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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------

                                  FORM 10-KSB

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
      ACT OF 1934.
                   FOR THE FISCAL YEAR ENDING JUNE 30, 1999.

                                       OR

[ ]   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)

<TABLE>
<S>                                            <C>
                MASSACHUSETTS                                    04-2837126
         (STATE OR OTHER JURISDICTION                          (IRS EMPLOYER
      OF INCORPORATION OR ORGANIZATION)                    IDENTIFICATION NUMBER)

             107 AUDUBON ROAD, #5
                WAKEFIELD, MA                                      01880
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                      (ZIP CODE)
</TABLE>

                                  781-246-0700
                          (ISSUER'S TELEPHONE NUMBER)

          SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

<TABLE>
<CAPTION>
                TITLE OF CLASS                   NAME OF EACH EXCHANGE ON WHICH REGISTERED
                --------------                   -----------------------------------------
<S>                                            <C>
         Common Stock, $.10 par value          American Stock Exchange, Boston Stock Exchange
                   Warrants                    American Stock Exchange, Boston Stock Exchange
</TABLE>

     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 no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is 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-KSB or any
amendment to this Form 10-KSB. [X]

     State issuer's revenues for its most recent fiscal year: $2,753,488

     The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $39,287,230 as of June 30, 1999 (based on the
closing price for such stock as of June 30, 1999).

     As of June 30, 1999, there were 5,069,320 shares of common stock
outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Registrant's Definitive Proxy Statement for its 1999 Annual
Meeting of Stockholders, expected to be filed with the Securities and Exchange
Commission on or before October 28, 1999, are incorporated by reference into
Items 9, 10, 11 and 12 of this Annual Report on Form 10-KSB.
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                                     PART 1

ITEM 1.  DESCRIPTION OF BUSINESS

     In addition to historical information, this Annual Report on Form 10-KSB
contains forward-looking statements. The forward-looking statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially from those reflected in such forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those discussed
in the sections entitled "Business', "Risk Factors" and "Management's 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 hereof. The Company undertakes
no obligation to revise or publicly release the results of any revision to these
forward-looking statements. Readers should carefully review the risk factors
described in this Annual Report and in other documents that the Company files
from time to time with the Securities and Exchange Commission, including the
Company's Registration Statement on Form SB-2 (Registration No. 333-64499) and
the Quarterly Reports on Form 10-Q filed by the Company in fiscal 1999.

     Implant Sciences Corporation (the "Company") incorporated in August 1984
has, over the past fifteen years, developed core technologies using ion
implantation and thin film coatings for medical device applications and has
proprietary processes and equipment for the manufacture of medical radiation
therapeutic devices. The Company plans to apply this technology to manufacture
radioactive prostate seeds ("I-Plant Seeds") using a non-radioactive fabrication
process which it believes will be more cost-effective and less hazardous than
conventional processes which use radioactive wet chemistry. The I-Plant seeds
will be made radioactive in a nuclear reactor prior to shipment to customers.
The Company believes that the opportunities for radioactive prostate seeds will
continue to grow as an attractive alternative to other methods of treatment. On
May 26, 1999, the Company received its notification of pre-market clearance for
its iodine-125 seed from the Food and Drug Administration ("FDA"). In the
interventional cardiology field, the Company has a joint development agreement
with a major stent manufacturer to develop radioactive coronary stents. The
Company believes these implants, radioactive seeds used for the treatment of
prostate cancer and radioactive coronary stents for the prevention of restenosis
(reclosure of the artery) after balloon angioplasty, will have a significant
competitive advantage over currently existing devices.

     The Company is currently developing its proprietary thin film coating
technology in order to apply it to radiopaque (visible by x-ray) coatings on
stents, guidewires, catheters and other devices used in interventional
cardiology procedures. In addition, the Company is applying its ion implantation
technologies to modify surfaces to reduce polyethylene wear generation in
orthopedic joint implants, manufactured by the Howmedica/Osteonics Division of
Stryker Corporation and Biomet Incorporated. The Company also supplies ion
implantation services to numerous semiconductor manufacturers, research
laboratories and universities. The Company currently has eleven issued United
States patents and fifteen United States patents pending covering its
technologies and processes. The Company also has two international patent
applications pending.

     Although there are a wide range of commercial applications for the
Company's proprietary technologies, the Company has chosen to focus on the
medical device industry. Within the medical device industry, the Company is
concentrating on the prostate cancer, interventional cardiology and orthopedic
segments.

TECHNOLOGIES

     General.  The Company uses two core technologies, ion implantation and thin
film coatings, to provide enhanced surfaces to various medical implants and
semiconductor products. With respect to each core technology, the Company has
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, wettability 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 has made it the standard for semiconductor manufacturing. Ion
implantation is generally preferred over other surface modification
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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. The Company believes its 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. The Company plans to use its proprietary
equipment to manufacture radioactive seed implants for the treatment of prostate
cancer and other carcinomas. The Company is in the process of developing
radioactive prostate seeds containing iodine-125, which can be manufactured
without expensive cyclotrons or linear accelerators and without hazardous
radioactive wet chemistry, the methods currently employed by existing suppliers.
The Company has three patents pending on its process. The Company also believes
it can cost-effectively implant ions of therapeutic radioisotopes including
phosphorous-32, palladium-103 or ytterbium-90 into a device such as a coronary
stent used to reduce restenosis following balloon angioplasty.

     Thin Film Coating.  A thin film coating is grown upon a substrate in a
vacuum by the gradual deposition of atoms on the substrate. The Company's
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. The Company's proprietary manufacturing
process allows for efficient utilization of precious metals and for cost
effective recovery and recycling of these precious metals. The Company is
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. The Company believes 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.

CURRENT AND FUTURE PRODUCTS

  Prostate Cancer Seeds

     General.  The alternatives generally presented to patients diagnosed with
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 is 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 catscan imaging equipment provide detailed and
precise measurements of prostate size and shape, for seed distribution and
placement.

     Prostate Seeds.  The Company has developed, and applied for three United
States patents covering radioactive seeds, implants and methods of manufacturing
radioactive seed implants by a proprietary process. On May 26, 1999, the Company
received notification of pre-market clearance from the Food and Drug
Administration for its iodine-125 seed and believes these seeds should be
available for commercial sale in the first half of 2000. These seeds are used
primarily in the treatment of prostate cancer. A ten-year study conducted by the
Northwest Hospital, Seattle, Washington (the "Northwest Hospital Study") shows
that this

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treatment has a ten-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, impotence and incontinence,
frequently associated with surgery and external beam radiation treatment. The
National Cancer Institute and American Cancer Society have reported that sexual
potency after implantation of radioactive seeds has been 86% to 92%, which
compares with rates of 10% to 40% for radical prostectomies and 40% to 60% for
external beam radiation therapy. The Company's production method, involving a
proprietary non-radioactive fabrication procedure, does not use radioactive wet
chemistry. On July 28, 1999 the Company received its Radioactive Sealed Source
Registration Certificate, a Nuclear Regulatory Commission ("NRC") requirement
administered by the Commonwealth of Massachusetts as a NRC Agreement State.

     Manufacturing.  Management believes that the Company's manufacturing
process will result in lower capital equipment and manufacturing assembly costs
and will be less hazardous than the manufacturing processes used by the
Company's competitors. Other radioactive prostate seed manufacturers use
radioactive wet chemistry during seed assembly for iodine-125 products. These
technologies require much higher capital equipment costs than the Company's
technologies. The Company's dry process, for which it has patents pending, uses
no radioactive fabrication, and the Company believes it requires fewer personnel
and yields faster throughput. Following seed assembly the Company sends its
seeds to a nuclear reactor for activation. Using this non-radioactive
fabrication process, seeds can be fabricated and inventoried in large quantities
and activated only when ordered. Due to the short half life of iodine-125 (60
days), the competition must assemble and ship seeds on a tight schedule so they
can be implanted into the patient at the appropriate strength.

     Sales.  The Company intends to manufacture and sell its own radioactive
prostate seeds to distributors of medical products and directly to major medical
centers, purchasing groups and hospitals. The Company has not yet sold any
prostate seeds for commercial use, however, on May 26, 1999, the Company
received notification of pre-market clearance from the Food and Drug
Administration for its iodine-125 seed and the Company believes these seeds
should be available for commercial sale in the first half of 2000. On July 28,
1999 the Company also received it Radioactive Sealed Source Registration
Certificate, a Nuclear Regulatory Commission ("NRC") requirement administered by
the Commonwealth of Massachusetts as a NCR Agreement State. In preparation for
commercialization the Company needs to complete its manufacturing equipment and
reach agreement with a distribution partner.

  Interventional Cardiology Devices

     General.  In cooperation with certain device manufacturers, the Company is
in the process of developing a number of devices to be used in interventional
cardiology procedures. Among these devices are intravascular radioactive stents
that are used to reduce restenosis following balloon angioplasty and stents,
guidewires and catheters containing radiopaque markers. Coronary stents are made
of metals which are not radiopaque and in many cases must be coated with dense
precious metals for increased visibility that is critical to their guiding,
positioning, manipulation and placement.

     Radioactive Stents.  The Company has four issued patents and has applied
for eight additional United States patents and has pending one international
patent application for, new methods of implanting radioactivity onto coronary
stents that it believes will reduce the incidence of restenosis. The Company has
developed a proprietary technique for the ion implantation of both pure beta and
pure x-ray emitters into stents, which management believes has significant
advantages over other methods. These radioisotopes produce short-range radiation
that only affect the targeted tissues, rather than the entire body or region.

     In fiscal 1998, the Company was awarded a grant from the National
Institutes of Health ("NIH") for the first phase of a possible two-phase program
to further develop its radioactive stents on a commercial basis. The Company
believes it will be awarded the $750,000 phase two grant based on its successful
phase I grant, to further develop its radioactive stents.

     Radiopaque Coatings.  The Company has developed proprietary methods for
applying radiopaque coatings onto a variety of medical devices manufactured by
its customers in order to increase the visibility of

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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. The Company uses this process to coat stents,
guidewires and catheters. For a fractional increase in the manufacturing cost of
a stent, the Company believes its coatings can provide significant added value
and enhanced performance. The Company's thin film coatings are being evaluated
by certain customers for stents, guidewires and catheters.

     Manufacturing.  For manufacture of radioactive stents, the Company uses a
proprietary ion implanter that has been optimized for this application. The
Company also has developed a proprietary ion source which uses a relatively
non-toxic form of phosphorous as the radioactive phosphorous-32 source material.
The Company believes its proprietary equipment can be used for commercial
production with the safety and quality control required by the FDA. For
manufacture of its radiopaque coatings, the Company has developed a proprietary
gold coating process and has built equipment that uses unbalanced magnetron
sputtering which provides adherent coatings on implants with complex shapes
(such as stents) and which allows for efficient recovery of precious metals not
consumed in the process.

  Orthopedic Total Joint Replacements

     General.  The Company provides 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
("CoCr") 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,
CoCr devices still suffer from particle generation where the metal and
polyethylene components articulate against each other. This particle generation
has been identified as a primary cause of implant loosening due to osteolysis
requiring repeat surgery.

     Orthopedics.  The Company implants CoCr components of total joint
replacements manufactured by its customers with nitrogen ions. Nitrogen ion
implantation of these components reduces polyethylene wear by modifying the
native oxide present in CoCr alloys. Laboratory tests and clinical studies have
shown that nitrogen ion-implanted CoCr components offer superior performance
over untreated components, significantly reducing wear and slowing the incidence
of osteolysis which ultimately leads to revision surgery.

     The Company is currently developing zirconia and alumina ceramic ion
implantation techniques and believes they will emerge as the preferred next
generation surface treatment method for orthopedic total joint replacements.
Management believes the use of monolithic ceramic or ceramic coated femoral
components holds greater promise than other types of components in reducing
osteolysis because ceramics have wear characteristics superior to metal and are
biocompatible and inert. The Company believes monolithic ceramic hip heads are
currently employed in a limited number of hip procedures in the United States.
Because of their brittle nature, monolithic ceramics are not likely to be
utilized for femoral knee components. As an alternative to monolithic ceramic
components, the Company's ceramic coatings of CoCr devices using its "blended
interface" process can be applied to either hip or knee joint replacements. The
Company believes that ceramic coatings of CoCr devices would combine the bulk
strength of a metal alloy with the superior surface characteristics of a
ceramic. Several orthopedic companies are considering the Company's surface
treatment methods to provide ceramic coated metal implants.

     Manufacturing.  The Company believes it now operates one of the highest
beam-current ion implanters used in the medical field. This equipment has higher
through-put and lower cost than equipment with a lower beam-current. For the
Company's new second generation orthopedic coating this equipment can provide a
ceramic coating with superior characteristics due to its patented "blended
interface" process.

     Sales.  The Company currently implants CoCr components of total joint
replacements made by its customers with nitrogen ions and is developing ceramic
ion implantation techniques for total joint replacements. The Company receives
untreated CoCr total joint replacements from its customers and implants them at
its facility. The Company then invoices and ships the implanted total joint
replacements to its customers.

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     Markets.  Osteoarthritis is a natural result of the aging process and is
the predominant cause of the need for joint replacement. The Company believes
that longer life expectancy as well as the growth in the number of people over
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 500,000 units in 1995 in the United
States. The Company treats approximately 55,000 units each year using its ion
implantation process for the Howmedica/Osteonics Division of Stryker Corporation
and Biomet, Incorporated. Research by the Company has shown that the Company's
ceramic coatings can decrease wear debris generation by two-thirds, which the
Company believes will reduce osteolysis and thereby reduce the need for revision
surgery.

  Semiconductor Ion Implantation

     The Company supplies ion implantation 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 the Company's customers have their own ion
implantation equipment, they often use the Company's 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.

     To serve this market, the Company offers the ion implantation of over 60 of
the 92 natural elements for its customers' research programs. The Company offers
all of the necessary dopants for silicon as well as for new materials such as
gallium arsenide, silicon carbide, indium phosphide and other advanced compound
semiconductors. The Company also performs high dose ion-implantation of silicon
and germanium to improve the crystallinity and to modify the semiconductor
properties of these materials.

MARKETING AND SALES

     The Company's marketing and sales methods vary according to the
characteristics of each of its main business areas. The Company's foreign sales
have comprised less than five percent of its total revenues. Sales and marketing
to the medical device and semiconductor markets are directed by the Company's
Vice President of Marketing and Sales who is assisted by the Company's Director
of Medical Devices and the Company's Director of Semiconductor Products. Sales
in the medical device and semiconductor arena are handled by three full time
salespeople, who handle both medical devices and semiconductor products. The
solicitation and proposal process for research and development contracts and
grants are conducted by the Company's President, its Chief Scientist, and its
scientific staff.

  Medical Sales and Marketing

     The Company plans to market its radioactive prostate seeds to distributors
of medical products as well as major hospitals and key physicians who might
purchase radioactive prostate seeds. The Company plans to hire additional sales
personnel to make direct calls on these potential customers. The Company plans
to market its implantation of radioactivity onto coronary stents directly to
stent manufacturers who will in turn sell the stents to hospitals.

     In the business of ion implantation for total joint replacements, the
Company concentrates on identifying and serving leading manufacturers. Where
possible, the Company attempts to become the sole provider of devices or surface
engineering services to each such manufacturer. The Company's marketing and
sales efforts require considerable direct contact and typically involve a
process of customer education in the merits of the Company's technology. The
Company accomplishes this by first researching customer needs, delivering
scientific papers at orthopedic and biomaterial conferences, and through
presentations at customer sites. The Company's internal research and government
research grants are an integral part of the marketing process. The Company's
patent portfolio is also very important in this process.

     To promote sales of its radiopaque coatings, the Company attends trade
shows and uses press releases. 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
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to roughly optimize a parameter set for deposition. After testing of samples
generated and considering cost estimates for production quantities, the customer
may authorize the Company 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 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. The Company's services are promoted and sold through
trade shows, advertising in trade magazines, direct mailings and press releases.
Most sales are between $600 and $2,500 per order, take less than one day to
complete, and the entire sales effort is often conducted by telephone. Most of
the Company's sales in this area are for outsourced customer-specified ion
implantation services which the customer's own ion implantation department is
unable or unwilling to perform.

  Government Contracts

     Research and development contracts from the U.S. government must be won
through a competitive proposal process which undergoes peer review. The Company
is in frequent contact with the National Institutes of Health, the Department of
Defense, the Department of Energy and other agencies at technical conferences to
stay informed of the government's needs. The Company believes its principals and
senior scientific staff have earned a strong reputation with these and other
agencies. To date the Company has been awarded research and development
contracts by the National Institute of Health, the Department of Defense, the
National Science Foundation, and the National Aeronautics and Space
Administration ("NASA").

RESEARCH AND DEVELOPMENT

     The technical staff of the Company consists of eight scientists including
four with Ph.D. degrees, and four with Bachelor Degrees and with expertise in
physical sciences and engineering. All of the Company's existing and planned
products rely on proprietary technologies developed in its research and
development laboratories. The Company's research and development efforts may be
self-funded, funded by corporate partners or by awards under the Small Business
Innovative Research ("SBIR") program. The Company has obtained over $4,000,000
in U.S. government grants and contracts over the past 10 years.

PATENTS AND PROPRIETARY TECHNOLOGY

     The Company's policy is to protect its proprietary position by, among other
methods, filing United States and foreign patent applications. The Company
currently has eleven issued United States patents and fifteen United States
patent applications pending. The Company has two international patent
applications pending.

     The Company has exclusive rights inter-alia under patents covering the
following technologies: (i) methods of rendering coronary stents radioactive,
(ii) a radioactive, radiopaque stent device, (iii) methods of growing ceramic
coatings on orthopedic implants, and (iv) methods of generating ion beams. In
addition, the Company has patents pending on (i) an iodine-125 radioactive
prostate seed, and (ii) a palladium-103 radioactive prostate seed.

     The Company is aware of a U.S. patent of a third party having broad claims
covering radioactive stents and methods of using radioactive stents for the
treatment of restenosis. The Company has not sought a formal opinion of counsel
regarding the validity of this patent or whether the Company's processes
infringe this patent. The Company plans to implant radioactivity onto coronary
stents manufactured by the patent holder, its licensees or others. If the
Company's plans to implant radioactivity onto the patent holder's stents do not
succeed and/or if the Company implants radioactivity onto stents that are not
manufactured by the patent holder or its licensees there can be no assurance
that the holder of this patent will not seek to enforce the

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patent against the Company or the manufacturer of the stents, or that the
Company would prevail in any such enforcement action.

     The Company intends to seek further patents on its technologies, if
appropriate. However, there can be no assurance that patents will issue for any
of the Company's 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 the Company sells its products and services, to provide
meaningful protection or any commercial advantage to the Company.

GOVERNMENT REGULATION AND ENVIRONMENTAL MATTERS

     Although the Company's present business itself is not directly regulated by
the FDA, the medical devices incorporating its technologies are subject to FDA
regulation. The burden of securing FDA clearance or approval for these medical
devices rests with the Company's medical device manufacturers or licensees.
However, the Company intends to prepare Device Master Files which may be
accessed by the FDA to assist it in its review of the applications filed by the
Company's medical device manufacturers. The Company's radioactive iodine-125
seed is subject to the FDA's 510(k) notification of pre-market clearance which
the Company received on May 26, 1999. The Company expects that this seed will be
available for sale in the first half of 2000.

     Supplemental or full pre-market approval ("PMA") reviews require a
significantly longer period. A PMA will be required for the Company's
radioactive coronary stents. Thus, significantly more time will be required to
commercialize applications subjected to PMA review. The Company believes its
radioactive coronary stents will not be available for commercial sale before
2001. Furthermore, sales of medical devices outside the U.S. are subject to
international regulatory requirements that vary from country to country. The
time required to obtain clearance or approval for sale internationally may be
longer or shorter than that required for FDA approval.

     In addition to FDA regulation, certain of the Company's activities are
regulated by, and require approvals from, other federal and state agencies. For
example, aspects of the Company's operations require the approval of the
Massachusetts Department of Public Health and registration with the Department
of Labor and Industries. On July 28, 1999 the Company received is Radioactive
Sealed Source Registration Certificate, a Nuclear Regulatory Commission ("NRC")
requirement administered by the Commonwealth of Massachusetts as a NRC Agreement
State. Furthermore, the Company's 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 may require
special reporting to the United States Environmental Protection Agency and/or
its state counterparts. The Company is not aware of any specific environmental
liabilities that it could incur. The Company's future operations may require
additional approvals from federal and/or state environmental agencies.

COMPETITION

     In radioactive products, such as prostate seed implants and radioactive
stents, the Company expects to compete with Nycomed Amersham plc, Theragenics
Corp., North American Scientific, Inc., International Isotopes Inc., Uromed
Corporation and UroCor, Inc. Of these, Nycomed Amersham plc, Theragenics Corp.
and North American Scientific, Inc. serve substantially the entire radioactive
prostate seed market and International Isotopes Inc., Uromed Corporation and
UroCor. Inc. have announced their plans to enter the seed market. In addition,
the Company's proposed radioactive stents will compete with alternative
technologies such as Novoste Corporation's Beta-Cath system, radioactive tipped
guidewires and radioactive filled balloons. The number and types of procedures
being performed on the prostate are increasingly drawing new entrants into the
market. The Company believes that competition, and, in turn, pricing pressures,
may increase. Many of the Company's competitors have substantially greater
financial, technical and marketing resources than the Company.

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     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. Overall, the Company believes the worldwide market for
surface modification technologies applicable to medical devices is very
fragmented with no competitor having more than a 10% market share. Many of the
Company's 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 the Company.

     With respect to ion implantation of orthopedic implants, the Company
primarily competes 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. The Company attempts to differentiate itself from its competition by
providing what it believes are high value-added solutions to surface
modification. Management believes 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, turn around
time, and the ability to work with a variety of materials. The Company believes
that its process competes favorably with respect to these factors. The Company
believes 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.

     The Company's primary competition in the semiconductor industry consists of
three companies: Ion Implant Services, The Implant Center, and Ion Implant
Corporation. These companies are all located in Silicon Valley, California and
primarily serve the silicon wafer production needs of semiconductor factories in
their local area, although Ion Implant Corporation does research and development
implants nationwide. The Company mostly serves east coast factories with silicon
production and research and development laboratories worldwide.

     Many of the Company's competitors and potential competitors have
substantially greater capital resources than the Company does 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 the Company's 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 the Company or that
would render the Company's technology and products obsolete or noncompetitive.
Additionally, there is no assurance that the Company will be able to compete
effectively against such competitors and potential competitors in terms of
manufacturing, marketing and sales.

PRODUCT LIABILITY AND INSURANCE

     The Company's business entails the risk of product liability claims.
Although the Company has not experienced any product liability claims to date,
there can be no assurance that such claims will not be asserted or that it will
have sufficient resources to satisfy any liability resulting from such claims.
The Company intends to acquire product liability insurance when its radioactive
prostate seed products and interventional cardiology devices are in commercial
production. 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 results of operations of the Company.

EMPLOYEES

     As of June 30, 1999, the Company had 34 full time employees. The Company
believes it maintains good relations with its employees. None of the Company's
employees is represented by a union or covered by a collective bargaining
agreement.

                                        8
<PAGE>   10

EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES

     The senior management of the Company consists of the following:

<TABLE>
<CAPTION>
NAME                                   AGE                           POSITION
----                                   ---                           --------
<S>                                    <C>   <C>
Anthony J. Armini*...................  61    President, Chief Executive Officer and Chairman of the
                                             Board of Directors
Stephen N. Bunker*...................  56    Vice President and Chief Scientist, Director
Darlene M. Deptula-Hicks*............  41    Vice President and Chief Financial Officer, Treasurer
Alan D. Lucas........................  43    Vice President of Marketing, Sales and Business
                                             Development
</TABLE>

---------------
(*) Executive Officer

     DR. ANTHONY J. ARMINI has been the President, Chief Executive Officer, and
Chairman of the Board of Directors since the Company's incorporation. From 1972
to 1984, prior to founding the Company, 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 eleven patents and fifteen patents pending in the field of implant technology
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 fifteen years experience with ion
implantation in the medical and semiconductor fields.

     DR. STEPHEN N. BUNKER has served as the Vice President and Chief Scientist
of the Company since 1987 and Director of the Company 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 seven
patents in the field of implant technology.

     DARLENE M. DEPTULA-HICKS joined the Company in July 1998 as Vice President
and Chief Financial Officer. Prior to joining the Company, from 1997 to 1998 Ms.
Deptula-Hicks was the Corporate Controller for ABIOMED, Inc., a medical device
manufacturer. From 1994 to 1997 Ms. Deptula-Hicks was an independent financial
consultant. From 1992 to 1994 Ms. Deptula-Hicks was the Vice President and Chief
Financial Officer of GCA, a division of General Signal Corporation, a
semiconductor equipment manufacturer. Ms. Deptula-Hicks holds a BS in Accounting
and an MBA.

     ALAN D. LUCAS joined the Company in March 1998 as Vice President of
Marketing, Sales and Business Development. Prior to joining the Company, Mr.
Lucas accumulated over 20 years experience in various marketing and business
development positions for medical device companies. Most recently, from 1996 to
1998, Mr. Lucas was the Director of Corporate Development at ABIOMED, Inc. From
1994 to 1996, Mr. Lucas was a strategic marketing and sales consultant focused
on medical technology. From 1991 to 1994 Mr. Lucas was the Director of Marketing
at Vision Sciences, Inc. a developmental stage medical device company.

ITEM 2.  DESCRIPTION OF PROPERTY

     The Company operates out of a 21,992 square foot leased facility in
Wakefield, Massachusetts. The facility is located approximately 15 miles north
of Boston. The lease expires in May 2000 and has an option to extend. This
facility houses all of the Company's research and development, production and
administrative offices. The Company expects to lease additional space early in
its fiscal year 2000.

ITEM 3.  LEGAL PROCEEDINGS

     The Company is not currently a party to any legal proceedings.

                                        9
<PAGE>   11

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     In September 1998, in connection with the planned initial public offering
of the Company's Common Stock, the Company amended and restated its Articles of
Organization by unanimous vote of the 4,372,291 shares (calculated on a post
7-for-1 stock split basis) that were present in person or by proxy at the
meeting. The amendment, among other things, included the following: (i) the
Company's Board of Directors and Stockholders increased the authorized Common
Stock to 20,000,000 shares, (ii) the Company's Board of Directors and
Stockholders authorized 5,000,000 shares of Preferred Stock ($.10 par value).
The Board of Directors was also authorized to issue the Preferred Stock in one
or more series, including dividend rights, conversion rights, voting rights,
redemption terms and liquidation preferences without any further action by the
Company's stockholders and (iii) the Board of Directors and Stockholders
declared a 7-for-1 stock split effected in the form of a stock dividend.

     On June 8, 1999 the Company amended and restated its Article of
Organization. The amendment, among other things, included a declaration by the
Board of Directors and Stockholders declaring a 6-for-7 reverse stock split of
Common Stock by unanimous vote of the 4,069,320 shares (calculated on a post
6-for-7 reverse stock split basis) that were present in person or by proxy at
the meeting, and an increase in the authorized Common Stock, affected by the
reverse stock split, from 17,142,857 to 20,000,000 shares, which was approved by
4,035,678 shares voting in favor of the proposal, 33,642 shares abstaining and
zero shares opposed.

                                    PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET PRICE

     As of June 30, 1999 the Company's Common Stock, $.10 par value, was traded
on the Nasdaq SmallCap Market under the symbol IMPLU and on the Boston Stock
Exchange under the symbol IMXU. On September 10, 1999 the Company was accepted
for listing and began trading on the American Stock Exchange under the symbol
IMX. At that time the listing on the Nasdaq SmallCap Market was dropped. The
following sets forth the range of high and low sale prices on the Nasdaq
SmallCap Market since the Company's Initial Public Offering on June 24, 1999.

<TABLE>
<CAPTION>
              FISCAL YEAR ENDED JUNE 30, 1999                 HIGH    LOW
              -------------------------------                 ----    ---
<S>                                                           <C>     <C>
Fourth Quarter..............................................  8 1/8   7 1/2
</TABLE>

NUMBER OF STOCKHOLDERS

     As of August 30, 1999, there were approximately 733 shareholders of record
of the Company's Common Stock, including multiple beneficial holders at
depositories, banks and brokers included as a single holder in the single street
name of each respective depository, bank or broker.

DIVIDENDS

     The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all future earnings
for the expansion and operation of its business, and does not anticipate paying
cash dividends in the foreseeable future. The Company's revolving credit line,
term loan and equipment purchase facility with its principle lender prohibit the
payment of dividends other than common stock dividends.

SALES OF UNREGISTERED SECURITIES

     There were no sales of unregistered securities.

USE OF PROCEEDS

     The Company received approximately $6,500,000 in net proceeds from it
initial public offering on June 24, 1999 and as of August 30, 1999 has used
approximately $330,000 of cash primarily to build

                                       10
<PAGE>   12

manufacturing equipment, add additional personnel, continue research and
development and satisfy general operating expenses. The Company is retaining the
balance for future needs to continue to ramp up its production equipment and
personnel, continue its research and development efforts, expand its sales and
marketing capabilities and general corporate purposes.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

     The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and the Company's Financial Statements and Notes
thereto included elsewhere in this document. This Annual Report on Form 10-KSB
contains forward-looking statements. The forward-looking statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially from those reflected in such forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those discussed
in the sections entitled "Business", "Risk Factors" and "Management's 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 hereof. The Company undertakes
no obligation to revise or publicly release the results of any revision to these
forward-looking statements. Readers should carefully review the risk factors
described in this Annual Report and in other documents that the Company files
from time to time with the Securities and Exchange Commission, including the
Company's Registration Statement on Form SB-2 (Registration No. 333-64499) and
the Quarterly Reports on Form 10-Q filed by the Company in fiscal 1999.

OVERVIEW

     Implant Sciences Corporation (the "Company") has, over the past fifteen
years, developed core technologies using ion implantation and thin film coatings
for medical device applications and has proprietary processes and equipment for
the manufacture of medical radiation therapeutic devices. The Company plans to
apply this technology to manufacture radioactive prostate seeds using a
non-radioactive fabrication process which it believes will be more
cost-effective and less hazardous than conventional processes which use
radioactive wet chemistry. The I-Plant seeds will be sealed and then made
radioactive in a nuclear reactor prior to shipment to customers. The Company
believes that the opportunities for radioactive prostate seeds will continue to
grow as an attractive alternative to other methods of treatment. On May 26,
1999, the Company received its notification of pre-market clearance for its
iodine-125 seed from the Food and Drug Administration ("FDA"). In the
interventional cardiology field, the Company has a joint development agreement
with a major stent manufacturer to develop radioactive coronary stents. The
Company believes these implants, radioactive seeds used for the treatment of
prostate cancer and radioactive coronary stents for the prevention of restenosis
(reclosure of the artery) after balloon angioplasty, will have a significant
competitive advantage over currently existing devices.

     The Company is currently developing its proprietary thin film coating
technology in order to apply it to radiopaque (visible by x-ray) coatings on
stents, guidewires, catheters and other devices used in interventional
cardiology procedures. In addition, the Company is applying its ion implantation
technologies to modify surfaces to reduce polyethylene wear generation in
orthopedic joint implants, manufactured by the Howmedica/Osteonics Division of
Stryker Corporation and Biomet Incorporated. The Company also supplies ion
implantation services to numerous semiconductor manufacturers, research
laboratories and universities. The Company currently has eleven issued United
States patents and fifteen United States patents pending covering its
technologies and processes. The Company also has two international patent
applications pending.

     Although there are a wide range of commercial applications for the
Company's proprietary technologies, the Company has chosen to focus on the
medical device industry. Within the medical device industry, the Company is
concentrating on the prostate cancer, interventional cardiology and orthopedic
segments.

                                       11
<PAGE>   13

RESULTS OF OPERATIONS

                             SELECT FINANCIAL DATA
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                              FISCAL YEARS ENDED JUNE 30,
                                                              ----------------------------
                                                                  1998            1999
                                                              ------------    ------------
<S>                                                           <C>             <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
  Product and contract research revenues....................   $2,904,429      $2,753,488
                                                               ----------      ----------
     Total revenues.........................................    2,904,429       2,753,488
Costs and expenses:
  Cost of product and contract research revenues............    1,693,662       1,536,244
  Research and development..................................      306,536         385,555
  Selling, general and administrative.......................    1,014,401       1,083,742
                                                               ----------      ----------
     Total costs and expenses...............................    3,014,599       3,005,541
                                                               ----------      ----------
Operating loss..............................................     (110,170)       (252,053)
Other income (expense)......................................       13,285         (55,116)
                                                               ----------      ----------
Loss before benefit for income taxes........................      (96,885)       (307,169)
Benefit for income taxes....................................      (38,900)        (36,700)
                                                               ----------      ----------
  Net loss..................................................   $  (57,985)     $ (270,469)
                                                               ==========      ==========
  Net loss per share -- basic...............................   $    (0.02)     $    (0.07)
                                                               ==========      ==========
  Net loss per share -- diluted.............................   $    (0.02)     $    (0.07)
                                                               ==========      ==========
  Weighted average common shares outstanding used for basic
     earnings per share.....................................    3,523,368       3,991,499
                                                               ==========      ==========
  Weighted average common shares outstanding used for
     diluted earnings per share.............................    3,523,368       3,991,499
                                                               ==========      ==========
</TABLE>

<TABLE>
<CAPTION>
                                                                      JUNE 30,
                                                              ------------------------
                                                                 1998          1999
                                                              ----------    ----------
<S>                                                           <C>           <C>
BALANCE SHEET DATA
Cash........................................................  $  311,189    $6,152,536
Current assets..............................................     871,289     7,034,706
Working capital.............................................     141,143     5,324,430
Total assets................................................   2,166,483     8,463,396
Current portion of long term debt, including capital
  lease.....................................................      55,352       191,048
Long term debt, including capital lease, net of current.....     246,581       631,977
Stockholders' equity........................................   1,177,456     6,092,143
</TABLE>

                                       12
<PAGE>   14

     The following table sets forth certain consolidated statements of
operations data for the periods indicated as a percentage of total revenues:

<TABLE>
<CAPTION>
                                                              YEAR ENDED JUNE 30,
                                                              --------------------
                                                               1998         1999
                                                              -------      -------
<S>                                                           <C>          <C>
Revenues:
  Product and contract research revenues:
     Medical................................................    77.0%        82.9%
     Semiconductor..........................................    23.0         17.1
                                                               -----        -----
          Total revenues....................................   100.0        100.0
Costs and Expenses:
     Cost of product and contract research revenues.........    58.3         55.8
     Research and development...............................    10.6         14.0
     Selling, general and administrative....................    34.9         39.4
                                                               -----        -----
          Total costs and expenses..........................   103.8        109.2
                                                               -----        -----
Operating loss..............................................    (3.8)        (9.2)
Other income (expense), net.................................     0.5         (2.0)
                                                               -----        -----
Loss before benefit for income taxes........................    (3.3)       (11.2)
Benefit for taxes...........................................    (1.3)        (1.4)
                                                               -----        -----
Net loss....................................................    (2.0)%       (9.8)%
                                                               =====        =====
</TABLE>

     Revenues.  Total revenues decreased to approximately $2,753,000 in the
twelve months ending June 30, 1999 from approximately $2,904,000 in the twelve
months ending June 30, 1998. The 5.2% decrease was primarily attributable to
soft semiconductor sales, a decrease in government contract and grant revenue as
three Phase I contracts reached completion during the twelve months ended June
30, 1999 and the rescheduled delivery of a $365,000 order which was forecasted
to ship by fiscal year end, which is now expected to ship in early fiscal 2000.
These decreases were offset by a 16.6% increase in orthopedic medical revenues.
Less than 5% of all revenues were derived from foreign sources.

     The Company's two major customers, the Howmedica/Osteonics Division of
Stryker Corporation and Biomet, Incorporated, accounted for 53.5% and 8.1%
respectively, of revenue in the twelve months ended June 30, 1999 and 42.3% and
6.0% respectively, in the twelve months ended June 30, 1998. The Company's
government contract and grant revenue accounted for 12.7% and 16.1% of revenue
for the twelve months ended June 30, 1999 and 1998, respectively.

     Cost of Product and Contract Research Revenues.  Cost of product and
contract research revenues decreased to approximately $1,536,000 from
approximately $1,694,000 for the twelve months ended June 30, 1999 and decreased
as a percentage of revenues to 55.8% from 58.3% the previous year. This decrease
in cost is primarily attributable to lower sales, a reduction in costs and
materials and government contract and grant related costs.

     Research and Development.  Research and development expenses increased to
approximately $386,000 from approximately $307,000 in the twelve months ended
June 30, 1999, a 25.7% increase, due to new product development. The Company
anticipates in future periods its research and development expenses will
continue to increase in total dollars expended as a result of its product
development plans.

     Selling, General and Administrative.  Selling, general and administrative
expenses increased to approximately $1,084,000 from approximately $1,014,000 in
the twelve months ended June 30, 1999. The 6.9% increase in selling, general and
administrative expenses is primarily attributable to increased personnel,
particularly the development of a senior management team. The Company
anticipates that in future periods its selling, general and administrative
expenses will increase in total dollars expended as a result of its plans to
commercialize new products.

                                       13
<PAGE>   15

     Other Income and Expenses, Net.  Other income and expenses, net consists
primarily of interest earned on the Company's short-term investments, interest
expense on loans and rental income for machine space. Other income and expense
increased to approximately $55,000, in fiscal 1999, from approximately ($13,000)
in fiscal 1998. The increase primarily reflects an increase in interest expense
on the Company's equipment purchase facility and line of credit.

     Liquidity and Capital Resources.  As of June 30, 1999 the Company had
approximately $6,153,000 in cash in the form of checking and marketable
securities, an increase of $5,841,000 over the fiscal year ended June 30, 1998.
The Company also had a $300,000 revolving line of credit from a commercial bank
at a rate of prime plus one percent, of which $145,000 was available at June 30,
1999. The Company also has a term loan and an equipment purchase facility with a
commercial bank, under which approximately $51,000 and $750,000, respectively,
were outstanding as of June 30, 1999. Under the provisions of its loan
agreements the Company is required to maintain compliance with certain financial
covenants, including debt service coverage, minimum levels of net worth and
restrictions of indebtedness. At June 30, 1999 the Company's debt service
coverage was less than the required amount. The Company's bank waived its rights
under the Loan Agreement with respect to compliance with this financial covenant
for a period of one year from June 30, 1999.

     During fiscal 1999, operating activities provided approximately $260,000 of
cash. Net cash provided by operating activities in fiscal 1999 primarily
reflects an increase in accrued expenses and a reduction in other noncurrent
assets offset by an increase in inventory.

     During the twelve months ending June 30, 1999, financing activities
provided cash of approximately $6,165,000. Net cash provided by financing
activities is due principally to the completion of the Company's initial public
offering of Common Stock. Although the Company does not have significant capital
commitments, the Company intends to make significant commitments over the next
several years to support the development and commercialization of its new
products and the expansion of its manufacturing equipment.

     During the twelve months ending June 30, 1999, investing activities used
approximately $584,000 in cash. Net cash used by investing activities primarily
includes the purchases of property and equipment.

     The Company plans to further increase its expenditures to complete
development and commercialize its new products, to increase its manufacturing
capacity, to ensure compliance with the FDA's Quality System Regulations and to
broaden its sales and marketing capabilities.

  Year 2000 Compliance

     As the year 2000 approaches, it is generally anticipated that certain
computers, software and other equipment utilizing microprocessors may be unable
to recognize or properly process dates after the year 1999 without software
modification. The Company has evaluated this potential issue with respect to
software, equipment, financial systems and suppliers. Expenditures by the
Company to date in connection with year 2000 compliance have not been material,
and the Company does not believe the year 2000 problem will have any material
adverse effect on its business, operations or financial condition.

                                  RISK FACTORS

ANTICIPATED LOSSES

     During the twelve months ended June 30, 1999, the Company had a net loss of
approximately $270,000. The Company plans to further increase its expenditures
to complete development and commercialization of its new products, to increase
its manufacturing capacity and equipment, to ensure compliance with the FDA's
Quality System Regulations and broaden its sales and marketing capabilities. As
a result, the Company believes that it will likely incur losses over the next
several quarters. The accumulated deficit as of June 30, 1999 was $535,829.

                                       14
<PAGE>   16

INTENSE COMPETITION; RAPID TECHNOLOGICAL CHANGE

     The medical device industry is characterized by rapidly evolving technology
and intense competition. Among the most closely competing products in
intracoronary radiation therapy are radioactive tipped guidewires and
radioactive fluid-filled balloons. Many of our competitors have substantially
greater capital resources, greater research and development, manufacturing and
marketing resources and experience and greater name recognition than we do.
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 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 effect on our business.

NO ASSURANCE OF ACCEPTANCE BY MEDICAL COMMUNITY OR MARKET ACCEPTANCE

     There can be no assurance that our radioactive prostate seeds and coronary
stents, orthopedic ceramic 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 the our
products and technologies as compared to those of other available products and
services. Failure of the our products and technologies to gain market acceptance
would have a material adverse effect on our business.

UNCERTAINTY OF ABILITY TO DISTRIBUTE

     Because our medical products will be targeted to the medical community, we
will have limited options in distributing our products and may incur additional
requirements imposed on us by the FDA or our customers or distribution partners
with respect to product characteristics and quality. A significant portion of
our sales to date have depended on our ability to provide products that meet the
requirements of other medical product companies. There can be no assurance that
we will be able to market our products successfully or that we will be able to
enter into contracts for distribution of our products. We have limited internal
marketing and sales resources and personnel. In order to market and sell our
products and services, we expect to enter into distribution agreements. There
can be no assurance that we will be able to enter into such agreements.

LIMITED COMMERCIALIZATION; UNCERTAINTY OF PRODUCT DEVELOPMENT

     We currently market or plan to market products, including radioactive
prostate seeds and radioactive coronary stents, orthopedic ceramic coatings, and
radiopaque coatings that may require substantial further investment in research,
product development, preclinical and clinical testing and governmental
regulatory
                                       15
<PAGE>   17

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.

     In particular, our radioactive coronary stents are in an early stage of
development. There can be no assurance that the clinical trials will ever be
undertaken or, if undertaken, will conclude that the radioactive coronary stents
have a sufficient degree of safety and efficacy. In addition, there can be no
assurance that the radioactive coronary stents will reduce the frequency of
restenosis outside of test conditions.

     Our product development efforts are subject to the risks inherent in the
development of such products. These risks include the possibility 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.

RISK OF THIRD-PARTY CLAIMS OF INFRINGEMENT

     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.

     We are aware of a U.S. patent of a third party having broad claims covering
radioactive stents and methods of using radioactive stents for the treatment of
restenosis. We have not sought a formal opinion of counsel regarding the
validity of this patent or whether our processes may infringe this patent. We
plan to implant radioactivity onto coronary stents manufactured by the patent
holder, its licensees or others. If our plans to implant radioactivity onto the
patent holder's stents do not succeed, and/or if we implant radioactivity onto
stents that are not manufactured by the patentholder or its licensees, there can
be no assurance that the holder of this patent will not seek to enforce the
patent against us or the manufacturer of the stents, or that we would prevail in
any such enforcement action.

     If the patent holder seeks to enforce the patent against us, we may be
required to engage in costly and protracted litigation; discontinue the
manufacture or activation of radioactive stents; develop non-infringing
technology; or enter into a license arrangement with respect to the patent.
There can be no assurance that we would be able to develop non-infringing
technology, or that any necessary licenses would be available, or that, if
available, such licenses could be obtained on commercially reasonable terms.
There can be no assurance that any such litigation would not result in the
patent holder obtaining an injunction which would prevent us from implanting
radioactivity onto stents. In addition, the costs associated with defending a
patent infringement claim are significant, even if we ultimately prevails, and
we would be required to commit considerable financial and management resources
in defending such claim which would have a material adverse effect on our
business, financial condition, and results of operations.

DEPENDENCE ON PATENTS AND PROPRIETARY TECHNOLOGY

     Although we have eleven United States patents issued and fifteen United
States and two international 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
                                       16
<PAGE>   18

claim rights in or ownership of the patents and other proprietary rights held
us. Furthermore, there can be no assurance that others have not or will not
develop similar products, duplicate any of our products or design around any
patents issued or that may be issued in the future to us. In addition, whether
or not patents are issued to us, others may hold or receive patents which
contain claims having a scope that covers products or processes developed by us.

     Moreover, there can be no assurances that patents issued to us will not be
challenged, invalidated or circumvented or that the rights thereunder will
provide any competitive advantage. We could incur substantial costs in defending
any patent infringement suits or in asserting any patent rights, including those
granted to third parties. Patents and patent applications in the United States
may be subject to interference proceedings brought by the U.S. Patent &
Trademark Office, or to opposition proceedings initiated in a foreign patent
office by third parties. We may incur significant costs defending such
proceedings. In addition, we may be required to obtain licenses to patents or
proprietary rights from third parties. There can be no assurance that such
licenses will be available on acceptable terms if at all. If we do not obtain
required licenses, we could encounter delays in product development or find that
the development, manufacture or sale of products requiring such licenses could
be foreclosed

     We also rely on unpatented proprietary technology, trade secrets and
know-how and no assurance can be given that others will not 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, there can be no assurance that such non-
disclosure agreements will provide adequate protection for our trade secrets or
other proprietary know-how.

NO ASSURANCE THAT THE COMPANY WILL SUCCESSFULLY MANAGE GROWTH

     We have very limited experience in the commercial production of radioactive
prostate seeds or the commercial implantation of therapeutic radiation onto
coronary stents. Our future success will depend upon, among other factors, our
ability to recruit, hire, train and retain highly educated, skilled and
experienced management and technical personnel, to generate capital from
operations, to scale-up its manufacturing process and expand our facilities and
to manage the effects of growth on all aspects of our business, including
research, development, manufacturing, distribution, sales and marketing,
administration and finance. Our failure to identify and exploit new product and
service opportunities, attract or retain necessary personnel, generate adequate
revenues or conduct our expansion or manage growth effectively could have a
material adverse effect on our business.

DEPENDENCE ON MAJOR CUSTOMERS

     Approximately 61.5% of our sales in fiscal 1999 were made to the
Howmedica/Osteonics Division of Stryker Corporation and Biomet, Incorporated.
All of these sales were of nitrogen ion implantation that enhance orthopedic
joint implants. We have no significant purchase commitments from these or other
customers extending beyond one year. There can be no assurance that these
customers will continue to purchase our products and services at the same levels
as in previous years or that such relationships will continue in the future. The
loss of a significant amount of business from any of these customers would have
a material adverse effect on the sales and operating results. We have an
agreement to supply an ion implantation process to a customer through January
2000.

GOVERNMENTAL REGULATION

     The manufacture and sale of our medical device products and services are
subject to extensive regulation principally by the Food and Drug Administration
(the "FDA") in the United States and corresponding foreign regulatory agencies
in each country in which it sells its 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 FDA authorizations and approvals requires
submission of extensive clinical data and supporting information. In most
instances, the

                                       17
<PAGE>   19

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 FDA. We expect to incur substantial product
development, clinical research and other expenses in connection with obtaining
final regulatory clearance or approval for and commercialization of our
products.

     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 FDA 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 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 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 FDA 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 U.S. 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.

HAZARDOUS MATERIALS

     Our research activities sometimes involve the use of various hazardous
materials. Although we believe that our safety procedures for handling,
manufacturing, distributing, transporting and disposing of such materials comply
with the standards for protection of human health, safety, and the environment,
prescribed by local, state, federal and international regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. Nor can we eliminate the risk that one or more of our hazardous
material or hazardous waste handlers may cause contamination for which, under
laws imposing strict liability, we could be held liable. While we currently
maintain insurance in amounts which we believe are appropriate in light of the
risk of accident, we could be held liable for any damages that might result from
any such event. Any such liability could exceed our insurance and available
resources and could have a material adverse effect on our business.

                                       18
<PAGE>   20

DEPENDENCE ON STRATEGIC ALLIANCES

     We intend to continue pursuing a strategy of researching, developing and
commercializing new products using the financial and technical support of
corporate partners. Our success will depend, in part, on our ability to attract
additional partners. There can be no assurance that we can successfully enter
into additional strategic alliances or that such alliances will result in
increased commercialization of our products.

UNCERTAIN AVAILABILITY OF THIRD PARTY REIMBURSEMENT; POSSIBLE HEALTH CARE
REFORMS

     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 produced or processed by us, including our
orthopedic implants, prostate seeds, radioactive stents, 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 varies considerably. Major third
party payers reimburse inpatient medical treatment, including all or most
operating costs and all or most furnished items or services, including devices
such as ours, at a prospectively fixed rate based on the diagnosis-related group
("DRG") that covers such treatment as established by the federal Health Care
Financing Administration. For interventional cardiology procedures, the fixed
rate of reimbursement is based on the procedure or procedures performed and is
unrelated to the specific devices used in such procedure. Therefore, the amount
of profit realized by suppliers of health care services in connection with the
procedure may be reduced by the use of our devices if they prove to be costlier
than competing products. If a procedure is not covered by a DRG, certain third
party payers may deny reimbursement.

     Alternatively, a DRG 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 RISKS; INSURANCE

     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 its 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 intend to obtain product liability insurance coverage when we
commence sales of our seeds and stents, 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 uninsured or underinsured liabilities could
have a material adverse effect on our business.

DEPENDENCE ON SUPPLIERS

     We rely on a limited number of suppliers to provide materials used to
manufacture our products. If we cannot obtain adequate quantities of necessary
materials and services from our suppliers, there can be no assurance that we
would be able to access alternative sources of supply within a reasonable period
of time or at

                                       19
<PAGE>   21

commercially reasonable rates. Moreover, in order to maintain our relationship
with major suppliers, we may be required to enter into preferred supplier
agreements that will increase the cost of materials obtained from such
suppliers, thereby also increasing the prices of our products. The limited
sources, the unavailability of adequate quantities, the inability to develop
alternative sources, a reduction or interruption in supply or a significant
increase in the price of raw materials or services could have a material adverse
effect on our business.

RELIANCE UPON MANAGEMENT

     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 maintain key man
life insurance policies of $1,000,000 and $500,000 respectively, insuring the
lives of Messrs. Armini and Bunker.

DEPENDENCE ON QUALIFIED PERSONNEL; ABILITY TO ATTRACT QUALIFIED PERSONNEL

     There is intense competition for qualified personnel in the medical device
field, and there can be no assurance that we will be able to continue to attract
and retain qualified personnel necessary for the development of our business.
The loss of the services of existing personnel as well as the failure to recruit
additional qualified scientific, technical and managerial personnel in a timely
manner would be detrimental to our anticipated growth and expansion into areas
and activities requiring additional expertise such as marketing. The failure to
attract and retain such personnel could adversely affect our business.

POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS

     We believe that our operating results may be subject to substantial
quarterly fluctuations due to several factors, some of which are outside our
control, including fluctuating market demand for, and declines in the average
selling price of our products, the timing of significant orders from customers,
delays in the introduction of new or improved products, delays in obtaining
customer acceptance of new or changed products, the cost and availability of raw
materials, and general economic conditions. We plan to further increase our
expenditures to complete development and commercialize our new products, to
increase our manufacturing capacity, to ensure compliance with the FDA's Quality
Systems Regulations and to broaden our sales and marketing capabilities. A
substantial portion of our revenue in any quarter historically has been derived
from orders booked in that quarter, and historically, backlog has not been a
meaningful indicator of revenues for a particular period. Accordingly, our sales
expectations currently are based almost entirely on its internal estimates of
future demand and not from firm customer orders.

ITEM 7.  FINANCIAL STATEMENTS

     The Company's Financial Statements and Related Report of Independent
Auditors are presented in the following pages. The Financial Statements filed in
this Item 7 are as follows:

     Report of Independent Auditors
     Balance Sheets as of June 30, 1998 and 1999
     Statements of Operations for the Years Ended June 30, 1998 and 1999
     Statements of Changes in Stockholders' Equity for the Years Ended June 30,
1998 and 1999
     Statements of Cash Flows for the Years Ended June 30, 1998 and 1999
     Notes to Financial Statements

ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

     There were no disagreements on accounting principles or practices or
financial statement disclosure between the Company and its accountants during
the fiscal year ended June 30, 1999.
                                       20
<PAGE>   22

                          IMPLANT SCIENCES CORPORATION

                         REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Implant Sciences Corporation

     We have audited the accompanying balance sheets of Implant Sciences
Corporation as of June 30, 1998 and 1999, and the related statements of
operations, stockholders' equity and cash flows for each of the two years in the
period ended June 30, 1999. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
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 financial statements referred to above present fairly,
in all material respects, the financial position of Implant Sciences Corporation
at June 30, 1998 and 1999 and the results of its operations and its cash flows
for each of the two years in the period ended June 30, 1999, in conformity with
generally accepted accounting principles.

                                                   ERNST & YOUNG LLP

Boston, Massachusetts
August 6, 1999

                                       21
<PAGE>   23

                          IMPLANT SCIENCES CORPORATION

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                               JUNE 30,      JUNE 30,
                                                                 1998          1999
                                                              ----------    ----------
<S>                                                           <C>           <C>
ASSETS
Current assets:
  Cash......................................................  $  311,189    $6,152,536
  Accounts receivable, less allowances of $2,000............     388,235       421,737
  Inventories...............................................      31,338       367,386
  Deferred income taxes.....................................      18,000        62,000
  Refundable income taxes...................................     118,781        24,785
  Prepaid expenses..........................................       3,746         6,262
                                                              ----------    ----------
     Total current assets...................................     871,289     7,034,706
Property and equipment, at cost:
  Machinery and equipment...................................   1,314,850     1,802,011
  Leasehold improvements....................................      62,553        71,356
  Computers and software....................................      36,335        47,757
  Furniture and fixtures....................................      49,833        60,509
  Motor vehicles............................................      14,822        14,822
  Leased property under capital lease.......................      28,360        28,360
                                                              ----------    ----------
                                                               1,506,753     2,024,815
     Less accumulated depreciation..........................    (692,808)     (811,240)
                                                              ----------    ----------
  Net property and equipment................................     813,945     1,213,575
Other assets:
  Patent costs, net of accumulated amortization of $15,699
     and $22,629 at June 30, 1998 and 1999, respectively....     117,738       177,194
  Other noncurrent assets...................................     363,511        37,921
                                                              ----------    ----------
                                                                 481,249       215,115
                                                              ----------    ----------
Total Assets................................................  $2,166,483    $8,463,396
                                                              ==========    ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Revolving line of credit..................................  $       --    $  155,000
  Accounts payable..........................................     107,359        99,868
  Accrued expenses..........................................     567,435     1,264,360
  Current portion of long-term debt.........................      50,278       185,376
  Obligations under capital lease...........................       5,074         5,672
                                                              ----------    ----------
                                                                 730,146     1,710,276
Long term liabilities:
  Long-term debt, net of current portion....................     224,491       615,781
  Obligations under capital lease...........................      22,090        16,196
  Deferred income taxes.....................................      12,300        29,000
                                                              ----------    ----------
                                                                 258,881       660,977
Stockholders' equity:
  Common stock, $0.10 par value; 6,500,000 authorized and
     622,613 outstanding at June 30, 1998 and 20,000,000
     authorized and 5,069,320 outstanding at June 30,
     1999...................................................      62,261       506,932
  Additional paid in capital................................   1,380,555     6,242,194
  Deferred compensation.....................................          --      (121,154)
  Accumulated deficit.......................................    (265,360)     (535,829)
                                                              ----------    ----------
     Total Stockholders' Equity.............................   1,177,456     6,092,143
                                                              ----------    ----------
     Total Liabilities and Stockholders' Equity.............  $2,166,483    $8,463,396
                                                              ==========    ==========
</TABLE>

   The accompanying notes are an integral part of these financial statements
                                       22
<PAGE>   24

                          IMPLANT SCIENCES CORPORATION

                            STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
                                                                YEAR ENDED JUNE 30,
                                                              ------------------------
                                                                 1998          1999
                                                              ----------    ----------
<S>                                                           <C>           <C>
Revenues:
  Product and contract research revenues
     Medical................................................  $2,237,417    $2,282,511
     Semiconductor..........................................     667,012       470,977
                                                              ----------    ----------
          Total revenues....................................   2,904,429     2,753,488
Costs and expenses:
  Cost of product and contract research revenues............   1,693,662     1,536,244
  Research and development..................................     306,536       385,555
  Selling, general and administrative.......................   1,014,401     1,083,742
                                                              ----------    ----------
          Total costs and expenses..........................   3,014,599     3,005,541
                                                              ----------    ----------
Operating loss..............................................    (110,170)     (252,053)
Other income (expense)
  Interest income...........................................      18,872        16,002
  Interest expense..........................................     (11,563)      (71,564)
  Other.....................................................       5,976           446
                                                              ----------    ----------
Loss before benefit for income taxes........................     (96,885)     (307,169)
Benefit for income taxes....................................     (38,900)      (36,700)
                                                              ----------    ----------
  Net loss..................................................  $  (57,985)   $ (270,469)
                                                              ==========    ==========
  Net loss per share -- basic...............................  $    (0.02)   $    (0.07)
                                                              ==========    ==========
  Net loss per share -- diluted.............................  $   ( 0.02)   $    (0.07)
                                                              ==========    ==========
  Weighted average common shares outstanding used for basic
     earnings per share.....................................   3,523,368     3,991,499
                                                              ==========    ==========
  Weighted average common shares outstanding used for
     diluted earnings per share.............................   3,523,368     3,991,499
                                                              ==========    ==========
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       23
<PAGE>   25

                          IMPLANT SCIENCES CORPORATION

                  STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                     ADDITIONAL                                    TOTAL
                              NUMBER OF     PAR       PAID-IN       DEFERRED     ACCUMULATED   STOCKHOLDERS'
                               SHARES      VALUE      CAPITAL     COMPENSATION     DEFICIT        EQUITY
                              ---------   --------   ----------   ------------   -----------   -------------
<S>                           <C>         <C>        <C>          <C>            <C>           <C>
BALANCE AT JUNE 30, 1997....    517,613   $ 51,761   $  971,601           --      $(207,375)    $  815,987
Net loss*...................                                              --        (57,985)       (57,985)
Issuance of common stock....    105,000     10,500      134,881           --             --        145,381
Forgiveness of obligation to
  stockholders, net of
  related tax effect........         --         --      274,073           --             --        274,073
                              ---------   --------   ----------    ---------      ---------     ----------
BALANCE AT JUNE 30, 1998....    622,613   $ 62,261   $1,380,555           --      $(265,360)    $1,177,456
Net loss*...................         --         --           --           --       (270,469)      (270,469)
Issuance of common stock --
  IPO, net..................  1,000,000    100,000    5,034,570           --             --      5,134,570
Issuance of common stock --
  other.....................      2,000        200       20,219           --             --         20,419
Adjustment to reflect
  6-for-1 stock split.......  3,069,458    306,946     (306,946)          --             --             --
Exercise of stock options
  for notes receivable......    375,249     37,525      (37,525)          --             --             --
Deferred compensation.......         --         --      151,321     (121,154)            --         30,167
                              ---------   --------   ----------    ---------      ---------     ----------
BALANCE AT JUNE 30, 1999....  5,069,320   $506,932   $6,242,194    $(121,154)     $(535,829)    $6,092,143
                              =========   ========   ==========    =========      =========     ==========
</TABLE>

---------------
* Net loss: equals comprehensive income for each period presented

   The accompanying notes are an integral part of these financial statements.
                                       24
<PAGE>   26

                          IMPLANT SCIENCES CORPORATION

                            STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                YEAR ENDED JUNE 30,
                                                              -----------------------
                                                                1998          1999
                                                              ---------    ----------
<S>                                                           <C>          <C>
CASH FLOWS OPERATING ACTIVITIES:
  Net loss..................................................  $ (57,985)   $ (270,469)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation and amortization.............................    101,075       125,362
  Amortization of deferred compensation.....................         --        30,167
  Deferred income tax benefit...............................     (3,200)      (27,300)
Changes in operating assets and liabilities:
  (Increase) decrease in accounts receivable................      1,174       (33,502)
  Increase in inventories...................................     (6,553)     (336,048)
  (Increase) decrease in prepaid income taxes...............   (118,781)       93,996
  (Increase) decrease in prepaid expenses...................      6,605        (2,516)
  (Increase) decrease in other noncurrent assets............   (351,146)       (8,808)
  Increase (decrease) in accounts payable...................     12,186        (7,491)
  Increase in accrued expenses..............................    333,436       696,925
                                                              ---------    ----------
     Net cash used in operating activities..................    (83,189)      260,316
CASH FLOWS USED IN INVESTING ACTIVITIES:
  Redemption of short-term investments......................    197,729            --
  Purchase of property and equipment........................   (558,886)     (518,062)
  Capitalized patent costs..................................    (30,939)      (66,386)
                                                              ---------    ----------
     Net cash used in investing activities..................   (392,096)     (584,448)
CASH FLOW PROVIDED BY FINANCING ACTIVITIES:
  Proceeds from common stock................................    145,381     5,489,387
  Proceeds from long-term debt..............................    200,000       521,092
  Repayments of long-term debt..............................    (31,983)           --
  Proceeds from revolving credit line.......................         --       155,000
  Repayments of revolving credit line.......................   (210,000)           --
                                                              ---------    ----------
     Cash provided by financing activities..................    103,398     6,165,479
  Net increase (decrease) in cash...........................   (371,887)    5,841,347
  Cash at beginning of year.................................    683,076       311,189
                                                              ---------    ----------
  Cash at end of year.......................................  $ 311,189    $6,152,536
                                                              =========    ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Interest paid.............................................  $  10,835    $   68,810
  Income taxes paid.........................................  $  98,393            --
  Forgiveness of obligation to stockholders.................  $ 460,573            --
  Obligations under capital lease...........................  $  28,360    $   21,868
</TABLE>

                       See notes to financial statements.
                                       25
<PAGE>   27

                          IMPLANT SCIENCES CORPORATION

                         NOTES TO FINANCIAL STATEMENTS

1. DESCRIPTION OF BUSINESS

     Implant Sciences Corporation is a provider of patented and proprietary
surface modification services to the medical device and semiconductor
industries. Ion implantation and thin film coating techniques are utilized to
enhance the surfaces of orthopedic implants (hip and knee total joint
replacements), to implant radioactive material into prostate seeds and coronary
stents, coatings on guidewires, stents and catheters for interventional
cardiology devices, and ion implantation of electronic dopants for the
semiconductor industry. The Company's principal markets are the orthopedic,
radiation oncology, interventional cardiology and semiconductor markets.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

  Cash and Cash Equivalents

     The Company considers any security with a maturity of 90 days or less at
the time of investment to be cash equivalents.

  Short-Term Investments

     The Company classifies any security, including marketable securities, with
a maturity of greater than 90 days as short-term investments.

  Inventories

     Inventory consists of gold and other precious metal raw material used in
the manufacturing process as well as the cost of direct materials, labor and
overhead on equipment orders. Inventories are valued at the lower of cost (first
in, first out) or market.

  Property and Equipment and Capital Lease

     Property and equipment are stated at cost and depreciated using the
straight-line method over the useful lives of the respective assets as follows:

<TABLE>
<S>                                                           <C>
Leasehold improvements......................................  life of lease
Furniture and fixtures......................................      5-7 years
Machinery and equipment.....................................        7 years
</TABLE>

     Equipment under the capital lease is being amortized over the life of the
lease.

  Warranty Costs

     The Company accrues warranty costs in the period the related revenue is
recognized. Warranty costs are not material to operating results.

  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 basis of assets and liabilities as well as net
operating loss and tax credit carryforwards 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.

                                       26
<PAGE>   28
                          IMPLANT SCIENCES CORPORATION

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

  Patent Costs

     The costs to obtain patents are capitalized. The Company amortizes the
costs of patents ratably over their legal lives commencing with the month in
which the patents are issued. As of June 30, 1999 there were 10 patents issued.
Accumulated amortization at June 30, 1998 and 1999 was $15,699 and $22,629.

  Concentration of Credit Risk

     The Company grants credit to its customers, primarily large corporations in
the medical device and semiconductor industries. The Company performs periodic
credit evaluations of customer financial condition 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. Financial instruments that potentially subject the Company to
concentration of credit risk consist of trade receivables.

     The Company has two major customers which accounted for the following
annual revenue:

<TABLE>
<CAPTION>
                                                         1998          1999
                                                      ----------    ----------
<S>                                                   <C>           <C>
Company A...........................................  $1,229,000    $1,471,652
Company B...........................................  $  175,000    $  221,940
</TABLE>

     The accounts receivable at June 30, 1998 and 1999 for Company A was
approximately $138,000 and $169,000, respectively.

  Stock Based Compensation

     The Company accounts for its stock based compensation arrangements under
the provisions of APB Opinion No. 25, accounting for Stock Issued to Employees,
rather than the alternative fair value accounting method provided for under FAS
No. 123, Accounting for Stock-Based Compensation. Under APB 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 is recorded.

  Use of Estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles 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. Actual results could differ from those estimates.

  Revenue Recognition

     Revenues are recognized at the time product is shipped. During fiscal 1999,
the Company accepted a purchase order to build a piece of customized
manufacturing equipment, which it expects to complete in fiscal 2000. Revenues
under this purchase order will be recognized when the equipment ships and
customer acceptance has occurred.

     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.

  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. Company

                                       27
<PAGE>   29
                          IMPLANT SCIENCES CORPORATION

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

funded research and development includes the excess of expenses over revenues on
its commercial and government research contracts and, therefore, is included in
cost of product and contract research revenues in the accompanying statement of
operations.

     The Company funded and customer funded research and development costs for
1998 and 1999 were as follows:

<TABLE>
<CAPTION>
                                                                    JUNE 30
                                                              --------------------
                                                                1998        1999
                                                              --------    --------
<S>                                                           <C>         <C>
Company funded..............................................  $495,098    $600,084
Customer funded.............................................   289,530     291,812
                                                              --------    --------
Total research and development..............................  $784,628    $891,896
                                                              ========    ========
</TABLE>

  Earnings per Share

     In 1998, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 128, Earnings per Share. This Standard revises certain
methodology for computing earnings per common share (EPS) and requires the
reporting of two earnings per share figures: basic earnings per share and
diluted earnings per share. Basic earnings per common share are computed by
dividing net income by the weighted-average number of common shares outstanding.
Diluted earnings per share are computed by dividing net income by the sum of the
weighted-average number of common shares outstanding plus the dilutive effect of
shares issuable through the exercise of stock options (common stock equivalents)
unless their inclusion would be antidilutive.

     The shares used for basic earnings per common share and diluted earnings
per common share are reconciled as follows:

<TABLE>
<CAPTION>
                                                                     JUNE 30
                                                              ----------------------
                                                                1998         1999
                                                              ---------    ---------
<S>                                                           <C>          <C>
Average shares outstanding for basic earnings per share.....  3,523,368    3,991,499
Dilutive effect of options..................................         --           --
                                                              ---------    ---------
Average shares outstanding for diluted earnings per share...  3,523,368    3,991,499
                                                              =========    =========
</TABLE>

  Impact of Recently Issued Accounting Standards

     In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement No. 130, Reporting Comprehensive Income and Statement No. 131,
Disclosures About Segments of an Enterprise and Related Information. Statement
No. 130 establishes standards for the reporting and display of comprehensive
income and its components. Statement No. 131 establishes standards for public
companies to report information about operating segments in financial
statements. It also establishes standards for related disclosures about products
and services, geographic areas, and customers. Statement 131 is effective for
financial statements for fiscal years beginning after December 15, 1997. Under
Statement 131 the Company believes that it will operate in one business segment.
Accordingly, the adoption of Statements 130 and 131 did not impact the Company's
financial position or results of operation.

                                       28
<PAGE>   30
                          IMPLANT SCIENCES CORPORATION

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

3. ACCRUED LIABILITIES

     Accrued liabilities consist of the following:

<TABLE>
<CAPTION>
                                                                     JUNE 30
                                                              ----------------------
                                                                1998         1999
                                                              --------    ----------
<S>                                                           <C>         <C>
Accrued legal, accounting and printing expense..............  $     --    $  641,350
Deferred revenue............................................   125,000       270,970
Accrued compensation and benefits...........................    90,573       204,932
Warranty....................................................     8,000        11,541
Accrued consulting fees.....................................   125,300         4,127
Other.......................................................   218,562       131,440
                                                              --------    ----------
                                                              $567,435    $1,264,360
                                                              ========    ==========
</TABLE>

4. 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 are firm-fixed
priced contracts and generally range in length from six to twenty four months.
Revenues under such arrangements were approximately $308,000 and $351,000 for
the year ended June 30, 1998 and 1999, respectively. Unbilled accounts
receivable relating to such arrangements was $91,000 for the year ended June 30,
1999.

     The Company also conducts research and development under cost-sharing
arrangements with its commercial customers. Revenues under such arrangements
were approximately $100,000 for the year ended June 30, 1998.

5. BANK BORROWINGS

     Maturities of long-term debt are as follows:

<TABLE>
<CAPTION>
                                                              1999
                                                            --------
<S>                                                         <C>
Year ending June 30:
2000......................................................  $185,376
2001......................................................   200,082
2002......................................................   180,406
2003......................................................   176,471
2004......................................................    58,822
                                                            --------
                                                             801,157
Less current portion......................................   185,376
                                                            --------
                                                            $615,781
                                                            ========
</TABLE>

     The Company finances its operations utilizing a Revolving Credit Facility
(Credit Facility) and an Equipment Term Loan (Term Loan) under a Loan Agreement
with its bank. Both borrowings under the Loan Agreement are cross-collateralized
and cross-defaulted. The Loan Agreement has a first lien on substantially all of
the Company's assets.

     The Credit Facility bears interest at the bank's base rate, plus 1% (8.75%
at June 30, 1999). Advances under the Credit Facility are limited to 70% of
qualifying accounts receivable. At June 30, 1999 the Company had $145,000
available under the Credit Facility which is payable on demand.

                                       29
<PAGE>   31
                          IMPLANT SCIENCES CORPORATION

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

     In August 1997, the Company refinanced its Term Loan. The Term Loan is
payable in 48 monthly installments of $1,968, and matures September 30, 2001.
Interest is payable monthly at the same rate as the Credit Facility.

     In January 1998, the Company increased the amount available under its Term
Loan by $750,000. The Company utilized this facility to finance capital
expenditures through October 1998. Principal repayments commenced August 1999 in
fifty one equal monthly installments. Interest is payable monthly at 1% above
the banks base rate commencing February 1998.

     The Company's Loan Agreement requires compliance with certain financial
covenants including cash flow, minimum levels of net worth and restrictions on
indebtedness. At June 30, 1999, the Company's cash flow covenant was less than
the required amount. The Company's bank has waived its rights under the Loan
Agreement with respect to this financial covenant at June 30, 1999 through June
30, 2000.

6. RELATED-PARTY TRANSACTIONS

     Accounts receivable from related parties as of June 30, 1999 consisted of a
loan of $137,500 to a principle shareholder and loans to ten employees, totaling
$137,500 both of which bear interest at 6%. These transactions were reported as
a reduction of stockholders' equity.

     Between 1983 and 1994, two officers and shareholders of the Company, Dr.
Anthony J. Armini and Dr. Stephen N. Bunker, did not receive certain
compensation. These underpayments of $562,070 for Dr. Armini and $249,755 for
Dr. Bunker were accrued by the Company as liabilities as the services were
rendered. In each of fiscal 1996 and 1997, a deferred compensation payment of
$193,252 and $119,000, respectively, was paid to Dr. Armimi and $20,000 and $0,
respectively, was paid to Dr. Bunker, which payments were partial payments of
the accrued compensation due to each of them. The remaining amounts were
reflected as deferred compensation on the June 30, 1997 balance sheet. During
fiscal 1998, these two principal officers discharged the Company from its
remaining obligation.

7. LEASE OBLIGATION

     The Company has a three-year operating lease for its manufacturing,
research and office space which expires on May 31, 2000. The Company has an
option to extend its lease for three additional years. Under the terms of the
lease, the Company is responsible for their proportionate share of real estate
taxes and operating expenses relating to this facility. Total rental expense per
year for fiscal years ended June 30, 1998 and 1999 was $160,224 and $209,027,
respectively.

     Included in property and equipment at June 30, 1999 is equipment recorded
under a capital lease with a book value of $21,868.

                                       30
<PAGE>   32
                          IMPLANT SCIENCES CORPORATION

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

     Future minimum rental payments required under capital leases and operating
leases with noncancelable terms in excess of one year at June 30, 1999, together
with the present value of net minimum lease payments:

<TABLE>
<CAPTION>
                                                      CAPITAL    OPERATING
                                                       LEASE       LEASE       TOTAL
                                                      -------    ---------    --------
<S>                                                   <C>        <C>          <C>
Year ending June 30:
2000................................................    7,176     163,963      171,139
2001................................................    7,176          --        7,176
2002................................................    7,176          --        7,176
2003................................................    6,356          --        6,356
2004................................................       --          --           --
                                                      -------    --------     --------
Net minimum lease payments..........................  $27,884    $163,963     $191,847
                                                                 ========     ========
Less finance charges................................    6,016
                                                      -------
Present value of net minimum lease payments.........  $21,868
                                                      =======
</TABLE>

8. INCOME TAXES

     The components of the income tax provision (benefit) are as follows:

<TABLE>
<CAPTION>
                                                          YEAR ENDED JUNE 30
                                                         --------------------
                                                           1998        1999
                                                         --------    --------
<S>                                                      <C>         <C>
Current:
  Federal..............................................  $(30,100)   $(14,000)
  State................................................    (5,600)      4,600
                                                         --------    --------
                                                          (35,700)     (9,400)
Deferred...............................................    (3,200)    (27,300)
                                                         --------    --------
                                                         $(38,900)   $(36,700)
                                                         ========    ========
</TABLE>

     The Company's effective income tax rate as of June 30, differed from the
U.S. federal statutory income tax rate as set forth below:

<TABLE>
<CAPTION>
                                                                1998        1999
                                                              --------    ---------
<S>                                                           <C>         <C>
Expected tax benefit at 34%.................................  $(32,900)   $(104,500)
State income taxes, net of federal benefit..................    (8,400)      (4,100)
Stock compensation expense..................................        --       10,300
Effect of valuation allowance...............................        --       57,500
Nondeductible expenses and other............................     2,400        4,100
                                                              --------    ---------
Income tax provision........................................  $(38,900)   $ (36,700)
                                                              ========    =========
</TABLE>

                                       31
<PAGE>   33
                          IMPLANT SCIENCES CORPORATION

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

     Significant components of the Company's deferred tax assets as of June 30
are as follows:

<TABLE>
<CAPTION>
                                                                1998       1999
                                                              --------    -------
<S>                                                           <C>         <C>
Deferred tax assets:
  Net operating loss and tax credit carryforwards...........  $  8,000    $46,100
  Accrued expenses..........................................    17,000     11,600
  Deferred revenue..........................................        --     60,600
  Other.....................................................     1,000      1,200
                                                              --------    -------
Total deferred tax assets...................................    26,000    119,500
  Valuation allowance.......................................        --    (57,500)
                                                              --------    -------
Net deferred tax assets.....................................    26,000     62,000
Deferred tax liabilities:
  Tax over book depreciation................................   (20,300)   (29,000)
                                                              --------    -------
Total deferred tax liabilities..............................   (20,300)   (29,000)
                                                              --------    -------
Net deferred tax asset......................................  $  5,700    $33,000
                                                              ========    =======
</TABLE>

     At June 30, 1999 the Company has unused net operating loss carryforwards of
$43,000 and tax credit carryforwards of $29,000 both of which expire through
2019. A valuation allowance has been established for a portion of the Company's
tax assets as their use is dependent on the generation of sufficient future
taxable income.

9. STOCKHOLDERS' EQUITY

     In September 1998, 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. The exercise price of the options
equals 100% 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 240,000 options were reserved
for issuance under the 1998 Plan. Upon adoption of the 1998 Plan, the 1992 Stock
Option Plan was terminated. No new stock options will be granted under the 1992
Stock Option Plan, which has been superseded by the 1998 Plan.

     The following table presents the activity of the 1992 and 1998 Stock Option
Plans for the years ended June 30, 1998, and 1999:

<TABLE>
<CAPTION>
                                                   1998                     1999
                                           ---------------------    --------------------
                                                        WEIGHTED                WEIGHTED
                                                        AVERAGE                 AVERAGE
                                                        EXERCISE                EXERCISE
                                            OPTIONS      PRICE      OPTIONS      PRICE
                                           ---------    --------    --------    --------
<S>                                        <C>          <C>         <C>         <C>
Outstanding at beginning of period.......  1,533,000     $0.82       718,200      1.14
Granted..................................     55,200      3.94        28,632      4.36
Exercised................................   (630,000)     0.46      (321,642)     0.43
Canceled.................................   (240,000)     1.51      (105,000)     1.38
                                           ---------     -----      --------     -----
Outstanding at end of period.............    718,200     $1.14       320,190      1.85
                                           =========     =====      ========     =====
Options exercisable at end of period.....    513,000     $0.78       264,755      1.46
                                           =========     =====      ========     =====
Weighted average fair value per share of
  options granted during the period......                $0.47                   $2.28
                                                         =====                   =====
</TABLE>

                                       32
<PAGE>   34
                          IMPLANT SCIENCES CORPORATION

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

     The following table presents weighted average price and life information
about significant option groups outstanding at June 30, 1999:

<TABLE>
<CAPTION>
                    OPTIONS OUTSTANDING            OPTIONS EXERCISABLE
           -------------------------------------   --------------------
                     WEIGHTED AVERAGE   WEIGHTED              WEIGHTED
RANGE OF                REMAINING       AVERAGE                AVERAGE
EXERCISE               CONTRACTUAL      EXERCISE              EXERCISE
 PRICES    NUMBER       LIFE (YRS)       PRICE      NUMBER      PRICE
--------   -------   ----------------   --------   --------   ---------
<S>        <C>       <C>                <C>        <C>        <C>
 $1.38     266,358         6.62          $1.38     256,356      $1.38
  4.00      50,400         8.85           4.00       8,399       4.00
  7.00       3,432         9.45           7.00          --         --
           -------                                 -------
           320,190                                 264,755
           =======                                 =======
</TABLE>

     The Company has adopted the disclosure provisions only of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-based Compensation
(FAS 123). If the compensation cost for the option plans had been determined
based on the fair value at the grant date for grants in 1998 and 1999,
consistent with the provisions of FAS 123, the pro forma net income per
share-diluted for 1998 and 1999, would have decreased by $55,000 and $70,000
respectively, and $0.01 per share and $0.08 per share, respectively.

     The Company has granted stock options to certain key executive employees.
There were 50,400 options issued and compensation expense totaling $30,000,
relating to these options was recorded during fiscal 1999.

     The 1998 Employee Stock Purchase Plan ("purchase plan") provides for the
issuance of 141,000 shares of common stock thereunder. Under the purchase plan,
eligible employees may purchase common shares at a price per share equal to 85%
of the lower of the fair market value of the common stock on the first or last
day of a one-year offering period. Participation in the offering period is
limited to $25,000 in any calendar year.

     The fair value of options and warrants issued at the date of grant were
estimated using the Minimum-Value method for 1998 and Black-Schols model for
1999 with the following weighted average assumptions:

<TABLE>
<CAPTION>
                                                       OPTIONS GRANTED
                                                  --------------------------
                                                     1998           1999
                                                  -----------    -----------
<S>                                               <C>            <C>
Volatility......................................      --             54%
Expected life (years)...........................       5              5
Risk free interest rate.........................  5.55%-5.75%    4.73%-5.49%
Dividend yield..................................      0%             0%
</TABLE>

     The Company has never declared nor paid dividends and does not expect to do
so in the foreseeable future.

     The effects on 1998 and 1999 pro forma net income of expensing the
estimated fair value of stock options are not necessarily representative of the
effects on the results of operations for future years as the periods presented
include only one and two years, respectively, of option grants under the
Company's plans.

     In connection with the Company's initial public offering of Common Stock
the Company amended and restated its article of organization in September 1998.
The amendment, among other things, included the following:

     - The Company's Board of Directors and Stockholders increased the
       authorized Common Stock to 20,000,000 shares.

     - The Company's Board of Directors and Stockholders authorized 5,000,000
       shares of preferred stock ($.10 par value). The Board of Directors was
       also authorized to issue the Preferred Stock in one or

                                       33
<PAGE>   35
                          IMPLANT SCIENCES CORPORATION

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

       more series, and to fix the powers, designations, preferences and other
       rights, including dividend rights, conversion rights, voting rights,
       redemption terms and liquidation preferences without any further action
       by the Company's stockholders.

     - The Board of Directors and Stockholders declared a 6 for 1 stock split
       effected in the form of a stock dividend. All historical data has been
       restated to reflect this 6 for 1 stock split.

     In January 1999, the Company entered into Loan Agreements with ten
employees. Pursuant to the terms of these Agreements, the Company loaned a total
of $137,500 to these ten employees for the purpose of exercising a total of
321,642 options to purchase Common Stock. The interest rate on the loans, which
are unsecured, is six percent per annum. This was accounted for as a reduction
of stockholders' equity.

     On June 24, 1999, the Company completed an initial public offering of
1,000,000 units at $7.50 per units realizing total gross proceeds of $7,500,000.

10. ROYALTY AGREEMENT

     Under the terms of the sale of a former product line, the Company is
entitled to minimum annual royalties which aggregate $175,000 over four years.
During 1998 and 1999, the Company recognized approximately $44,000 of royalties
under this arrangement.

11. 401K PLAN

     The Company has a defined contribution retirement plan which contains a
401(k) program. All employees who are 21 years of age and who have completed one
year of service during which they worked at least 1,000 hours are eligible for
participation in the plan. The Company makes discretionary contributions. The
Company made cash contributions to the plan of $8,589 and $9,872 in 1998 and
1999, respectively.

12. SUBSEQUENT EVENTS

     During the first quarter of fiscal 2000 the Underwriters over-allotment
option was exercised and an additional 138,00 units were issued at the initial
public offering price of $7.50 per unit.

                                       34
<PAGE>   36

                                    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS PROMOTERS AND CONTROL PERSONS OF THE
REGISTRANT

     The information required by this Item 9 is hereby incorporated by reference
to the text appearing under Part 1, Item 1 -- Business under the caption
"Executive Officers and Significant Employees" of the Registrant in this Report,
and by reference to the Company's definitive proxy statement to be filed by the
Company within 120 days after the close of its fiscal year (October 28, 1999).

ITEM 10.  EXECUTIVE COMPENSATION

     The information required by this Item 10 is hereby incorporated by
reference to the information under the heading "Executive Compensation" in the
Company's definitive proxy statement to be filed by the Company within 120 days
after the close of its fiscal year (October 28, 1999).

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this Item 11 is hereby incorporated by
reference to the information under the heading "Securities Beneficially Owned by
Directors, Officers and Principal Stockholders" in the Company's definitive
proxy statement to be filed by the Company within 120 days after the close of
its fiscal year (October 28, 1999).

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this Item 12 is hereby incorporated by
reference to the information under the heading "Certain Transactions", if any,
in the Company's definitive proxy statement to be filed by the Company within
120 days after the close of its fiscal year (October 28,1999).

ITEM 13.  EXHIBITS, LIST AND REPORTS ON FORM 8-K

<TABLE>
<C>         <S>
   (a)      The following documents are filed as part of this report.
            (1) Financial Statements
            Independent Auditor's Report
            Financial Statements
            Balance Sheets as of June 30, 1998 and 1999
            Statements of Operations for the Years Ended June 30, 1998
            and 1999
            Statements of Changes in Stockholders Equity for the Years
            Ended June 30, 1998 and 1999
            Statements of Cash Flows for the Years Ended June 30, 1998
            and 1999
            Notes to Financial Statements
            (2) Financial Statement Schedules
            Supplemental schedules are not provided because of the
            absence of conditions under which they are required or
            because the required information is given in the financial
            statements or notes thereto.
            (3) Exhibits
                 The following Exhibits are filed as part of this
            report:
    *3.2    By-Laws of the Company
    *3.3    Articles of Amendment to the Articles of Organization of the
            Company, dated June 9, 1999
    *3.4    Restated Articles of Organization of the Company, dated June
            9, 1999
   **4.1    Specimen certificate for the Common Stock of the Company
</TABLE>

                                       35
<PAGE>   37
<TABLE>
<C>         <S>
   **4.2    Specimen certificate for the Redeemable Warrants of the
            Company
  ***4.3    Specimen certificate for the Units of the Company
   **9      Armini Voting Trust Agreement, dated November 1, 1991
  **10.1    Employment Agreement with Anthony J. Armini, dated September
            26, 1998
  **10.2    Employment Agreement with Stephen N. Bunker, dated September
            26, 1998
   *10.3    Employment Offer Letter to Darlene Deptula-Hicks, dated June
            15, 1998
   *10.4    Employment Offer Letter to Alan Lucas, dated March 20, 1998
   *10.5    Amendment to Employment Offer Letter to Alan Lucas, dated
            September 24, 1998
   *10.6    Form of Employee Agreement on Ideas, Inventions, and
            Confidential Information used between 1993 and 1995
   *10.7    Form of Employee Agreement on Ideas, Inventions, and
            Confidential Information used in 1993
   *10.8    Form of Employee Agreement on Ideas, Inventions, and
            Confidential Information used between 1997 and 1998
   *10.9    Loan Agreement between the Company and US Trust, dated May
            1, 1996
   *10.10   $100,000 Commercial Promissory Note signed by the Company in
            favor of US Trust, dated May 1, 1996
   *10.11   $300,000 Commercial Promissory Note signed by the Company in
            favor of US Trust, dated May 1, 1996
   *10.12   Guaranty of Loan Agreement between the Company and US Trust,
            by Anthony J. Armini, dated May 1, 1996
   *10.13   Security Agreement between the Company and US Trust, dated
            May 1, 1996
   *10.14   Lessor's Subordination and Consent between the Company and
            Teacher's Insurance and Annuity Association of America,
            dated May 1, 1996
   *10.15   First Amendment to Loan Agreement between the Company and US
            Trust, dated July 24, 1997
   *10.16   $300,000 Commercial Promissory Note signed by the Company in
            favor of US Trust, dated July 24, 1997
   *10.17   $94,444.40 Commercial Promissory Note signed by the Company
            in favor of US Trust, dated August 12, 1997
   *10.18   Second Amendment to Loan Agreement between the Company and
            US Trust, dated January 16, 1998
   *10.19   $750,000 Commercial Promissory Note signed by the Company in
            favor of US Trust, dated January 16, 1998
   *10.20   Promissory Note signed by Anthony J. Armini in favor of the
            Company, dated September 26, 1998
   *10.21   Shareholders Agreement between NAR Holding Corporation and
            Anthony J. Armini, dated July 15, 1987
   *10.22   Lease between the Company and Teachers Insurance and Annuity
            Association of America, dated September 29, 1995
   *10.23   First Amendment to Lease and Expansion Agreement between the
            Company and Teachers Insurance and Annuity Association of
            America, dated July 29, 1998
   *10.24   Standard Cooperative Research and Development Agreement
            between the Company and the Naval Research Laboratory, dated
            January 21, 1997+
</TABLE>

                                       36
<PAGE>   38
<TABLE>
<C>         <S>
   *10.25   Cooperative Agreement between the Company and the United
            States of America U.S. Army Tank-Automotive and Armaments
            Command Armamanet Research, Development and Engineering
            Center, dated September 30, 1997+
   *10.26   Vendor Agreement Memorandum between the Company and
            Osteonics, dated February 2, 1998+
   *10.27   Sample Purchase Order between the Company and MicroSpring
            Company, Inc., dated October 24, 1996+
   *10.28   Asset Purchase Agreement between the Company and Falex
            Corporation, dated November 17, 1995+
   *10.29   Settlement between the Company and Erik Akhund, dated July
            1, 1998
   *10.30   1992 Stock Option Plan
   *10.31   Form of Stock Option Agreement under the 1992 Stock Option
            Plan
   *10.32   1998 Incentive and Nonqualified Stock Option Plan
  **10.33   Form of Incentive Stock Option under the 1998 Incentive and
            Nonqualified Stock Option Plan
  **10.34   Form of Nonqualified Stock Option under the 1998 Incentive
            and Nonqualified Stock Option Plan
  **10.35   Form of Nonqualified Stock Option for Non-Employee Directors
            under the 1998 Incentive and Nonqualified Stock Option Plan
   *10.36   Form of Lock-Up Agreement
  **10.37   Agreement Appointing Transfer Agent and Registrar between
            the Company and American Securities Transfer & Trust, Inc.,
            dated October 19, 1998
  **10.38   Certification of Corporate Secretary dated October 19, 1998
            concerning Agreement Appointing Transfer Agent and Registrar
            between the Company and American Securities Transfer &
            Trust, Inc.
  **10.39   Research and Development Agreement between the Company and
            Guidant Corporation, dated May 20, 1998+
  **10.40   Letter Agreement between the Company and Guidant
            Corporation, dated September 29, 1998+
 ***10.41   Form of Medical Advisory Board Agreement
 ***10.42   Form of Loan Agreement, dated January 7, 1999, between the
            Company and the following employees in the following
            amounts: Donald J. Dench ($12,500), Diane J. Ryan ($12,500),
            Mark and Kathleen Gadarowski ($12,500), Gregory Huntington,
            Sr. ($12,500), Leonard DeMild ($25,000), Michael Nelson
            ($12,500), Richard Sahagian ($12,500), Darryl Huntington
            ($12,500), Dennis Gadarowski ($12,500) and David Santos
            ($12,500)
 ***10.43   Terms and Conditions from Sample Purchase Order between the
            Company and Biomet, Incorporated
****10.44   Unit and Warrant Agreement between the Company and American
            Securities Transfer & Trust, Inc., dated April 9, 1999
   *10.45   Agreement between the Company and U.S. Army Space and
            Missile Defense Command, dated May 27, 1999
   *21.1    Subsidiaries of the Company
   *23.2    Consent of Foley, Hoag & Eliot LLP
   *24.1    Power of Attorney
</TABLE>

                                       37
<PAGE>   39
<TABLE>
<C>         <S>
    27.1    Financial Data Schedule
</TABLE>

-------------------------
   * Previously filed in the Registration Statement on Form SB-2 (Registration
     No. 333-64499) filed on September 29, 1998.

  ** Previously filed in Amendment No. 1 to the Registration Statement, filed on
     December 21, 1998.

 *** Previously filed in Amendment No. 2 to the Registration Statement, filed on
     February 11, 1999.

**** Previously filed in Amendment No. 3 to the Registration Statement, filed on
     April 30, 1999.

   + Filed under application for confidential treatment.

                                       38
<PAGE>   40

                                   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

<TABLE>
<S>                                             <C>
                                                /s/ ANTHONY J. ARMINI
                                                  ---------------------------------------------------
                                                  Anthony J. Armini
                                                  President, Chief Executive Officer,
                                                  Chairman of the Board of Directors
                                                  (Principal Executive Officer)
</TABLE>

     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.

<TABLE>
<S>                                             <C>
Date: September 28 1999                         /s/ ANTHONY J. ARMINI
                                                  ---------------------------------------------------
                                                  Anthony J. Armini
                                                  President, Chief Executive Officer, Chairman of the
                                                  Board of Directors (Principal Executive Officer)

Date: September 28, 1999                        /s/ DARLENE M. DEPTULA-HICKS
                                                  ---------------------------------------------------
                                                  Darlene M. Deptula-Hicks
                                                  Vice President and Chief Financial Officer
                                                  (Principal Financial and Accounting Officer)

Date: September 28, 1999                        /s/ STEPHEN N. BUNKER
                                                  ---------------------------------------------------
                                                  Stephen N. Bunker
                                                  Vice President and Chief Scientist, Director

Date: September 28, 1999                        /s/ ROBERT E. HOISINGTON
                                                  ---------------------------------------------------
                                                  Robert E. Hoisington, Director

Date: September 28, 1999                        /s/ SHUNKICHI SHIMIZU
                                                  ---------------------------------------------------
                                                  Shunkichi Shimizu, Director
</TABLE>

                                       39