
        assets, had a 4-month term and bore interest at a rate equal to the prime
        rate
        plus once percent (1%). In connection with the financing, on September 30,
        2005,
        the Company issued Laurus a warrant to purchase up to 250,000 shares of the
        Company’s common stock at a price equal to $3.75 per share. The warrants were
        valued using the Black Scholes model and the following assumptions: volatility
        of 67%, expected life of 5 years and a risk free interest rate of 3.77%.
        Net
        proceeds from the financing were used for increasing the capacity of the
        Quantum
        SnifferTM production line, increasing unit inventories and the repayment of
        certain indebtedness due and owed by the Company to the former shareholders
        of
        Accurel in connection with the acquisition of this wholly-owned subsidiary.
 
 On
        September 30, 2005, the Company issued 500,000 shares of Series D Convertible
        Redeemable Preferred Stock (“Series D”) having a stated value of $10 per share,
        pursuant to a Securities Purchase Agreement with Laurus. The Company received
        $5,000,000 in gross proceeds, less a management and placement agent fee of
        approximately $90,000, and related transaction costs of approximately $27,000.
        The Company utilized the proceeds to repay the $3 million term note with
        Laurus
        signed on July 7, 2005. The Series D has a dividend equal to the prime rate
        plus
        one percent (1%) (9.25% at June 30, 2006) and provides for redemption over
        a
        thirty-six month period pursuant to an amortization schedule. The monthly
        redemption amount of approximately $152,000 may be paid in cash or common
        shares
        at the option of the Company, subject to certain restrictions, commencing
        on
        January 1, 2006, at a fixed conversion price of $6.80 per common share. The
        Company also issued to Laurus a warrant to purchase 50,000 shares of common
        stock at $10.20 per share. The warrants were valued using the Black Scholes
        model and the following assumptions: volatility of 80%, an expected life
        5
        years, and a risk free interest rate of 4.12%. The Securities Purchase Agreement
        with Laurus provides for a security interest in substantially all of the
        Company’s assets and provides Laurus a right of first refusal on future
        financing arrangements during the term of the agreement. In the event Laurus
        declines to exercise its right of first refusal, it agreed to enter into
        such
        documentation as shall be reasonable requested by the Company in order to
        subordinate its rights under the Series D to the subsequent financier. Net
        cash
        proceeds from this financing were $1,883,000 (which included repayments of
        $3,000,000 of principal related to the July 6, 2005 term note and $117,000
        of
        issuance costs).
 
 
 On
        May
        31, 2006, the Company amended the Series D and the Certificate of Vote of
        Directors Establishing a Class or Series of Stock. The terms of the amendment
        permit the Company to defer approximately $455,000 of cash payments,
        representing the January 2006, February 2006 and March 2006 amortization
        payments, and to defer the October 2006 amortization payment, should such
        payment be required in cash, to the mandatory redemption date of September
        30,
        2008. In consideration, the Company has agreed to the conversion of the April
        2006, May 2006, June 2006, July 2006, August 2006 and September 2006
        amortization payments into 261,233 shares of common stock of the Company
        at a
        conversion price of $3.48 per share, representing a reduction in principal
        of
        approximately $909,000, and to reduce the Fixed Conversion Price of the
        remaining Series D stock from $6.80 per share to $4.15 per share. In addition,
        Laurus was granted a warrant to purchase 150,000 shares of the Company’s common
        stock at an exercise price of $4.26 per share. The warrants were valued using
        the Black Scholes model and the following assumptions: volatility of 79%,
        an
        expected life 5 years, and a risk free interest rate of 4.89%. The amendment
        of
        the Series D, as described above, was accounted for as an extinguishment
        of debt
        in accordance with EITF 96-19 "Debtor's Accounting for a Modification or
        Exchange of Debt Instruments." The Company determined a substantial difference
        in the net present value of the cash flows under the terms of the amendment
        was
        more than 10 percent different from the present value of the remaining cash
        flows under the terms of the original Series D agreement. Due to the substantial
        difference, the Company determined an extinguishment of debt had occurred
        with
        the amendment, and as such, it was necessary to reflect the Series D at its
        fair
        market value. Accordingly, the following table shows the basis for the Series
        D
        extinguishment:
 Extinguishment
                    of Series D debt instrument at May 31, 2006:Redemption
                    payments
                    due
                
                $   909,000Unamortized
                    discount of warrants, derivative value of preferred stock conversion
                    and
                    issue costs
                
                266,000Derivatives
                    related to the preferred stock features
                
                578,000Subtotal
                
                $1,753,000Record
                    New Series D debt instrument at May 31, 2006:Fair
                    value of redemption payments made
                
                $1,011,000Issuance
                    of 150,000 warrants
                
                375,000Unamortized
                    discount of warrants, derivative value of preferred stock conversion
                    and
                    issue costs
                
                266,000Derivatives
                    related to the preferred stock features
                
                1,395,000Subtotal
                
                $3,047,000Loss
                    on extinguishment of Series D debt instrument
                
                $1,294,000
 
 The
        $1,294,000 aggregate loss from these transactions, accounted for as an
        extinguishment of debt, is included in Other expenses for the year ended
        June
        30, 2006.
  On
        September 7, 2006, the Company extended the expiration date of its revolving
        credit facility for $1,500,000 with Silicon Valley based Bridge Bank, N.A.
        The
        revolving credit facility expiring December 31, 2007, provides for advances
        of
        up to eighty percent (80%) of the Company’s eligible accounts receivable, bears
        interest at the prime rate plus one-half percent (1/2%), and is collateralized
        by certain assets of the Company. The credit facility is also subject to
        various
        financial covenants. As of June 30, 2006, $1,000,000 has been drawn on this
        credit facility and the Company is in compliance with the covenants.
 
 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 Laser IMS technology, which includes
        the use of laser beams in combination with ion mobility spectrometry, to
        electronically detect minute quantities of explosive vapor molecules in the
        air.
 
 This
        project is currently being undertaken by both our internal scientists and
        outside contractors. The development of new applications is typically funded
        through government grants or internal funding. Since March 2000, we have
        received seventeen contracts totaling over $12 million for detection of toxic
        chemicals or explosives from agencies such as the Departments of the Army,
        Air
        Force, Marine Corps, Navy and the Department of Homeland Security.
 
 In
        June
        2000, we developed our first generation device, which demonstrated sensitivity
        to the explosive TNT. In June 2001, we developed a second generation prototype
        with increased sensitivity and selectivity. This device can detect and specify
        an increasing number of compounds within various explosive materials. The
        explosives that have been tested to date are TNT, RDX, PETN, EGDN, and DNT.
        RDX
        is the primary component of C3 and C4 explosives, such as Datasheet and Semtex,
        as well as certain types of black powder explosives. We believe these explosives
        represent the majority of the explosives presently used in terrorist activities.
 
 We
        are
        now manufacturing several versions of our explosives detection systems,
        including: (i) a table-top unit, which can be used to screen passengers and
        carry-on baggage in airports and (ii) a portable system, which can be used
        to
        clear buildings, aircrafts, or ships where hidden bombs are believed to exist.
        We are also developing, in conjunction with a contract from the Transportation
        Security Administration, a walk-through passenger portal. We are currently
        selling our portable and bench-top version of these products both domestically
        and internationally. We plan to market these systems to U.S. government agencies
        for use in airports, government buildings and facilities.
 
 We
        are
        currently expending significant resources to develop the next generation
        of our
        current product and to develop new products. Although we continue to fund
        as
        much research and development as possible through government grants and
        contracts in accordance with the provisions of the respective grant awards
        we
        will require additional funding in order to continue the advancement of the
        commercial development and manufacturing of the explosives detection system.
        We
        will attempt to obtain such financing by: (i) government grants, (ii) private
        financing, or (iii) strategic partnerships. However, there can be no assurance
        that we will be successful in our attempts to raise such additional
        financing.
 
 
 Consistent
        with our policy to protect our proprietary technologies, we have been awarded
        five patents and have submitted an additional four patent applications to
        the
        United States Patent and Trademark Office. These patents and applications
        will
        cover specific design configurations that are responsible for our improved
        vapor
        detection sensitivity.
 
 We
        will
        require substantial funds for further research and development, regulatory
        approvals and the marketing of our explosives detection products. Our capital
        requirements depend on numerous factors, including but not limited to, the
        progress of our research and development programs; the cost of filing,
        prosecuting, defending and enforcing any intellectual property rights; competing
        technological and market developments; changes in our development of
        commercialization activities and arrangements; and the hiring of additional
        personnel and capital equipment.
 
 As
        of
        June 30, 2006, we were conducting our operations with approximately $2,204,000
        in cash and cash equivalents. We estimate that our cash flow from operations
        and
        funds available on our revolving line of credit to be sufficient to fund
        our
        working capital in the next twelve months. Future expenditures for research
        and
        product development, especially relating to outside testing, are discretionary
        and, accordingly, can be adjusted, as can certain selling, general and
        administrative expenses, based on the availability of cash.
  Based
        on
        the current sales, expense and cash flow projections, the Company believes
        that
        the current level of cash and cash-equivalents on hand, the net proceeds
        from
        its revolving line of credit and a $3.6M contract received from the U.S.
        Army in
        August 2006, will be sufficient to fund operations until the Company achieves
        positive cash flow. However, because there can be no assurances that sales
        will
        materialize as forecasted, management will continue to closely monitor and
        attempt to control costs at the Company and will continue to actively seek
        the
        needed capital through government grants and awards, strategic alliances,
        private financing sources, and through its lending institutions. The financial
        statements do not include any adjustments relating to the recoverability
        and
        classification of asset amounts or the amounts and classification of liabilities
        that might be necessary should the Company be unable to continue as a going
        concern.
  The
        Company’s future minimum payments under contractual obligations related to
        capital leases, operating leases and term notes as of June 30, 2006 are as
        follows:
  **Debt
                  and Capital Lease**
              
              **Operating
                  Lease**
              
              **MED-TEC
                  (2)**
              
              **Total**Year
                  ending June 30:2007
              
              $
                  455,000
              
              $
                  1,678,000
              
              $
                  275,000
              
              $2,408,0002008
              
              443,000
              
              1,709,000
              
              -
              
              2,152,0002009
              
              194,000
              
              1,454,000
              
              -
              
              1,648,0002010
              
              66,000
              
              838,000
              
              -
              
              904,0002011
              
              44,000
              
              150,000
              
              -
              
              194,000Total
              
              $
                  1,202,000
              
              $
                  5,829,000
              
              $
                  275,000
              
              $7,306,000
  (2)
        Relates to MED-TEC payment obligation and includes $42,000 accrued interest.
 (See
        Note
        15 of the consolidated financial statements)
  *Critical
        Accounting Policies*
 
 Our
        significant accounting policies are described in Note 2 to the consolidated
        financial statements included in Item 8 of our Form 10-K as of June 30, 2006.
        Our discussion and analysis of our financial condition and results of operations
        are based upon the consolidated financial statements, which have been prepared
        in accordance with accounting principles generally accepted in the United
        States
        of America. The preparation of these consolidated 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, embedded derivatives 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. However, results may differ
        from these estimates under different assumptions or conditions.
 
 The
        Company has identified the following as critical accounting policies, based
        on
        the significant judgments and estimates used in determining the amounts reported
        in its financial statements:
 *·*
              *Revenue
                  Recognition - Product and Government Contract Revenues*
  The
        Company recognizes revenue when there is persuasive evidence of an arrangement
        with the customer which states a fixed or determinable price and terms, delivery
        of the product has occurred or the service performed in accordance with the
        terms of the arrangement, and collectibility of the sale is reasonably assured.
 
 Government
        contract revenue under cost-sharing research and development agreements is
        recognized as eligible research and development expenses are incurred. The
        Company’s obligation with respect to these agreements is to perform the research
        on a best-efforts basis. For government contracts with a deliverable, revenue
        is
        recognized based upon the proportional performance method,
 
 Revenues
        for which the Company has received payment, but has not yet recognized the
        revenues, pending fulfilling its obligations under the sales agreement, are
        reflected on the balance sheet as deferred revenues.
 
 
 Treatment
        systems planning revenues consists of sales of software licenses and maintenance
        agreements, product related training, installation, and consulting, and the
        associated hardware. Revenue from sales of software licenses and maintenance
        agreements is recognized ratably over the maintenance contract period, which
        is
        generally one year, pursuant to the guidance provided by Statement of Position
        (“SOP”) 97-2, “ *Software
        Revenue Recognition* ”
(SOP
        97-2), issued by the American Institute of Certified Public Accountants (AICPA).
        Revenue from training, installation, consulting services and the associated
        hardware are recognized as the services are performed or product is delivered,
        provided there is vendor specific objective evidence (VSOE) of fair value
        which
        is the price charged when the services are sold separately. Revenues related
        to
        such sales generated during the year ended June 30, 2006 were $121,000. Revenues
        related to such sales in 2005 were immaterial and there were no such revenues
        generated during the year ended June 30, 2004.
  *·*
            *Accounts
                Receivable and Allowance for Doubtful
                Accounts*  The
        Company maintains allowances for estimated losses resulting from the inability
        of its customers to make required payments. Judgments are used in determining
        the allowance for doubtful accounts and are based on a combination of factors.
        Such factors include historical collection experience, credit policy and
        specific customer collection issues. In circumstances where the Company is
        aware
        of a specific customer’s inability to meet its financial obligations to us
        (e.g., bankruptcy filings), we record a specific reserve for bad debts against
        amounts due to reduce the net recognized receivable to the amount we reasonably
        believe will be collected. We perform ongoing credit evaluations of our
        customers and continuously monitor collections and payments from our customers.
        While actual bad debts have historically been within our expectations and
        the
        provisions established, we cannot guarantee that we will continue to experience
        the same bad debt rates that we have in the past. A significant change in
        the
        liquidity or financial position of any of our customers could result in the
        uncollectibility of the related accounts receivable and could adversely impact
        our operating cash flows in that period.
  *·*
            *Sales
                Returns and Allowances*  The
        Company records reductions to revenue for estimated customer returns and
        allowances. We record estimated allowances against revenues in the same period
        the revenue is recorded. These estimates are based upon historical analysis
        of
        our credit memo data and other known factors for pricing and disputes that
        arise
        in the normal course of business. To date, allowances have not been material.
        Actual returns may differ significantly from our estimates if factors such
        as
        economic conditions or competitive conditions differ from our
        expectations.
  *·*
            *Inventories*  We
        value
        our inventories at lower of cost or market. Cost is determined by the first-in,
        first-out (FIFO) method, including material, labor and factory overhead.
        In
        assessing the ultimate realization of inventories, management judgment is
        required to determine the reserve for obsolete or excess inventory. Inventory
        on
        hand may exceed future demand either because the product is obsolete, or
        because
        the amount on hand is more than can be used to meet future need. We provide
        for
        the total value of inventories that we determine to be obsolete or excess
        based
        on criteria such as customer demand and changing technologies.
  *·*
            *Warranties*  We
        provide for the estimated cost of product warranties at the time revenue
        is
        recognized. We record an estimate for warranty related costs at the time
        of sale
        based on our actual historical return rates and repair costs. While our warranty
        costs have historically been within our expectations and the provisions
        established, we cannot guarantee that we will continue to experience the
        same
        warranty return rates or repair costs that we have in the past. A significant
        increase in warranty return rates or costs to repair our products could have
        a
        material adverse impact on our operating results for the period or periods
        in
        which such returns or additional costs materialize.
  *·*
            *Valuation
                of Certain Marketable Equity
                Securities*  The
        Company currently classifies its investment securities as available-for-sale
        securities. Pursuant to SFAS No. 115, “Accounting for Certain Investments in
        Debt and Equity Securities,” such securities are measured at fair market value
        in the financial statements with unrealized gains or losses recorded in
        accumulated other comprehensive income until the securities are sold or
        otherwise disposed of. However, in accordance with SFAS No. 115, a decline
        in
        fair market value below cost that is other than temporary is accounted for
        as a
        realized loss. To date, we have not experienced any realized losses .
  *·*
                    *Income
                        Taxes*
  The
              income tax accounting process involves estimating our current tax expense
              together with assessing temporary differences resulting from differing
              treatment
              of items for tax and accounting purposes. These differences result
              in the
              recognition of deferred tax assets and liabilities. We must then record
              a
              valuation allowance to reduce our net deferred tax assets to the amount
              that is
              more likely than not to be realized.
  Significant
        management judgment is required in determining our provision for income taxes,
        our deferred tax assets and liabilities and any valuation allowance recorded
        against deferred tax assets. We have recorded a full valuation allowance
        against
        our net deferred tax assets of $8,295,000 as of June 30, 2006, due to
        uncertainties related to our ability to utilize these assets. The valuation
        allowance is based on our estimates of taxable income and the period over
        which
        our deferred tax assets will be recoverable. In the event that actual results
        differ from these estimates or we adjust these estimates in future periods
        we
        may need to adjust our valuation allowance which could materially impact
        our
        financial position and results of operations.
 
 *·*
            *Goodwill
                and Intangible Assets*  SFAS
        No.
        142, “Goodwill and Other Intangible Assets,” requires that goodwill and
        intangible assets with indefinite lives no longer be amortized but instead
        be
        measured for impairment at least annually or whenever events indicate that
        there
        may be an impairment. In order to determine if an impairment exists, management
        compares the reporting unit's carrying value to the reporting unit's fair
        value.
        Determining the reporting unit's fair value requires management to make
        estimates based on market conditions and operational performance. Absent
        an
        event that indicates a specific impairment may exist, management has selected
        August 31st as the date of performing the annual goodwill impairment test.
        Future events could cause management to conclude that impairment indicators
        exist and that goodwill associated with the Company’s acquired businesses is
        impaired. Any resulting impairment loss could have a material adverse impact
        on
        the Company’s financial condition and results of operations.
  Intangible
        assets with finite lives consist of acquired customer base, technology and
        trademarks and are valued according to the future cash flows they are estimated
        to produce. These assigned values are amortized on a basis which matches
        the
        periods in which those cash flows are estimated to be produced, or straight
        line
        over the estimated useful lives, if no other method provides a better result.
        The Company continually evaluates whether events or circumstances have occurred
        that indicate that the estimated remaining useful life of our intangible
        assets
        may warrant revision or that the carrying value of these assets may be impaired.
        To compute whether intangible assets with finite lives been impaired, the
        estimated undiscounted future cash flows for the estimated remaining useful
        life
        of the assets are compared to the carrying value. To the extent that the
        future
        cash flows are less than the carrying value, the assets are written down
        to the
        estimated fair value of the asset.
 
 *·*
            *Equity
                Transactions*  The
        Company evaluates the proper classification of its equity transactions under
        SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristic
        of Both Liabilities and Equity.” SFAS No. 150 requires that for instruments that
        embody an unconditional obligation requiring the issuer to redeem it by
        transferring assets at a determinable date or that contain certain conditional
        obligations, typically classified as equity, be classified as a liability.
 
 In
        many
        of our financing transactions, warrants have been issued. Additionally, we
        issue
        options and warrants to non-employees from time to time as payment for services.
        In all of these cases, we apply the principles of SFAS No. 123-R “Accounting for
        Stock-based Compensation” to value these awards, which inherently include a
        number of estimates and assumptions including stock price volatility factors.
        The Company records financing and certain offering costs associated with
        its
        capital raising efforts in its statements of operations. These include
        amortization of debt issue costs such as cash, warrants and other securities
        issued to finders and placement agents, and amortization of preferred stock
        discount created by in-the-money conversion features on convertible debt
        accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue 98-5,
“Accounting for Convertible Securities with Beneficial Conversion Features
        or
        Contingently Adjustable Conversion Ratios,” and Issue 00-27, “Application of
        Issue 98-5 to Certain Convertible Instruments,” by other securities issued in
        connection with preferred stock as a result of allocating the proceeds amongst
        the securities in accordance with Accounting Principles Board (“APB”) Opinion
        No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase
        Warrants,” based on their relative fair values. We based our estimates and
        assumptions on the best information available at the time of valuation, however,
        changes in these estimates and assumptions could have a material effect on
        the
        valuation of the underlying instruments.
 
 The
        Company determined its Series D Redeemable Convertible Preferred Stock contained
        certain derivative instruments and accounts for such instruments under SFAS
        No.
        133, “Accounting for Derivative Instruments and Hedging Activities.” Under SFAS
        No. 133, the Company bifurcated these derivative instruments from the Series
        D
        Redeemable Convertible Preferred Stock, recorded them as a liability, and
        includes the changes in the fair value of the instruments within other income
        (expense) in the accompanying consolidated statement of operations.
  
 *Recent
        Accounting Pronouncements*
  In
        May
        2005, t he
        Financial Accounting Standards Board (“FASB”) issued FAS 154, Accounting Changes
        and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No.
        3. This Statement shall be effective for accounting changes and corrections
        of
        errors made in fiscal years beginning after December 15, 2005. Early adoption
        is
        permitted for accounting changes and corrections of errors made in fiscal
        years
        beginning after the date this Statement is issued. This Statement does not
        change the transition provisions of any existing accounting pronouncements,
        including those that are in a transition phase as of the effective date of
        this
        Statement. The adoption of this statement is not expected to have a material
        impact on the Company’s financial position or results of
        operations.
  In
        February 2006, the FASB issued FAS 155, Accounting for Certain Hybrid Financial
        Instruments—an amendment of FASB Statements No. 133 and 140. This Statement
        shall be effective for all financial instruments acquired, issued, or subject
        to
        a remeasurement (new basis) event occurring after the beginning of an entity’s
        first fiscal year that begins after September 15, 2006. The fair value election
        provided for in paragraph 4(c) of this Statement may also be applied upon
        adoption of this Statement for hybrid financial instruments that had been
        bifurcated under paragraph 12 of Statement 133 prior to the adoption of this
        Statement. Earlier adoption is permitted as of the beginning of an entity’s
        fiscal year, provided the entity has not yet issued financial statements,
        including financial statements for any interim period, for that fiscal year.
        The
        adoption of this statement is not expected to have a material impact on the
        Company’s financial position or results of operations.
  In
        June
        2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes—an
        interpretation of FASB Statement No. 109, is effective for fiscal years
        beginning after December 15, 2006. Earlier application is encouraged if the
        enterprise has not yet issued financial statements, including interim financial
        statements, in the period the Interpretation is adopted. This interpretation
        of
        FAS 109 is not expected to have a material impact on the Company’s financial
        position or results of operations.
  In
        September 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on
        Issue No. 05−07, *Accounting
        for Modifications to Conversion Options Embedded in Debt Instruments and
        Related
        Issues* (“EITF
        05−07”). EITF 05−07 requires that a change in the fair value of a conversion
        option brought about by ** modifying
        the debt agreement be included in analyzing in accordance with EITF consensus
        on
        Issue No. 96−19, *Debtor’s
        Accounting for a Modification or Exchange of Debt Instruments* (“EITF
        96−19”), whether a debt instrument is considered extinguished. Under EITF
        96−19’s requirements, an issuer who modifies ** a
        debt
        instrument must compare the present value of the original debt instrument’s cash
        flows to the present value of the cash flows of the modified debt. If
        the ** present
        value of those cash flows varies by more than 10 percent, the modification
        is
        considered significant and extinguishments accounting is applied to
        the ** original
        debt. If the change in the present value of the cash flows is less than 10
        percent, the debt is considered to be modified and is subject to EITF
        96−19’s ** modification
        accounting. EITF 05−07 requires that in applying the 10 percent test the change
        in the fair value of the conversion option be treated in the same ** manner
        as
        a current period cash flow. EITF 05−07 also requires that, if a modification
        does not result in an extinguishment, the change in fair value of
        the ** conversion
        option be accounted for as an adjustment to interest expense over the remaining
        term of the debt. The issuer should not recognize a beneficial ** conversion
        feature or reassess an existing beneficial conversion feature upon modification
        of the conversion option of a debt instrument that does not result in
        an ** extinguishment.
        EITF 05−07 is effective for modifications of debt instruments beginning in the
        first interim or annual reporting period beginning after December ** 15,
        2005.
        The adoption of EITF 05−07 did not have a material impact on the
        Company’s consolidated financial position, results of ** operations
        or cash flows.
  In
        September 2005, the EITF reached a consensus on Issue No. 05−08, *Income
        Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion
        Feature* (“EITF
        05−08”). Under EITF 05−08, the issuance of convertible debt with a beneficial
        conversion feature results in a temporary difference for purposes of applying
        FAS No. 109, *Accounting
        for Income Taxes* .
        The
        deferred taxes recognized for the temporary difference should be recorded
        as an
        adjustment to paid−in capital. EITF 98−05, *Accounting
        for Convertible Securities with Beneficial Conversion Features or Contingently
        Adjustable Conversion Ratios* ,
        and
        EITF 00−27, *Application
        of Issue No. 98−05 to Certain Convertible Instruments* ,
        require
        that the nondetachable conversion feature of a convertible debt security
        be
        accounted for separately if it is a beneficial conversion feature. A beneficial
        conversion feature is recognized and measured by allocating to additional
        paid−in capital a portion of the proceeds equal to the conversion feature’s
        intrinsic value. A discount on the convertible debt is recognized for the
        amount
        that is allocated to additional paid−in capital. The debt discount is accreted
        from the date of issuance to the stated redemption date of the convertible
        instrument or through the earliest conversion date if the instrument does
        not
        have a stated redemption date. The U.S. Federal Income Tax Code includes
        the
        entire amount of proceeds received at issuance as the tax basis of the
        convertible debt security. EITF 05−08 should be applied retrospectively to all
        instruments with a beneficial conversion feature accounted for under EITF
        98−05
        and EITF 00−27 for periods beginning after December 15, 2005. The Company does
        not expect the adoption of EITF 05−08 to have material impact on the Company’s
        consolidated financial position, results of operations or cash
        flows.
 
 In
        November 2005, the FASB issued FSP FAS 115−1 and FAS 124−1, *The
        Meaning of Other−Than−Temporary Impairment and Its Application to Certain
        Investments* (“FSP
        FAS
        115−1 and FAS 124−1”). This FSP nullifies certain requirements of EITF Issue No.
        03−01 and supersedes EITF Abstracts, Topic No. ** D−44, *Recognition
        of Other−Than−Temporary Impairment upon the Planned Sale of a Security Whose
        Cost Exceeds Fair Value.* Based
        on
        the clarification ** provided
        in FSP FAS 115−1 and FAS 124−1, the amount of any other−than−temporary
        impairment that needs to be recognized will continue to be dependent
        on ** market
        conditions, the occurrence of certain events or changes in circumstances
        relative to an investee and an entity’s intent and ability to hold the
        impaired ** investment
        at the time of the valuation. FSP FAS 115−1 and FAS 124−1 are effective for
        reporting periods beginning after December 15, 2005. The Company does not
        expect
        the impact of adopting the guidance in FSP FAS 115−1 and FAS 124−1 to have a
        material impact on the Company’s consolidated financial position, results of
        operations and ** cash
        flows.
 
 In
        September 2006, the FASB issued FAS No. 157, *Fair
        Value Measurement* (“FAS
        157”). FAS 157 defines fair value, establishes a framework for measuring fair
        value and expands disclosures about fair value measurements. FAS 157 is
        effective for financial statements issued for fiscal years beginning after
        November 15, 2007 and interim periods within those fiscal years. The Company
        is
        evaluating the impact of adopting FAS 157 on the Company’s consolidated
        financial position, results of operations and cash flows.
  **ITEM
        7A.**  **QUANTITATIVE
        AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**
  
 The
        Company’s financial instruments include cash and cash equivalents. Cash and cash
        equivalents include cash on hand, demand deposits and short-term investments
        with maturities of three months or less when acquired. Cash equivalents
        represent a deposit in a money market account and a certificate of deposit.
        The
        Company does not utilize derivative financial instruments, derivative commodity
        instruments or other market risk sensitive instruments, positions or
        transactions in any material fashion. The principal objective of the Company’s
        asset management activities is to maximize net investment income, while
        maintaining acceptable levels of interest rate risk and facilitating its
        funding
        needs. At June 30, 2006, the carrying values of the Company’s financial
        instruments approximated fair values based upon current market prices and
        rates.
  
 **ITEM
        8.**  **CONSOLIDATED
        FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**
 
 Our
        consolidated financial statements and related report of independent registered
        public accounting firm are appended to the end of this Form 10-K for the
        fiscal
        year ended June 30, 2006 and contain the following:
 
 
 Reports
                  of Independent Registered Public Accounting FirmsConsolidated
                  Balance Sheets as of June 30, 2006 and 2005Consolidated
                  Statements of Operations for the years ended June 30, 2006, 2005
                  and
                  2004Consolidated
                  Statements of Changes in Stockholders’ Equity and Comprehensive Income
                  (Loss) for the years ended June 30, 2006, 2005 and 2004Consolidated
                  Statements of Cash Flows for the years ended June 30, 2006, 2005
                  and
                  2004Notes
                  to Consolidated Financial Statements
 
 
  
   
   
  
     
  Report
        of
        Independent Registered Public Accounting Firm
 
 To
        the
        Board of Directors and Stockholders of
 Implant
        Sciences Corporation:
 
 
 We
        have
        audited the accompanying consolidated balance sheet of Implant Sciences
        Corporation and subsidiaries (the “Company”) as of June 30, 2006 and the related
        consolidated statements of operations, stockholders’ equity and
        comprehensive loss and cash flows for the year then ended. These financial
        statements are the responsibility of the Company’s management. Our
        responsibility is to express an opinion on these financial statements based
        on
        our audit.
 
 We
        conducted our audit in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. The Company is not required
        to
        have, nor were we engaged to perform, an audit of its internal controls over
        financial reporting. Our audit included consideration of internal control
        over
        financial reporting as a basis for designing audit procedures that are
        appropriate in the circumstances, but not for the purpose of expressing an
        opinion on the effectiveness of the Company’s internal control over financial
        reporting. Accordingly, we express no such opinion. An audit also includes
        examining, on a test basis, evidence supporting the amounts and disclosures
        in
        the financial statements, assessing the accounting principles used and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audit provides a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the consolidated financial statements referred to above present
        fairly,
        in all material respects, the financial position of Implant Sciences Corporation
        and subsidiaries at June 30, 2006, and the results of their operations and
        their
        cash flows for the year then ended, in conformity with accounting principles
        generally accepted in the United States of America.
  The
        accompanying consolidated financial statements have been prepared assuming
        that
        the Company will continue as a going concern. As discussed in Note 1 to the
        consolidated financial statements, the Company has suffered recurring losses
        from operations which raises substantial doubt about its ability to
        continue as a going concern. Management's plans in regard to these matters
        are
        also described in Note 1. The consolidated financial statements do not include
        any adjustments that might result from the outcome of this
        uncertainty.
 
 /s/
        UHY
        LLP
 
 
 Boston,
        Massachusetts
 September
        20, 2006
 
 
 
 
  
  
 Report
        of
        Independent Registered Public Accounting Firm
 
 To
        the
        Board of Directors and Stockholders of
 Implant
        Sciences Corporation:
 
 
 We
        have
        audited the accompanying consolidated balance sheet of Implant Sciences
        Corporation and subsidiaries (the “Company”) as of June 30, 2005 and the related
        consolidated statements of operations, stockholders’ equity and comprehensive
        income (loss) and cash flows for each of the two years in the period ended
        June
        30, 2005. These financial statements are the responsibility of the Company’s
        management. Our responsibility is to express an opinion on these financial
        statements based on our audits.
 
 We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. The Company is not required
        to
        have, nor were we engaged to perform, an audit of its internal controls over
        financial reporting. Our audits included consideration of internal control
        over
        financial reporting as a basis for designing audit procedures that are
        appropriate in the circumstances, but not for the purpose of expressing an
        opinion on the effectiveness of the Company’s internal control over financial
        reporting. Accordingly, we express no such opinion. An audit also includes
        examining, on a test basis, evidence supporting the amounts and disclosures
        in
        the financial statements, assessing the accounting principles used and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audits provide a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the consolidated financial statements referred to above present
        fairly,
        in all material respects, the financial position of Implant Sciences Corporation
        and subsidiaries at June 30, 2005, and the results of their operations and
        their
        cash flows for each of the two years in the period ended June 30, 2005, in
        conformity with accounting principles generally accepted in the United States
        of
        America.
  The
        accompanying consolidated financial statements have been prepared assuming
        that
        the Company will continue as a going concern. As discussed in Note 1 to the
        consolidated financial statements, the Company has suffered recurring losses
        from operations and has working capital and stockholder deficits as of June
        30,
        2005. These matters raise substantial doubt about its ability to continue
        as a
        going concern. Management's plans in regard to these matters are also described
        in Note 1. The consolidated financial statements do not include any adjustments
        that might result from the outcome of this uncertainty.
 
 /s/
        BDO
        Seidman, LLP
 
 
 Boston,
        Massachusetts
 October
        10, 2005
 
 
 
 
 
 
 
 
 
 
 
 
  
  **IMPLANT
                  SCIENCES CORPORATION****CONSOLIDATED
                  BALANCE SHEETS****June
                  30,****ASSETS**
              **2006**
              
              **2005**Current
                  assets:Cash
                  and cash equivalents
              $
                  2,204,000
              
              $
                  1,549,000Accounts
                  receivable, less allowance of $121,000 and $147,000,
                  respectively
              3,695,000
              
              3,003,000Accounts
                  receivable, unbilled
              43,000
              
              298,000Inventories
              1,532,000
              
              1,204,000Investments
                  - available for sale securities
              222,000
              
              204,000Prepaid
                  expenses and other current assets
              505,000
              
              224,000Total
                  current assets
              8,201,000
              
              6,482,000Property
                  and equipment, net
              8,909,000
              
              10,434,000Amortizable
                  intangible assets, net
              1,620,000
              
              2,340,000Investment
                  in unconsolidated subsidiary
              174,000
              
              531,000Other
                  non-current assets
              229,000
              
              228,000Goodwill
              11,666,000
              
              12,213,000Total
                  assets
              $
                  30,799,000
              
              $
                  32,228,000**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  liabilities:Current
                  maturities of long-term debt and obligations under capital
                  lease
              $
                  420,000
              
              $
                  2,052,000Line
                  of credit
              1,000,000
              
              -Payable
                  to Med-Tec
              233,000
              
              348,000Accrued
                  expenses
              1,985,000
              
              2,445,000Accounts
                  payable
              1,699,000
              
              1,526,000Current
                  portion of long- term lease liability
              126,000
              
              102,000Deferred
                  revenue
              479,000
              
              773,000Total
                  current liabilities
              5,942,000
              
              7,246,000Long-term
                  liabilities:Long-term
                  debt and obligations under capital lease, net of current maturities
              692,000
              
              897,000Long-term
                  lease liability
              575,000
              
              701,000Derivatives
                  related to preferred stock features
              1,094,000
              
              -Total
                  liabilities
              8,303,000
              
              8,844,000Commitments
                  and contingencies (Note 10)Series
                  D Cumulative Redeemable Convertible Preferred Stock; $10 stated
                  value;
                  500,000 shares authorized 409,091 outstanding as of June 30, 2006
              2,568,000
              
              -Stockholders'
                  equityCommon
                  stock, $0.10 par value; 50,000,000 and 20,000,000 shares authorized
                  at
                  June 30, 2006 and 2005, respectively; 11,733,804 and 10,756,842
                  shares
                  issued and outstanding, at June 30, 2006 and 2005,
                  respectively
              1,173,000
              
              1,075,000Additional
                  paid-in capital
              55,284,000
              
              50,995,000Accumulated
                  deficit
              (36,290,000)
              
              (28,115,000)Deferred
                  compensation
              (17,000)
              
              (349,000)Accumulated
                  other comprehensive income (loss)
              14,000
              
              (5,000)Treasury
                  stock, 26,994 and 22,449 common shares, respectively, at cost
              (236,000)
              
              (217,000)Total
                  stockholders' equity
              19,928,000
              
              23,384,000Total
                  liabilities and stockholders' equity
              $
                  30,799,000
              
              $
                  32,228,000
    The
        accompanying notes are an integral part of these consolidated financial
        statements.
 
 
 **IMPLANT
                    SCIENCES CORPORATION****CONSOLIDATED
                    STATEMENTS OF OPERATIONS****Years
                    Ended June 30,****2006**
                
                **2005**
                
                **2004**Revenues:Medical
                $
                    4,464,000
                
                $
                    4,146,000
                
                $
                    4,957,000Semiconductor
                15,056,000
                
                6,630,000
                
                1,022,000Security
                    products
                6,871,000
                
                1,510,000
                
                2,587,000Total
                    revenues
                26,391,000
                
                12,286,000
                
                8,566,000Cost
                    of revenues:Cost
                    of medical revenues
                3,869,000
                
                3,821,000
                
                3,822,000Cost
                    of semiconductor revenues
                11,953,000
                
                6,316,000
                
                1,280,000Cost
                    of security product revenues
                6,222,000
                
                1,919,000
                
                1,084,000Total
                    cost of revenues
                22,044,000
                
                12,056,000
                
                6,186,000Gross
                    margin
                4,347,000
                
                230,000
                
                2,380,000Operating
                    expenses:Research
                    and development
                1,313,000
                
                1,942,000
                
                1,631,000Selling,
                    general and administrative
                8,933,000
                
                5,524,000
                
                4,599,000Impairment
                    of goodwill
                457,000
                
                -
                
                -Total
                    operating expenses
                10,703,000
                
                7,466,000
                
                6,230,000Loss
                    from operations
                (6,356,000)
                
                (7,236,000)
                
                (3,850,000)Other
                    income (expenses):Interest
                    income
                50,000
                
                48,000
                
                23,000Interest
                    expense
                (246,000)
                
                (142,000)
                
                (135,000)Loss
                    on extinguishment of debt instrument
                (1,294,000)
                
                -
                
                -Change
                    in fair value of embedded derivatives related to preferred stock
                    features
                1,121,000
                
                -
                
                -Equity
                    losses in unconsolidated subsidiaries
                (359,000)
                
                (75,000)
                
                (50,000)Total
                    other expense, net
                (728,000)
                
                (169,000)
                
                (162,000)Net
                    loss
                (7,084,000)
                
                (7,405,000)
                
                (4,012,000)Preferred
                    distribution, dividends and accretion
                (1,089,000)
                
                (1,183,000)
                
                (2,527,000)Net
                    loss applicable to common shareholders
                $
                    (8,173,000)
                
                $
                    (8,588,000)
                
                $
                    (6,539,000)Net
                    per share applicable to common shareholders, basic and
                    diluted
                $
                    (0.72)
                
                $
                    (0.91)
                
                $
                    (0.89)Weighted
                    average common shares outstanding used in computing basic and
                    diluted loss
                    per share
                11,325,842
                
                9,412,548
                
                7,317,677
  
 The accompanying notes are an integral
        part of
        these consolidated financial statements.
  
 
   **IMPLANT
              SCIENCES CORPORATION**
 **CONSOLIDATED
              STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE
              LOSS**
 **FOR
              EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 2006**
 
 Common
                        Stock
                    
                    
                    
                    
                    Treasury
                        StockNumber
                        of
                      shares
                    $.10
                        par value
                    Additional
                      Paid-in
                      Capital
                    Accumulated
                        Deficit
                    Deferred
                        Compensation
                    Accumulated
                        Other Comprehensive Income
                    Shares
                    Cost
                    Notes
                        Receivable from Employees
                    Total
                      Stockholders'
                      Equity
                    Comprehensive
                        LossBalance
                        at June 30, 2003
                    6,650,156
                    $665,000
                    $16,064,000
                    $(12,988,000)
                    $
                        (7,000)
                    $
                        117,000
                    -
                    $
                        -
                    $
                        (223,000)
                    $
                        3,628,000
                    -Issuance
                        of common stock pursuant to exercise of stock options
                    138,635
                    14,000
                    516,000
                    -
                    -
                    -
                    -
                    -
                    -
                    530,000
                    -Issuance
                        of common stock pursuant to exercise of warrants
                    186,120
                    19,000
                    1,083,000
                    -
                    -
                    -
                    -
                    -
                    -
                    1,102,000
                    -Issuance
                        of common stock pursuant to employee stock purchase plan
                    7,135
                    1,000
                    28,000
                    -
                    -
                    -
                    -
                    -
                    -
                    29,000
                    -Issuance
                        of common stock pursuant to private financing agreement,
                        net of issuance
                        costs of $310,000
                    468,604
                    47,000
                    4,642,000
                    -
                    -
                    -
                    -
                    -
                    -
                    4,689,000
                    -Conversion
                        of 7% Series A Cumulative Convertible Preferred Stock and
                        related accrued
                        dividends into common stock
                    301,143
                    30,000
                    1,501,000
                    (32,000)
                    -
                    -
                    -
                    -
                    -
                    1,499,000
                    -Conversion
                        of 5% Series B Cumulative Convertible Preferred Stock and
                        related accrued
                        dividends into common stock
                    371,336
                    37,000
                    2,057,000
                    (63,000)
                    -
                    -
                    -
                    -
                    -
                    2,031,000
                    -Issuance
                        of common stock to consultants in exchange for services
                    11,205
                    1,000
                    109,000
                    -
                    -
                    -
                    -
                    -
                    -
                    110,000
                    -Accretion
                        and dividends on 7% Series A Cumulative Convertible Preferred
                        Stock
                    -
                    -
                    -
                    (532,000)
                    -
                    -
                    -
                    -
                    -
                    (532,000)
                    -Accretion
                        of the beneficial conversion feature and common stock warrants
                        in
                        connection with the 5% Series B Cumulative Convertible Preferred
                        Stock
                    -
                    -
                    1,009,000
                    (1,224,000)
                    -
                    -
                    -
                    -
                    -
                    (215,000)
                    -Accretion
                        of the beneficial conversion feature and common stock warrants
                        in
                        connection with the 5% Series C Cumulative Convertible Preferred
                        Stock
                    -
                    -
                    1,005,000
                    (638,000)
                    -
                    -
                    -
                    -
                    -
                    367,000
                    -Conversion
                        of 5% Series C Cumulative Convertible Preferred Stock and
                        related accrued
                        dividends into common stock
                    175,000
                    17,000
                    1,164,000
                    -
                    -
                    -
                    -
                    -
                    -
                    1,181,000
                    -Repayment
                        of notes receivable from employees
                    -
                    -
                    -
                    -
                    -
                    -
                    -
                    -
                    223,000
                    223,000
                    -Investment
                        in unconsolidated subsidiaries
                    10,344
                    1,000
                    112,000
                    -
                    -
                    (6,000)
                    3,103
                    (34,000)
                    -
                    73,000
                    (6,000)Fair
                        value associated with warrants and nonqualified stock options
                        issued to
                        nonemployees
                    -
                    -
                    992,000
                    -
                    2,000
                    -
                    -
                    -
                    -
                    994,000
                    -Stock-based
                        compensation associated with warrants and nonqualified stock
                        options
                        issued to employees below fair market value
                    50,660
                    5,000
                    1,040,000
                    -
                    (444,000)
                    -
                    -
                    -
                    -
                    601,000
                    -Unrealized
                        gain on available for sale securities
                    -
                    -
                    -
                    -
                    -
                    202,000
                    -
                    -
                    -
                    202,000
                    202,000Value
                        of underwriter IPO unit warrant extension
                    -
                    -
                    38,000
                    (38,000)
                    -
                    -
                    -
                    -
                    -
                    -
                    -Net
                        loss
                    -
                    -
                    -
                    (4,012,000)
                    -
                    -
                    -
                    -
                    -
                    (4,012,000)
                    (4,012,000)Balance
                        at June 30, 2004
                    8,370,338
                    $
                        837,000
                    $
                        31,360,000
                    $
                        (19,527,000)
                    $
                        (449,000)
                    $
                        313,000
                    3,103
                    $(34,000)
                    $
                        -
                    $
                        12,500,000
                    $
                        (3,816,000)
 
 The
              accompanying notes are an integral part of these consolidated financial
              statements
  
  
 **IMPLANT
              SCIENCES CORPORATION**
 **CONSOLIDATED
              STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE
              LOSS**
 **FOR
              EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 2006**
 
 Common
                        Stock
                    
                    
                    
                    
                    Treasury
                        StockNumber
                        of
                      shares
                    $.10
                        par value
                    Additional
                      Paid-in
                      Capital
                    Accumulated
                        Deficit
                    Deferred
                        Compensation
                    Accumulated
                        Other Comprehensive Income (Loss)
                    Shares
                    Cost
                    Total
                      Stockholders'
                      Equity
                    Comprehensive
                      LossBalance
                        at June 30, 2004
                    8,370,338
                    $
                        837,000
                    $
                        31,360,000
                    $
                        (19,527,000)
                    $
                        (449,000)
                    $
                        313,000
                    3,103
                    $
                        (34,000)
                    $
                        12,500,000
                    -Issuance
                        of common stock pursuant to exercise of stock options
                    153,160
                    15,000
                    856,000
                    -
                    -
                    -
                    -
                    -
                    871,000
                    -Issuance
                        of common stock pursuant to exercise of warrants
                    42,810
                    4,000
                    137,000
                    -
                    -
                    -
                    -
                    -
                    141,000
                    -Issuance
                        of common stock pursuant to employee stock purchase plan
                    3,075
                    -
                    25,000
                    -
                    -
                    -
                    -
                    -
                    25,000
                    -Issuance
                        of common stock pursuant to private financing agreement,
                        net of issuance
                        costs
                    1,080,780
                    108,000
                    7,181,000
                    -
                    -
                    -
                    -
                    -
                    7,289,000
                    -Conversion
                        of 5% Series C Cumulative Convertible Preferred Stock and
                        related accrued
                        dividends into common stock
                    208,289
                    21,000
                    1,417,000
                    (55,000)
                    -
                    -
                    -
                    -
                    1,383,000
                    -Accretion
                        and dividends on 5% Series C Cumulative Convertible Preferred
                        Stock
                    -
                    -
                    -
                    (649,000)
                    -
                    -
                    -
                    -
                    (649,000)
                    -Investment
                        in unconsolidated subsidiaries
                    76,687
                    8,000
                    742,000
                    -
                    -
                    (78,000)
                    13,346
                    (129,000)
                    543,000
                    (78,000)Issuance
                        of common stock pursuant to investment in Core Systems
                    311,437
                    31,000
                    3,219,000
                    -
                    -
                    -
                    -
                    -
                    3,250,000
                    -Issuance
                        of common stock in exchange for the retirement of debt in
                        connection with
                        the acquisition of Core Systems
                    48,875
                    5,000
                    505,000
                    -
                    -
                    -
                    -
                    -
                    510,000
                    -Issuance
                        of common stock warrants in connection with the acquisition
                        of Core
                        Systems
                    -
                    -
                    1,122,000
                    -
                    -
                    -
                    -
                    -
                    1,122,000
                    -Issuance
                        of common stock pursuant to investment in Accurel Systems
                        International
                    418,194
                    42,000
                    3,478,000
                    -
                    -
                    -
                    -
                    -
                    3,520,000
                    -Fair
                        value associated with warrants and nonqualified stock options
                        issued to
                        nonemployees
                    -
                    -
                    228,000
                    -
                    (129,000)
                    -
                    -
                    -
                    99,000
                    -Value
                        ascribed to stock options issued to employees below fair
                        market
                        value
                    -
                    -
                    144,000
                    -
                    (144,000)
                    -
                    -
                    -
                    -
                    -Purchase
                        of treasury stock
                    -
                    -
                    -
                    -
                    -
                    -
                    6,000
                    (54,000)
                    (54,000)
                    -Amortization
                        of deferred compensation
                    -
                    -
                    (94,000)
                    -
                    373,000
                    -
                    -
                    -
                    279,000
                    -Issuance
                        of common stock for assets acquired from Rosses Medical
                    43,197
                    4,000
                    196,000
                    -
                    -
                    -
                    -
                    -
                    200,000
                    -Unrealized
                        gain on available for sale securities
                    -
                    -
                    -
                    -
                    -
                    (240,000)
                    -
                    -
                    (240,000)
                    (240,000)Value
                        of underwriter IPO unit warrant extension
                    -
                    -
                    479,000
                    (479,000)
                    -
                    -
                    -
                    -
                    -Net
                        loss
                    -
                    -
                    -
                    (7,405,000)
                    -
                    -
                    -
                    -
                    (7,405,000)
                    (7,405,000)Balance
                        at June 30, 2005
                    10,756,842
                    $
                        1,075,000
                    $
                        50,995,000
                    $
                        (28,115,000)
                    $
                        (349,000)
                    $
                        (5,000)
                    22,449
                    $(217,000)
                    $
                        23,384,000
                    $(7,723,000)
 
 The
              accompanying notes are an integral part of these consolidated financial
              statements
 
  
  
  **IMPLANT
              SCIENCES CORPORATION**
 **CONSOLIDATED
              STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE
              LOSS**
 **FOR
              EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 2006**
 
 Common
                        Stock
                    
                    
                    
                    
                    Treasury
                        StockNumber
                        of
                      shares
                    $.10
                        par value
                    Additional
                      Paid-in
                      Capital
                    Accumulated
                        Deficit
                    Deferred
                        Compensation
                    Accumulated
                        Other Comprehensive Income (Loss)
                    Shares
                    Cost
                    Total
                      Stockholders'
                      Equity
                    Comprehensive
                      LossBalance
                        at June 30, 2005
                    10,756,842
                    $
                        1,075,000
                    $
                        50,995,000
                    $
                        (28,115,000)
                    $
                        (349,000)
                    $
                        (5,000)
                    22,449
                    $(217,000)
                    $
                        23,384,000
                    -Employee
                        stock purchase plan
                    41,204
                    4,000
                    100,000
                    -
                    -
                    -
                    -
                    -
                    104,000
                    -Stock
                        issued for option exercises
                    41,700
                    4,000
                    66,000
                    -
                    -
                    -
                    4,545
                    (19,000)
                    51,000
                    -Stock
                        issued with warrant exercises
                    16,185
                    2,000
                    69,000
                    -
                    -
                    -
                    -
                    -
                    71,000
                    -Warrants
                        issued to consultants for services
                    -
                    -
                    119,000
                    -
                    -
                    -
                    -
                    -
                    119,000
                    -S-3
                        expenses
                    -
                    -
                    (7,000)
                    -
                    -
                    -
                    -
                    -
                    (7,000)
                    -Shares
                        issued in conjunction with Core Systems
                    112,495
                    11,000
                    (11,000)
                    -
                    -
                    -
                    -
                    -
                    -
                    -Shares
                        issued in conjunction with Accurel Systems
                    504,145
                    51,000
                    (51,000)
                    -
                    -
                    
                    -
                    -
                    -
                    -Series
                        D expenses
                    -
                    -
                    (71,000)
                    -
                    -
                    -
                    -
                    -
                    (71,000)
                    -Warrants
                        issued in connection with Series D
                    -
                    -
                    672,000
                    -
                    -
                    -
                    -
                    -
                    672,000
                    -Amortization
                        of deferred compensation
                    -
                    -
                    (305,000)
                    -
                    332,000
                    -
                    -
                    -
                    27,000
                    -Share-based
                        compensation
                    -
                    -
                    2,348,000
                    -
                    -
                    -
                    -
                    -
                    2,348,000
                    -Shares
                        issued in conjunction with conversion of Series D
                    261,233
                    26,000
                    883,000
                    -
                    -
                    -
                    -
                    -
                    909,000
                    -Series
                        D conversion expense
                    -
                    -
                    477,000
                    -
                    -
                    -
                    -
                    -
                    477,000
                    -Series
                        D accretion and dividends
                    -
                    -
                    -
                    (1,089,000)
                    -
                    -
                    -
                    -
                    (1,089,000)
                    -Unrealized
                        gain on available for sale securities
                    -
                    -
                    -
                    -
                    -
                    19,000
                    -
                    -
                    19,000
                    19,000Net
                        loss
                    -
                    -
                    -
                    (7,084,000)
                    -
                    -
                    -
                    -
                    (7,084,000)
                    (7,084,000)Balance
                        at June 30, 2006
                    11,733,804
                    $1,173,000
                    $55,284,000
                    $(36,290,000)
                    $(17,000)
                    $14,000
                    26,994
                    $(236,000)
                    $19,928,000
                    ($7,103,000)
 
  
 The
              accompanying notes are an integral part of these consolidated financial
              statements
  
   **IMPLANT
                  SCIENCES CORPORATION****CONSOLIDATED
                  STATEMENTS OF CASH FLOWS****Years
                  Ended June 30,****Cash
                  flows from operating activities:**
              **2006**
              
              **2005**
              
              **2004**Net
                  loss
              $
                  (7,084,000)
              
              $
                  (7,405,000)
              
              $
                  (4,012,000)Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Depreciation
                  and amortization
              2,332,000
              
              1,611,000
              
              881,000Amortization
                  of intangible assets
              721,000
              
              589,000
              
              382,000Share-based
                  compensation expense
              2,493,000
              
              378,000
              
              1,668,000Equity
                  loss in unconsolidated subsidiaries
              359,000
              
              75,000
              
              50,000Loss
                  on equipment write down
              43,000
              
              357,000
              
              -Change
                  in fair value of embedded derivatives
              (1,121,000)
              
              -
              
              -Loss
                  on extinguishment of debt instrument
              1,294,000
              
              -
              
              -Impairment
                  charge
              457,000
              
              -
              
              -Changes
                  in operating assets and liabilities, net of effect of
                  acquisitions:Accounts
                  receivable
              (437,000)
              
              433,000
              
              (1,365,000)Inventories
              (328,000)
              
              (549,000)
              
              (8,000)Prepaid
                  expenses and other current assets
              (281,000)
              
              59,000
              
              (102,000)Accounts
                  payable
              180,000
              
              (19,000)
              
              (171,000)Accrued
                  expenses
              (533,000)
              
              454,000
              
              (6,000)Deferred
                  revenue
              (294,000)
              
              714,000
              
              36,000Long-term
                  lease liability
              -
              
              (26,000)
              
              -Net
                  cash used in operating activities
              (2,199,000)
              
              (3,329,000)
              
              (2,647,000)**Cash
                  flows from investing activities:**Purchase
                  of property and equipment
              (618,000)
              
              (688,000)
              
              (355,000)Proceeds
                  from sale of equipment
              -
              
              1,400,000
              
              -Investment
                  in- available for sale securities
              (1,000)
              
              (25,000)
              
              (40,000)Acquisition
                  of Core Systems, net of cash received
              -
              
              (2,404,000)
              
              -Acquisition
                  of Accurel Systems International, net of cash received
              -
              
              (6,425,000)
              
              -Increase
                  in other non-current assets
              (33,000)
              
              (75,000)
              
              (105,000)Net
                  cash used in investing activities
              (652,000)
              
              (8,217,000)
              
              (500,000)**Cash
                  flows from financing activities:**Proceeds
                  from issuance of common stock including the
                exercise
                  of options and the Employee Stock Purchase Plan
              49,000
              
              896,000
              
              559,000Proceeds
                  from warrant exercise
              70,000
              
              141,000
              
              1,102,000Proceeds
                  from issuance of 5% Series B Cumulative Convertible
                Preferred
                  Stock, net of issuance costs
              -
              
              -
              
              1,818,000Proceeds
                  from issuance of 5% Series C Cumulative Convertible
                Preferred
                  Stock, net of issuance costs
              -
              
              -
              
              2,282,000Proceeds
                  from term note, net of issuance costs
              2,833,000
              
              -
              
              -Proceeds
                  from issuance of Series D Cumulative Redeemable Convertible
                Preferred
                  Stock, net of issuance costs
              1,894,000
              
              -
              
              -Dividends
                  on Series D Cumulative Redeemable Convertible Preferred
                  Stock
              (279,000)
              
              -
              
              -Principal
                  payments of long-term debt and capital lease obligations
              (2,061,000)
              
              (2,083,000)
              
              (1,579,000)Borrowing
                  from line of credit
              1,000,000
              
              -
              
              -Acquisition
                  of treasury shares
              -
              
              (54,000)
              
              -Principal
                  payments of notes receivable from employees
              -
              
              -
              
              223,000Proceeds
                  from issuance of common stock in connection with
                private
                  placement, net of issuance costs
              -
              
              7,289,000
              
              4,689,000Net
                  cash flows provided by financing activities
              3,506,000
              
              6,189,000
              
              9,094,000Net
                  change in cash and cash equivalents
              655,000
              
              (5,357,000)
              
              5,947,000Cash
                  and cash equivalents at beginning of year
              1,549,000
              
              6,906,000
              
              959,000Cash
                  and cash equivalents at end of year
              $
                  2,204,000
              
              $
                  1,549,000
              
              $
                  6,906,000
 
   
   **Years
                  ended June 30,****2006**
              
              **2005**
              
              **2004****Supplemental
                  Disclosure of Cash Flow Information:**Interest
                  paid in cash
              $
                  -
              
              $
                  167,000
              
              $
                  135,000**Noncash
                  Investing and Financing Activity:**Value
                  of IPO warrant extension
              $
                  -
              
              $
                  479,000
              
              $
                  38,000Issuance
                  of Series B warrants
              $
                  -
              
              $
                  -
              
              $
                  184,000Noncash
                  beneficial conversion feature - Series B
              $
                  -
              
              $
                  -
              
              $
                  826,000Issuance
                  of Series C warrants
              $
                  -
              
              $
                  -
              
              $
                  305,000Noncash
                  beneficial conversion feature - Series C
              $
                  -
              
              $
                  -
              
              $
                  700,000Capital
                  equipment acquired under capital lease
              $
                  223,000
              
              $
                  -
              
              $
                  -Conversion
                  of Series A Cumulative Convertible Preferred stockand
                  accrued dividends into common stock
              $
                  -
              
              $
                  -
              
              $
                  1,531,000Conversion
                  of Series B Cumulative Convertible Preferred stockand
                  accrued dividends into common stock
              $
                  -
              
              $
                  -
              
              $
                  2,064,000Conversion
                  of Series C Cumulative Convertible Preferred stockand
                  accrued dividends into common stock
              $
                  -
              
              $
                  1,438,000
              
              $
                  1,181,000Conversion
                  of Series D Cumulative Convertible Preferred stockinto
                  common stock
              $
                  909,000
              
              $
                  -
              
              $
                  -Accretion
                  of 7% Series A Cumulative Convertible Preferred Stockdividends,
                  beneficial conversion feature and warrants
              $
                  -
              
              $
                  -
              
              $
                  564,000Accretion
                  of 5% Series B Cumulative Convertible Preferred Stockdividends,
                  beneficial conversion feature and warrants
              $
                  -
              
              $
                  -
              
              $
                  1,287,000Accretion
                  of 5% Series C Cumulative Convertible Preferred Stockdividends,
                  beneficial conversion feature and warrants
              $
                  -
              
              $
                  704,000
              
              $
                  638,000Accretion
                  of Series D Cumulative Redeemable Convertible Preferred Stockdividends,
                  derivatives and warrants
              $
                  628,000
              
              $
                  -
              
              $
                  -Value
                  of intangible asset acquired in exchange for long-term notepayable
              $
                  -
              
              $
                  -
              
              $
                  1,007,000Value
                  of software technology acquired in exchange for cash andshares
                  of common stock
              $
                  -
              
              $
                  300,000
              
              $
                  -Repayment
                  of term note with Series D Cumulative Redeemable Convertible Preferred
                  Stock
              $
                  3,000,000
              
              $
                  -
              
              $
                  -Modification
                  of embedded derivative related to Series D conversion
                  feature
              $
                  817,000
              
              $
                  -
              
              $
                  -
 
  **Supplemental
        Disclosure of Cash Flow Information**
 **On
                    October 15, 2004, the Company acquired Core Systems Incorporated
                    -****Fair
                    value of assets:**Accounts
                    receivable
                
                $
                    518,000Inventory
                
                174,000Property,
                    plant and equipment
                
                3,422,000Intangible
                    assets
                
                335,000Goodwill
                
                4,647,000Other
                    assets
                
                74,000**Liabilities
                    assumed:**Accounts
                    payable and accrued expenses
                (1,063,000)Debt
                    and capital leases
                
                (621,000)**Purchase
                    price:**Cash
                    paid for purchase of Core Systems, net of cash acquired
                (2,604,000)Fair
                    value of warrants issued
                
                (1,122,000)Fair
                    value of common stock issued
                
                $
                    3,760,000
 **On
                  March 9, 2005, the Company acquired Accurel Systems International
                  Corporation -****Fair
                  value of assets:**Accounts
                  receivable
              
              $
                  1,073,000Property,
                  plant and equipment
              
              3,957,000Assets
                  held for sale
              
              1,400,000Intangible
                  assets
              
              1,670,000Goodwill
              
              7,566,000Other
                  assets
              
              183,000**Liabilities
                  assumed:**Accounts
                  payable and accrued expenses
              (557,000)Long-term
                  lease liability
              
              (829,000)Debt
                  and capital leases
              
              (2,440,000)**Purchase
                  price:**Debt
                  issued to selling shareholders
              
              (1,650,000)Cash
                  paid for purchase of Accurel, net of cash acquired
              (6,853,000)Fair
                  value of common stock issued
              
              $
                  3,520,000
 The
          accompanying notes are an integral part of these consolidated financial
          statements.
 
 **1.**
            **Description
                of Business**  Implant
        Sciences Corporation (the “Company”) develops products for the medical device
        and security products industry. Its core technology involves ion implantation
        and thin film coatings of radioactive and non-radioactive materials. The
        Company
        has received Food and Drug Administration 510(k) clearance to market both
        its
        I-Plant ’ Iodine-125 radioactive seed for the treatment of prostate cancer and its
        Ytterbium-169 source for breast cancer therapy. The Company also modifies
        the
        surface characteristics of orthopedic joint implants to reduce polyethylene
        wear
        and thereby increasing the life of the implant. The Company provides ion
        implantation and analytical services to the semiconductor industry and also
        semiconductor equipment. The Company markets and sells its existing trace
        explosives detector products while continuing to make significant investments
        in
        developing the next generation of these products.
  *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 year ended June
        30,
        2006, the Company reported a net loss of $7,084,000 and used $2,199,000 in
        cash
        from operations. As of June 30, 2006, the Company had an accumulated deficit
        of
        approximately $36,290,000 and working capital of $2,259,000. The Company
        has
        drawn $1,000,000 on a $1,500,000 revolving credit facility with a bank, which
        subsequent to June 30, 2006 was modified to extend its expiration date to
        December 31, 2007. 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.
 
 Management
        has prepared operating plans which would indicate the Company has sufficient
        financial resources to sustain operations for at least the next twelve months.
        These plans depend on the successful increase in the semiconductor service
        revenue. Management has also developed plans which provide for cost cutting
        measures should projected revenues not be met. Management believes that these
        cost cutting measures will be sufficient to allow the Company to continue
        as a
        going concern should revenue projections not be met.
  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 raised net proceeds
        aggregating approximately $3,506,000 during the year ended June 30, 2006
        from
        the sale of common stock in connection with a private placement and the exercise
        of options and warrants. Since the end of our fiscal year ended June 30,
        2006,
        the Company has taken several steps to mitigate the risk of its ability to
        continue as a going concern. The Series D preferred stock contains mandatory
        redemptions on a monthly basis beginning in October 2006. 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. There can be no assurances that
        forecasted results will be achieved or that the Company’s stock price will
        remain at a level to allow the Company to redeem the outstanding shares of
        Series D preferred and accrued dividends with shares of its common stock.
 
 During
        the course of fiscal 2006 the Company experienced significant growth in both
        its
        semiconductor and security product businesses. The semiconductor business
        growth
        came as a result of a full year of revenue from two companies acquired in
        fiscal
        2005. In the fiscal 2006, the Security Division was successful in transitioning
        its prototype products to manufacturable products. While initially, the Company
        manufactured the product internally, over the course of the year, as a way
        to
        reduce the cost, the manufacturing process was outsourced to a contract
        manufacturer.
  The
        Company has a history of being active in submitting proposals for government
        sponsored grants and contracts and successful in being awarded grants and
        contracts from government agencies. Management will continue to pursue
        government grants and contracts to support its research and development efforts
        in the areas of semiconductor, medical device and explosives and toxic
        substances detection.
 
 Based
        on
        the current sales, expense and cash flow projections, the Company believes
        that
        the current level of cash and cash-equivalents on hand, and the net proceeds
        from the government awards mentioned above would be sufficient to fund
        operations until the Company achieves profitability. However, because there
        can
        be no assurances that sales will materialize as forecasted, management will
        continue to closely monitor and attempt to control costs at the Company and
        will
        continue to actively seek the needed capital through government grants and
        awards, strategic alliances, private financing sources, and through its lending
        institutions.
  These
        conditions raise substantial doubt about the Company's ability to conginue
        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.
 
  
 **2.**
            **Summary
                of Significant Accounting
                Policies**  *Principles
        of Consolidation*
  The
        accompanying consolidated financial statements include the accounts of the
        Company and its wholly owned subsidiaries. All intercompany balances have
        been
        eliminated in consolidation *.*
  *Use
        of Estimates*
  The
        preparation of these financial statements in conformity with accounting
        principles generally accepted in the United States of America, requires
        management to make estimates and assumptions that affect the reported amounts
        of
        assets and liabilities and disclosure of contingent assets and liabilities
        at
        the date of the financial statements and the reported amounts of revenues
        and
        expenses during the reporting periods. Some of the more significant estimates
        include allowance for doubtful accounts, allowance for sales returns, inventory
        valuation, warranty reserves, accounting for embedded derivatives, and
        impairment of goodwill and intangibles. Management's estimates are based
        on the
        facts and circumstances available at the time estimates are made, past
        historical experience, risk of loss, general economic conditions and trends
        and
        management's assessments of the probable future outcome of these matters.
        Consequently, actual results could differ from such estimates.
  *Cash,
        Cash Equivalents, and Investments*
  The
        Company considers any securities with original maturities of 90 days or less
        at
        the time of investment to be cash equivalents.
  The
        Company accounts for investments in accordance with Statement of Financial
        Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in
        Debt and Equity Securities.” Under SFAS No. 115, securities purchased in order
        to be held for indefinite periods of time and not intended at the time of
        purchase to be held until maturity are classified as available-for-sale
        securities. At June 30, 2006, these securities consisted of common stock
        in
        CardioTech International, Inc. (“CardioTech”), a related party. This common
        stock is recorded at fair market value with any unrealized gains and losses
        reported as a separate component of equity in other accumulated comprehensive
        income (loss).
  *Comprehensive
        Loss*
  The
        Company has accumulated other comprehensive losses resulting from the unrealized
        losses on an investment in marketable securities of CardioTech and the
        recognition of the unrealized loss of the Company’s share of CardioTech stock
        owned by CorNova, Inc. (“CorNova”), which is recorded as a separate component of
        equity in other accumulated comprehensive loss.
  *Financial
        Instruments*
 
 The
        estimated fair values of the Company’s financial instruments, which at June 30,
        2006 and 2005 include cash equivalents, investments in available for sale
        securities, accounts receivable, accounts payable and long-term debt
        approximates their carrying values due to their short-term nature or market
        variable rates of interest.
 
 *Inventories*
 
 Inventories
        consist of raw materials, work-in-process and finished goods. Work-in-process
        and finished goods includes labor and overhead, and are stated at the lower
        of
        cost (first in, first out) or market.
 
 *Property
        and Equipment*
  Equipment
        and leasehold improvements are stated at cost. Equipment is depreciated using
        the straight-line method over the estimated useful lives of the assets, ranging
        from three to seven years. Equipment purchased under 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. Expenditures for repairs and maintenance are charged
        to
        expense as incurred.
  Estimated
                  LivesMachinery
                  and equipment
              5
                  -
                  7 yearsComputers
                  and software
              3
                  -
                  5 yearsLeasehold
                  improvements and equipment under capital leases
              Lesser
                  of the remaining life of the lease or the useful lifeFurniture
                  and fixtures
              5
                  -
                  7 yearsMotor
                  vehicles
              7
                  years
  
 *Warranty
        Costs*
  The
        Company accrues warranty costs in the period the related revenue is recognized.
        The following table details the changes in the Company’s warranty
        reserve:
   **Year
                  ended June 30,****2006**
              ****
              **2005**
              ****
              **2004**Beginning
                  balance
              $
                  66,000
              
              $
                  2,000
              
              $
                  2,000Accrued
                  warranty expense
              133,000
              
              64,000
              
              -Charges
                  against the reserve
              (133,000)
              
              -
              
              -Ending
                  balance
              $
                  66,000
              
              $
                  66,000
              
              $
                  2,000
 
 *Income
        Taxes*
  The
        liability method is used to account for income taxes. Deferred tax assets
        and
        liabilities are determined based on differences between the financial reporting
        and income tax bases of assets and liabilities as well as net operating loss
        and
        tax credit carry forwards and are measured using the enacted tax rates and
        laws
        that will be in effect when the differences reverse. Deferred tax assets
        may be
        reduced by a valuation allowance to reflect the uncertainty associated with
        their ultimate realization.
  *Patent
        Costs*
  As
        of
        June 30, 2006, there were 17 active patents issued. The Company expenses
        patent
        costs as incurred.
  *Goodwill
        and Intangible Assets*
 
 In
        accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
        Long-Lived Assets,” the Company reviews the carrying values of its long-lived
        assets for possible impairment whenever events or changes in circumstances
        indicate that the carrying amounts of the assets may not be
        recoverable
 
 **** At
        June
        30, 2006, the Company had goodwill and intangible assets of $13,286,000.  SFAS
        No.
        142, “Goodwill and Other Intangible Assets,” requires that goodwill and
        intangible assets with indefinite lives no longer be amortized but instead
        be
        measured for impairment at least annually or whenever events indicate that
        there
        may be an impairment. In order to determine if impairment exists, management
        continually compares the reporting unit's carrying value to the reporting
        unit's
        fair value. The Company has four reporting units, medical, explosives detection,
        semiconductor wafer processing and semiconductor analytical services. All
        of the
        Company’s goodwill is allocated to the semiconductor wafer processing and the
        semiconductor analytical services reporting units. Determining the reporting
        unit's fair value requires management to make estimates based on market
        conditions and operational performance. Absent an event that indicates a
        specific impairment may exist, management has selected August 31st as the
        date
        of performing the annual goodwill impairment test and has concluded the goodwill
        is impaired in its semiconductor wafer processing reporting unit. The assessment
        required a write down of our goodwill by $457,000 which has been expensed
        in the
        year ended June 30, 2006. Future events could cause management to conclude
        that
        additional impairment indicators exist and that goodwill associated with
        the
        Company’s acquired businesses is impaired. Any resulting impairment loss could
        have a material adverse impact on the Company’s financial condition and results
        of operations.
 
 Intangible
        assets with finite lives consist of acquired customer base, technology and
        trademarks and are valued according to the future cash flows they are estimated
        to produce. These assigned values are amortized on a basis which matches
        the
        periods in which those cash flows are estimated to be produced. The Company
        continually evaluates whether events or circumstances have occurred that
        indicate that the estimated remaining useful life of its intangible assets
        may
        warrant revision or that the carrying value of these assets may be impaired.
        To
        compute whether intangible assets with finite lives have been impaired, the
        estimated undiscounted future cash flows for the estimated remaining useful
        life
        of the assets are compared to the carrying value. To the extent that the
        future
        cash flows are less than the carrying value, the assets are written down
        to the
        estimated fair value of the asset. The intangible assets were not considered
        to
        be impaired at June 30, 2006 and 2005.
  
 *Concentration
        of Credit Risk and Major Customers*
  Financial
        instruments that potentially subject the Company to concentration of credit
        risk
        consist of trade receivables.
 
 The
        Company grants credit to its customers, primarily large corporations in the
        medical device and semiconductor industries and the U.S. government. The
        Company
        performs periodic evaluations of customer’s payment history and generally does
        not require collateral. Receivables are generally due within thirty days.
        Credit
        losses have historically been minimal, which is consistent with management’s
        expectations. Reserves are provided for estimated amounts of accounts receivable
        which may not be collected. The Company has no significant off-balance sheet
        risk such as foreign-exchange contracts, option contracts or other foreign
        hedging arrangements. The Company places its cash with financial institutions
        which it believes are of high credit quality.
 
 The
        Company had two major customers with revenues in excess of 10% of the Company’s
        total revenues for the years ended June 30, 2006 and 2005 and three in 2004,
        that accounted for the following annual revenue:
  **2006**
              **2005**
              **2004**Revenues
              %
                  of Total Revenues
              Revenues
              %
                  of Total Revenues
              Revenues
              %
                  of Total RevenuesCompany
                  A
              $3,478,000
              13%
              $2,020,000
              16%
              $2,969,000
              35%Company
                  B
              1,457,000
              6%
              1,586,000
              13%
              1,585,000
              19%Company
                  C
              -
              -
              -
              -
              883,000
              10%Company
                  D
              2,650,000
              10%
              -
              -
              -
              -
  At
        June
        30, 2006 and 2005, this customer accounted for the following amounts of accounts
        receivable:
  **2006**
              **2005**Accounts
                  Receivable (1)
              %
                  of Total A/R
              Accounts
                  Receivable (1)
              %
                  of Total A/RCompany
                  A
              $
                  362,000
              10%
              $
                  843,000
              26%
 (1)
        Contains
        billed and unbilled revenue
 
 The
        following table details the changes in the Company’s reserve for uncollectible
        accounts:
  **Year
                  ended June 30,****2006**
              ****
              **2005**
              ****
              **2004**Beginning
                  balance
              $
                  147,000
              
              $
                  89,000
              
              $
                  50,000Additional
                  accruals to the reserve
              3,000
              
              78,000
              
              39,000Charges
                  against the reserve
              (29,000)
              
              (20,000)
              
              -Ending
                  balance
              $
                  121,000
              
              $
                  147,000
              
              $
                  89,000
 
  *Employee
        Stock-Based Compensation*
  On
        December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
        No. 123 (Revised 2004) “Share-Based Payments,” (“SFAS 123R”), which is a
        revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 123R
        supersedes Accounting Principal Board (“APB”) Opinion No. 25, “Accounting for
        Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.”
Generally, the approach in SFAS 123R is similar to the approach described
        in
        SFAS 123, however, SFAS 123R requires all share-based payments to employees,
        including grants of employee stock options and stock issued from certain
        employee stock purchase plans, to be recognized in earnings based on their
        modified-grant date fair values. Pro forma disclosure is no longer an
        alternative.
  Prior
        to
        July 1, 2005, as was permitted under SFAS No. 123, the Company accounted
        for
        stock-based awards using the intrinsic value method under APB No. 25. In
        general, pursuant to APB No. 25, when the exercise price of options granted
        to
        employees and non-employee directors under these plans equals the market
        price
        of the underlying stock on the date of the grant, no compensation expense
        was
        recorded.
 
 
 Effective
        July 1, 2005, the Company adopted SFAS 123R. The Company selected the modified
        prospective method of adoption in which compensation cost is recognized
        beginning with the effective date for all share-based payments to employees
        after June 30, 2005 and any unvested share-based payments to employees as
        of the
        effective date. In accordance with the modified prospective method of adoption,
        the Company’s results of operations for prior periods have not been
        restated.
 
 The
        Company has refined certain estimates used previously based upon the guidance
        provided under SFAS 123R, specifically the expected life of the option and
        estimated forfeitures. The calculation of the fair value of the awards for
        quarters ended September 30, 2005 and thereafter has been adjusted to reflect
        these refined assumptions.
 
 The
        following table illustrates the effect on net loss applicable to common
        shareholders and net loss per share applicable to common shareholders as
        if the
        fair value method had been applied to all outstanding and unvested awards
        in the
        prior period:
 
  **Years
                  Ended June 30,****2005**
              
              **2004**Net
                  loss applicable to common shareholders, as reported
              $
                  (8,588,000)
              
              $
                  (6,539,000)Add:
                  stock-based employee compensation expense included in reported
                  net loss
                  applicable to common shareholders, net of tax
              279,000
              
              295,000Deduct:
                  total stock-based employee compensation expense determined under
                  the fair
                  value based method of all awards, net of tax
              (1,901,000)
              
              (856,000)Pro
                  forma net loss applicable to common shareholders
              $
                  (10,210,000)
              
              $
                  (7,100,000)Net
                  loss per share applicable to common shareholders, basic and
                  diluted:As
                  reported
              $
                  (0.91)
              
              $
                  (0.89)Proforma
              $
                  (1.08)
              
              $
                  (0.97)
  Under
        the
        provisions of SFAS 123R the Company recorded $2,348,000 of stock based
        compensation, which includes $58,000 of compensation expense attributable
        to its
        Employee Stock Purchase Plan. Included in the consolidated statement of
        operations for the year ended June 30, 2006 is $145,000 of compensation expense
        attributable to other non-employee options and warrants.
 
 The
        total
        non-cash stock-based compensation expense included in the consolidated statement
        of operations for the year ended June 30, 2006 is included in the following
        expense categories:
  **Years
                  Ended****2006**
              **2005**
              **2004**Cost
                  of revenues
              $
                  620,000
              $
                  2,000
              $
                  89,000Research
                  and development
              122,000
              241,000
              300,000Selling,
                  general and administrative
              1,751,000
              135,000
              1,279,000Total
              $2,493,000
              $
                  378,000
              $
                  1,668,0000
 
 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 option forfeitures
        within the valuation model. The expected term of options granted is calculated
        using the “Simplified Method” as outlined SFAS 123R and reflects the period of
        time that options granted are expected to be outstanding. The risk-free rate
        for
        periods within the contractual life of the option is based on the U.S Treasury
        yield curve in effect at the time of grant.
 
 **Stock
                  Option Plans**
              ****
              **Stock**
                **Purchase
                  Plan****2006**
              **2005**
              **2004**
              ****
              **2006**Risk
                  free interest rate
              3.72
                  %-4.89%
              4.10%-4.73%
              2.87%-6.69%
              
              4.33%
                  - 4.79%Expected
                  dividend yield
              0%
              0%
              0%
              
              0%Expected
                  lives (years)
              2.5
                  - 6 years(1)
              5
                  -
                  10 years
              5
                  -
                  10 years
              
              6
                  monthsExpected
                  volatility
              68%
                  - 81%
              62%
                  - 68%
              47%
                  - 68%
              
              49%
                  - 61%Expected
                  forfeiture rate
              4%
              0%
              0%
              
              0%Contractual
                  term
              5
                  -
                  10 years
              5
                  -
                  10 years
              5
                  -
                  10 years
              
              6
                  months
   (1)
            The
                estimate of an option’s expected life has been updated and revised for all
                grants outstanding prior to adoption based upon guidance provided
                under
                SFAS 123R and the Securities and Exchange Commission’s Staff Accounting
                Bulletin (“SAB”) Topic 107. The estimate of expected life was revised to
                use the “simplified method” to determine the expected life of an option
                versus the contractual life as previously
                used.  
 *Revenue
        Recognition*
  The
        Company recognizes revenue when there is persuasive evidence of an arrangement
        with the customer which states a fixed or determinable price and terms, delivery
        of the product has occurred or the service performed in accordance with the
        terms of the sale, and collectibility of the sale is reasonably assured.
        The
        Company provides for estimated returns at the time of shipment based on
        historical data. Shipping costs charged to the customer are include in revenues
        and are not significant.
  Contract
        revenue under cost-sharing research and development agreements is recognized
        as
        eligible research and development expenses are incurred. The Company’s
        obligation with respect to these agreements is to perform the research on
        a
        best-efforts basis.
  Treatment
        systems planning revenues c onsists
        of sales of software licenses and maintenance agreements, product related
        training, installation, and consulting, and the associated hardware. Revenue
        from sales of software licenses and maintenance agreements is recognized
        ratably
        over the maintenance contract period, which is generally one year, pursuant
        to
        the guidance provided by Statement of Position (“SOP”) 97-2, “ *Software
        Revenue Recognition* ”
(SOP
        97-2), issued by the American Institute of Certified Public Accountants (AICPA).
        Revenue from training, installation, consulting services and the associated
        hardware are recognized as the services are performed or product is delivered,
        provided there is vendor specific objective evidence (VSOE) of fair value
        which
        is the price charged when the services are sold separately. Revenues from
        treatment planning systems is included in medical revenues and amounted to
        $121,000 in 2006. Revenue from treatment planning systems was immaterial
        in 2005
        and $0 in 2004.
  Deferred
        revenues are recorded when the Company receives payments for product or services
        for which it has not yet completed its obligation to deliver product or has
        not
        completed services required by agreements.
  *Accounts
        Receivable*
 
 Contract
        revenue under cost sharing research and development agreements is recognized
        as
        eligible expenses are incurred. Invoicing of research and development contracts
        occurs in accordance with the terms of the contract. Revenue recognized but
        unbilled is recorded as unbilled accounts receivable. At June 30, 2006, 2005
        and
        2004 unbilled accounts receivable represented approximately 1%, 9% and 67%
        of
        total accounts receivable. Generally, there are no prerequisites necessary
        to
        invoice.
 
 *Research
        and Development Costs*
 
 All
        costs
        of research and development activities are expensed as incurred. The Company
        performs research and development for itself and under contracts with others,
        primarily the U.S. government. In addition, periodically, the Company may
        continue its research on such projects at its own expense. These costs are
        considered Company funded research and development. Customer funded research
        and
        development are considered cost of revenues.
  The
        Company funded and customer reimbursed research and development costs were
        as
        follows:
  **Years
                  ended June 30,****2006**
              **2005**
              **2004**Company
                  funded
              
              $
                  1,313,000
              $
                  1,942,000
              $
                  1,631,000Customer
                  funded
              
              2,775,000
              1,691,000
              2,210,000Total
                  research and development
              $4,088,000
              $3,633,000
              $3,841,000
  *Software
        Development Costs*
 
 The
        Company accounts software development costs in accordance with SFAS No. 86,
        “ *Accounting
        for the Costs of Computer Software to Be Sold, Leased or Otherwise
        Marketed* .”
        Accordingly, the costs for the development of new software and substantial
        enhancements to existing software are expensed as incurred until technological
        feasibility has been established, at which time, any additional costs are
        capitalized. The Company believes technological feasibility has been established
        at the time at which a working model of the software has been completed and
        costs eligible for capitalization are immaterial.
 
 
 *Earnings
        (Loss) per Share*
 
 Basic
        earnings (loss) per share is computed based only on the weighted average
        number
        of common shares outstanding during the period. Diluted earnings per share
        is
        computed by using the weighted average number of common shares outstanding
        during the period, plus the dilutive effects of shares issuable through the
        exercise of stock options (common stock equivalents) unless their inclusion
        would be antidilutive. In calculating diluted earnings per share, the dilutive
        effect of stock options and warrants is computed using the average market
        price
        for the period. Basic and diluted net loss per share available for common
        shareholders is the same for all periods presented as outstanding common
        stock
        options and warrants have been excluded because they are antidilutive.
 
 The
        Company had the following potential dilutive securities outstanding on June
        30,
        2006: options and warrants to purchase 1,836,551 and 1,756,228 shares,
        respectively, of the Company’s common stock at weighted average exercise prices
        of $5.41 and $7.679 per share, respectively and (ii) Series D Preferred Stock
        convertible into an aggregate of 985,761 shares of the Company’s common stock.
        Such potential dilutive securities were not included in the calculation of
        diluted loss per share in 2006 because the inclusion thereof would be
        antidilutive.
 
 The
        Company had the following potential dilutive securities outstanding on June
        30,
        2005: options and warrants to purchase 1,908,331 and 2,324,389 shares,
        respectively, of the Company’s common stock at weighted average exercise prices
        of $5.66 and $9.53 per share, respectively. Such potential dilutive securities
        were not included in the calculation of diluted loss per share in 2005 because
        the inclusion thereof would be antidilutive.
 
 The
        Company had the following potential dilutive securities outstanding on June
        30,
        2004: (i) options and warrants to purchase 1,162,065 and 1,876,803 shares,
        respectively, of the Company’s common stock at weighted average exercise prices
        of $5.55 and $9.72 per share, respectively, and (ii) Series C Preferred Stock
        convertible into an aggregate of 195,370 shares of the Company’s common stock.
        Such potential dilutive securities were not included in the calculation of
        diluted loss per share in 2004 because the inclusion thereof would be
        antidilutive.
 
 *Advertising
        Costs*
 
 Advertising
        costs are expensed when incurred within selling, general and administrative
        expense. Advertising costs were immaterial for the years ended June 30 2006,
        2005 and 2004.
 
 *Shipping
        and Handling*
  The
        Company accounts for its shipping and handling cost within its cost of
        revenues.
 
 *Recent
        Accounting Pronouncements*
  The
        Financial Accounting Standards Board (“FASB”) issued FAS 154,
        Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and
        FASB Statement No. 3. This Statement shall be effective for accounting changes
        and corrections of errors made in fiscal years beginning after December 15,
        2005. Early adoption is permitted for accounting changes and corrections
        of
        errors made in fiscal years beginning after the date this Statement is issued.
        This Statement does not change the transition provisions of any existing
        accounting pronouncements, including those that are in a transition phase
        as of
        the effective date of this Statement. The adoption of this statement is not
        expected to have a material impact on the Company’s financial position or
        results of operations.
  The
        Financial Accounting Standards Board (“FASB”) issued FAS 155, Accounting for
        Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and
        140. This Statement shall be effective for all financial instruments acquired,
        issued, or subject to a remeasurement (new basis) event occurring after the
        beginning of an entity’s first fiscal year that begins after September 15, 2006.
        The fair value election provided for in paragraph 4(c) of this Statement
        may
        also be applied upon adoption of this Statement for hybrid financial instruments
        that had been bifurcated under paragraph 12 of Statement 133 prior to the
        adoption of this Statement. Earlier adoption 6 is permitted as of the beginning
        of an entity’s fiscal year, provided the entity has not yet issued financial
        statements, including financial statements for any interim period, for that
        fiscal year. The adoption of this statement is not expected to have a material
        impact on the Company’s financial position or results of
        operations.
 
 The
        Financial Accounting Standards Board (“FASB”) issued FIN 48, Accounting for
        Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, is
        effective for fiscal years beginning after December 15, 2006. Earlier
        application is encouraged if the enterprise has not yet issued financial
        statements, including interim financial statements, in the period the
        Interpretation is adopted. This interpretation of FAS 109 is not expected
        to
        have a material impact on the Company’s financial position or results of
        operations.
 
 In
        September 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on
        Issue No. 05−07, *Accounting
        for Modifications to Conversion Options Embedded in Debt Instruments and
        Related
        Issues* (“EITF
        05−07”). EITF 05−07 requires that a change in the fair value of a conversion
        option brought about by ** modifying
        the debt agreement be included in analyzing in accordance with EITF consensus
        on
        Issue No. 96−19, *Debtor’s
        Accounting for a Modification or Exchange of Debt Instruments* (“EITF
        96−19”), whether a debt instrument is considered extinguished. Under EITF
        96−19’s requirements, an issuer who modifies ** a
        debt
        instrument must compare the present value of the original debt instrument’s cash
        flows to the present value of the cash flows of the modified debt. If
        the ** present
        value of those cash flows varies by more than 10 percent, the modification
        is
        considered significant and extinguishments accounting is applied to
        the ** original
        debt. If the change in the present value of the cash flows is less than 10
        percent, the debt is considered to be modified and is subject to EITF
        96−19’s ** modification
        accounting. EITF 05−07 requires that in applying the 10 percent test the change
        in the fair value of the conversion option be treated in the same ** manner
        as
        a current period cash flow. EITF 05−07 also requires that, if a modification
        does not result in an extinguishment, the change in fair value of
        the ** conversion
        option be accounted for as an adjustment to interest expense over the remaining
        term of the debt. The issuer should not recognize a beneficial ** conversion
        feature or reassess an existing beneficial conversion feature upon modification
        of the conversion option of a debt instrument that does not result in
        an ** extinguishment.
        EITF 05−07 is effective for modifications of debt instruments beginning in the
        first interim or annual reporting period beginning after December ** 15,
        2005.
        The adoption of EITF 05−07 did not have a material impact on the Company’s
        consolidated financial position, results of ** operations
        or cash flows.
  
 In
        September 2005, the EITF reached a consensus on Issue No. 05−08, *Income
        Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion
        Feature* (“EITF
        05−08”). Under EITF 05−08, the issuance of convertible debt with a beneficial
        conversion feature results in a temporary difference for purposes of applying
        FAS No. 109, *Accounting
        for Income Taxes* .
        The
        deferred taxes recognized for the temporary difference should be recorded
        as an
        adjustment to paid−in capital. EITF 98−05, *Accounting
        for Convertible Securities with Beneficial Conversion Features or Contingently
        Adjustable Conversion Ratios* ,
        and
        EITF 00−27, *Application
        of Issue No. 98−05 to Certain Convertible Instruments* ,
        require
        that the nondetachable conversion feature of a convertible debt security
        be
        accounted for separately if it is a beneficial conversion feature. A beneficial
        conversion feature is recognized and measured by allocating to additional
        paid−in capital a portion of the proceeds equal to the conversion feature’s
        intrinsic value. A discount on the convertible debt is recognized for the
        amount
        that is allocated to additional paid−in capital. The debt discount is accreted
        from the date of issuance to the stated redemption date of the convertible
        instrument or through the earliest conversion date if the instrument does
        not
        have a stated redemption date. The U.S. Federal Income Tax Code includes
        the
        entire amount of proceeds received at issuance as the tax basis of the
        convertible debt security. EITF 05−08 should be applied retrospectively to all
        instruments with a beneficial conversion feature accounted for under EITF
        98−05
        and EITF 00−27 for periods beginning after December 15, 2005. The Company does
        not expect the adoption of EITF 05−08 to have material impact on the Company’s
        consolidated financial position, results of operations or cash
        flows.
 
 In
        November 2005, the FASB issued FSP FAS 115−1 and FAS 124−1, *The
        Meaning of Other−Than−Temporary Impairment and Its Application to Certain
        Investments* (“FSP
        FAS
        115−1 and FAS 124−1”). This FSP nullifies certain requirements of EITF Issue No.
        03−01 and supersedes EITF Abstracts, Topic No. ** D−44, *Recognition
        of Other−Than−Temporary Impairment upon the Planned Sale of a Security Whose
        Cost Exceeds Fair Value.* Based
        on
        the clarification ** provided
        in FSP FAS 115−1 and FAS 124−1, the amount of any other−than−temporary
        impairment that needs to be recognized will continue to be dependent
        on ** market
        conditions, the occurrence of certain events or changes in circumstances
        relative to an investee and an entity’s intent and ability to hold the
        impaired ** investment
        at the time of the valuation. FSP FAS 115−1 and FAS 124−1 are effective for
        reporting periods beginning after December 15, 2005. The Company does not
        expect
        the impact of adopting the guidance in FSP FAS 115−1 and FAS 124−1 to have a
        material impact on the Company’s consolidated financial position, results of
        operations and ** cash
        flows.
 
 In
        September 2006, the FASB issued FAS No. 157, *Fair
        Value Measurement* (“FAS
        157”). FAS 157 defines fair value, establishes a framework for measuring fair
        value and expands disclosures about fair value measurements. FAS 157 is
        effective for financial statements issued for fiscal years beginning after
        November 15, 2007 and interim periods within those fiscal years. The Company
        is
        evaluating the impact of adopting FAS 157 on the Company’s consolidated
        financial position, results of operations and cash flows.
  **3** **.  
        Acquisitions**
 
 **Core
        Systems Incorporated**
  On
        October 15, 2004, the Company completed the acquisition of Core Systems
        Incorporated (“Core”), a privately held semiconductor wafer processing company.
        The transaction was structured as a reorganization of Core with and into
        a newly
        formed, wholly-owned subsidiary of the Company. The operating results of
        Core
        Systems have been included in the Company’s statement of operations beginning
        October 15, 2004.
  The
        aggregate purchase price of Core was $7,486,000, which consisted of $2,000,000
        in cash; 311,437 shares of the Company's common stock with an aggregate fair
        value of $3,250,000; direct acquisition costs of approximately $1,726,000
        and
        the payment of approximately $510,000 of debt and other obligations coincident
        with the closing which were paid by issuing 48,875 shares of the Company’s
        common stock. The number of shares issued was initially determined by the
        average price of the Company’s stock over a twenty day period ending October 8,
        2004. The share price was subject to adjustment limiting the gain or loss
        in the
        value of the Company stock, over a twenty day period at the end of a six
        month
        lock-up, ending April 15, 2005, to 25% from the initial value. The twenty
        day
        average price of the stock for the period ending April 15, 2005 was $5.75
        which
        resulted in the need to issue an additional 112,475 shares. These shares
        were
        issued in August 2005. The fair value of the Company's common stock was
        determined based on the average market price of the Company's common stock
        over
        a period of time before October 15, 2004, the date fair value is to be
        determined, pursuant to Emerging Issues Task Force ("EITF") Issue
        No. 99-12, “Determination of the Measurement Date for the Market Price of
        Acquirer Securities Issued in a Purchase Business Combination.” In addition the
        purchase was subject to an earn out, payable in Company stock, which if earned
        would be accounted for as additional purchase price. The earn out period
        measurement date was October 14, 2005. No earn out payments became due.
 
 
 Core
                  Purchase PriceCash
              $
                  2,000,000Common
                  stock
              3,250,000Common
                  stock used to retire debt
              510,000Warrant
              1,122,000Direct
                  costs
              604,000$7,486,000
  
 The
        following table summarizes the allocation of the purchase price to the fair
        value of the assets acquired and liabilities assumed at the date of acquisition:
 
 October
                  15, 2004Accounts
                  receivable
              
              $
              518,000Inventory
              
              
              174,000Property
                  and equipment
              
              
              3,422,000Other
                  intangible assets
              
              
              335,000Goodwill
              
              
              4,647,000Other
                  assets
              
              
              74,000Accounts
                  payable and accrued expenses
              
              
              (1,063,000)Debt
                  and capital leases
              
              
              (621,000)$
              7,486,000
  The
        allocation of purchase price is the responsibility of management. The Company
        has considered a number of factors, including professional appraisals, for
        the
        valuation of equipment acquired, in making its purchase price allocation
        determination. The acquisition of Core resulted in goodwill of $4,647,000.
        The
        Company also identified $335,000 of intangible assets with finite lives.
        The
        intangible assets are being amortized over a period of sixty months, the
        estimated useful lives of the assets, from the date of acquisition, October
        15,
        2004. Amortization expense for the year ended June 30, 2006 and 2005 related
        to
        these intangible assets was $66,000 and $47,000, respectively. In fiscal
        2006,
        after performing its annual assessment of goodwill and other intangible assets,
        management recorded an impairment charge of $457,000 against the goodwill
        attributable to Core. This charge is reflected in the statement of operations
        for the year ended June 30, 2006.
  The
        acquisition of Core is accounted for as a purchase under SFAS No. 141,
“Business Combinations.” Accordingly, the operating results of Core are included
        in the accompanying consolidated financial statements since the acquisition
        date
        as part of the Company's semiconductor reporting segment.
  **Accurel
        Systems International Corporation**
 
 On
        March
        9, 2005, the Company acquired all of the stock of Accurel Systems International
        Corporation (“Accurel”), a California S Corporation, from existing
        shareholders.  The aggregate purchase price of Accurel of $12,176,000
        consists of the issuance of 418,194 shares of the Company’s common stock with a
        fair value of $3,520,000 based upon a value per share of $8.42, $6,036,000
        in
        cash, $1,650,000 note payable to the former Accurel shareholders and estimated
        direct acquisition costs of $970,000. The shareholder notes became due in
        120
        days from the closing and earned interest at 5%. The notes were collateralized
        by all of the equipment of Accurel. The notes were paid in full on July 8,
        2005.
        The shares issued were determined based on the average market price of the
        securities over a twenty day period ending March 8, 2005. The share price
        for
        valuation purposes was determined by the average share price for the period
        just
        prior to the date of the merger agreement announcement, pursuant to the guidance
        in EITF Issue No. 99-12. The purchase is subject to a 12-month holdback of
        $500,000 subject to the settlement of any and all pre-acquisition contingencies
        not specifically identified in the closing balance sheet. The shares issued
        were
        also subject to adjustment if the Company’s average stock price during the
        twenty trading days prior to the end of a three month lock-up is 25% higher
        or
        lower than the price on the closing date. The effect of this adjustment is
        to
        limit the selling shareholders’ gain or loss on the Company’s common stock to
        25% during the lock-up period ended June 9, 2005. The average stock price
        for
        the twenty day period ended June 9, 2005 was $2.97. In August 2005, an
        additional 504,144 shares of Company common stock was issued as a result
        of this
        adjustment. Accurel’s results from operations are included in the Company’s
        consolidated statement of operations beginning March 9, 2005, the date of
        acquisition.
  Accurel
                  Purchase PriceCash
              $
                  6,036,000Common
                  stock
              3,520,000Notes
                  payable to former shareholders
              1,650,000Direct
                  costs
              970,000$
                  12,176,000
  The
        following table summarizes the preliminary allocation of the purchase price
        to
        the fair value of the assets acquired and liabilities assumed at the date
        of
        acquisition :
  March 9, 2005Cash
              $
                  153,000Accounts
                  receivable
              1,073,000Prepaid
                  expenses and other assets
              183,000Property,
                  plant and equipment
              3,957,000Intangible
                  assets with finite lives
              1,670,000Goodwill
              7,566,000Assets
                  held for sale
              1,400,000Other
                  liabilities
              (1,386,000)Debt
                  and capital leases
              (2,440,000)$
                  12,176,000
 
 
 The
        above
        allocation of the purchase price includes the value of the intangible assets,
        determined to be $1,670,000 and goodwill of $7,566,000. The intangible assets
        are being amortized over periods of eighteen months to seven years based
        on
        their estimated useful lives. Amortization expense for these assets for the
        years ended June 30, 2006 and 2005 was $320,000 and $108,000, respectively. The
        allocation of the purchase price of Accurel is based on management estimates
        and
        assumptions and the results of independent appraisals. The
        allocation of purchase price is the responsibility of management. The Company
        considered a number of factors, including professional appraisals, in making
        its
        final determination. Included in the above allocation is an unfavorable lease
        obligation of $829,000, which was recorded as a long-term lease liability
        in
        accordance with SFAS 141. This liability reflects the estimated amount that
        Accurel’s future obligations under its facility lease are above the fair value
        of the leased facility, based on current market conditions on the acquisition
        date. The lease expires in 2010. During the years ended June 30, 2006 and
        2005,
        the Company amortized approximately $102,000 and $26,000, respectively, related
        to this long-term lease liability.
 
 The
        acquisition of Accurel is accounted for as a purchase under SFAS No. 141.
        Accordingly, the operating results of Accurel are included in the accompanying
        consolidated financial statements since the acquisition date as part of the
        Company's semiconductor reporting segment.
  The
        following table presents selected unaudited financial information of the
        Company
        including Core Systems Incorporated and Accurel Systems International
        Corporation as if the acquisitions had occurred on July 1, 2003. The unaudited
        pro forma results are not necessarily indicative of the results that would
        have
        occurred had the acquisition of Core Systems and Accurel been consummated
        on
        July 1, 2003, or of future results.
 
 **Year
                  Ended****June
                  30,****2005**
              
              **2004**Revenues
              
              
              $19,126,000
              
              $21,100,000Loss
                  from operations
              
              
              (7,356,000)
              
              (3,601,000)Net
                  loss
              
              
              (7,735,000)
              
              (3,921,000)Preferred
                  distribution, dividends and accretion
              
              
              (1,183,000)
              
              (2,527,000)Net
                  loss applicable to common shareholders
              
              
              ($8,918,000)
              
              ($6,448,000)Net
                  loss per share applicable to common shareholders, basic and
                  diluted
              
              
              ($0.88)
              
              ($0.74)Weighted
                  average common shares outstanding, basic and diluted
              
              
              10,168,743
              
              8,663,924
  **4.
        Inventories**
  Inventories
        consist of the following:
 **June
                  30,****2006**
              **2005**Raw
                  materials
              
              $
                  965,000
              $
                  548,000Work-in-progress
              
              291,000
              416,000Finished
                  goods
              
              276,000
              240,000$
                  1,532,000
              $
                  1,204,000
 
 The
        reserve
        for excess and obsolete inventory was $356,000, $204,000 and $81,000 as of
        June
        30, 2006, 2005 and 2004, respectively.
  **Year
                  ended June 30,****2006**
              
              **2005**
              
              **2004**Beginning
                  balance
              $
                  204,000
              
              $
                  81,000
              
              $
                  61,000Additional
                  expense accrued to the reserve
              212,000
              
              204,000
              
              81,000Charges
                  against the reserve
              (60,000)
              
              (81,000)
              
              (61,000)Ending
                  balance
              $
                  356,000
              
              $
                  204,000
              
              $
                  81,000
 
 
 
 **5.**  **Property
        and Equipment**
 
 Property
        and equipment consists of the following **:**
  **June
                  30,****2006**
              **2005**Machinery
                  and equipment
              $
                  13,901,000
              $
                  13,812,000Construction
                  in progress
              679,000
              474,000Computers
                  and software
              769,000
              648,000Leasehold
                  improvements
              445,000
              356,000Furniture
                  and fixtures
              337,000
              212,000Equipment
                  under capital lease
              282,000
              122,000Total
                  property and equipment
              16,413,000
              15,624,000Less:
                  Accumulated depreciation and amortization
              (7,504,000)
              (5,190,000)$
                  8
                  ,909,000
              $
                  10,434,000
 
  The
        Company recorded depreciation expense of approximately $2,423,000, $1,580,000
        and $866,000 for the years ended June 30, 2006, 2005 and 2004, respectively.
        Capitalized 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.
  **6.**  **Accrued
        Expenses**
 
 Accrued
        expenses consist of the following:
 **June
                  30,****2006**
              **2005**Accrued
                  costs related to acquisitions
              $
                  304,000
              $
                  794,000Accrued
                  compensation and benefits
              883,000
              730,000Other
                  accrued liabilities
              798,000
              921,000$
                  1,985,000
              $
                  2,445,000
 
 **7.**  **Investment
        in Unconsolidated Subsidiaries**
 
 In
        March
        2004, the Company entered into an Exchange & Venture Agreement with
        CardioTech International, Inc. (“CardioTech”), a public company and related
        party of the Company, and CorNova, Inc. (“CorNova”) (Note 9). CorNova is a
        start-up company incorporated as a Delaware corporation on October 12, 2003.
        CorNova’s focus is the development and marketing of innovative interventional
        cardiology products. The Company has determined that its technology may have
        applications in CorNova’s products. In connection with the agreement, in March
        2004, the Company and CardioTech issued 10,344 and 12,931 shares, respectively,
        of their respective common stock (the “Contributory Shares”) bearing an
        aggregate fair market value of $113,000 and $76,000, respectively, as of
        the
        date of the issuance. In exchange, the Company and CardioTech each received
        1,500,000 shares of CorNova’s common stock, which represented a 30% ownership
        position for each party. In February 2005, upon CorNova’s securing of an
        additional $3,000,000 in financing (“Series A”), CardioTech and the Company each
        issued an additional shares of their common stock (the “Investment Shares”),
        which was equal in value to twenty-five percent (25%) of the gross proceeds
        of
        the Series A Financing, or $750,000. The Company and CardioTech issued
        additional 76,687 and 308,642 shares of their common stock, respectively.
        As of
        June 30, 2006 and 2005, the Company’s shares represent an 18% and 18.9%
        respectively, ownership position in CorNova, and had a position on the Board
        of
        Directors.
  Both
        the
        Contributory Shares and the Investment Shares (collectively, the “Securities”)
        are restricted securities within the meaning of Rule 144 of the Securities
        and
        Exchange Commission under the Securities Act of 1933, as amended (the
“Securities Act”) and none of the Securities may be sold except pursuant to an
        effective registration statement under the Securities Act or under the
        securities laws of any state, or in a transaction exempt from registration
        under
        the Securities Act.
  The
        Company is accounting for this investment under the equity method pursuant
        to
        APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common
        Stock.” As of June 30, 2006, 87,031 shares have been issued to CorNova by the
        Company, 16,449 of which have been categorized as treasury stock in the
        accompanying balance sheet. These shares represent an approximate 18% of
        the
        shares issued. The Company’s Chief Executive Officer (“CEO”) is one of the
        directors of CorNova. For the years ended June 30, 2006, 2005 and 2004, the
        Company recognized approximately $359,000, $75,000 and $50,000, respectively,
        of
        equity losses in unconsolidated subsidiaries, representing the Company’s portion
        of CorNova’s net loss. The Company also recorded approximately $2,000 as an
        unrealized gain in 2006 and $78,000 and $6,000 as unrealized losses for the
        years ended June 30, 2005 and 2004, respectively. Gains and losses are recorded
        as other comprehensive income in the equity section of the Company’s financial
        statements. CorNova’s unaudited results for the twelve month period ended June
        30, 2006 were:
 
 
  **Year
                  Ended June 30**,**2006**
              
              **2005**
              
              **2004**Revenue
              $
                  92,000
              
              $
                  34,000
              
              -Expenses
              2,201,000
              
              646,000
              
              $
                  45,000Income
                  tax benefit
              180,000
              
              240,000
              
              -Net
                  Loss
              ($1,929,000)
              
              ($372,000)
              
              ($45,000)
 
 
 CorNova
        is developing a series of coronary stents used in angioplasty procedures. 
The ultimate goal is to market and sell a new drug eluting stent based on
        proprietary technology provided by the Company and CardioTech. All stents
        are
        primarily to be distributed in the non-US markets.  The first part of the
        plan is to market a new Cobalt-Chrome stent which has been developed and
        is
        scheduled to be released early in calendar 2007.  The drug eluting version
        which is based upon the Cobalt-Chrome base is still undergoing development
        testing.
 
 **8.**  **Research
        and Development Arrangements**
 
 The
        Company is the recipient of several grants under the U.S. Government’s Small
        Business Innovative Research (SBIR) Program. These grants from the National
        Institute of Health are firm-fixed priced contracts and generally range in
        length from six to twenty-four months. Contracts received from the Department
        of
        Defense are both firm-fixed price and cost-plus type programs and also range
        from six to twenty-four months. Revenues under such arrangements were
        approximately $3,478,000, $2,022,000 and $2,969,000 for the years ended June
        30,
        2006, 2005 and 2004, respectively. Revenues earned under these contracts
        are
        recognized in the appropriate business segment.
  
 **Year
                  ended June 30,**Segment
              
              **2006**
              
              **2005**
              
              **2004**Medical
              
              $
                  365,000
              
              $
                  444,000
              
              $
                  506,000Semiconductor
              
              -
              
              -
              
              -Security
                  products
              
              3,113,000
              
              1,294,000
              
              2,463,000Total
              
              $
                  3,478,000
              
              $
                  1,738,000
              
              $
                  2,969,000
 
 Unbilled
        accounts receivable relating to such arrangements was approximately $21,000,
        $298,000 and $1,434,000 at June 30, 2006, 2005 and 2004, respectively.
 
 **9.**  **Related
        Party Transactions**
 
 SFAS
        No.
        57, “Related Party Disclosures,” specifies the nature of information that should
        be disclosed in financial statements regarding related party transactions.
        CardioTech, a publicly traded company whose common stock trades under the
        symbol
        CTE on the American Stock Exchange, is a related party with the Company by
        virtue of its significant business relationships.
  Certain
        directors of the Company hold positions as directors of CardioTech. The CEO
        and
        Chairman of the Board of Directors of the Company is also a director of
        CardioTech. The CEO and Chairman of the Board of Directors of CardioTech
        is also
        a director of the Company.
  In
        March
        2000, the Company entered into a joint research agreement with CardioTech
        to
        develop a proprietary porous polymer biocompatible coating technology as
        a
        platform for the Company’s proprietary radioactive brachytherapy technology. In
        consideration for this agreement, the Company agreed to pay $150,000 in cash
        and
        purchase 100,000 shares of CardioTech stock at a price of $1.00 per share.
        As of
        June 30, 2006, the Company has purchased these shares, the fair market value
        of
        which is $196,000 and is recorded as investments in available for sale
        securities in the accompanying consolidated balance sheet. The unrealized
        holding gains and losses are recorded as accumulated other comprehensive
        income
        (loss) within stockholders’ equity.
  In
        March
        2004 the Company entered into an Exchange & Venture Agreement with
        CardioTech and CorNova (Note 7). The Company’s CEO and the Company’s Chairman of
        the Nominating Committee are also on the Board of Directors of CorNova.
  
 **10.**  **Commitments
        and Contingencies**
  (a)
        Capital and Operating Leases
  The
        Company has an operating lease for its manufacturing, research and office
        space
        in Wakefield, MA which expires on December 31, 2008. The Company has an option
        to extend the lease for five additional years. Under the terms of the lease,
        the
        Company is responsible for its proportionate share of real estate taxes and
        operating expenses relating to this facility. The Company also has leases
        for
        both of its facilities in Sunnyvale, CA. The leases expire in December 2009
        and
        September 2010 and the Company has an option to extend each lease for five
        additional years. The Company also has a small satellite facility in Austin,
        TX
        with a lease that expired in September 2006. The Company is currently
        negotiating a new lease for this location. Under the terms of the leases,
        the
        Company is responsible for its proportionate share of real estate taxes and
        operating expenses relating to these facilities. Total rental expense, including
        maintenance and real estate tax expenses, for the fiscal years ended June
        30,
        2006, 2005 and 2004 was $2,042,000, $1,352,000 and $644,000,
        respectively.
  In
        conjunction with the acquisition of Accurel, the Company recorded a lease
        liability of $829,000. This liability reflects managements 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.
        The
        balance of the lease liability on June 30, 2006 is $701,000, of which $126,000
        is current.
  Future
        minimum rental payments required under capital leases and operating leases
        with
        non-cancelable terms in excess of one year at June 30, 2006, together with
        the
        present value of net minimum lease payments are as follows:
  **Capital
                  Lease Payments**
              
              **Operating
                  Lease Payments**Year
                  ending June 30:2007
              
              $
                  105,000
              
              $
                  1,678,0002008
              
              93,000
              
              1,709,0002009
              
              77,000
              
              1,454,0002010
              
              66,000
              
              838,0002011
              
              44,000
              
              150,000Total
                  future minimum lease payments
              $385,000
              
              $
                  5,829,000Less:
                  amounts representing interest
              (90,000)Present
                  value of future minimum lease payments
              295,000Less:
                  current portion
              (70,000)Capital
                  lease obligation, net of current portion
              $225,000
 
  (b)
        Employment Agreements
  On
        June
        30, 2004, the Company entered into an employment agreement with Dr. Anthony
        J.
        Armini, the Company’s President and CEO, with an initial term of three years and
        an automatic renewal for a successive period of three years, unless the Company
        or Dr. Armini give the other party not less than three months written notice
        of
        non-renewal. Under this employment agreement, Dr. Armini serves as the Company’s
        president and chief executive officer at a base salary of up to $210,000
        and is
        subject to increase as authorized by the Compensation Committee. In addition,
        Dr. Armini may participate in the Company’s employee fringe benefit plans or
        programs generally available to employees of comparable status and position.
        The
        Company is entitled to terminate his employment for any material breach of
        his
        employment agreement at any time upon at least 30 days’ written notice. In the
        event the Company terminates Dr. Armini’s employment without cause, the Company
        will pay him 12 months salary. Under his employment agreement, he is subject
        to
        restrictive covenants, including confidentiality provisions. Also, during
        his
        employment and for a period of two years after the term of the employment
        agreement, Dr. Armini is subject to a non-competition provision.
  On
        June
        30, 2004, the Company entered into an employment agreement with Dr. Stephen
        Bunker, the Company’s Vice President and Chief Scientist, with an initial term
        of three years and an automatic renewal for a successive period of three
        years,
        unless the Company or Dr. Bunker give the other party not less than three
        months
        written notice of non-renewal. Under this employment agreement, Dr. Bunker
        serves as the Company’s vice president and chief executive scientist at a base
        salary of up to $150,000, subject to increase as authorized by the Compensation
        Committee. In addition, Dr. Bunker may participate in the Company’s employee
        fringe benefit plans or programs generally available to employees of comparable
        status and position. The Company is entitled to terminate his employment
        for any
        material breach of his employment agreement at any time upon at least 30
        days’
written notice. In the event the Company terminates Dr. Bunker’s employment
        without cause, the Company will pay him 12 months salary. Under his employment
        agreement, he is subject to restrictive covenants, including confidentiality
        provisions. Also, during his employment and for a period of two years after
        the
        term of the employment agreement, Dr. Bunker is subject to a non-competition
        provision.
 
 On
        October 15, 2004, the Company entered into an employment agreement with Walter
        J. Wriggins, the Company’s Vice President and General Manager of Core Systems,
        with an initial term of one year and an automatic renewal for a successive
        period of one year, unless the Company or Mr. Wriggins give the other party
        not
        less than thirty days written notice of non-renewal. Under this employment
        agreement, Mr. Wriggins serves as the Company’s vice president of business
        development/operations  and
        general manager of Core Systems at a base salary of $140,000. In addition,
        Mr.
        Wriggins may participate in the Company’s employee fringe benefit plans or
        programs generally available to employees of comparable status and position.
        The
        Company is entitled to terminate his employment for any material breach of
        his
        employment agreement at any time upon at least 30 days’ written notice. In the
        event the Company terminates Mr. Wriggins’ employment without cause, the Company
        will pay him the balance of the salary due for the term of the agreement.
        Under
        his employment agreement, he is subject to restrictive covenants, including
        confidentiality provisions. Also, during his employment and for a period
        of two
        years after the term of the employment agreement, Mr. Wriggins is subject
        to a
        non-competition provision
 
 
  (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
          or
          about March 8, 2006, the Company commenced an arbitration under the Rules
          of the
          American Arbitration Association against Respondents Majid Ghafghaichi
          (“Majid”)
          and Vahe Sarkissisian (“Vahe”), seeking a total of $3,994,000 for
          indemnification of various “Losses,” as defined in, and expressly allowed
          pursuant to, a Stock Purchase Agreement dated March 9, 2005 (the “Agreement”),
          between the Company, as the purchaser, Accurel Systems International Corporation
          (“Accurel), and  Majid and Vahe, as the sellers of 100% of the issued and
          outstanding shares of Accurel stock.
 More
            specifically, there are four claims asserted by the Company against Respondents:
            (1) Damages of $3.4 million resulting from misrepresentations concerning
            the
            loss of business from a key Accurel customer; (2) unauthorized withdrawals
            in
            the amount of approximately $276,000 from Accurel by the Respondents
            prior to
            the closing; (3) approximately $49,000 of disallowed transaction expenses
            that
            the Respondents improperly received; and (4) undisclosed net liabilities
            totaling approximately $269,000.
 
 Respondents
            have asserted counterclaims seeking “an aggregate amount in excess of
            $1,750,000,” based on the allegedly “late payment” to Respondents of Company
            stock and a Secured Promissory Note as part of the consideration for
            their sale
            of Accurel stock.  The Company has filed a detailed denial of all
            counterclaims.
 
 The
            arbitration is now in the discovery phase, and the hearings are scheduled
            for
            February, 2007.
 
 At
            this
            early stage of the proceedings, particularly before the commencement
            of
            depositions, it is difficult to assess the final outcome of this arbitration.
            However, the Company believes that the counterclaims have no merit, and
            will
            vigorously defend such counterclaims
 On
        March
        23, 2005, we entered into a Development, Distribution and Manufacturing
        Agreement (the “Agreement”) with Rapiscan Systems, Inc. (“Rapiscan”). 
Under the terms of this agreement, we gave Rapiscan the exclusive worldwide
        rights to market our Quantum
        Sniffer TM  portable
        and benchtop trace detection devices under their private label.  We also
        agreed to give Rapiscan the exclusive worldwide rights to distribute certain
        other new security products which we may develop in the future with their
        funding, as well as rights, in some circumstances, to manufacture certain
        components of the Quantum
        Sniffer TM  portable
        and benchtop trace detection devices.
 
 On
        March
        24, 2006, the Company brought suit in the United States District Court in
        the
        District of Massachusetts against Rapiscan and its parent, OSI Systems, Inc.
        (“OSI”). The Company is requesting rescission of the Agreement, for lack of
        performance and other grounds. In the alternative, the Company is seeking
        termination of the Agreement due to material breaches of contract and 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.
 
 On
        March
        27, 2006, the Company received notice that Rapiscan filed a complaint against
        the Company and its contract manufacturer, Columbia Tech Manufacturing Services,
        in the United States District Court for the Central District of California,
        regarding the Agreement. Rapiscan’s complaint against the Company is based upon
        claims of breach of contract and breach of warranty and is requesting a decree
        for specific performance, declaratory relief and injunctive relief. Rapiscan’s
        complaint against Columbia Tech is based upon injunctive relief, declaratory
        relief and tortuous interference with contractual relations. On April 12,
        2006,
        Rapiscan dismissed all claims against Columbia Tech.
 As
          of
          August 18, 2006, as a result of motions made by both parties, the two lawsuits
          have been consolidated in the United States District Court for the Central
          District of California with the Company as plaintiff. Presently, discovery
          is in
          process. Rapiscan and OSI have filed a motion to dismiss certain of the
          Company’s claims. The Company has not yet responded to the motion. It is
          expected that the Court will hear and rule on the motion in October
          2006.
 
 Should
        the Company be unsuccessful in prosecuting this matter, it may have a material
        adverse affect on its business and results of operations.
 
 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 affect on our
        business.
  
 **11.
        Income Taxes**
  A
        reconciliation of the federal statutory rate to the Company’s effective tax rate
        for the years ended June 30, 2006, 2005 and 2004 are as follows:
 
 **2006**
              **2005**
              **2004**Income
                  tax provision (benefit) at federal statutory rate
              (34.0%)
              (34.0%)
              (34.0%)Increase
                  (decrease) in tax resulting fromState
                  tax provision, net of federal benefit
              (3.95%)
              (8.5%)
              (8.0%)Non-deductible
                  expenses
              14.32%
              1.9%
              (3.6%)Credits
                  and other, net
              (-%)
              (-%)
              (.3%)Change
                  in valuation allowance
              23.63%
              40.6%
              45.9%Effective
                  income tax rate
              -
                  %
              -
                  %
              -%
  Significant
        components of the Company’s net deferred tax asset are as follows:
   ***Deferred
                  Tax Components*****2006**
              **2005**Deferred
                  tax assets:Net
                  operating loss and tax credit carryforwards
              $
                  10,517,000
              $
                  9,774,000Accrued
                  expenses
              721,000
              589,000Stock-based
                  compensation
              -
              4,000Total
                  deferred tax assets
              11,238,000
              10,367,000Deferred
                  tax liabilities:Excess
                  depreciation
              2,394,000
              2,787,000Excess
                  amortization
              462,000
              466,000Investment
                  in affiliates
              87,000
              224,000Total
                  deferred tax liabilities
              2,943,000
              3,477,000Net
                  deferred tax assets
              8,295,000
              6,890,000Valuation
                  allowance
              (8,295,000)
              (6,890,000)Net
                  deferred tax asset
              $                   -
              $               
                   -
 
  
 A
        valuation allowance has been established for the Company’s tax assets as their
        use is dependent on the generation of sufficient future taxable income, which
        cannot be predicted at this time. Included in the valuation allowance is
        approximately $1,439,000 related to certain operating loss carryforwards
        resulting from the exercise of employee stock options, the tax benefit of
        which,
        when recognized, will be accounted for as a credit to additional paid in
        capital
        rather than a reduction in income tax.
  At
        June
        30, 2006, the Company has the following unused net operating loss and tax
        credit
        carryforwards available to offset federal and state taxable income, both
        of
        which expire at various times through 2025.
 Net
                    Operating Loss
                Investment,
                    AMT
                  and
                    R & D Credits
                Expiration
                    DatesFederal
                $
                    25,109,000
                $
                    264,000
                2019
                    to 2025State
                $
                    23,771,000
                $
                    341,000
                2006
                    to 2010
  The
        Company’s federal net operating loss carryforwards are subject to review and
        possible adjustment by the Internal Revenue Service and are subject to certain
        limitations in the event of cumulative changes in the ownership interest
        of
        significant stockholders over a three-year period in excess of 50%.
  
  **12.**  **Redeemable
        Convertible Preferred Stock**
 
 On
        July
        6, 2005, the Company executed a $3.0 million secured term note payable to
        Laurus
        Master Fund, Ltd. (“Laurus”). The Company received $3,000,000 in gross proceeds,
        less a management fee of $135,000 and related transaction costs of approximately
        $32,000. The term note was collateralized by substantially all of the Company’s
        assets, had a 4-month term and bore interest at a rate equal to the prime
        rate
        plus one percent (1%). In connection with the financing, on September 30,
        2005,
        the Company issued Laurus a warrant to purchase up to 250,000 shares of the
        Company’s common stock at a price equal to $3.75 per share. The
        warrants were valued using the Black Scholes model and the following
        assumptions: volatility of 67%, expected life of 5 years and a risk free
        interest rate of 3.77%. Net proceeds from the financing were used for increasing
        the capacity of the Quantum SnifferTM production line, increasing unit
        inventories and the repayment of certain indebtedness due and owed by the
        Company to the former shareholders of Accurel in connection with the acquisition
        of this wholly-owned subsidiary.
  On
        September 30, 2005, the Company issued 500,000 shares of Series D Redeemable
        Convertible Preferred Stock (“Series D”) having a stated value of $10 per share,
        pursuant to a Securities Purchase Agreement with Laurus. The Company received
        $5,000,000 in gross proceeds, less a management and placement agent fee of
        approximately $90,000, and related transaction costs of approximately $27,000.
        The Company utilized the proceeds to repay the $3 million term note with
        Laurus
        signed on July 6, 2005. The Series D has a dividend equal to the prime rate
        plus
        one percent (1%) (9.25% at June 30, 2006) and provides for redemption over
        a
        thirty-six month period pursuant to an amortization schedule. In conjunction
        with the Series D, the Company also issued to Laurus a warrant to purchase
        up to
        50,000 shares of the Company’s common stock at a price equal to $10.20 per
        share. The warrants were valued using the Black Scholes model and the following
        assumptions: volatility of 80%, an expected life 5 years, and a risk free
        interest rate of 4.12%. Net cash proceeds from this financing were $1,883,000
        (which included repayments of $3,000,000 of principal related to the July
        6,
        2005 term note and $117,000 of issuance costs).
  The
        following table reflects the required redemption of the Series D before the
        effect of the accrued dividends:
 
 Year
                  ending June 30:
              
              Preferred
                  Stock Monthly Redemption Schedule2007
              
              $
                  1,364,0002008
              
              1,818,0002009
              
              909,000Total
              
              $
                  4,091,000
 
 The
        monthly redemption of approximately $152,000 plus accrued dividends commences
        on
        October 1, 2006. At its option the Company deferred the October redemption
        to
        the end of the term. Subject to certain conditions, it is at the Company’s
        option to pay this amount in cash or in common stock at a fixed conversion
        price
        of $4.15 per common share. This fixed conversion price is subject to reset
        should the Company declare a stock dividend or split, combine the outstanding
        common stock into a smaller number of shares, or issue, by reclassification
        of
        its common stock, any shares or other securities of the Company. The fixed
        conversion price shall be adjusted proportionately so that the holder of
        the
        Series D shall be entitled to receive the kind and number of shares or other
        securities of the Company which such Laurus would have owned or have been
        entitled to receive after the happening of any of the events described above,
        had such shares of Series D Preferred Stock been converted immediately prior
        to
        the happening of such event.
 
 The
        following conditions must be met in order for the Company to be permitted
        to pay
        in common stock: (1) the shares must be issued pursuant to an effective
        registration statement, (2) the average closing market price of the common
        stock
        for the five trading days immediately preceding a payment date must exceed
        the
        fixed conversion price by 110% and no one day’s closing price may be less than
        the fixed conversion price, and (3) the conversion dollar value may not exceed
        the aggregate of the prior 22 trading days’ dollar volume. The dividend rate is
        subject to a 2% decrease for every 25% the average trading price for the
        five
        trading days prior to a repayment date exceeds the fixed conversion price,
        to a
        minimum of 0%. In addition, upon notifying the holder, the Company has the
        option of redeeming any outstanding shares of Series D with cash by paying
        130%
        of the stated value plus accrued interest.
  
 As
        a
        condition of closing, the Company and each of its Subsidiaries granted a
        security interest in their respective assets as well as providing Laurus
        a right
        of first refusal on future financing arrangements during the term of the
        Agreement. In the event Laurus declines to exercise its right of first refusal,
        it agreed to enter into such documentation as shall be reasonably requested
        by
        the Company in order to subordinate its rights under the Series D to the
        subsequent financier. The registration rights associated with the Agreement
        state that the Company will use its best efforts to have the registration
        statement effective within 120 days from closing. In addition, the Company
        is
        required to maintain an effective registration statement, and ensure that
        shares
        are not suspended from trading. Upon notice from Laurus, should the Company
        be
        declared in default of these items and have not cured the default within
        the
        prescribed period, the Company may be assessed liquidated damages equal to
        1/30 th of 0.1%
        of the outstanding preferred balance, payable in cash, for each day the event
        has occurred and remains outstanding. However, pursuant to the Agreement,
        “liquidated damages do not apply should the Securities and Exchange Commission
        (“SEC”) have an issue with respect to the Holder or with respect to the
        structure of the transaction.”
 
 In
        accordance with the provisions of Emerging Issues Task Force (“EITF”) Issue
        00-19, “Accounting for Derivative Financial Instruments Indexed to, and
        Potentially Settled in, a Company’s Own Stock,” the Company concluded that the
        Series D contained a conversion feature which should be valued at fair value
        and
        be recorded as a liability on the balance sheet. This conversion feature
        is not
        considered to be a “conventional preferred” instrument because the Agreement
        includes certain conditions under which the conversion price may be reset.
        This
        condition would suggest that the number of shares to be issued upon conversion
        is not fixed, which is a requirement of a “conventional preferred” instrument.
        This conversion feature was also determined to be a liability since it may
        be
        required to be repaid in cash, cannot be paid in unregistered shares and
        has
        certain penalties. These conditions define the conversion feature as an embedded
        derivative which must be separated from the host and reported at fair value
        pursuant to SFAS 133, “Accounting for Derivative Instruments and Hedging
        Activities” (“SFAS No. 133”).
 
 The
        Series D also contains certain other embedded derivatives which, pursuant
        to
        SFAS No. 133, must be bifurcated from the host contract and reported at its
        fair
        market value. The first feature includes a dividend rate that is subject
        to
        adjustment based on the market price of the Company’s common stock. The second
        feature, related to potential default provisions, could potentially increase
        the
        dividend and redemption price, similar to a default or penalty clause in
        a
        debt-like instrument. Although the Company has valued all embedded derivatives
        of the host contract as one derivative instrument, the Company believes the
        value of the adjustable dividend rate and the potential default provisions
        features are immaterial. Management considered a number of factors, including
        independent appraisals when making this determination. The Company will continue
        to measure all derivatives at each reporting period as future changes in
        value
        may become material.
 
 
 The
        conversion feature aggregated to $1,397,000 on September 30, 2005 based on
        the
        Black- Scholes valuation model and the following assumptions: volatility
        80%,
        expected life 1.5 years, and a risk free interest rate of 3.96%.  The
        conversion feature is marked to market at each reporting period with
        changes flowing through the statement of operations. As of June 30, 2006,
        the
        fair value of this conversion feature approximated $1,094,000.   
The value of the embedded derivates related to the adjustable dividend
        rate and the potential default provisions were determined to be immaterial
        at
        June 30, 2006.
 
 The
        Company valued the Series D at issuance at its residual value of $2,700,000
        based on the fair values of the financial instruments issued in connection
        with
        this preferred stock financing, including the warrants, the embedded derivative
        instruments and offering costs. The amounts recorded in the financial statements
        represent the amounts attributed to the sale of the Series D preferred stock,
        the amount allocated to warrants of $672,000, the value attributed to the
        embedded derivatives of $1,397,000 and $271,000 of issuance costs (including
        $154,000 of unamortized costs of the July 6, 2005 term note). Approximately
        $40,000 of the warrant value was accounted for as interest expense in the
        period
        ended December 31, 2005. 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 June 30, 2006, $777,000 was amortized. The outstanding balance
        on the Series D was $4,091,000 at June 30, 2006.
 
 On
        May
        31, 2006, the Company amended the Series D and the Certificate of Vote of
        Directors Establishing a Class or Series of Stock. The terms of the amendment
        permit the Company to defer approximately $455,000 of cash payments,
        representing the January 2006, February 2006 and March 2006 amortization
        payments, and to defer the October 2006 amortization payment, should such
        payment be required in cash, to the mandatory redemption date of September
        30,
        2008. In consideration, the Company has agreed to the conversion of the April
        2006, May 2006, June 2006, July 2006, August 2006 and September 2006
        amortization payments into 261,233 shares of common stock of the Company
        at a
        conversion price of $3.48 per share, representing a reduction in principal
        of
        approximately $909,000, and to reduce the Fixed Conversion Price of the
        remaining Series D stock from $6.80 per share to $4.15 per share. In addition,
        Laurus was granted a warrant to purchase 150,000 shares of the Company’s common
        stock at an exercise price of $4.26 per share. The warrants were valued at
        $375,000 using the Black Scholes model and the following assumptions: volatility
        of 79%, an expected life 5 years, and a risk free interest rate of 4.89%.
 
 The
            amendment of the Series D, as described above, was accounted for as an
            extinguishment of debt in accordance with EITF 96-19 "Debtor's Accounting
            for a
            Modification or Exchange of Debt Instruments." The Company determined
            a
            substantial difference in the net present value of the cash flows under
            the
            terms of the amendment was more than 10 percent different from the present
            value
            of the remaining cash flows under the terms of the original Series D
            agreement.
            Due to the substantial difference, the Company determined an extinguishment
            of
            debt had occurred with the amendment, and as such, it was necessary to
            reflect
            the Series D at its fair market value. Accordingly, the following table
            shows
            the basis for the Series D extinguishment:
 
 Extinguishment
                    of Series D debt instrument at May 31, 2006:Redemption
                    payments
                    due
                
                $909,000Unamortized
                    discount of warrants, derivative value of preferred stock conversion
                    and
                    issue costs
                
                266,000Derivatives
                    related to the preferred stock features
                
                578,000Subtotal
                
                $1,753,000Record
                    New Series D debt instrument at May 31, 2006:Fair
                    value of redemption payments made
                
                $1,011,000Issuance
                    of 150,000 warrants
                
                375,000Unamortized
                    discount of warrants, derivative value of preferred stock conversion
                    and
                    issue costs
                
                266,000Derivatives
                    related to the preferred stock features
                
                1,395,000Subtotal
                
                $3,047,000Loss
                    on extinguishment of Series D debt instrument
                
                $1,294,000
  The
        $1,294,000 aggregate loss from these transactions is accounted for as an
        extinguishment of debt and is included in Other expenses for the year ended
        June
        30, 2006.
  
 **13.
        Stockholders’ Equity**
 
 (a)
        IPO
        Units
 
 In
        June
        1999, the Company issued 1,138,000 Units, consisting of one share of common
        stock and one redeemable common stock purchase warrant (the “IPO Warrants”), in
        connection with its initial public offering. Each Unit carries the right
        to
        purchase one share of common stock at $9.00, and is redeemable by the Company
        at
        $0.20 per warrant if the closing bid price of the common stock averages in
        excess of $10.50 for a period of 20 consecutive trading days. On April 15,
        2003,
        the Company extended the expiration date of the IPO Warrants from June 30,
        2003
        to June 30, 2005. The Company did not receive any consideration from the
        holders
        of the warrants; accordingly, the Company recognized the value of this
        transaction as a preferred distribution based upon the estimated fair value
        of
        the extension of approximately $195,000. On March 14, 2005, the Company again
        extended the expiration date of the IPO Warrants from June 30, 2005 to March
        31,
        2006. The Company did not receive any consideration from the holders of the
        warrants; accordingly, the Company recognized the value of this transaction
        as a
        preferred distribution based upon the estimated fair value of the extension
        of
        approximately $479,000. On March 31, 2006, the IPO warrants expired. There
        are
        no IPO Warrants outstanding.
 
 (b)
        Option Activity
 
 In
        September 1998, the Company adopted the 1998 Stock Option Plan (the “1998
        Plan”). The 1998 Plan provides for the grant of incentive stock options and
        nonqualified stock options to employees and affiliates. The exercise price
        of
        the options equals 100% or 110% of the fair market value on the date of the
        grant. The exercise price of the options equal 100% of the fair market value
        on
        the date of the grant or 110% of the fair market value for greater than 10%
        beneficial owners of the Company stock. Options expire between five and ten
        years from the date of the option grant and have various vesting periods.
        Options may be exercised by the Holder delivering to the Company cash in
        an
        amount equal to such aggregate exercise price, or with the consent of the
        Committee, shares of Company Common Stock having a fair market value equal
        to
        such aggregate exercise price, a personal recourse note issued to the Company
        in
        a principal amount equal to such aggregate exercise price or other acceptable
        consideration including a cashless exercise/resale procedure or any combination
        of the foregoing. The Committee may in its discretion provide upon the grant
        of
        any option that the Company shall have an option to repurchase, upon terms
        and
        conditions determined by the Committee, all or any number of shares purchased
        upon exercise of such option. A total of 280,000 options were reserved for
        issuance under the 1998 Plan. Upon adoption of the 1998 Plan, the 1992 Stock
        Option Plan was terminated.
  In
        December 2000, the Company adopted the 2000 Incentive and Non Qualified Stock
        Option Plan (the “2000 Plan”). The 2000 Plan provides for the grant of incentive
        stock options and nonqualified stock options to employees and affiliates.
        The
        exercise price of the options equal 100% of the fair market value on the
        date of
        the grant or 110% of the fair market value for greater than 5% beneficial
        owners
        of the Company stock. Options expire between five and ten years from the
        date of
        the option grant and have various vesting periods. Options may be exercised
        by
        the Holder delivering to the Company cash in an amount equal to such aggregate
        exercise price, or with the consent of the Committee, shares of Company Common
        Stock having a fair market value equal to such aggregate exercise price,
        a
        personal recourse note issued to the Company in a principal amount equal
        to such
        aggregate exercise price or other acceptable consideration including a cashless
        exercise/resale procedure or any combination of the foregoing. The Committee
        may
        in its discretion provide upon the grant of any option that the Company shall
        have an option to repurchase, upon terms and conditions determined by the
        Committee, all or any number of shares purchased upon exercise of such option.
        A
        total of 600,000 options were originally reserved for issuance under the
        2000
        Plan. In December 2003, the stockholders of the Company approved an increase
        in
        the 2000 Incentive and Non-Qualified Stock Option Plan from 600,000 shares
        to
        1,000,000 shares. In December 2004, the stockholders of the Company approved
        an
        increase in the 2000 Incentive and Non-Qualified Stock Option Plan from
        1,000,000 shares to 1,500,000 shares.
 
 In
        December 2004, the Company adopted the 2004 Stock Option Plan. The 2004 Plan
        provides for the grant of incentive stock options and nonqualified stock
        options
        to employees and affiliates. A total of 500,000 options were originally reserved
        for issuance under the 2000 Plan. The exercise price of the options equa1
        100%
        of the fair market value on the date of the grant or 110% of the fair market
        value for greater than 10% beneficial owners of the Company stock. Options
        expire between five and ten years from the date of the option grant and have
        various vesting periods. At the December 2005 annual meeting the shareholders
        voted to increase the shares available for issuance under the 2004 Plan by
        500,000 to 1,000,000 shares. Options may be exercised by the Holder delivering
        to the Company cash in an amount equal to such aggregate exercise price,
        or with
        the consent of the Committee, shares of Company Common Stock having a fair
        market value equal to such aggregate exercise price, a personal recourse
        note
        issued to the Company in a principal amount equal to such aggregate exercise
        price or other acceptable consideration including a cashless exercise/resale
        procedure or any combination of the foregoing. In December 2005, the
        stockholders of the Company approved an increase in the 2004 Incentive and
        Non-Qualified Stock Option Plan from by 500,000 shares to 1,000,000 shares.
  As
        of
        June 30, 2006, a total of 109,003, 141,490, and 398,664 shares are available
        for
        issuance under the 1998 Plan, 2000 Plan and 2004 Plan, respectively.
 
 In
        September 1998, the Company adopted the 1998 Employee Stock Purchase Plan
        (the
“Plan”). The Plan provides a method whereby employees of the Company will have
        an opportunity to acquire an ownership interest in the Company through the
        purchase of shares of common stock of the Company through payroll deductions.
        After 12 months of employment, an employee is eligible to participate and
        can
        defer up to 10% of their wages into this Plan, with a maximum of $25,000
        in any
        calendar year. The purchase price of the common stock is calculated at the
        lower
        of 85% of the closing price of the stock on the first day of the plan period
        or
        the last day of the plan period. The periods are January 1 to June 30 and
        July 1
        to December 31. Fractional shares are not issued. Participants may withdraw
        at
        any time by giving written notice to the Company and will be credited the
        amounts of deferrals in their account. The maximum number of shares eligible
        to
        be issued under the Plan is 141,000. As of June 30, 2006, a total of 78,163
        shares are available for issuance under the Plan.
 
 
 The
        following table presents the activity of the 1992, 1998, 2000 and 2004 Stock
        Option Plans for the years ended June 30, 2006, 2005 and 2004:
  **2006**
              
              **2005**
              
              **2004****Shares**
              
              **Weighted-**
                **Average**
                **Exercise**
                **Price**
              
              **Shares**
              
              **Weighted-**
                **Average**
                **Exercise**
                **Price**
              
              **Shares**
              
              **Weighted-**
                **Average**
                **Exercise**
                **Price**Outstanding
                  at beginning of period
              1,908,331
              
              $
                  5.66
              
              1,162,065
              
              $
                  5.55
              
              953,500
              
              $
                  5.55Granted
              557,750
              
              4.43
              
              973,726
              
              5.91
              
              352,200
              
              6.75Exercised
              (
                  41,700)
              
              3.46
              
              (153,160)
              
              5.69
              
              (138,635)
              
              3.77Canceled
              (587,830)
              
              6.62
              
              (74,300)
              
              8.74
              
              (5,000)
              
              7.74Outstanding
                  at end of period
              1,836,551
              
              $
                  5.41
              
              1,908,331
              
              $
                  5.66
              
              1,162,065
              
              $
                  5.55Options
                  exercisable at end of period
              1,113,947
              
              $
                  4.98
              
              1,016,362
              
              $4.51
              
              665,560
              
              $4.90Weighted-average
                  fair value of options granted during the year
              
              
              $
                  2.72
              
              $
                  4.37
              
              
              
              $5.15
  
 The
        following table presents weighted average price and life information about
        significant options groups
        outstanding at June 30, 2006:
  **Options
                  Outstanding**
              
              **Options
                  Exercisable**Range
                  of Exercise Prices
              
              Number
                  of Shares
              Weighted
                  Average Remaining Contractual Life (in years)
              Weighted
                  Average Exercise Price
              Intrinsic
                  Value
              
              Number
                  of Shares
              Weighted
                  Average Exercise Price
              Intrinsic
                  Value$0.00
                  - $2.31
              
              128,101
              2.04
              $1.10
              $
                  2.20
              
              128,101
              $1.10
              $
                  2.20$3.07
                  - $4.65
              
              914,550
              6.97
              4.01
              (0.71)
              
              615,150
              4.14
              (0.81)$5.25
                  - $6.96
              
              418,900
              8.02
              6.28
              (2.98)
              
              185,596
              6.28
              (2.98)$7.50
                  - $9.97
              
              288,000
              7.18
              9.00
              (7.70)
              
              131,100
              8.80
              (5.50)$10.00
                  - $14.00
              
              87,000
              7.87
              10.35
              (7.05)
              
              54,000
              10.36
              (7.06)**1,836,551**
              **6.94**
              **$5.41**
              **($
                  2.11)**
              
              **1,113,947**
              **$4.98**
              **($
                  1.68)**
  As
        of
        June 30, 2006 there was $1,871,000 of total unrecognized compensation expense
        related to unvested share based compensation arrangements under the various
        share-based compensation plans. This expense is expected to be recognized
        as
        follows:
 
 Year
                  ending June 30:2007
              $1,206,0002008
              569,0002009
              96,000Total
              $1,871,000
 
 
 (c)
        Warrants
 
 During
        the year ended June 30, 2004, the Company issued a warrant to an investor
        relations company to purchase 250,000 shares of common stock at an exercise
        price of $14.00, in exchange for services. This warrant was fully vested
        and
        expired on June 30, 2004. The fair value of this warrant was approximately
        $230,000 and was recorded as compensation expense in the accompanying statement
        of operations for the year ended June 30, 2004. In June 2004, the Company
        issued
        this investor relations company another warrant to purchase 150,000 shares
        of
        the common stock at an exercise price of $14.00, in exchange for continued
        services. These warrants were fully vested upon issuance and expire 3 years
        from
        the date of grant. The fair value of these warrants was approximately $638,000
        and was recorded as compensation expense in the accompanying statement of
        operations during the year ended June 30, 2004.
 
 During
        the year ended June 30, 2004, the Company issued other warrants to various
        advisors and individuals in exchange for services to purchase a total of
        10,000
        shares of common stock at exercise prices ranging from $9.95 to $10.25. The
        fair
        value of these warrants was approximately $58,000 and was recorded as
        compensation expense in the accompanying statement of operations during the
        year
        ended June 30, 2004.
  In
        October 2004, the Company issued 200,000 common stock warrants, at an exercise
        price of $9.75, to a consultant in connection with the Core acquisition.
        The
        warrants were fully vested upon issuance and expire 5 years from the date
        of
        grant. The Company recorded the fair value of these warrants, of approximately
        $1,122,000, as additional costs associated with the Core acquisition and
        included this value in the total purchase price of the acquisition.
  In
        March
        2005, in connection with a private placement, the Company issued warrants
        to the investors to purchase 270,195 shares of common stock, and warrants
        to
        placement agents to purchase 43,231 shares of common stock, at an exercise
        price
        of $9.35, which are exercisable anytime between September 4, 2005 and September
        4, 2010.
 
 In
        July
        2005, in connection with the a short term note with Laurus Master Fund, the
        Company issued warrants
        to the investor to purchase up to 250,000 shares of common stock at an exercise
        price of $3.75, which are exercisable anytime between September 30, 2005
        and
        September 30, 2010.
 
 In
        September 2005, in conjunction with the Series D financing, the Company issued
        warrants to the investors to purchase 50,000 shares of common stock at an
        exercise price of $10.20, which are exercisable anytime between September
        30,
        2005 and September 20, 2010.
  In
        April
        2006, in connection with an agreement with two investors, the Company issued
        warrants to purchase a total of 35,000 shares of common stock at an exercise
        price of $3.75 per share, which are exercisable between April 17, 2006 and
        July
        6, 2010. The Company recorded the fair value of these warrants, of approximately
        $67,000, as an operating expense in the accompanying statement of operations
        during the year ended June 30, 2006.
 
 In
        May
        2006, in conjunction with a modification to the Series D financing, the Company
        issued warrants to purchase 150,000 shares of common stock at an exercise
        price
        of $4.26 per share. The warrants are exercisable between May 31, 2006 and
        May
        31, 2011. The Company recorded the fair value of these warrants of approximately
        $375,000 as a conversion expense in the accompanying statement of operations
        during the year ended June 30, 2006.
 
 During
        the year ended June 30, 2006, the Company issued fully vested warrants to
        various advisors in exchange for services, to purchase a total of 27,500
        shares
        of common stock at exercise prices ranging from $3.40 to $4.14. The Company
        recorded the fair value of these warrants of approximately $52,000 as stock
        based compensation expense. In addition, approximately $26,000 of additional
        compensation expense was recorded relating to certain warrants issued in
        prior
        years being expensed over their vesting period.
 
 The
        Company estimated the fair value of the warrants issued during 2006, 2005
        and
        2004 using the Black-Scholes option-pricing model. The Company estimated
        the
        fair value of the warrants using the following input assumptions:
 ****
 **2006**
              **2005**
              **2004**Volatility
              78.5%
                  - 80.4%
              62.0%
                  - 65.0%
              63.0%
                  - 67.5%Dividend
                  yield
              0%
              0%
              0%Risk-free
                  interest rate
              3.86%
                  - 4.89%
              3.47%
                  - 4.17%
              .94%
                  - 4.50%Expected
                  lives
              2.5
                  - 5 years
              1
                  year - 5 years
              3
                  months - 5 years
 
  The
        following table presents the weighted average exercise price of warrants
        outstanding at June 30, 2006:
 
 **Warrants
                  Outstanding and Exercisable**Range
                  of Exercise Prices
              
              Number
                  of Warrant Shares
              Weighted
                  Average Exercise Price
              Weighted
                  Average Intrinsic Value$3.16
                  - $5.24
              
              659,902
              $
                  3.95
              (
                  $
                  0.65)$6.23
                  - $10.25
              
              828,426
              8.86
              (
                  5.56)$11.33
                  - $14.00
              
              267,675
              13.13
              (
                  9.83)Total
              
              1,756,003
              $
                  7.67
              (
                  $
                  4.37)
   
 The
        following table presents the warrant activity for the years ended June 30,
        2006,
        2005 and 2004:
   **2006**
              ****
              **2005**
              ****
              **2004**Shares
              
              Weighted
                  Average Exercise Price
              
              Shares
              
              Weighted
                  Average Exercise Price
              
              Shares
              
              Weighted
                  Average Exercise PriceOutstanding
                  at beginning of period
              2,324,389
              
              9.53
              
              1,876,803
              
              $9.72
              
              1,651,775
              
              $8.80Granted
              512,500
              
              4.53
              
              559,426
              
              9.01
              
              723,088
              
              12.65Exercised
              (15,961)
              
              4.32
              
              (42,810)
              
              3.28
              
              (186,120)
              
              6.06Canceled
              (1,064,700)
              
              9.00
              
              (69,030)
              
              14.40
              
              (311,940)
              
              13.84Warrants
                  Outstanding at end of period
              1,756,003
              
              $7.67
              
              2,324,389
              
              $9.53
              
              1,876,803
              
              $9.72Warrants
                  exercisable at end of period
              1,740,669
              
              $7.64
              
              2,293,389
              
              $9.01
              
              1,876,803
              
              $12.65Weighted-average
                  fair value of warrants granted during the year
              
              
              $4.53
              
              
              
              $9.01
              
              
              
              $12.65
 
 
 **14.
        401k Plan**
  The
        Company has a defined contribution retirement plan which contains a 401(k)
        plan.
        Currently, Wakefield and one of the California subsidiaries employee groups
        are
        in the same plan. The second subsidiary maintained a separate plan through
        June
        30, 2006. Effective July 1, 2006, all employee groups will be under the same
        401(k) Plan. Although all of the plans are 401(k) plans, eligibility
        requirements vary from location to location. All employees who meet the age
        requirement, either 18 or 21, and who have completed the minimum service
        requirement are eligible for participation in the plan. The Company may make
        discretionary contributions to the 401(k) plan. During the years ended June
        30,
        2006, 2005 and 2004, the Company made no contributions to the plan.
  **15.**  **Long-term
        Debt**
  *MED-TEC
        Payment Obligation*
  On
        July
        31, 2003, the Company entered into an agreement with its former exclusive
        distributor of prostate seeds, to release each other from further obligations
        under the original Distributor Agreement.  The new agreement conveys to the
        Company direct marketing and sales capabilities to sell its I-Plant Seed
        brachytherapy seeds for use in the treatment of prostate cancer.  In
        connection with this, the Company’s former exclusive distributor agreed to work
        cooperatively to transition customers and marketing materials directly to
        the
        Company.  The distributor also agreed not to compete with the Company for a
        period of three years.  The present value of this payment obligation was
        recorded as approximately $1,007,000, using a rate of 10.24%. This amount
        was
        recorded as an intangible asset and is being amortized over its estimated
        useful
        life of 29 months.  During the years ended June 30, 2006, 2005 and 2004,
        approximately $208,000, $417,000 and $383,000, respectively, of amortization
        expense was recognized, which is included in selling, general and administrative
        expenses in the accompanying consolidated statements of operations. As of
        June
        30, 2006, the outstanding principal balance is approximately $233,000.  For
        the years ended June 30, 2006, 2005 and 2004, the Company recorded approximately
        $30,000, $46,000 and $68,000, respectively, of interest expense relating
        to this
        transaction.
  *Installment
        Note*
 
 Accurel
        Systems has a $1,400,000 fixed rate installment note with a bank. The note
        calls
        for monthly payments of $29,000 plus interest at a rate of 6.84%, through
        September 1, 2008 (the “Loan Agreement”). As of June 30, 2006 the note balance
        is $817,000 of which approximately $350,000 becomes due during the year ending
        June 20, 2007. The note is collateralized by substantially all assets of
        Accurel. The bank has consented to continue the note under the same terms
        after
        the acquisition. During the years ended June 30, 2006 and 2005, the Company
        recorded interest expense of approximately $71,000 and $25,000, respectively,
        in
        connection with this note.
  The
        Loan
        Agreement requires Accurel to report monthly financial results to the bank
        and
        for Accurel to comply with certain financial covenants. As of June 30, 2006
        Accurel was in compliance with the covenants.
 
 Future
        principal payments on this note are as follows:
 
 Year
                  ending June 30,2007
              
              $350,0002008
              
              350,0002009
              
              117,000Total
              
              $817,000
 
 
 **16.
        Financial Information by Segment**
 
 Under
        SFAS No. 131, “Disclosures about Segments of an Enterprise and Related
        Information,” operating segments are defined as components of an enterprise
        about which separate financial information is available that is evaluated
        regularly by the chief operating decision maker, or decision making group,
        in
        deciding how to allocate resources and in assessing performance. The Company's
        chief operating decision making group is composed of the chief executive
        officer
        and members of senior management. The Company's reportable segments are:
        Medical, Semiconductor and Security Products.
 
 Gross
        margin is the measure that management uses when evaluating the Company’s
        segments, therefore, operating expenses are excluded from the financial
        information below.
  The
        revenues, expenses and assets related to these segments for the years
        ended June 30, 2006, 2005 and 2004 are:
 Medical
                
                Semiconductor
                
                Security
                
                TotalYear
                    Ended June 30, 2006Revenue
                $
                    4,464,000
                
                $
                    15,056,000
                
                $
                    6,871,000
                
                $
                    26,391,000Cost
                    of revenues
                3,869,000
                
                11,953,000
                
                6,222,000
                
                22,044,000Gross
                    margin
                $
                    595,000
                
                $
                    3,103,000
                
                $
                    649,000
                
                $
                    4,347,000Total
                    assets
                $
                    3,822,000
                
                $
                    24,312,000
                
                $
                    2,665,000
                
                $
                    30,779,000Year
                    Ended June 30, 2005Revenue
                $
                    4
                    ,146,000
                
                $
                    6,630,000
                
                $
                    1,510,000
                
                $
                    12,286,000Cost
                    of revenues
                (3,821,000)
                
                (6,316,000)
                
                (1,919,000)
                
                (12,056,000)Gross
                    margin
                $
                    325,000
                
                $
                    314,000
                
                $
                    (409,000)
                
                $
                    230,000Total
                    assets
                $
                    5,227,000
                
                $
                    25,492,000
                
                $
                    1,509,000
                
                $
                    32,228,000Year
                    Ended June 30, 2004Revenue
                $
                    4,957,000
                
                $
                    1,022,000
                
                $
                    2,587,000
                
                $
                    8,566,000Cost
                    of revenues
                (3,822,000)
                
                (1,280,000)
                
                (1,084,000)
                
                (6,186,000)Gross
                    Margin
                $
                    1,135,000
                
                $
                    (258,000)
                
                $
                    1,503,000
                
                $
                    2,380,000Total
                    assets
                $
                    9,173,000
                
                $
                    3,084,000
                
                $
                    2,967,000
                
                $
                    15,224,000
 **17.**  **Goodwill
          and Other Intangible Assets**
  At
        June **** 30,
        2006
        and 2005, the Company had goodwill and intangible assets of $13,286,000 and
        $14,270,000, respectively. SFAS No. 142, “Goodwill and Other Intangible Assets”,
        requires that goodwill and intangible assets with indefinite lives no longer
        be
        amortized but instead be measured for impairment at least annually or whenever
        events indicate that there may be an impairment. In order to determine if
        impairment exists, management continually estimates the reporting unit’s fair
        value based on market conditions and operational performance. The Company
        may
        employ the work of independent appraisers in making its determination. The
        Company will make its annual assessment as of August 31st of each year to
        determine if its goodwill is impaired. As of June 30, 2006 the Company has
        determined that its goodwill at its semiconductor implantation reporting
        unit
        was impaired. As a result of this impairment the Company took an impairment
        charge of $457,000 in the year ended June 30, 2006. Goodwill and intangible
        assets with indefinite lives at the Company’s semiconductor testing unit are not
        impaired. Future events could cause management to conclude that impairment
        indicators exist and that goodwill and intangible assets with indefinite
        lives
        associated with the Company’s acquired businesses are impaired. Any resulting
        impairment loss could have a material adverse impact on the Company’s financial
        condition and results of operations.
  Intangible
        assets with finite lives are valued according to the future cash flows they
        are
        estimated to produce. These assigned values are amortized over the period
        of
        time those cash flows are estimated to be produced. Management continually
        evaluates whether events or circumstances have occurred that indicate that
        the
        estimated remaining useful life or the carrying value of these assets has
        been
        impaired. As of June 30, 2006 management believes no impairment
        exists.
  Changes
        in the carrying value of goodwill for the years ended June 30, 2006 and 2005,
        by
        reportable segment, are as follows:
  Semiconductor
                  Services
              
              Semiconductor
                  TestingBalance
                  as of June 30, 2004
              $    
                              -
              
              $                
                  -Goodwill
                  acquired during the period
              4,647,000
              
              7,566,000Balance
                  as of June 30, 2005
              4,647,000
              
              7,566,000Adjustments
                  to purchase price
              (99,000)
              
              8,000Impairment
              (457,000)
              
              -Balance
                  as of June 30, 2006
              $
                  4,091,000
              
              $
                  7,574,000
 
 
 The
        following table summarizes the Company’s intangible assets as of June 30, 2006
        and 2005:
 
 **Gross
                  carrying amount**
              
              **Accumulated
                  Amortization**
              
              **Net
                  Carrying Amount****June
                  30, 2005**
              **Additions**
              **June
                  30, 2006**
              
              **June
                  30, 2005**
              **Additions**
              **June
                  30, 2006**
              
              **June
                  30, 2006**Non-Compete
              
              $1,057,000
              $             
                  -
              $1,057,000
              
              $809,000
              $241,000
              $1,050,000
              
              $7,000Name
                  Recognition
              
              200,000
              -
              200,000
              
              9,000
              29,000
              38,000
              
              162,000Customer
                  Base
              
              1,630,000
              -
              1,630,000
              
              119,000
              326,000
              445,000
              
              1,185,000Technology
              
              125,000
              -
              125,000
              
              18,000
              25,000
              43,000
              
              82,000Treatment
                  Planning System
              
              300,000
              -
              300,000
              
              16,000
              100,000
              116,000
              
              184,000Total
              
              $3,312,000
              $              
                  -
              $3,312,000
              
              $971,000
              $721,000
              $1,692,000
              
              $1,620,000**Gross
                  carrying amount**
              
              **Accumulated
                  Amortization**
              
              **Net
                  Carrying Amount****June
                  30, 2004**
              **Additions**
              **June
                  30, 2005**
              
              **June
                  30, 2004**
              **Additions**
              **June
                  30, 2005**
              
              **June
                  30, 2005**Non-Compete
              
              $1,007,000
              $50,000
              $1,057,000
              
              $382,000
              $427,000
              $809,000
              
              $248,000Name
                  Recognition
              
              -
              200,000
              200,000
              
              -
              9,000
              9,000
              
              191,000Customer
                  Base
              
              -
              1,630,000
              1,630,000
              
              -
              119,000
              119,000
              
              1,511,000Technology
              
              -
              125,000
              125,000
              
              -
              18,000
              18,000
              
              107,000Treatment
                  Planning System
              
              -
              300,000
              300,000
              
              -
              16,000
              16,000
              
              284,000Total
              
              $1,007,000
              $2,305,000
              $3,312,000
              
              $382,000
              $589,000
              $971,000
              
              $2,057,000
  Estimated
        amortization expense for intangible assets with finite lives on our balance
        sheet as of June 30, 2006, for the fiscal years ending June 30, is as
        follows :
 
 2007
              
              $
                  486,0002008
              
              462,0002009
              
              380,0002010
              
              246,0002011
              
              46,000$
                  1,620,000
 
 18.   **Treasury
        Stock**
  In
        June
        2004, the Board authorized the Company to repurchase up to 300,000 shares
        of the
        Company’s common stock, from time to time in the open market, privately
        negotiated transactions, block transactions or at time and prices deemed
        appropriate by management. During July 2004, the Company repurchased 6,000
        shares of common stock at prices ranging from $8.91 to $9.02 per share with
        an
        average cost per share of $8.97 and a total cost of approximately $54,000,
        which
        is recorded as treasury stock in the accompanying consolidated balance sheet.
        As
        of June 30, 2006, the maximum number of shares authorized to be repurchased
        are
        294,000.
  In
        March
        2004, the Company entered into an Exchange & Venture Agreement with
        CardioTech International and CorNova and issued 10,344 shares of common stock
        bearing an aggregate fair market value of $113,000. In February 2005, the
        Company issued an additional 76,687 shares of common stock bearing an aggregate
        fair market value of $750,000. As of June 30, 2006 and 2005, 16,449 shares,
        representing an 18% and 18.9%,ownership, respectively, of Company common
        stock
        held by CorNova, have been categorized as treasury stock.
 
 In
        January 2006, as the result of a cashless exercise of an Incentive Stock
        Option,
        the Company acquired 4,545 shares of common stock having a fair value of
        approximately $19,000.
  19.  **Credit
        Arrangements**
  On
        June
        8, 2005, the Company executed a revolving credit facility for $1,500,000
        with
        Silicon Valley based Bridge Bank, N.A. The revolving credit facility provides
        for advances of up to eighty percent (80%) of the Company’s eligible accounts
        receivable, bears interest at the prime rate plus one-half percent (1/2%)
        which
        is subject to a one-half percent (1/2%) increase should minimum cash balances
        not be maintained. The revolving credit facility is collateralized by certain
        assets of the Company and is subject to certain covenants. As of June 30,
        2006,
        the Company has drawn down $1,000,000 on the credit facility. On September
        7,
        2006, the expiration date of the facility was extended to December 31, 2007.
  **20.  
        Rosses Medical**
  On
        May 6,
        2005, the Company purchased certain software technology assets from Rosses
        Medical Systems for an aggregate purchase price of $300,000, consisting of
        $100,000 in cash and 43,197 shares of the Company’s common stock with a fair
        value of $200,000. In conjunction with this asset acquisition, the Company
        entered into consulting agreements with the former owners and a former employee
        of Rosses Medical and granted 181,426 non-qualified stock options. These
        options
        are fully vested, have no exercise price and are exercisable upon achieving
        certain sales milestones, commencing November 6, 2005. The value of these
        options will be recorded as additional purchase price in the period earned.
        Should all sales milestones be achieved, the Company has estimated the fair
        value of these options using the Black Scholes option pricing model to be
        $796,000. As of June 30, 2006, 129,590 of the options have been forfeited
        as the
        sales goal targets have not been achieved. This asset is included in intangible
        assets on the Company’s consolidated balance sheet and is being amortized over
        three years on a straight line basis.
 
 
 
 **ITEM
                  9**
              **CHANGES
                  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                  DISCLOSURE**
 
 On
        October 27, 2005, BDO Seidman LLP resigned as the Company’s independent
        registered public accounting firm. The audit reports issued by BDO on the
        Company's consolidated financial statements as of and for the years ended
        June
        30, 2005 and 2004 did not contain an adverse opinion or a disclaimer of opinion,
        nor were they qualified or modified as to audit scope or accounting principles.
        The audit report as of and for the year ended June 30, 2005 was modified
        as to
        an uncertainty relative to the Company’s ability to continue as a going concern.
        During the two most recent fiscal years ended June 30, 2005 and 2004 and
        the
        subsequent interim period from July 1, 2005 through the date of this report,
        there were no disagreements with BDO on any matter of accounting principles
        or
        practices, financial statement disclosure, or auditing scope or procedure,
        which
        disagreements, if not resolved to the satisfaction of BDO, would have caused
        it
        to make reference to the subject matter of the disagreement in connection
        with
        its report on the Company’s consolidated financial statements.
 
 On
        January 9, 2006, Brown & Brown was appointed as the Company’s independent
        registered accounting firm.
 
 **ITEM** **9A.**  **CONTROLS
        AND PROCEDURES**
 
 EVALUATION
        OF OUR DISCLOSURE CONTROLS AND INTERNAL CONTROLS
  As
        of the
        end of the period covered by this Annual Report, we evaluated the effectiveness
        of the design and operation of our disclosure controls and procedures
        ("Disclosure Controls") and our internal controls and procedures for financial
        reporting ("Internal Controls"). This evaluation (the "Controls Evaluation")
        was
        done under the supervision and with the participation of our management,
        including our Chief Executive Officer ("CEO") and Chief Financial Officer
        ("CFO"). Rules adopted by the SEC require that in this section of the Annual
        Report, we present the conclusions of our CEO and the CFO about the
        effectiveness of our Disclosure Controls and Internal Controls based on and
        as
        of the date of the Controls Evaluation.
 
 CEO
        AND
        CFO CERTIFICATIONS
  Appearing
        as exhibits to this Annual 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 Annual
        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 Annual Report, is recorded,
        processed, summarized and reported within the time periods specified in the
        SEC's rules and forms. Disclosure Controls are also designed with the objective
        of ensuring that such information is accumulated and communicated to our
        management, including the CEO and CFO, as appropriate, to allow timely decisions
        regarding required disclosure. Internal Controls are procedures which are
        designed with the objective of providing reasonable assurance that (1) our
        transactions are properly authorized, recorded and reported; and (2) our
        assets
        are safeguarded against unauthorized or improper use, to permit the preparation
        of our financial statements in conformity with generally accepted accounting
        principles.
 
 LIMITATIONS
        ON THE EFFECTIVENESS OF CONTROLS
  Our
        management, including the CEO and CFO, has concluded that our disclosure
        controls and procedures are designed to provide reasonable assurance of
        achieving their objectives and have concluded that the controls and procedures
        are effective at that reasonable assurance level.
 
 SCOPE
        OF
        THE CONTROLS EVALUATION
  The
        CEO/CFO evaluation of our Disclosure Controls and Internal Controls included
        a
        review of the controls' objectives and design, the controls’ implementation by
        us and the effect of the controls on the information generated for use in
        this
        Annual Report. In the course of the Controls Evaluation, management sought
        to
        identify data errors, controls problems or acts of fraud and to confirm that
        appropriate corrective action, including process improvements, were being
        undertaken. This type of evaluation will be done on a quarterly basis so
        that
        the conclusions concerning controls effectiveness can be reported in our
        Quarterly Reports on Form 10-Q and Annual Report on Form 10-K. The overall
        goals
        of these various review and evaluation activities are to monitor our Disclosure
        Controls and Internal Controls and to make modifications as necessary; our
        intent in this regard is that the Disclosure Controls and the Internal Controls
        will be maintained as dynamic systems that change (including with improvements
        and corrections) as conditions warrant.
  Among
        other matters, management sought in its evaluation to determine whether there
        were any "significant deficiencies" or "material weaknesses" in our Internal
        Controls, or whether we had identified any acts of fraud involving personnel
        who
        have a significant role in our Internal Controls. In the professional auditing
        literature, "significant deficiencies" are referred to as “reportable
        conditions;” these
        are control issues that could have a significant adverse effect on the ability
        to record, process, summarize and report financial data in the financial
        statements. A "material weakness" is defined in the auditing literature as
        a
        particularly serious reportable condition where the internal control does
        not
        reduce to a relatively low level the risk that misstatements caused by error
        or
        fraud may occur in amounts that would be material in relation to the financial
        statements and not be detected within a timely period by employees in the
        normal
        course of performing their assigned functions.
 
 
 CONCLUSIONS
  Based
        upon the Controls Evaluation, our CEO and CFO have concluded that, as of
        the end
        of the period covered by this Annual Report, our Disclosure Controls are
        effective to provide reasonable assurance that our financial statements are
        fairly presented in conformity with generally accepted accounting principles.
  Our
          independent auditors have reported to our Audit Committee certain matters
          involving internal controls that our independent auditors considered to
          be a
          significant deficiency. A
          significant deficiency is a control deficiency or combination of control
          deficiencies, that adversely affects the company’s ability to initiate,
          authorize, record, process, or report external financial data reliably
          in
          accordance with generally accepted accounting principles such that there
          is more
          than a remote likelihood that a misstatement of the company’s annual or interim
          financial statements that is more than inconsequential will not be prevented
          or
          detected.
 
 The
          reportable condition related primarily to the closing and financial reporting
          process.  Management is confident that our financial statements for
          the year ended June 30, 2006 fairly present, in all material respects,
          our
          financial condition and results of operations.
 
 The
          reportable condition has been discussed in detail among management, our
          Audit
          Committee and our independent auditors, and we are committed to addressing
          and
          resolving these matters fully and promptly, by putting in place the personnel,
          processes, technology and other resources appropriate to support our financial
          close processes. As
          part
          of this commitment, beginning in the second quarter of our fiscal year
          ended
          June 30, 2007, we intend to use the services of an outside consultant to
          evaluate our closing and financial reporting process and make
          recommendations to management to improve these processes.
 **ITEM
        9B. OTHER INFORMATION**
 
 None ****
 
 **PART
        III**
  **ITEM
                  10.**
              **DIRECTORS,
                  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**
 
 SECTION
        16 COMPLIANCE
 
 Section
        16(a) of the Securities Exchange Act of 1934, as amended, requires our officers,
        directors and persons who beneficially own more than 10% of a registered
        class
        of our equity securities ("ten percent stockholders") to file reports of
        ownership and changes in ownership with the Securities and Exchange Commission.
        Officers, directors and ten percent stockholders are charged by the SEC
        regulations to furnish us with copies of all Section 16(a) forms they
        file.
  Based
        solely upon a review of Forms 3, 4, and 5 and amendments thereto furnished
        to us
        during the past fiscal year, and, if applicable, written representations
        that
        Form 5 was not required, we believe that all Section 16(a) filing requirements
        applicable to our officers, directors and ten percent stockholders were
        fulfilled. The following are our executive officers and directors:
 
 Name
              Age
              Position
              Position
                  SinceAnthony
                  J. Armini(1)
              68
              President,
                  Chief Executive Officer and Chairman of the Board
              1984Stephen
                  N. Bunker(1)
              63
              Vice
                  President and Chief Scientist, Director
              1987Diane
                  J. Ryan(1)
                
                
                Walter
                  Wriggins(1)
                
                
                John
                  Traub(1)
                
                R.
                  Erik Bates(1)
              46
                
                
                62
                
                
                59
                
                50
              Vice
                  President Finance and Chief Financial Officer
                
                Vice
                  President and General Manager Core Systems
                
                Vice
                  President and President Accurel Systems
                
                Vice
                  President, EDS Manufacturing
              2003
                
                
                2004
                
                
                2005
                
                
                2005Michael
                  Szycher(2)
              67
              Director
              1999David
                  B. Eisenhaure(2)
                  (4)
              60
              Director
              2002Michael
                  Turmelle(2)
                  (3) (4)
              47
              Director
              2005
 
 (1) Executive
        Officer
 (2)  Member
        of the Audit Committee for the fiscal year ended June 30, 2006
 (3)  Chairman
        of the Audit Committee
 (4)  Member
        of the Compensation Committee for the fiscal year ended June 30,
        2005.
 
 *Dr.
        Anthony J. Armini* has been
        the Company’s President, Chief Executive Officer, and Chairman of the Board of
        Directors since the Company’s incorporation. From 1972 to 1984, prior to the
        Company’s founding, Dr. Armini was Executive Vice President at Spire
        Corporation. From 1967 to 1972, Dr. Armini was a Senior Scientist at McDonnell
        Douglas Corporation. Dr. Armini received his Ph.D. in nuclear physics from
        the
        University of California, Los Angeles in 1967. Dr. Armini is the author of
        twenty two patents and fourteen publications in this field. Dr. Armini has
        over
        thirty years of experience working with cyclotrons and linear accelerators,
        the
        production and characterization of radioisotopes, and over twenty years
        experience with ion implantation in the medical and semiconductor fields.
        Since
        October 2000, Dr. Armini has been on the Board of Directors of CardioTech
        International, Inc., a publicly traded company of which Dr. Szycher was
        President and Chief Executive Officer and is now a consultant.
 
 *Dr.
        Stephen N. Bunker* has
        served as the Company’s Vice President and Chief Scientist since 1987 and a
        Director since 1988. Prior to joining the Company, from 1972 to 1987, Dr.
        Bunker
        was a Chief Scientist at Spire Corporation. From 1971 to 1972, Dr. Bunker
        was an
        Engineer at McDonnell Douglas Corporation. Dr. Bunker received his Ph.D.
        in
        nuclear physics from the University of California, Los Angeles in 1969. Dr.
        Bunker is the author of sixteen patents with four more pending in the field
        of
        ion beam technology.
 
 *Diane
        J. Ryan* has
        served as the Company’s Vice President of Finance and Chief Financial Officer
        since May 2003. Ms. Ryan has
        been
        employed with Implant Sciences Corporation since March 1989. From March 2003
        to
        May 2003, she was the Corporate Controller of the Company. Ms. Ryan graduated
        from Salem State College with a B.S. in Business Administration and a minor
        in
        management.
 
 *Walter
        J. Wriggins* has
        served as the Company’s Vice President and General Manager of Core Systems,
        since October 2004. Prior to
        his career at Core Systems, Mr. Wriggins had over 22 years experience in
        semiconductor industry. His career began as a materials scientist in the
        GE
        aircraft engine group, from which he transitioned to a sales and marketing
        career at various semiconductor companies throughout the country. These
        companies, at which he held senior management positions, include: Axcelis
        (formally Eaton Corporation), Applied Materials, Varian Thin Films, and Ion
        Implant Services. Mr. Wriggins received a B.A. in Applied Science, and a
        B.S. in
        Material Science and Engineering from Lehigh University and an MBA from Boston
        University.
 
 
 *John
        Traub* has
        served as the Company’s Vice President and President of Accurel Systems
        International, since March 2005 and prior to that as Executive
        Vice President and Chief Operating Officer of Accurel Systems, Inc.. Mr.
        Traub
        has held senior posts with several semiconductor equipment and services
        companies including Microfab Systems, Align-Rite Limited, Systems Chemistry
        Inc.
        and at Ultratech Stepper. John also serves on the Santa Clara University
        Board
        of Fellows Executive Committee and as Chairmen of the Board of Governors
        of
        American Theatre of San Jose.
  *R.
        Erik Bates* has
        served as the Company’s Vice President of Operations, Security Products
        Division, since March 2005. Mr.
        Bates has over twenty five years of experience encompassing engineering,
        manufacturing, operations, and business development. The majority of his
        experience has been in the medical device industry. Mr. Bates has a B.S.
        in
        plastics engineering from the University of Lowell and an MBA from Rivier
        College. He is actively involved in public education, and is on the Advisory
        Board for the College of Engineering at UMass Lowell.
 
 *Dr.
        Michael Szycher* joined
        the Company’s Board of Directors in December 1999. He has been President and
        Chief Executive Officer and Chairman of CardioTech International, Inc., a
        publicly traded manufacturer of medical devices and biocompatible polymers
        from
        1996 until August 2006 and continues as a consultant to CardioTech. From
        1988 to
        1996, Dr. Szycher was Chairman and Chief Technology Officer of Polymedica
        Industries. Dr. Szycher is a recognized authority on polyurethanes and blood
        compatible polymers. He is the editor of six books on various subjects in
        blood
        compatible materials and devices and the author of eighty original research
        articles.
 
 *David
        B. Eisenhaure* has
        served on the Company’s board of directors since November 2002. He has been the
        President, Chief Executive Officer and Chairman of the Board of SatCon
        Technology Corporation since 1985. From 1974 until 1985, Mr. Eisenhaure was
        associated with the Charles Stark Draper Laboratory, Incorporated and with
        its
        predecessor, the Massachusetts Institute of Technology's Instrumentation
        Laboratory, from 1967 to 1974. Dr. Eisenhaure also holds an academic position
        at
        M.I.T., as a lecturer in the Department of Mechanical Engineering. Mr.
        Eisenhaure serves on the board of directors of Mechanical Technology
        Incorporated and Beacon Power. He holds a S.B., S.M. and an Engineer's Degree
        in
        Mechanical Engineering from M.I.T.
 
 *Michael
        Turmelle* has
        served on the Company’s board of directors since December 2005. He has been the
        President of SatCon Power Systems since February 2005 and prior to that as
        SatCon Technology Corporation’s Chief Operating Officer. Mr. Turmelle has over
        20 years of manufacturing, financial and operations experience and holds
        a B.A.
        degree in Economics from Amherst College.
 
  CODE
        OF
        ETHICS
  The
        Company has adopted a code of ethics that applies to its directors, officers
        and
        employees and has been posted on the Company’s website: www.implantsciences.com .
  AUDIT
        COMMITTEE
  The
        Board
        has designated from among its members an Audit Committee, which consisted
        of Mr.
        Michael Turmelle (Chairman), Dr. Michael Szycher and Mr. David Eisenhaure,
        all
        of whom are independent members. Mr. Turmelle meets the requirements to
        qualify as a financial expert. The Audit Committee has the responsibility
        to
        ascertain that the Company’s financial statements reflect fairly the financial
        condition and operating results of the Company and to appraise the soundness,
        adequacy and application of accounting and operating controls. The Audit
        Committee recommends the independent auditors to the Board, reviews the scope
        of
        the audit functions of the independent auditors and reviews the audit reports.
        The Audit Committee held a meeting each quarter during fiscal 2006. The
        responsibilities of the Audit Committee are outlined in a written charter
        available for review on the Company’s website: www.implantsciences.com .
  
  
 **ITEM
        11.**  **EXECUTIVE
        COMPENSATION**
  The
        following table sets forth the aggregate cash compensation paid by us with
        respect to the three fiscal years ended June 30, 2004, 2005 and 2006 to our
        executive officers:
  
  **SUMMARY
                  COMPENSATION TABLE**Name
                and Principal Position
              Year
              Salary($)
              Bonus
                ($)
              Other Annual
                Compensation($)(1)
              Shares Underlying
                Options
                  Granted (#)Anthony
                  J. Armini
                President,
                  Chief Executive Officer
                and
                  Chairman of the Board
              2006
                2005
                2004
              $214,712
                $213,101
                $197,684
              -
                -
                $59,700
              $12,353
                $15,417
                $12,260
              100,000
                -
                50,000Stephen
                  N. Bunker
                Vice
                  President,
                Chief
                  Scientist and Director
              2006
                2005
                2004
              $55,814
                $103,377
                $114,228
              -
                -
                $23,150
              $1,100
                $1,077
                $1,049
              50,000
                30,000
                50,000Diane
                  J. Ryan
                Vice
                  President Finance and
                Chief
                  Financial Officer
              2006
                2005
                2004
              $137,308
                $120,393
                $93,102
              -
                $25,000
                $25,050
              $1,217
                $1,147
                $812
              80,000
                30,000
                50,000Walter
                  J. Wriggins(2)
                
                
                John
                  Traub(3)
                
                
                
                R.
                  Erik Bates(3)
              2006
                2005
                2004
                
                2006
                2005
                2004
                
                2006
                2005
                2004
              $139,462
                $101,124
                -
                
                $170,000
                $53,615
                -
                
                $134,366
                $33,231
                -
              -
                -
                -
                
                $20,000
                -
                -
                
                -
                -
                -
              $1,231
                -
                -
                
                $1,427
                -
                -
                
                $1,206
                -
                -
              30,000
                70,000
                -
                
                30,000
                50,000
                -
                
                30,000
                30,000
                -
 
 (1)  Other
        annual compensation consists of life and disability insurance premiums and
        401(k) plan benefits paid   by
        us on
        behalf of these executive officers.
 (2)
            Joined
                the Company in October 2004. (3)
            Joined
                the Company in March 2005 
 **Employment
        Agreements**
 
 *Anthony
        J. Armini.* On June
        30, 2004, we entered into an employment agreement, with an initial term of
        three
        years and an automatic renewal for a successive period of three years, unless
        the we or Dr. Armini give the other party not less than three months written
        notice of non-renewal. Under this employment agreement, Dr. Armini serves
        as our
        president and chief executive officer at a base salary of up to $210,000
        and is
        subject to increase as authorized by the Compensation Committee. In addition,
        Dr. Armini may participate in our employee fringe benefit plans or programs
        generally available to employees of comparable status and position. We are
        entitled to terminate his employment for any material breach of his employment
        agreement at any time upon at least 30 days written notice. In the event
        we
        terminate Dr. Armini’s employment without cause, we will pay him 12 months
        salary. Under his employment agreement, he is subject to restrictive covenants,
        including confidentiality provisions. Also, during his employment and for
        a
        period of two years after the term of the employment agreement, Dr. Armini
        is
        subject to a non-competition provision.
 
 *Stephen
        N. Bunker.* On June
        30, 2004, we entered into an employment agreement, with an initial term of
        three
        years and an automatic renewal for a successive period of three years, unless
        the we or Dr. Bunker give the other party not less than three months written
        notice of non-renewal. Under this employment agreement, Dr. Bunker serves
        as our
        vice president and chief executive scientist at a base salary of up to $150,000
        and is subject to increase as authorized by the Compensation Committee. In
        addition, Dr. Bunker may participate in our employee fringe benefit plans
        or
        programs generally available to employees of comparable status and position.
        We
        are entitled to terminate his employment for any material breach of his
        employment agreement at any time upon at least 30 days’ written notice. In the
        event we terminate Dr. Bunker’s employment without cause, we will pay him 12
        months salary. Under his employment agreement, he is subject to restrictive
        covenants, including confidentiality provisions. Also, during his employment
        and
        for a period of two years after the term of the employment agreement, Dr.
        Bunker
        is subject to a non-competition provision.
 
 *Walter
        J. Wriggins.* On
        October 15, 2004, we entered into an employment agreement, with an initial
        term
        of one years and an automatic renewal for a successive period of one year,
        unless we or Mr. Wriggins give the other party not less than thirty days
        written
        notice of non-renewal. Under this employment agreement, Mr. Wriggins serves
        as
        our Vice President of Business Development/Operations  and
        general manager of Core Systems at a base salary of $140,000. In addition,
        Mr.
        Wriggins may participate in our employee fringe benefit plans or programs
        generally available to employees of comparable status and position. We are
        entitled to terminate his employment for any material breach of his employment
        agreement at any time upon at least 30 days’ written notice. In the event we
        terminate Mr. Wriggins’ employment without cause, we will pay him the balance of
        the salary due for the term of the agreement. Under his employment agreement,
        he
        is subject to restrictive covenants, including confidentiality provisions.
        Also,
        during his employment and for a period of two years after the term of the
        employment agreement, Mr. Wriggins is subject to a non-competition
        provision.
 
 
  **Director
        Compensation**
  Our
        directors who are our employees do not receive any compensation for service
        on
        the board of directors. Directors, who are not our employees, are paid a
        yearly
        stipend of $2,500 and are reimbursed for reasonable travel expenses incurred
        in
        connection with attendance at board and committee meetings.
  Under
        the
        2004 incentive and nonqualified stock option plan, each director who is not
        our
        employee, automatically receives an annual grant of options to purchase 10,000
        shares of our common stock at an exercise price equal to the closing price
        of
        the common stock on that date for each year of service. Each such option
        will
        have a term of ten years and will vest in full on the date of the
        grant.
  **Stock
        Option and Purchase Plans**
 
 In
        September 1998, the Company adopted the 1998 Stock Option Plan (the “1998
        Plan”). The 1998 Plan provides for the grant of incentive stock options and
        nonqualified stock options to employees and affiliates. The exercise price
        of
        the options equals 100% or 110% of the fair market value on the date of the
        grant. Options expire ten years from the date of the option grant and vest
        ratably over a three-year period commencing with the second year. A total
        of
        280,000 options were reserved for issuance under the 1998 Plan. Upon adoption
        of
        the 1998 Plan, the 1992 Stock Option Plan was terminated.
 
 In
        December 2000, the Company adopted the 2000 Incentive and Non Qualified Stock
        Option Plan (the “2000 Plan”). The 2000 Plan provides for the grant of incentive
        stock options and nonqualified stock options to employees and affiliates.
        The
        exercise price of the options equal 100% of the fair market value on the
        date of
        the grant or 110% of the fair market value for greater than 10% beneficial
        owners of the Company stock. Options expire between five and ten years from
        the
        date of the option grant and have variable vesting periods. A total of 600,000
        options were originally reserved for issuance under the 2000 Plan. In December
        2003, the stockholders of the Company approved an increase in the 2000 Incentive
        and Non-Qualified Stock Option Plan from 600,000 shares to 1,000,000 shares.
        In
        December 2004, the stockholders of the Company approved an increase in the
        2000
        Incentive and Non-Qualified Stock Option Plan from 1,000,000 shares to 1,500,000
        shares.
 
 In
        December 2004, the Company adopted the 2004 Stock Option Plan. The 2004 Plan
        provides for the grant of incentive stock options and nonqualified stock
        options
        to employees and affiliates. A total of 500,000 options were originally reserved
        for issuance under the 2000 Plan. The exercise price of the options equa1
        100%
        of the fair market value on the date of the grant or 110% of the fair market
        value for greater than 10% beneficial owners of the Company stock. Options
        expire between five and ten years from the date of the option grant and have
        variable vesting periods. In December 2005, the stockholders of the Company
        approved an increase in the 2004 Incentive and Non-Qualified Stock Option
        Plan
        from by 500,000 shares to 1,000,000 shares. As of June 30, 2006, a total
        of
        109,003, 141,490, and 398,664 shares are available for issuance under the
        1998,
        2000 and 2004 stock option plans, respectively.
  The
        Board
        of Directors administers the Stock Plan. Subject to the provisions of the
        Stock
        Plan, the Board of Directors has the authority to select the optionees or
        restricted stock recipients and determine the terms of the options or restricted
        stock granted, including: (i) the number of shares, (ii) option exercise
        terms,
        (iii) the exercise or purchase price (which in the case of an incentive stock
        option cannot be less than the market price of the Common Stock as of the
        date
        of grant), (iv) type and duration of transfer or other restrictions and (v)
        the
        time and form of payment for restricted stock and upon exercise of options.
        Generally, an option is not transferable by the option holder except by will
        or
        by the laws of descent and distribution. Also, as defined by the specific
        plans’
provisions, options must be exercised within 60 or 90 days following termination
        of employment, 90 days in cases of retirement, and between 6 and 12 months
        in
        the case of disability. However, in the event that termination is due to
        death,
        the exercise period varies by plan and ranges between 180 days and the
        expiration date of the grant.
 
 In
        September 1998, the Company adopted the 1998 Employee Stock Purchase Plan
        (the
“Plan”). The Plan provides a method whereby employees of the Company will have
        an opportunity to acquire an ownership interest in the Company through the
        purchase of shares of common stock of the Company through payroll deductions.
        After 12 months of employment, an employee is eligible to participate and
        can
        defer up to 10% of their wages into this Plan, with a maximum of $25,000
        in any
        calendar year. The purchase price of the common stock is calculated at the
        lower
        of 85% of the closing price of the stock on the first day of the plan period
        or
        the last day of the plan period. The periods are January 1 to June 30 and
        July 1
        to December 31. Fractional shares are not issued. Participants may withdraw
        at
        any time by giving written notice to the Company and will be credited the
        amounts of deferrals in their account. The maximum number of shares eligible
        to
        be issued under the Plan is 141,000. As of June 30, 2006, a total of 78,163
        shares are available for issuance under the Plan.
  97
  **OPTION
        GRANTS IN FISCAL 2006**
  The
        following table sets forth certain information regarding stock options held
        as
        of June 30, 2006 by the executive officers.
  
 Name
                  and Principal Position
              
              Number
                  of Securities Underlying Options Granted
              
              %
                  of Total Granted to Employees in Fiscal Year
              
              Exercise
                  Price ($/sh)
              
              Expiration
                  DateAnthony
                  J. Armini
              
              100,000
              
              18%
              
              $4.50
              
              12/13/2010President,
                  Chief Executive Officeand
                  Chairman of the BoardStephen
                  N. Bunker
              
              50,000
              
              9%
              
              $4.09
              
              12/13/2015Vice
                  President and Chief ScientistDiane
                  J. Ryan
              
              30,000
              
              5%
              
              $3.80
              
              11/01/15Vice
                  President Finance and
              
              50,000
              
              9%
              
              $4.09
              
              12/13/15Chief
                  Financial OfficerWalter
                  J. Wriggins
              
              30,000
              
              5%
              
              $3.89
              
              10/31/15Vice
                  President Business Development/Operationsand
                  General Manager of Core Systems, Inc.John
                  Traub
              
              30,000
              
              5%
              
              $4.20
              
              03/02/16President
                  Accurel Systems International Corp.R.
                  Erik Bates
              
              30,000
              
              5%
              
              $3.35
              
              04/11/16Vice
                  President OperationsSecurity
                  Products Division
 
 COMPENSATION
        COMMITTEE
  The
        Compensation Committee, which met one time during fiscal 2006, had two members,
        Mr. David Eisenhaure (Chairman) and Mr. Michael Turmelle both of whom are
        independent board members. The Compensation Committee reviews and determines
        on
        both an annual and an as-needed basis the compensation of the Company’s chief
        executive officer (the “CEO”).  The Compensation Committee determines all
        elements of the CEO’s compensation, including salary, bonus, options, benefits
        and all other aspects of the total compensation package based on the
        compensation earned by a CEO in a similar corporation and industry. Additional
        responsibilities of the Compensation Committee are outlined in a written
        charter
        available for review on the Company’s website: www.implantsciences.com .
  
 COMPENSATION
        COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
  No
        person
        serving on the Compensation Committee at any time during fiscal 2006 was
        a
        present or former officer or employee of the Company or any of its subsidiaries.
        During fiscal 2006, other than Dr. Armini, no executive officer of the
        Company served as a member of the board of directors or compensation 
committee (or other board committee performing equivalent functions) of another
        entity. During fiscal 2006, Dr. Armini served on the board of
        directors of Cardio-tech International, one of whose executive officers served
        on the Company’s Board or Compensation Committee as well as on the board of
        directors of CorNova.
  COMPARATIVE
        STOCK PERFORMANCE
  The
        comparative stock performance graph below compares the cumulative stockholder
        return on the Common Stock of Implant Sciences Corporation (“IMX”) for the
        period from July 1, 2001, and through the fiscal years ended June 30, 2002,
        2003, 2004, 2005 and 2006 with the cumulative total return on: (i) the American
        Stock Exchange Composite Index (the “AMEX”) and (ii) a peer group (the “Peer
        Group”) determined by the Company. The graph assumes the investment of $100 in
        Implant Sciences’ common stock, the AMEX Composite Index, and the Peer Group on
        June 30, 2001, and reinvestment of all dividends.  Measurement points are
        on June 30, 2001, 2002, 2003, 2004, 2005 and 2006.
  The
        Peer
        Group consists of Isonics Corporation, North American Scientific Incorporated,
        RAE Systems, Spire Corporation and Ibis Technology Corporation. Management
        selected the Peer issuers in good faith and on an industry or line-of-business
        basis.
  
  Value
                  of $100 investment on June 30, 2001 at each of the following measurement
                  points.June
                  30,2001
              2002
              2003
              2004
              2005
              2006IMX
              100
              139
              58
              119
              32
              36AMEX
              100
              97
              106
              136
              168
              210Peer
                  group
              100
              59
              67
              116
              106
              83
  
  **AGGREGATE
        OPTIONS EXERCISABLE IN LAST FISCAL YEAR**
 **AND
        FISCAL YEAR END OPTION VALUES**
  Number
                  of Securities Underlying Unexercised Options at June 30,
                  2006
              
              Value
                  of Unexercised In-the-Money Options at June 30, 2006
                  (1)(2)Name
                  and Principal Position
              
              Exercisable
              Unexercisable
              
              Exercisable
              UnexercisableAnthony
                  J. Armini
              
              191,700
              16,500
              
              -
              -President,
                  Chief Executive Officeand
                  Chairman of the BoardStephen
                  N. Bunker
              
              133,500
              16,500
              
              -
              -Vice
                  President and Chief ScientistDiane
                  J. Ryan
              
              174,500
              36,300
              
              $7,852
              -Vice
                  President Finance andChief
                  Financial OfficerWalter
                  J. Wriggins
              
              47,600
              92,400
              
              -
              -Vice
                  President Business Development/Operationsand
                  General Manager of Core Systems, Inc.John
                  Traub
              
              17,000
              63,000
              
              -
              -President
                  Accurel Systems International Corp.R.
                  Erik Bates
              
              10,200
              49,800
              
              -
              -Vice
                  President OperationsSecurity
                  Products Division(1)
                (2)
              As
                  of June 30, 2006, the market value of a share of common stock was
                  $3.30
                Represents
                  a 10 year option
  
  **ITEM
                  12.**
              **Security
                  Ownership of Certain Beneficial Owners and Management and Related
                  Stockholder Matters**
  The
        following table sets forth information as of August 31, 2006, with respect
        to
        the beneficial ownership of our common stock of each director and nominee
        for
        director, each named executive officer in the executive compensation table
        above, all of our directors and current officers as a group, and each person
        known by us to be a beneficial owner of five percent or more of our common
        stock. This information is based upon information received from or on behalf
        of
        the individuals named therein.
   Name
                  of Beneficial Owner
              Number
                  of Shares Beneficially Owned (1)
              Percent
                  of Class (2)Anthony
                  J. Armini(3)
              1,382,138
              11%Stephen
                  N. Bunker(4)
              768,548
              6%Diane
                  J. Ryan(5)
              228,740
              2%Walter
                  J. Wriggins(6)
              76,814
              1%John
                  Traub(7)
              17,000
              *R.
                  Erik Bates(8)
              10,200
              *Michael
                  Szycher(9)
              71,000
              1%David
                  Eisenhaure(10)
              66,000
              1%Michael
                  Turmelle(11)
              10,000
              **
              Less
                  than 1%(1)
              Unless
                  otherwise noted, each person identified possesses sole voting and
                  investment power over the shares(2)
              The
                  calculation of percentage of class is based on 11,800,466 shares
                  of common
                  stock issued and outstanding as of August 31, 2006 plus any shares
                  issuable upon exercise of options, to such persons and included
                  as being
                  beneficially owned by him.(3)
              Includes
                  208,200 shares exercisable within 60 days of the date
                  hereof.(4)
              Includes
                  150,000 shares exercisable within 60 days of the date
                  hereof.(5)
              Includes
                  200,900 shares exercisable within 60 days of the date
                  hereof.(6)
              Includes
                  76,814 shares exercisable within 60 days of the date
                  hereof.(7)
              Includes
                  10,200 shares exercisable within 60 days of the date
                  hereof.(8)
              Includes
                  10,200 shares exercisable within 60 days of the date
                  hereof.(9)
              Includes
                  71,000 shares exercisable within 60 days of the date
                  hereof.(10)
              Includes
                  66,000 shares exercisable within 60 days of the date
                  hereof.(11)
              Includes
                  10,200 shares exercisable within 60 days of the date
                  hereof.
 
  
 **ITEM
                  13.**
              **Certain
                  Relationships and Related
                  Transactions**
  Our
        CEO
        and Chairman of the Board of Directors is also a director of CardioTech.
        The CEO
        and Chairman of the Board of Directors of CardioTech, until August 2006,
        is also
        our director.
 
 In
        March
        2000, the Company entered into a joint research agreement with CardioTech
        to
        develop a proprietary porous polymer biocompatible coating technology as
        a
        platform for the Company’s proprietary radioactive brachytherapy technology. In
        consideration for this agreement, the Company agreed to pay $150,000 in cash
        and
        purchase 100,000 shares of CardioTech stock at a price of $1.00 per share.
        As of
        June 30, 2005, the Company has purchased these shares, the fair market value
        of
        which is $196,000 and is recorded as investments in available for sale
        securities in the accompanying consolidated balance sheet.
  In
        March 2004 the Company entered into
        an Exchange & Venture Agreement with CardioTech International, Inc.
        (“CardioTech”), a public company and related party of the Company, and CorNova,
        Inc. (“CorNova”). CorNova is a start-up company incorporated as a Delaware
        corporation on October 12, 2003. CorNova’s focus is the development and
        marketing of innovative interventional cardiology products. In connection
        with
        the agreement, in March 2004, the Company and CardioTech issued 10,344 and
        12,931 shares, respectively, of their respective common stock (the “Contributory
        Shares”) bearing an aggregate fair market value of $113,000 and $76,000,
        respectively, as of the date of the issuance. In exchange, the Company and
        CardioTech each received 1,500,000 shares of CorNova’s common stock, which
        represented a 30% ownership position for each party. In February 2005, upon
        CorNova’s securing of an additional $3,000,000 in financing (“Series A”),
        CardioTech and the Company each issued additional shares of their common
        stock,
        which was equal in value to twenty-five percent (25%) of the gross proceeds
        of
        the Series A Financing, or $750,000. As of June 30, 2006, the Company’s shares,
        represent a 18% ownership position. Anthony Armini, our CEO and Michael Szycher,
        the Chairman of our Nominating Committee, are also on the Board of Directors
        of
        CorNova.
 
  **ITEM
        14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**
  
  **June
                  30,****2006**
              
              **2005**
              
              **2004**Audit
                  fees
              $
                  191,000
              
              $
                  297,500
              
              $
                  138,000Audit
                  related fees
              56,000
              
              17,650
              
              8,000Total
              $
                  247,000
              
              $
                  315,150
              
              $
                  146,000
 
  The
        firm
        of UHY LLP ("UHY") acts as our principal independent registered public
        accounting firm. Through June 30, 2006, UHY had a continuing relationship
        with
        UHY Advisors, Inc. (“Advisors”) from which it leased auditing staff who were
        full time, permanent employees of Advisors and through which UHY’s partners
        provide non-audit services. UHY has no full time employees and therefore,
        none
        of the audit services performed were provided by permanent full-time employees
        of UHY. UHY manages and supervises the audit services and audit staff, and
        is
        exclusively responsible for the opinion rendered in connection with its
        examination.
 
  The
        Company’s Audit Committee must pre-approve all audit services to be provided to
        the Company, whether provided by the principal auditor or other firms, and
        all
        other services (review, attest and non-audit) to be provided to the Company
        by
        the independent auditor, provided, however, that *de
        minimis* non-audit services may instead be approved in accordance with applicable
        SEC
        rules. The Company’s principal financial and accounting officer communicates to
        both the Chairman of the Audit Committee and the auditing services firm any
        services requested to be provided. After receiving a fee quote for services
        from
        the service provider, a letter from the Chairman of the Audit Committee is
        prepared and submitted to the service provider as evidence of approval of
        the
        requested services.
  
  
  
  **ITEM
        15.**  **EXHIBIT
        INDEX**
  
 The
                  following are filed as part of this Form10-KExhibitNo.
              Ref.No.
              Description3.2
              1
              By-Laws
                  of the Company3.3
              1
              Articles
                  of Amendment to the Articles of Organization of the Company, dated
                  June 9,
                  19993.4
              1
              Restated
                  Articles of Organization of the Company, dated June 9.
                  19993.5
              5
              Certificate
                  of Vote of Directors establishing Series A 7% Cumulative Convertible
                  Preferred Stock, dated October 7, 20023.6
              6
              Certificate
                  of Vote of Directors establishing Series B 5% Cumulative Convertible
                  Preferred Stock, dated August 26, 20033.7
              7
              Certificate
                  of Vote of Directors establishing Series C 5% Cumulative Convertible
                  Preferred Stock, dated November 25, 2003.3.8
              19
              Certificate
                  of Vote of Directors establishing Series D Convertible Preferred
                  Stock,
                  dated September 30, 20053.9
              20
              Form
                  of Amendment to Series D Cumulative Convertible Preferred Stock
                  and
                  Securities Purchase Agreement dated May 31, 2006.4.1
              2
              Specimen
                  certificate for the Common Stock of the Company10.01
              1
              1992
                  Stock Option Plan10.02
              1
              Form
                  of Stock Option Agreement under the 1992 Stock Option Plan10.03
              1
              1998
                  Incentive and Nonqualified Stock Option Plan10.04
              2
              Form
                  of Incentive Stock Option under the 1998 Incentive and Nonqualified
                  Stock
                  Option Plan10.05
              2
              Form
                  of Nonqualified Stock Option under the 1998 Incentive and Nonqualified
                  Stock Option Plan10.06
              2
              Form
                  of Nonqualified Stock Option for Non-Employee Directors under the
                  1998
                  Incentive and Nonqualified Stock Option Plan10.07
              5
              Common
                  Stock Purchase Warrant for 55,000 shares issued to Laurus Master
                  Fund,
                  Ltd. Dated October 7, 2002.10.08
              6
              Common
                  Stock Purchase Warrant for 70,000 shares issued to Laurus Master
                  Fund,
                  Ltd. Dated August 28, 2003.10.09
              7
              Securities
                  Purchase Agreement between Implant Sciences Corporation and Laurus
                  Master
                  Fund, Ltd, Dated November 25, 2003.10.10
              7
              Security
                  Agreement between Implant Sciences Corporation and Laurus Master
                  Fund,
                  Ltd. Dated November 25, 2003.10.11
              7
              Common
                  Stock Purchase Warrant for 100,000 shares issued to Laurus Master
                  Fund,
                  Ltd. Dated November 25, 2003.10.12
              8
              Exchange
                  and Venture agreement between Implant Sciences Corporation, CardioTech
                  International, and CorNova, Inc. dated March 5, 2004.10.13
              9
              Form
                  of Securities Purchase Agreement between Implant Sciences and certain
                  investors10.14
              9
              Form
                  of Warrant dated June, 17, 200410.15
              9
              Form
                  of Additional Investors Rights Agreement dated June 17, 2004 between
                  Implant Sciences and certain investors10.16
              9
              Form
                  of Registration Rights Agreement dated June 17, 2004 between Implant
                  Sciences and certain investors10.17
              10
              Employment
                  Agreement with Anthony J. Armini, dated June 30, 200410.18
              11
              Agreement
                  and Plan of Merger and Reorganization, dated October 13, 2004,
                  by and
                  among the Company, C Acquisition Corp., Core Systems Incoporationd
                  and
                  Donald W. Lindsey.10.19
              12
              Securities
                  Purchase Agreements, dated March 4, 2005, by and between the Company
                  and
                  the Purchasers thereunder, with attached schedules.10.20
              12
              Form
                  of Common Stock Purchase Warrant, dated March 4, 2005, by the Company
                  in
                  favor of Pacific Wave Partners Limited.10.21
              12
              Form
                  of Common Stock Purchase Warrant, dated March 4, 2005, by the Company
                  in
                  favor of the Purchasers.10.22
              12
              Form
                  of Additional Investment Right, dated March 4, 2005, by and between
                  the
                  Company in favor of the purchasers.10.23
              12
              Registration
                  Rights Agreement, dated March 4, 2005, by and between the Company
                  and the
                  parties thereto.10.24
              13
              Stock
                  Purchase Agreement dated March 9, 2005 by and among the Company,
                  Accurel
                  and the Stockholders.10.25
              13
              Form
                  of the Securted Promissory Note dated March 9, 2005 made out by
                  the
                  Company in favor of the Stockholders.10.26
              13
              Note
                  and Security Agreement dated March 9, 2005, by and among the Company,
                  the
                  Stockholders and the Escrow Agent thereunder.10.27
              13
              Holdback
                  and Escrow Agreement dated March 9, 2005, by and among the Company,
                  the
                  Stockholders and the Escrow Agent thereunder.10.28
              14*
              Development,
                  Distribution and Manufacturing Agreement dated March 23, 2005 by
                  and
                  between the Company and Rapiscan Systems, Inc.10.29
              16
              Form
                  of Business Financing Agreement dated June 1, 2005 between the
                  Company and
                  Bridge Bank, N.A.10.30
              16
              Form
                  of Intellectual Property Security Agreement dated June 1, 2005
                  between
                  Implant Sciences Corporation and Bridge Bank, N.A.10.31
              16
              Form
                  of Intellectual Property Security Agreement dated June 1, 2005
                  between C
                  Acquisition Corp. and Bridge Bank, N.A.10.32
              17
              Form
                  of Securities Purchase Agreement, dated as of July 6, 2005, by
                  and between
                  the Company and Laurus Master Fund, Ltd.10.33
              17
              Form
                  of Secured Term Note, dated as of July 6, 2005, by the Company
                  in favor of
                  Laurus Master Fund, Ltd.10.34
              17
              Form
                  of Subsidiary Guaranty, dated as of July 6, 2005, by the Company
                  in favor
                  of Laurus Master Fund, Ltd.10.35
              17
              Form
                  of Common Stock Purchase Warrant, by the Company in favor of Laurus
                  Master
                  Fund, Ltd.10.36
              17
              Form
                  of Funds Escrow Agreement10.37
              17
              Form
                  of Master Security Agreement10.38
              19
              Securities
                  Purchase Agreement by and between the Company and Laurus Master
                  Fund,
                  dated September 30, 2005.10.39
              19
              Registration
                  Rights Agreement by and between the Company and Laurus Master Fund,
                  dated
                  September 30, 2005.10.40
              19
              Subsidiary
                  Guaranty dated September 30, 200510.41
              19
              Form
                  of Common Stock Purchase Warrant dated September 30, 2005.10.42
              19
              Form
                  of Funds Escrow Agreement by and among the Company, Laurus Master Fund and
                  Loeb & Loeb LLP10.43
              19
              Form
                  of Master Security Agreement by and among the Company, C-Acquisition
                  Corporation, Accurel Systems and Laurus Master Fund, dated September
                  30,
                  2005.10.44
              19
              Form
                  of Stock Pledge Agreement by and between the Company and Laurus
                  Master
                  Fund dated September 30, 2005.10.45
              20
              Form
                  of Common Stock Purchase Warrant, by the Company in favor of Laurus
                  Master
                  Fund, Ltd. , dated May 31, 2006.10.46
              20
              Form
                  of Amendment to Securities Purchase Agreement by and between the
                  Company
                  and Laurus Master Fund dated May 31, 2006.10.47
              21
              2000
                  Incentive and Non-Qualified Stock Option Plan21.1
              18
              Subsidiaries
                  of the Company23.1
              
              Consent
                  of UHY LLP23.2
              
              Consent
                  of BDO Seidman, LLP31.1
              
              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 2002.1
              Previously
                  filed in the Registration Statement on Form SB-2 (Registration
                  No.
                  333-64499) filed on September 29, 1998, and is incorporated herein
                  by
                  reference.2
              Previously
                  filed in Amendment No. 1 to the Registration Statement, filed on
                  December
                  21, 1998, and is incorporated herein by reference.3
              Previously
                  filed in Amendment No. 2 to the Registration Statement, filed on
                  February
                  11, 1999, and is incorporated herein by reference.5
              Previously
                  filed in the Annual Report on Form 10 KSB for the fiscal year ended
                  June
                  30, 2002 filed on October 15, 2002 and is incorporated herein by
                  reference6
              Previously
                  filed in the Annual Report on Form 10 KSB for the fiscal year ended
                  June
                  30, 2003 filed on September 29, 2003 and is incorporated herein
                  by
                  reference7
              Previously
                  filed on Form 8-K on December 12, 2003, and is incorporated herein
                  by
                  reference8
              Previously
                  filed on Form 8-K on March 18, 2004, and is incorporated herein
                  by
                  reference9
              Previously
                  filed on Form S-3 on July 14, 2004, and is incorporated herein
                  by
                  reference10
              Previously
                  filed in the Annual Report on Form 10-KSB for the fiscal year ended
                  June
                  30, 2004, and is incorporated herein by reference.11
              Previously
                  filed on Form 8-K on October 19, 2004, and is incorporated herein
                  by
                  reference.12
              Previously
                  filed on Form 8-K or Amendment form Form 8-K on March 9, 2005 and
                  is
                  incorporated herein by reference.13
              Previously
                  filed on Form 8-K on March 11, 2005 and is incorporated herein
                  by
                  reference.14
              Previously
                  filed on an Amendment to Form 8-K on April 7, 2005 and is incorporated
                  herein by reference.15
              Previously
                  filed with this Registration Statement16
              Previously
                  filed on Form 8-K on June 13, 2005 and is incorporated herein by
                  reference17
              Previously
                  filed on Form 8-K on July 14, 2005 and is incorporated herein by
                  reference18
              Previously
                  filed on Form S-3 on August 4, 2005 and is incorporated herein
                  by
                  reference.19
              Previously
                  filed on Form 8-K on October 5, 2005 and is incorporated herein
                  by
                  reference.20
              Previously
                  filed on Form 8-K on June 6, 2006 and is incorporated herein by
                  reference.21
              Previously
                  filed on Form S-8 on December 12, 2003 and is incorporated herein
                  by
                  reference*
              filed
                  pursuant to a request for confidential treatment
      
  **SIGNATURES**
 
 In
        accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
        this report to be signed on its behalf by the undersigned, thereunto duly
        authorized.
 
 Implant
        Sciences Corporation
 
 Date:
        October 12, 2006      /s/
        Anthony J. Armini
 Anthony
        J. Armini
 President,
        Chief Executive Officer,
 Chairman
        of the Board of Directors
 (Principal
        Executive Officer)
 
 In
        accordance with the Exchange Act, this report has been signed below by the
        following persons on behalf of the registrant and in the capacities and on
        the
        dates indicated, and each of the undersigned officers and directors of Implant
        Sciences Corporation hereby severally constitutes and appoints Anthony J.
        Armini
        his true and lawful attorney-in-fact and agent, with full power to him, to
        sign
        for him, in his name in the capacity indicated below, all amendments to such
        report on Form 10-K, hereby ratifying and confirming his signature as it
        may be
        signed by his attorney to such report and any and all amendments
        thereto.
 
 
 
 Date:
        October 12,
        2006  /s/
        Anthony J. Armini
 Anthony
        J. Armini
 President,
        Chief Executive Officer,
 Chairman
        of the Board of Directors
 (Principal
        Executive Officer)
 
 
 Date:
        October 12,
        2006      /s/
        Diane J. Ryan
 Diane
        J.
        Ryan
 VP
        Finance and CFO
 (Principal
        Financial and Accounting Officer)
 
 
 Date:
        October 12,
        2006    /s/
        Stephen N. Bunker
 Stephen
        N. Bunker
 Vice
        President and Chief Scientist,
 Director
 
 
 Date:
        October 12,
        2006      /s/
        Michael Szycher
 Michael
        Szycher, Director
 
  Date:
        October 12,
        2006      /s/
        David Eisenhaure
 David
        Eisenhaure, Director
 
 
 Date:
        October 12,
        2006  /s/
        Michael Turmelle
 Michael
        Turmelle, Director